Comparing COVID-19 to the bursting of the carbon bubble

In the current market environment, the realization of what it means to be exposed to systemic risk has never been so clear. COVID-19 is disrupting the global economy and financial markets. It is affecting all sectors and all regions.

The overall picture is nuanced by sectoral and regional differences depending on their relative resilience and capacity to address the risk. Several sectors, like those catering to digital communication platforms, medical products and food supplies are even experiencing upward potential.

In this way the COVID-19 crisis’ risk has many parallels to the potential bursting of the carbon bubble.  In the case of a carbon bubble burst, the trigger is a sudden market sentiment shock related to the transition to net zero emissions. As is the case with the current crisis, all sectors and regions could be affected. The total effect could be highly impactful to markets generally, but will be marked by significant differences between region-sector combinations.

However, at this time (26 March 2020), the COVID-19 shock to equity markets is already larger than the expected shock related to the carbon bubble burst. In the last month, the US and European stock markets lost around 35%. In our Disorderly Paris scenario, we model a region-dependent total stock market correction that is actually smaller than the price correction that we have seen in the last month. This total equity price correction related to the carbon bubble burst is built up of a sentiment shock (the Minsky moment) and the repricing of equities due to a change in the output growth forecasts. 

In short, the current crisis’ effects on equity returns are larger than what even the most severe disorderly climate transition scenarios foresaw. The current situation underlines the importance of:

• including a systemic, macro-economic and top-down perspective, that includes externalities, in risk analysis, and
• conducting forward-looking scenario analysis, including stress testing. 

Finally, it is important for governments and the financial sector to remember that climate change is a risk amplifier. It amplifies many risks, including that of disease vectors. Climate action is as urgent as ever. Churchill’s classic quote, “Never waste a good crisis”, seems apt at this time. As regulators step in to stabilize markets and investors adjust their holdings, we strongly urge them to lay the foundation for a net-zero emissions, resilient and socially inclusive post-COVID 19 future.

To find out more on systemic climate risk modeling,  the potential impact of a carbon bubble burst on the economy and financial markets, and your specific investment portfolio, contact the Ortec Finance Climate and ESG solution at Climate@ortec-finance.com.