Portfolios need to be adapted to extreme weather and a disorderly transition
At the beginning of August, the Intergovernmental Panel on Climate Change (IPCC) published its sixth report on climate change. Its message could not have been more clear: climate change is man-made and if we do not change our ways, keeping global warming to either 1.5°C or even 2°C above pre-industrial levels by 2100 would be ‘beyond reach’. The report came to the devastating conclusion based on research by 234 scientists from more than 60 countries, which should propel investors into action because even with a global temperature increase of 1.5°C the physical impacts will be felt all over the world. At the same time, if governments are going to honor their Paris-commitments, investors should be prepared for a disorderly transition where some sectors and countries will be hit hard.
The report offers different scenarios depending on how optimistic or pessimistic we are about the likelihood companies and governments are really going to do their best to mitigate climate change. In the worst-case scenario, we are looking at a 3°C increase by 2060 and almost 6°C by the turn of the century. Under that scenario, sea levels will have risen 1 meter by 2100.
Why do we mention that pessimistic scenario? Because since the Paris Climate Agreement little progress has been made to honor the commitments made almost 6 years ago. According to Climate Action Tracker, currently only Morocco and the Gambia are on track for a 1.5°C world. The world’s largest carbon emitters’ climate actions are either insufficient (EU), highly insufficient (China), critically insufficient (Russia), or data is entirely missing (US).
In order to limit global warming to 1.5°C, the world can only add another 300 Gigaton CO2 equivalent (GtCO2e) of carbon to the atmosphere, the IPCC estimates. In 2020, global energy-related carbon emissions was already 32 GtCO2e, according to the International Energy Agency. According to the Emissions Gap Report 2020, global GHG emissions continued to grow for the third consecutive year in 2019, reaching a record high of 52.4 GtCO2e without including land-use change (LUC) emissions. Over the last 10 years, the top four emitters (China, US, EU+UK, and India) have contributed to 55% of total GHG emissions without LUC.
Even if we are able to limit the world to 1.5°C of global warming, heavy rainfall and flooding will intensify and be more frequent in many regions, as we have seen in Europe, China, Canada, and the US this summer. All around the world we will experience increases in extreme heat, with heatwaves becoming more severe and flooding more likely because of extreme rainfall in urban areas that are not build to absorb all that water and the sea level rise. In the latest climate report, the IPCC once again stresses that all cities need larger investments in climate adaptation to increase resilience against extreme weather, such as early warning systems, better sewers, and water services.
Our research partner Cambridge Econometrics (CE) estimates, based on its macro-economic model, that global physical damages in the business-as-usual scenario of 4°C in 2050 can reach up to 7.5% of GDP by 2050 and stay below 4.5% in a well-below 2°C scenario, with large country-level variations. Because of the exponential shape of the damage function of the CE-model, losses can grow by up to 65% and 30% of GDP by 2100 in the two scenarios, respectively. However, it is not all doom and gloom. CE-economist Zsofi Kőműves wrote in her blog that ‘our modelling finds that low-carbon transition has net positive global impacts and can increase global GDP by about 1.3% by 2050. Countries investing in low-carbon technologies could realize even greater benefits while fossil fuel exporters lose in a global transition’.
Creating Resilient Portfolios
For investors, the IPCC report should be a call for action – an incentive to start by creating net zero aligned and climate resilient portfolios. It is wonderful to see that many of our clients have already started on this journey.
We do notice that, across the board, the focus seems to be on managing more near term-transition related risks. And even though transition risks can be very material, especially if the transition is a disorderly one, transition risks tend to be much less impactful over the medium to longer term than physical risks.
Thinking through the financial impacts of various climate risk scenarios and creating a net-zero roadmap may feel somewhat overwhelming. At Ortec Finance, we are here to help. Don’t hesitate to reach out to us, or take a look at our Climate & ESG solutions page.
Ortec Finance delivers state-of-the-art customizable solutions for climate resilient investment decision-making. We combine independent, research-backed climate change & ESG knowledge, advanced financial models and innovative technology for:
- Climate scenario analysis
- Climate-aware Strategic Asset Allocation & ALM
- Alignment to Net Zero
- Forward-looking extreme weather risk
- TCFD & regulatory disclosure
- AI driven ESG analytics