The Changing Investment Climate Around Climate Change

Investors need to pay attention regardless of the uncertainties (and the politics). The changing climate is already changing a lengthening list of prices, which is changing the climate for investments.

The first blast of severe winter brings fresh worries about climate change, which in the United States these days is often just a short step from a shouting match across the political divide. But if you are an investor, you had better start to pay attention regardless of your political stripes and despite the manifest uncertainty around the long-term forecasts.

The changing climate is already changing a lengthening list of prices, which is changing the climate for investments. 

Even if you doubt the scientific consensus or disdain the dire predictions, keep your eyes peeled for all the forces at work that are already affecting investment returns. Consider these:

• Property prices have risen more slowly in flood-prone areas of Miami, while the values of real estate engulfed by Hurricane Sandy haven’t bounced back as they typically do after major storm.
• Insurance companies are charging more to cover homes that are deemed increasingly vulnerable to wildfires.
• Warmer weather seems to be driving lobsters from Maine while setting up southern England as a major rival to French champagne.
• A Connecticut nuclear power plant has struggled with its operations because the waters of Long Island Sound have grown too warm to cool its reactor.
• Stronger wind patterns are making long-haul flights several expensive minutes longer. 

The problem is that these troubling data points⁠—and many others like them—are difficult to price into any reasonable investment case over any reasonable time frame. It’s what outgoing Bank of England Governor Mark Carney calls the “tragedy of the horizon.” Even the scariest scenarios are unlikely to have much impact on any public official’s odds of re-election or investors’ chances to earn their next bonus. 

If only we could get a better handle on the timing and the cost of the potential damage, we could incorporate these assumptions as we calculate the net present value of returns. The immediate costs of transitioning to renewable energy would seem much easier to justify if we knew more precisely how much future profits might be diminished by the impact of climate change.

It’s all about incorporating climate risks into net present value calculations. This, above all, requires better data on carbon footprints and better corporate disclosure, which the Financial Stability Board has championed through its Task Force on Climate-related Disclosures. 

It may sound crazy for central banks to spend so much time talking about climate change, but getting bankers and investors to think harder about the risks may be the best we can do until more governments put a real and transparent price on carbon emissions. Ultimately, it will be up to businesses, consumers and investors to adjust their behavior according to incentives that manage the transition appropriately. 

As Carney himself points out, if there are risks of moving too slowly, there are equal risks of moving too fast. Draconian regulations and steep carbon taxes to force a switch to alternative energy sources could throttle economic activity, strand investments in fossil fuels and possibly cripple the technological progress required to make the leap.  

Moving too slowly, of course, may bring a much longer list of climate-related costs for business activities that are unprepared to bear them. These include everything from falling prices of vulnerable coastal real estate to rising health care costs to expanding flows of refugees in search of arable land. 

With so little guidance from governments and so much uncertainty around the scenarios, investors have lined up in roughly three camps.

Some believe human activity and carbon emissions are raising the planet's temperature, and they want to do their part to shove the world economy toward zero carbon emissions as quickly as possible. Many of them were represented on the field of the most recent Harvard-Yale football game by students urging that university endowments be divested from all fossil fuels.

Some suspect there might be a little fear-mongering about rising sea levels in Boston and expanding tropical zones in southern Europe, but understand that peer pressure may be assuaged if they own solar panel stock.

Still others are more closely focused on the fact that new government rules and new consumer preferences are already changing the returns on investments, and they had better do the best they can to peer into a very uncertain future.

They recognize that the very essence of investing is to peer into a deeply uncertain future, gauge risk and do a better than average job guessing at potential returns. Climate-related risks are just one more layer of uncertainty on top of a lot of other risks that can’t really be measured very well either. It’s far better to push for disclosure, for some kind of measurement and make a best guess than to shrug your shoulders and declare the change too hard to assess.

And so it doesn’t matter what you believe about the causes of climate change or how you cope with the uncertainties around it. It does matter that you look at how prices are changing and make your investments with your eyes wide open.