Is climate risk a ‘black swan’?

Or more importantly, can we prevent carbon and climate change risk from becoming a ‘black swan’ - an unpredictable, high impact event? This is a message that we hear more and more in discussions about divesting from fossil fuel assets and investing in renewables and clean technologies with each closely matching the other in both pace and scale.

The pace of divestment and investment is rapid and the money involved is staggering.  The investment and business communities are playing an increasingly significant role in influencing the energy mix, and rapid changes need to be closely watched and managed. 
 

As of December 2015 the total dollar value of institutional funds, currently earmarked for divestment is $3.4 trillion. In September 2014, this number sat at $50 billion . That equates to a 68 fold increase in potential divestment assets in little over 12 months. The Montreal Carbon Pledge, which requires investors to commit to measuring and publicly disclosing the carbon footprint of their investment portfolios, currently has over 120 investor signatories managing more than $10 trillion in assets. 

On the investment side, 2015 saw a record $329 billion in global clean energy investment according to Bloomberg New Energy Finance. China is beginning to see a clear delineation between GDP growth and growth in energy consumption. In 2015, China reduced coal imports by 30%, corresponding with a 5% reduction in overall coal consumption.  Yet there was a 0.5% increase in total electricity generation and a 6.9% increase in GDP.

The investment and divestment numbers demonstrate the direction the global climate change risk pendulum is swinging. However the true telling of the rate of change is the current global perception of climate change and carbon risk. The impacts of climate change are no longer a fringe consideration for investors and companies when assessing asset risk profiles, rather they are now seen by many as a crucial consideration in any due diligence exercise. The 2016 Global Risk Report released by the World Economic Forum (WEF) lists “failure of climate change mitigation and adaptation” as the number one global risk in terms of impact . The majority of the other global risks falling within the WEF top 10 are directly correlated to the long term physical and financial impacts of climate change.

This is in addition to the World Bank (along with 25 other global financial institutions) calling for financial institutions to “mainstream climate action”  when directing capital through investment and lending decisions. Far from creating additional risk, this approach is designed to demonstrate to the market the opportunities, risks and potential returns that are associated with low carbon investments. 

With the WEF announcement; the World Bank’s push to mainstream climate risk considerations; over 120 signatories to the Montreal Pledge for portfolio decarbonisation, and ongoing commercial support for an accelerated low carbon transition through the “We Mean Business” coalition, it would seem that 2016 is the year that climate change receives global recognition as the number one risk for our generation to manage.

Here in Australia, the recent Victorian Government announcement of aiming for a net zero emissions state by 2050 will only work to send additional market signals to our fossil fuel sector. This announcement follows the South Australian Government’s similar target of being net zero emissions by 2050, and the ACT Government strategy to be carbon neutral by 2020.

For the Australian fossil fuel sector, opportunities to operate in net zero emissions states will be extremely limited.

There is a clear trend which is both global and local. While governments are implementing policies in support of clean energy, the global business and investment community are proving to be the strongest drivers of change.  With their backing, climate risk will not be the ‘black swan’ issue of our generation. Also, in managing climate risks, there is also a myriad of opportunities to be seized. 

The business and investment community has both the global awareness and the tools required to transition to a 1.5 - 2oC world. The only remaining question is who amongst the business community will lead the way and use these tools. 

Steps that can be taken by Australian businesses to position themselves ahead of these rapidly changing global investment flows include:

  • Engaging senior management and a variety of internal stakeholders
  • Examining the types of climate related risks on the business, its assets, and regions of operation
  • Assessing the likelihood, consequence and materiality of these risks over different time horizons
  • Assessing the sensitivity of the company’s goods and services to changes in demand, and stress-testing the company’s resilience in different economic scenarios 
  • Determining appropriate steps to mitigate these risks
  • Developing a communication strategy for information published in the public domain and for specific responses to investor groups.

Energetics can assist with the different elements of risk assessment and opportunity identification.
 

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