Putting a Price on Climate Risk

Last year in California new financial history was made when Pacific Gas & Electricity PG&E filed for bankruptcy. What made this event historic and unique was that it was the first corporate collapse caused by climate change.

What turned the fire into the worst natural disaster in Californian history was the result of a changing climate.  Wetter winters encouraged the growth of brush in Californian forests, which followed by hotter and drier springs and summers created the ideal conditions for forest fires. When investigations started the cause of the fire was found to be fault in one of PG&E sub-stations. Expensive lawsuits soon followed along with a collapsing share price which led the company to file for bankruptcy. PG&E had faced similar lawsuits from wildfires in the past, but the size and destruction caused by the 2018 fire made it unprecedented.

This story is a taste of the future. While this was the first climate related corporate failure it certainly will not be the last. History is littered with countries and companies failing to see long term threats until it is too late and climate related risks fall firmly into that category.

As climate breakdown grips the planet physical climate risks will lead to increased extreme weather events such as flooding, cyclones and heatwaves as well as long term changes such as rising sea levels along with drier climates and desertification. These weather events will hit companies hard, the costs will soon spiral into billions.

The drive to decarbonise economies is gaining traction as more countries commit to carbon neutral economies and move away from fossil fuels. This will leave many carbon intensive economies and ventures with stranded assets and structural weaknesses. Think of an oil focused economy like Saudi Arabia, a carbon neutral world will leave the nation without an income and stripped of its wealth.

The creation of the Task Force on Climate Related Financial Disclosures (TCFD) was created to allow banks and insurers to put a price on their climate related risks. If these institutions are lending to projects like roads, ports or agribusinesses, but these will be hit by extreme weather, unviable due to rising sea levels, roads swept away by flooding or uneconomic as farms turn arid and barren. Then these risks should be factored to the creditworthiness of the project.

If conducted correctly the TCFD will result in carbon intensive projects being avoided, the climate resilience of the assets considered and improved, and climate risk being taken seriously by the financial sector. The TCFD should force the corporate sector away from dirty coal projects and help them work out how climate resilient their projects really are and how they could be improved.

Already three quarters of the world’s largest banks and eight out of ten of the world’s biggest asset managers have signed up in principle to the recommendations.

But there is much difficult work which needs to be done before we can put an accurate price on physical climate risk. Banks need to map their investments against climate risks and then figure out what the financial impact will be on the project.

Mapping and modelling climate risk is not exact, we know there will be major changes, but we don’t know how these changes will unfold, but we know they will be hugely disruptive.

The implementation of the recommendations is a risky process because Bank’s clients will react badly to being told their project holds long term risks and is potentially unviable due to climate change

But the risk of inaction is immeasurably higher.

There are also opportunities for companies that act now. Climate resilient companies can survive and even thrive in the face of climate change, while watching unprepared firms fail.

There will be a host of business opportunities for those who can build climate resilience infrastructure, sell environmental technology like desalination plants, carbon capture and water efficient agriculture.

But all this means implementing and acting on the recommendations now, before it is too late.

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