Could your investments go up in smoke?

31 January 2020

6 minute read

By Damian Payiatakis, London UK, Head of Impact Investing

As the frequency of extreme weather events rises and global temperatures climb, it’s time to appreciate the physical risks of climate change for your investments.

With the start of the year, wildfires in Australia have led to countless animal deaths, people fleeing from blazes into the ocean and skies darkened by smoke. It highlights how climate change is exacerbating the extent and severity of natural catastrophes.

The effects of the Australian fires have not yet been fully costed or assessed. But, in the three months to 7 January, insurers received more than six times the annual average number of claims received over the prior five years1. By comparison, Californian utility group Pacific Gas and Electric, which was an A- rated credit in 2017, was the first company to declare bankruptcy, in 2019, pointing to climate change’s effects in respect of the state’s Camp Fire wildfires seen in 2018.

Physical effects from climate change have severe implications for communities, companies and investors. In our Outlook 2020, we highlighted the value of starting to position portfolios for the implications of climate change. To help that process, we now look at the physical risks that climate change produces.

More frequent and severe weather

Weather has always been variable. Extreme weather events have occurred in the past. Yet, these events are becoming more frequent and intense with climate change (see chart).

natural disasters chart

Physical effects of climate change are driven by the increase in average temperatures along with change in global and local weather patterns. Their impact can be through acute weather events (such as stronger hurricanes due to warmer oceans) or “chronic” longer term changes to trend (for instance, rising sea levels due to a combination of thermal expansion and the melting of land ice). In combination, they can be particularly devastating.

When listed, the range of weather events sounds apocalyptic — storms, heatwaves, droughts, rising sea levels, flooding or ocean acidification. However, the sad reality is that we are experiencing such events today, and with increasing regularity.

Implications of physical risks for companies

With increases in both acute and chronic physical effects, their potential materiality and cost increases too. The Task Force on Climate Related Financial Disclosures highlights potential financial impacts of physical risks to include2:

  • Reduced revenue from decreased production capacity (for instance, transport difficulties, supply chain interruptions)
  • Reduced revenue and higher costs from negative impacts on the workforce (such as health, safety, absenteeism)
  • Write-offs and early retirement of existing assets (for instance, damage to property and assets in “high-risk” locations)
  • Increased operating costs (say, inadequate water supply for hydroelectric plants or to cool nuclear and fossil fuel plants)
  • Increased capital costs
  • Reduced revenues from lower sales/output
  • Increased premiums and potentially reduced availability of insurance on assets in “high-risk” locations

Assessing whether the above financial impacts will occur depends on the likelihood of primary physical risks and then any secondary implications. Primary physical risks cause direct damage to assets (such as land, buildings, stock and infrastructure) due to the physical effects of climate-related events.

Secondary physical risks arise as climate change generates more indirect risks that affect supply chains and extended value chains. For example, availability of key resources, like water, sourcing and quality of raw materials, or rising costs of assets and commodities. In the extreme, extended physical damage in a country or region can produce conflict and mass migration due to food and resource scarcity.

All sectors of the economy face both types of risks from the physical effects of climate change. The chance, and consequences, of any particular risk and impact will vary by sector, company, and location. The table below summarises some of the physical climate impacts and their effects on a company’s value chain.

Sector Illustrative climate effects
(short and long-term)
Potential impact on value chain
Agriculture, Food & Beverage
  • Increasing average temperatures
  • Heatwaves and wildfires
  • Flood and landslide
  • Water scarcity and drought.
  • Decreased crop yield and potential crop failures
  • Increased irrigation demand and costs
  • Loss of productive land (e.g. due to increased soil salinity)
  • Altered growing conditions and seasons (e.g. resulting in price volatility)
  • Disruptions to distribution network, farmers and labour force.
  • Rising average temperatures
  • More frequent extreme weather events
  • Changing rainfall patterns and increased rainfall
    intensity - water scarcity and drought
  • Changes in pest and disease distribution and prevalence.
  • Fluctuating availability, quality and cost
  • Disruptions for operations and workers at manufacturing facilities
  • Disruptions in supply chain and distribution network, including transport, warehouses and stores
  • Shifting consumer preferences (e.g. less reliable seasonal cycles and temperatures.
  • Increased weather extremes and variability
  • Rising sea level and coastal erosion
  • Droughts, heatwave and wildfires
  • Increased exposure to diseases.
  • Damage to infrastructure ad facilities
  • Decreased attractiveness of tourism destinations
  • Disruptions of transportation (e.g. flights, cruises).
  • Virtually all physical effects, including hurricanes
    and storms, wildfires, floods, droughts, sea level rise,
    thawing permafrost and increased exposure to diseases
  • Increase claims, losses and liabilities
  • Difficulty in pricing physical perils (e.g. new products to address physical climate risks)
  • Reduced availability and affordability of some types of insurance
  • Reduced value of investment portfolio
Electric Power
  • Increased intensity and duration of extreme weather
    events, such as heat waves, storms and floods
  • Rising sea level and higher storm surges
  • Water scarcity.
  • Reduced output - disruptions in supply chain and distribution network
  • Damage to infrastructure and facilities
  • Changing seasonal power demand and increased peak demand
  • Increased electricity losses in transmission and distribution systems due to heat load.
Oil & Gas and Mining
  • Increased intensity and duration of extreme weather events
  • Rising sea level, high storm surges and increased coastal erosion
  • Land and sea ice melting and permafrost thawing
  • Changes in pets and disease distribution and prevalence.
  • Damage to infrastructure and facilities
  • Constrained access and production of resources/reserves
  • Constrained exploration, processing, refining and site rehabilitation
  • Higher decommissioning costs
  • Disruption of transport and distribution systems
  • Rising risks to employee health and safety.

Checking portfolios for climate-related risk

With climate change posing greater material financial risks, investors need to consider how to incorporate the physical risks into their portfolios. Assessing physical risks can be approached starting by a sector or geography and/or evaluating a specific company. Vulnerability to these risks goes beyond physical assets and across the value chain, as well as supply chain, customers, and markets. More importantly, resilience depends on company or governmental management, planning, and governance.

Climate change is accelerating and becoming more visible. Weather-related natural catastrophes are causing hundreds of billions of dollars-worth of losses worldwide. Longer term shifts in weather patterns, while not as obvious today, have deeper implications for companies and communities. Whether continued climate degradation can be sufficiently addressed, society faces greater risks. Investors should prepare accordingly.


Market Perspectives February 2020

Barclays Private Bank investment experts highlight our key investment themes. Despite a strong start to 2020 by financial markets, trade tensions and rising geopolitical risks feed into a general feeling of apprehensiveness.


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