When the Penny Drops: The financial risk of climate change

15536248 - world euro melt  elements in this image furnished by nasa

The increasingly acute impacts and wide-ranging implications of climate change present significant financial risk to business.

From the way raw materials are sourced to the way our goods are manufactured and distributed – and the ability to attract capital investment and sustain growth in competitive markets – changes brought about by our changing atmosphere continue to put pressure on companies across the sectors.

The World Economic Forum’s latest Global Risks Report, which polled 750 experts from a  range of disciplines to determine the biggest threat to society and the economy right now, puts extreme weather, natural disasters and environmental and climate risks at the top of the pile. It is no wonder that a much more interested and demanding group of investors has emerged; some 822 institutional investors, representing more than $95tn of assets, currently make use of CDP’s climate change data, for example.

An effective and progressive management of carbon output is seen as a crucial strategy for any leading business in the 21st century.

Stranded assets

However, overcoming our reliance on dirty fuels is not going to be easy. Despite recent advances in renewable production, fossil fuels still make up more than 80% of our planet’s energy use. And there are some good, practical, economic reasons why coal, oil and gas dominate supply in the global economy.

But false estimates have been made as to the value of fossil fuels, blinding us to the challenges which arise from their use. Beyond the greenhouse gas pollution caused by the burning of irreplaceable stored energy, the belief that fossil fuel energetically outcompetes other sources of energy has lead to distorted markets and numerous incentives to pursue resources that are ever harder to exploit.

Projects such as Carbon Tracker have begun to highlight the extent of the problem, suggesting that just 20-40% of carbon assets held by listed companies could be burnt without exceeding global warming of 2°C.

Yet the worth currently assigned to these assets can only be realised if they are used. These so-called ‘stranded assets’ might be valuable in the short term, but potentially catastrophic in the long-term, both in financial and planetary terms.

Carbon taxes

Carbon tax regimes differ across the world – from the UK’s Climate Change Levy (CCL) designed to encourage energy providers to boost non-domestic energy efficiency, to Costa Rica’s 3.5% carbon tax on hydrocarbon fuels, a scheme which funds sustainable development and forest conservation projects to the tune of $15m a year. In the US, where Congress has generally baulked at the idea of raising taxes for oil and gas companies, a change of President at the end of 2016 is likely to put the idea of a nation-wide carbon tax firmly back on the table. Democratic candidate Hilary Clinton has vowed to move forward with methane emission limits and restrictions on fossil fuel leasing on public lands.

Divestment

The growing call for fossil fuel divestment – taking money out of funding pots which are helping to support unsustainable companies and industries, like coal, oil, gas and tar sands – poses significant challenges too.

From Bill McKibben’s 350.org campaign to shut down of the world’s most dangerous fossil fuel projects, to The Guardian’s Keep It In The Ground campaign launched by the outgoing former editor Alan Rusbridger as a legacy vanity project – hundreds of thousands of people are galvanising to push for big foundations to divest from fossil fuel.

Late last year it was announced that institutions and individuals representing more than $2.6 trillion in assets under management are committed to fossil fuel divestment. And this number is only likely to grow, as 84% of millennials say they favour ESG investing. Roughly $41 trillion will pass from baby boomers to millennials over the next 35 years.

Bringing new assets to life, particularly in the extractives and mining sectors, is going to get even tougher in the not-too-distant future.

Ultimately, companies that measure their environmental risk are better able to manage it strategically. As such, the results of CDP surveys – revealing corporate performance on everything from greenhouse gas emissions and supply chain risks, to water and deforestation reduction efforts – continue to influence investor relations and Google Finance scores. More than $20 trillion was invested in 2014 in funds with environmental, social and governance mandates – up 61% from the previous two years.