Is 2020 the watershed year when the world begins to realize the concept of systemic risk in our interactions with the natural environment? What explains the recent drumbeat headlines in the financial media and the accompanying fund flow?
Covid-1 is a cause. The epidemic has fueled interest in environmental, social and governance (ESG) investments and affected government policy, economic activity and markets in dramatic, rapid and completely global ways. This is in contrast to the systemic risks associated with climate change, whose awareness has evolved over a much longer period of time.
Although epidemics tend to be rare, seasonal weather events in the United States appear to have become more frequent and more intense in recent years. Hurricanes have devastated our coast, floods have swept the Midwest, and wildfires have engulfed the West. This year, the word “Dereco” has entered our vocabulary as winds of up to 150 miles per hour have devastated Iowa, torn down roofs and knocked down trees and powerlines.
If California were a sovereign country, it would be the fifth largest economy in the world. Its annual gross domestic product (GDP) of 3.2 trillion will put it behind Germany and ahead of India in the global rankings. Such success is due to its many natural and human resources, in particular, its role as a world technology and recreation center.
But as of this writing, by 2020, California has burned more than%. This year alone, more than 1,000,000 fires have been reported in the state. Five of the six largest fires in the state since the first record was set in 1932. Oregon has struggled with its own horrific wildfires season, like a number of other Western states
In the Gulf region, residents had to take shelter for the second time due to the terrible air quality from the fire, after the houses were locked up with shelter orders due to the epidemic. And rolling blackouts have affected millions of residents for the first time in 19 years.
In a testimony to the U.S. Congress earlier this year, John McWilliams of Columbia University’s Center on Global Energy Policy observed:
“Although the level of forecasting varies, the scientific literature almost universally suggests significant climate change – fire activity and intensity increased across the United States towards the end of the century. By the middle of this century, the annual burning area in the western United States could increase two to six times from the current, depending on the geographical area, the ecosystem, and the local climate. ‘
“Importantly, current fire activity in California is of national concern due to its population, the size of its economy, and climate leadership. The largest increase in fire activity in other states is expected. A 2015 study by the International Journal of Wildland Fire Can be affected.As painfully clear on the map, many regions may be at increased risk, especially in the south-east and north-west of the country.
Reviewing information about California is instructive. It highlights the trends that have led to this year’s record-breaking wildfires.
In 2018, for example, a devastating campfire fire destroyed the city of Paradise. This led to the final bankruptcy of the power supplier PG&E the following year.
California Fire: A total of one acre has been burned for years
But as the graphic above shows, 2020 was a normal year for wildfires compared to 2020. Many more acres have been burned this year. Fires increase the release of carbon dioxide released into the atmosphere. One study found that climate response to fire is 5% to 10% of global CO.2 Average emissions per year.
The average temperature rise in California is no doubt on dry conditions, and warmer temperatures have also contributed to more frequent thunderstorms. Which has been blamed for recent fires.
Drought areas of California
Extreme drought has devastated the state in the last decade and made the situation worse. But California has moved toward reducing emissions through its renewable energy program, and today it leads the country with about 30% of the electricity generated by renewable energy.
The total renewable generation provides the California load by resource type
So, what does all this mean from an investment perspective? In the case of utilities, markets cannot determine the value of climate risk because there is an underlying assumption that bidders and insurers will cover costs, according to the Centre’s energy policy.
California2018 responded to the 2018 fire by creating a wildfire insurance fund to help those directly affected. But it has specifically failed to reform the legal framework that allows utilities to be held accountable for their losses, putting them at risk for future companies and losers. In the meantime, Californians pay almost twice the national average for power.
In addition to stocks, investors are reconsidering their investments in reinsurance. This resource class is not determining the value of climate risk. The low level of activity in the Insurance Linked Securities (ILS) sector since 2011 is evident, which speaks of a change of regime. Zurich Ray, CEO of Chief Reinsurer, went further, pointing to the need to assess climate risk as a component of premiums, which is not the current practice in the insurance business.
And finally, what about the risk of municipal bonds? The risks to cities and states seem obvious when considering the potential budget impact of floods, fires, and wind mitigation and reconstruction or the permanent damage caused by sea level rise. But the Center for American Progress summarizes a new issue that sees municipal markets as unprecedented risks due to climate change and calls for greater risks:
“Much like the coronavirus epidemic, the complex effects of climate change will be an unprecedented event in human history. In the coming years and decades, cities and states will face unexpected fluctuations in both revenue and expenditure as they engage in long-term environmental change and an increase in catastrophic events. Federal regulations should include issuers’ comprehensive and maximum quantitative visual-based climate risk exposure for these fluctuations and to preserve the liquidity of the municipal bond market.
Climate action is needed. In the meantime, investors must continue to assess these risks across a wide range of asset classes. While California continues to fight its crisis, it is clear that a range of contributing factors has developed over the years.
So investors need to prepare now. Systemic risks from climate change will spread to other states and geographies in the very near future.
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All posts are the author’s opinion. As such, they should not be construed as investment advice, or the opinions expressed must not reflect the views of the CFA Institute or the author’s employer.
Photo Credit: © Getty Images / Max Geller