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Climate change: investment risks and opportunities

Richard Turnill  |  21 Sep 2016Text size  Decrease  Increase  |  

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Climate factors have been underappreciated and under-priced, yet this could change as the effects of climate change become more visible, BlackRock says.


A tide of new regulations to combat climate change is rising. The risks are underappreciated, yet could soon start to unfold.

Significant spending on sustainable infrastructure and government incentives are needed to meet emissions-reduction targets. These present large investment risks and opportunities.

Most countries have signed the Paris Agreement to limit global warming to less than 2 degrees Celsius above pre-industrial levels--the threshold where many scientists see irreversible damage and extreme weather effects kicking in.

The countries have submitted plans to reduce carbon emissions in so-called intended nationally determined contributions. Yet scientists say these commitments alone are not enough to keep temperature rises below 2 degrees Celsius.

There is no one-size-fits-all solution to reducing emissions. Developed regions such as the European Union and US are placing a greater emphasis on improving energy efficiency, while emerging market economies such as India and China are prioritising low-carbon energy generation such as wind and solar power.

Coordinated action is key, since carbon emissions do not respect national borders. Emissions are a global problem.

No place to hide

The world is rapidly using up its carbon budget. To keep the average rise in global temperature below 2 degrees Celsius, cumulative carbon dioxide emissions need to be capped at 1 trillion metric tons above the levels of the late 1800s, the Intergovernmental Panel on Climate Change estimated in its latest assessment in 2013.

The problem? We have already burned through over half that amount. To meet the 2 degrees Celsius warming cap, three-quarters of proven coal, oil and gas reserves would have to remain in the ground, the World Resources Institute estimates.

These assets could be effectively "stranded"--with their owners exposed to write-downs. The sums at risk are enormous.

The damage from climate change could shave 5 per cent to 20 per cent off global GDP annually by 2100, according to the landmark Stern Review prepared for the UK government in 2006.

The economic impacts are not just in the distant future. More frequent--and more intense--extreme weather events such as hurricanes, flooding and droughts are already affecting assets and economies.

Even if you are sceptical about the science of climate change, there is no escaping a swelling tide of climate-related regulation.

Technological changes in areas such as renewables and batteries are already causing disruption, while pressures on companies and asset owners to support sustainability are increasing.

Governments, investors and consumers have been slow to appreciate climate factors. Why?

Scientific uncertainty is one reason. Behavioural biases also offer some clues: Risks or opportunities that are unlikely to materialise over the next few years but could be significant over longer horizons tend to be under-priced or underappreciated.

This is similar to a consumer who chooses a cheap, high-energy appliance over an expensive energy-efficient model that saves money in the long run.

Markets tend to focus on the shark closest to the boat. Risks we can see, especially visceral ones, occupy most of our attention. Contentious elections, referenda and monetary policy decisions dominate headlines.

The effects of climate change are less visible and perceived by many as distant. This leads to a bias toward inaction.

Bottom line: We believe climate factors have been underappreciated and under-priced. Yet this could change as the effects of climate change become more visible.

Green infrastructure

Meeting emissions-reduction targets requires steps such as retooling energy-inefficient infrastructure and reducing fossil fuel subsidies.

This creates opportunities in areas such as renewable infrastructure and underscores the importance of using investment tools that incorporate climate factors.

The global economy will require big investments in infrastructure as populations and the middle class grow--especially in energy systems and cities.

The demand for new infrastructure could top $90 trillion over 2015-30, according to The New Climate Economy's 2014 report, "Better Growth, Better Climate".

The drive to cut carbon emissions changes the mix of this spending. Clean energy, efficient power grids and energy-efficient buildings are on the menu.

The energy and transport sectors make up two-thirds of the needs, a 2016 McKinsey report estimates. Water and waste take up a fifth.

Most of the spending is needed in emerging markets. There has arguably never been a better time for governments to finance sustainable infrastructure.

Financing is cheap, with around one-third of government bonds in the developed world today yielding below zero.

We expect more public spending on infrastructure as countries pivot from monetary to fiscal stimulus.

Yet we also see the private sector playing a key role. The challenge is finding ways to leverage the available financing.

The world is currently spending only half the amount needed to meet the $90 trillion target by 2030, the New Climate Economy estimates.

Private investors could fill much of the gap, with the right incentives.

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Richard Turnill is global chief investment strategist at BlackRock, the world's largest asset manager. This article initially appeared on the Morningstar UK website. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind.

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