Underestimating climate change cheats investors
As the effects of climate change unfold, its impact on business will grow more severe: altered rain patterns will affect agriculture, floods will disrupt supply lines, heat waves will prevent employees from working. If markets are to work well, investors need to know about these consequences, and the number of companies that voluntarily disclose their estimates of climate-linked risks has risen markedly over the past 15 years.
Of course, information only helps if it’s accurate. A comprehensive new study has assessed the plausibility of these corporate disclosures, comparing them to the best scientific and economic estimates of the likely costs of adjusting to climate change. The good news: Every year, more businesses start taking climate risks more seriously. However, current reporting also has serious blind spots that could leave investors uninformed and exposed.
In 2015, Bank of England Governor Mark Carney warned in a speech to Lloyd’s of London about the “Tragedy of the Horizon,” his term for global risk arising from the inherent disparity between the short-term thinking of financial markets and the long-term nature of climate. Companies concerned with pressing challenges, he suggested, may not be accurately disclosing to investors the risks they face due to climate change. To test Carney’s hunch, Allie Goldstein of the environmental organization Conservation International and colleagues took the voluntary disclosures made in 2016 by more than 1,600 large companies worldwide and compared the risk estimates within to estimates from scientists and economists.
According to their findings, most compa- nies expect climate change will increase their operational costs and reduce or disrupt production capacity due to events such as floods, drought or hurricane damage. And awareness is growing rapidly: The number of companies seeing such risks as either “virtually certain” or “more likely than not” to occur surged from 34 percent in 2011 to 67 percent in 2016. Yet serious complacency persists.
Economists have used so-called integrated assessment models to make crude estimates of the likely costs that will be incurred dealing with the physical aspects of climate change. Through 2100, this approach leads to figures varying from around $2 trillion to $20 trillion, or 2 to 20 percent of current total financial assets. In striking contrast, Goldstein and colleagues found, companies estimate their financial risk only in the tens of billions of dollars. That’s an alarming 100 times smaller than even the most conservative scientific estimate.
Another problem the researchers found: Businesses seem to be ignoring the indirect costs that might arise from disruptions to supply chains or changes in customers’ behavior. For example, estimates of how rising temperatures will impact productivity by 2100 forecast a 20 percent drop in global income per capita, which would naturally lead to falling overall demand for goods and services. Even so, fewer than 3 percent of companies on their disclosures considered it plausible that climate change could impact their businesses this way.
It looks like Carney was right about financial markets ignoring climate risks, which raises questions about their ability to steer investments wisely. This mighthave to do with the culture of business itself, as mainstream business models generally work on the assumption that current economic and social conditions will continue into the indefinite future, regardless of what happens to the Earth’s environment.
ACCORDING TO THEIR FINDINGS, MOST COMPANIES EXPECT CLIMATE CHANGE WILL INCREASE THEIR OPERATIONAL COSTS AND REDUCE OR DISRUPT PRODUCTION CAPACITY DUE TO EVENTS SUCH AS FLOODS, DROUGHT OR HURRICANE DAMAGE.