Account for climate risk or lose billions, investors warned

Fund managers told to take a prudent view of risk and use better long term models to account for changing climate

(Pic: Mercer report opening page - Investing in a Time of Climate Change)

(Pic: Mercer report opening page – Investing in a Time of Climate Change)

By Ed King

Coal companies, utilities and countries wedded to high carbon energy face potentially severe losses over the next 35 years as a result of climate change policy and extreme weather events.

That’s one of the key findings of a major new study into climate risk released on Thursday, released by consultants Mercer and backed by the World Bank, along with the UK and German governments.

Returns in the coal sector could fall between 18-75% by 2050, says Mercer, while renewables could grow anywhere between 6-54%.

“Oil and utilities could also be significantly negatively impacted over the next 35 years, with expected average returns potentially falling from 6.6% p.a. to 2.5% p.a. and 6.2% p.a. to 3.7% p.a. respectively,” says the report.

It suggests investors examine how their assets could be hit by the removal of fossil fuel subsidies, the imposition of a price on carbon or irregular access to water as a result of climate impacts.

The authors say fund managers must start to take a “prudent view of risk” and start evolving their investment portfolios and improving their modelling to take extreme weather events into account.

“There is strong evidence that, if we follow our current [emissions] trajectory, there will be a high risk of irreversible and severe impacts across the globe,” it says.

While high carbon sources of energy are deemed to be the highest risk for investors, agriculture, timber and global real estate could also suffer if warming accelerates.

Costing risk

Jane Ambachtsheer, chair of Mercer’s responsible investment team, said the aim of the study was to help investors “build resilience” into their portfolios.

“We recognise that markets do not always price in change; they are notoriously poor at anticipating incremental structural change and long-term downside risk until it is upon us,” she said.

While climate change does not currently feature as a risk for fiduciaries in the UK, the authors believe that will change.

A proposed global climate change deal – due to be signed off in Paris this December – could also change the investment climate for low carbon energy.

The most optimistic scenario painted by Mercer predicts that $65 trillion could be directed towards low carbon sources of energy and efficiency measures by 2050, bleeding support for fossil fuels.

National focus

Tougher global steps to address climate change will hit some countries harder than others, with those deemed to have ignored the risks hurt most.

“We believe that the Australian economy is more susceptible to a policy shock than other developed markets given the uncertainty surrounding its national climate change policy, which currently lags other developed markets, combined with the level of dependency of the Australian economy on carbon-intensive sectors,” the study says.

In the longer term the authors say UK, Australian, and Canadian equities are likely to be more sensitive to moves to cut greenhouse gas emissions given their high exposure to carbon-intensive sectors.

“Investors should consider increasing exposure to emerging market equities and sustainable real assets if they envision strong or very strong action on climate change.”

“Key downside risks come either from structural change during the transition to a low-carbon economy, where investors are unprepared for change, or from higher physical damages,” they add later in the report.

Ray Dhirani, corporate stewardship manager on sustainable finance at WWF-UK labelled it a “landmark report.”

“While it highlights the significant portfolio risks from climate change, it also shows that there are opportunities for long term investors in a low carbon world,” he said.

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