Climate change: now a risk not uncertainty

As we learned from the recent financial crisis, systemic issues can wreck portfolios and undermine investor confidence for years. For many, climate change is emerging as a major systemic issue facing investors: economic damage from extreme weather and shifting climatic belts is likely to get worse, and governments are unlikely to sit on the side-lines. Investors need to act now, developing a coherent, flexible strategy to manage the risk of intervention.

The “unburnable carbon” issue has become polarised.  Those advocating full divestment are seen by many as extreme, particularly as divestment entails the wilful avoidance of dividend streams and a risk of underperformance if energy prices rise.  However, recent statements from fossil fuel E&P companies to challenge the analysis behind stranded asset risk and/or downplay its significance have been less than persuasive.

Asset owners are increasingly frustrated, particularly if faced with rising stakeholder pressure to reduce exposure to fossil fuels.  Although there have been a few high profile announcements of wholesale divestment, for the vast majority, the default response is to do nothing and wait for further developments.

Polarised responses are irrational for two reasons.  First, recent developments in science and policy have had a major impact on the climate change issue, recasting it as a risk rather than an uncertainty, thereby facilitating the use of traditional investment management tools, particularly asset allocation.  And second, developments in energy efficiency markets have created options for investors to mitigate some of the risks implied by divestment.