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Linking Climate Change to Investment Risk

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The insurance industry has been pricing extreme weather-related risks for many years. Every few years a ‘mega cat’ comes along, resulting in rises in general insurance and reinsurance rates. Direct man-made environmental disasters such as the chemical explosion in Tianjin have far-ranging consequences, as RSA owners found out recently. In auto-land, the VW problem has handed a golden opportunity to the electric vehicle industry, provided it can bring costs down and performance up. Driverless cars may use less fuel and could cut into the 10 percent of global oil demand generated by North American motorists.

Linking Climate Change With Investment Risk

Market Realist – Investors should take note of climate change. According to a report by Solterra Solutions, global mean surface temperatures have risen 0.75º Celsius (1.3º Fahrenheit) in the last century. The report observes that the 16 warmest years were recorded between 1995 to 2011.

There has also been an increase in average Arctic temperatures. The pace of warming has been twice the average global rates in the past century. In such a scenario, linking climate change to investment risks may indeed be a smart move by investors.

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The Cancun Agreement of 2010 saw commitments by governments to limit global warming to 2° Celsius above the temperatures observed in the pre-industrial era. According to Carbon Tracker, the global carbon budget for 2000–2050 needs to be fixed at 886 GtCO2 to give us an 80% chance of achieving this target.

According to Carbon Tracker, the global economy (ACWI) exhausted more than 33% of the budget by 2011. This effectively means that only 565 GT of CO2 can be emitted between 2011 and 2050 to stay within the targets.

This has a huge impact on fossil fuel companies (KOL). Only one-fifth of the fossil fuel reserves can be burned in the next 40 years. The rest technically would need to be classified as “stranded assets,” if the carbon budget is respected, which should be listed as liabilities on the balance sheet of fossil fuel companies. You can see this in the above chart.

Linking Climate Change With Investment Risk

The decarbonizing of the world is bound to have adverse effects on fossil fuel (IEO) (GUSH) and energy companies. A recent report by Mercer attempts to link climate change to investment risks. According to the report, returns in the coal sector could drop 18%–75%. The average expected annual returns could fall from 6.6% to 1.7%–5.4% over the next 35 years.

Oil and utilities (IDU) (XLU) could also be adversely affected, with a potential fall to 2.5% and 3.7% from 6.6% and 6.2%, respectively. According to the report, renewables could benefit from an increase in average expected returns to 10.1%, as you can see in the above graph. For the long-term investor, renewables (QCLN) could actually be an attractive option.

The iShares Global Clean Energy ETF (ICLN) could be an attractive opportunity for investors. The ETF invests in renewable and clean energy companies such as First Solar (FSLR), SolarCity (SCTY), and Covanta Holding (CVA).

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