-
""

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
Agricultre, 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.
Apparel
  • 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.
  • Fluctiating 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.
Tourism
  • 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).
Insurance
  • 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)
  • Reducred 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
  • Constratined 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.

""

We give you versatility and a choice of services

Barclays Private Bank provides discretionary and advisory investment services, investments to help plan your wealth and for professionals, access to market.

Investments can fall as well as rise in value. Your capital or the income generated from your investment may be at risk.

This document has been issued by the Investments division at Barclays Private Banking division and is not a product of the Barclays Research department. Any views expressed may differ from those of Barclays Research. All opinions and estimates included in this document constitute our judgment as of the date of the document and may be subject to change without notice. No representation is made as to the accuracy of the assumptions made within, or completeness of, any modeling, scenario analysis or back-testing.

Barclays is not responsible for information stated to be obtained or derived from third party sources or statistical services, and we do not guarantee the information’s accuracy which may be incomplete or condensed.

This document has been prepared for information purposes only and does not constitute a prospectus, an offer, invitation or solicitation to buy or sell securities and is not intended to provide the sole basis for any evaluation of the securities or any other instrument, which may be discussed in it.

Any offer or entry into any transaction requires Barclays’ subsequent formal agreement which will be subject to internal approvals and execution of binding transaction documents. Any past or simulated past performance including back-testing, modeling or scenario analysis contained herein does not predict and is no indication as to future performance. The value of any investment may also fluctuate as a result of market changes.

Neither Barclays, its affiliates nor any of its directors, officers, employees, representatives or agents, accepts any liability whatsoever for any direct, indirect or consequential losses (in contract, tort or otherwise) arising from the use of this communication or its contents or reliance on the information contained herein, except to the extent this would be prohibited by law or regulation..

This document and the information contained herein may only be distributed and published in jurisdictions in which such distribution and publication is permitted.  You may not distribute this document, in whole or part, without our prior, express written permission. Law or regulation in certain countries may restrict the manner of distribution of this document and persons who come into possession of this document are required to inform themselves of and observe such restrictions.

The contents herein do not constitute investment, legal, tax, accounting or other advice. You should consider your own financial situation, objectives and needs, and conduct your own independent investigation and assessment of the contents of this document, including obtaining investment, legal, tax, accounting and such other advice as you consider necessary or appropriate, before making any investment or other decision.

THIS COMMUNICATION IS PROVIDED FOR INFORMATION PURPOSES ONLY AND IS SUBJECT TO CHANGE. IT IS INDICATIVE ONLY AND IS NOT BINDING.