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Nick Cunningham

Nick Cunningham

Nick Cunningham is an independent journalist, covering oil and gas, energy and environmental policy, and international politics. He is based in Portland, Oregon. 

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Are Investors Ignoring The Largest Financial Risk Ever?

Financial markets are vastly underestimating the financial risk from climate change, according to the International Monetary Fund. 

Global temperatures have already increased by 1.1 degrees Celsius since preindustrial times and are on track to warm somewhere around 3 degrees C by the end of the century, although much depends on what governments do to rein in greenhouse gas emissions. That level of warming is “expected to adversely impact the world’s stock of natural assets,” the IMF said in its Global Financial Stability Report in April. Or, put bluntly, “the projected increase in the frequency and severity of disasters due to climate change is a potential threat to financial stability.” 

Climate change poses massive financial risk to physical infrastructure, a rather straightforward concept. For example, the predicted losses from floods in the world’s 136 largest coastal cities could exceed $1 trillion annually in 2050 with no change in policies, the IMF said. 

But markets are not adequately assessing this risk, and a “sudden shift in investors’ perception of this future risk could lead to a drop in asset values, generating a ripple effect on investor portfolios and financial institutions’ balance sheets,” the Fund said. After the 2011 floods in Thailand, for instance, the country’s stock market fell 30 percent over 40 days. 

Pricing in this risk is “daunting,” the IMF said, but with the climate crisis worsening, the risk is rising and asset values are not reflecting the danger. “Equity valuations as of 2019 do not appear to reflect the predicted changes in physical risk under various climate change scenarios,” the IMF said. 

Related: Oil Falls Back On Large Fuel Build
Meanwhile, there is also “transition risk,” or the array of policies, technological change, and shifts in markets towards a low-carbon economy that render certain asset classes much less valuable. 

There is roughly $18 trillion in equity and $8 trillion of corporate bonds linked to the fossil fuel system, according to a separate report from Carbon Tracker. That equates to about 24 percent of the global equity market and 53 percent of the non-financial corporate bond market. 

These assets are in danger of a dramatic repricing downward. Carbon Tracker says that the rents, capex and profits of fossil fuel system, along with the financial assets tied into those flows, are “at risk of losses long before infrastructure is written down.” The group pointed to the European electricity, coal and oil services sector as an example where that has already begun to unfold. 

The fossil fuel system is “ripe for disruption,” because it is “low growth, high fixed cost, low return, and (incredibly) planning on expansion even as demand peaks,” the report said. The COVID-19 pandemic has blown up the sector, and, to be sure, what happens next is unclear. But demand may not bounce back to pre-pandemic levels for years, if ever. 

It does not take oil demand dropping to zero for there to be massive financial disruption. Renewables only need to capture all the growth in demand going forward. The challenger (i.e. renewables) “typically has a market share of under 5%” when it takes all the growth, Carbon Tracker notes. At that point, the incumbent (i.e. fossil fuels), “by definition enters into terminal decline.” In other words, “peak demand happens early in energy transitions.” 

Related: Is This The Next Major Market For U.S. LNG?

The financial danger is made much worse when incumbents plan for indefinite growth, a vision that many oil companies do not shy away from. “The gap between their plans and reality is a major source of stranded assets, overcapacity and lower prices,” Carbon Tracker warned.

On top of that, externalities are not accounted for – some economists put global warming and pollution costs at around 100 euros per tonne of CO2 – and are dumped onto society at large. That could easily change with stricter climate policy, leaving fossil fuel assets much less lucrative or stranded altogether. 

Adding to the sector’s woes, renewable energy is not standing still either. Costs continue to decline. 

These dynamics are reinforcing in a virtuous (or vicious, depending on one’s perspective) circle, with technology, policy, and capital markets conspiring against the incumbent. For example, a coal plant begins to lose market share in the electricity sector, investors turn against the company, political influence wanes and stricter climate policy adds further pain. Capital dries up and companies go out of business. The cost of cleanup is put on the public. 

What happened for coal will happen for oil and gas. “Now is the time to put in place an orderly wind-down of assets, rather than trying to rebuild the unsustainable,” Carbon Tracker said.

By Nick Cunningham of Oilprice.com

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  • Andrew West on June 03 2020 said:
    I don't know if you believe in the Bible but I don't care if you don't. But yeah it's already predicted in the Bible that it's going to get hotter near the end times or whatever you want to call them Not because it's the end times" But specifically because the sun is heating up and getting more active than ever. everyone is ignoring the sun and the sun is causing the heat. The heat of the sun is a prediction and the book of Revelations I Believe. it doesn't even matter if I believe it's true or not it's something that was written almost thousands of years ago And it'll come to pass...
  • Carlos Everett on June 03 2020 said:
    Just one question-if the seas are going to overcome coatal areas, why is Barrack Obama buying a home on the sea at Martha's Vinyard and Bill Gates buys a home on the Ocean in Del Mar.

    These are two of the most green celebrities out their and they are risking there investment and safety. Your logic is a bit tainted.
  • Lee James on June 04 2020 said:
    Nick, nice article, blending the thoughts of the IMF with those of Carbon Tracker.

    I might add that the investing world is now seeing increasing interest in clean-energy and socially responsible investing. And, these funds are weathering unusual events like the COVID-19 virus better than traditional funds. See Morningstar.com about this development taking place over the last few years.

    This article highlights the key points that we need to pay attention to: dumping pollution for free may come to an end, clean energy capturing the net increase in energy demand may lead to terminal decline of fossil fuels, consumer perception of future environmental and economic risk may shift suddenly, equity investment is likely over-valued, and oil and gas costs are going up while renewable energy cost is going down.

    "Oil always bounces back." But is investing in what is unsustainable, prudent?
  • Maxander on June 04 2020 said:
    Preindustrial period means 120 years back? 1.1 deg C increase can be easily manageable. & further 2-3 deg C increase can be also adaptable.
    As we know, we humans keep evolving, we already have changed our health habits, our standard of living which can accommodate that increment of 1.1 deg C. So that increment of 1.1 deg C is really not worrisome really.
  • Maxander on June 04 2020 said:
    Climate Change activities can wait for another 50-100 years, not now at the time when world economy is fighting pandemic led loss.
    Economy is at the prime importance now, not climate change.
  • Mamdouh Salameh on June 04 2020 said:
    There is a growing trend among financial institutions like the International Monetary Fund (IMF), oil supermajors and governments particularly in the European Union (EU) to burnish their environmental credentials to please increasingly militant environmental activists and divestment campaigners against oil and natural gas assets.

    If the financial markets are vastly underestimating the financial risk from climate change as the IMF is claiming, it is because these markets are receiving so many contradictory guesswork estimates from various quarters including the IMF. The IMF prediction that losses from floods in the world’s 136 largest coastal cities could exceed $1 trillion annually in 2050 is one of those estimates.

    There is no doubt that climate change is happening. But the continuous bombardment of its destructive impact on the globe by media, environmental scientists and doomsday seers is not only infuriating a huge section of the world’s population but it is also putting their backs out. Is it any wonder then why shareholders in France’s giant oil company ‘Total’ recently rejected overwhelmingly a proposed resolution calling on the company to do more for climate change.

    There were many instances where environmental scientists and University professors have massaged facts and stretched them to breaking point just to justify their research or their political leanings.

    Even where events like solar storms are projected to happen with destructive magnitude in the future, why talking about them when even scientists can neither predict their time of occurrence nor will humanity be able to protect itself against their impact. It only worries people unnecessarily about things that may or may not happen.

    If solar storms were until recently believed to be a rare occurrence—only happening once every couple of centuries or so, what has changed to make scientists think there is reason to believe they may happen a lot more frequently? Could they let us know the scientific evidence they discovered to justify their claims and to reach the bombastic conclusion that solar storms could be the worst-case scenario for space weather events against the modern civilization?

    Moreover, how did astrophysicists calculate that the fallout from a severe solar storm could cost up to a trillion dollars? Is their estimate based on real science or fiction? Furthermore, how would humanity prepare against some mythical event that might or might not happen anyway?

    May be environmental scientists and doomsday seers could temper their doom and gloom projections and let humanity cope with daily life chores rather than worry about scientific hallucinations.

    Furthermore, it is ludicrous to claim that what is happening to coal will happen to oil and gas. Coal is declining because there are many cleaner and more efficient alternatives to it for electricity generation. Oil, for instance, will remain the dominant fuel for global transport system throughout the 21st century and far beyond while natural gas will continue to be the pivot for global energy transition well into the future.

    Why not let energy diversification take its course with alternative sources to fossil fuels, notably renewables, growing alongside, not at the expense of the incumbents, without militant pressure from environmental activists and divestment campaigners.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London
  • Keith Rowe on June 04 2020 said:
    You understand that oil isn't shrinking nor coal. Sure in the US it is shrinking because of Natural Gas is so much simpler and cheaper in so many ways. Coal is still rising everywhere Natural Gas is not available except Europe (but they built the Nordstream II no? So perhaps this will change too), which is the only one really pushing for this "energy transition" right now. It's a small percent of the world. If Trump gets in again it will spell the end of this "transition". Oddly enough electric cars aren't on a tear nor is renewable investment....so it's "hopeful thinking"? Perhaps all the investment in electric cars will be a "stranded asset", but then again many of those billions of investment is from national coffers.

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