Prepare for a range of climate futures
Investors can manage risk while also embracing the opportunities that will arise on the road to net zero, reports Sophie Heald.
In the face of escalating climate change, the global community finds itself at a critical crossroad. As the world collectively undertakes decarbonisation efforts to limit global warming to 1.5C as outlined in the Paris Agreement, is this outcome still achievable?
If not, what are the potential implications and how can investors and financial institutions best prepare?
According to the latest estimates, with no further climate action, end-of-century warming is expected to reach 2.7C above pre-industrial levels. Limiting global warming to 1.5C remains technically feasible, but despite some positive progress, meeting this goal is becoming increasingly challenging.
Positive signs
Clean technologies are becoming more cost-effective than their fossil fuel counterparts. Over the past decade, the cost of photovoltaic panels has reduced by almost 90%, making it the cheapest form of electricity generation.
Similarly, cost reductions and advances in battery technology are overcoming barriers to the widespread adoption of electric vehicles.
The decreasing cost of clean technology is also fuelling a significant increase in take-up, triggering subsequent cost reductions and driving continued expected growth in the low-carbon and renewable energy sectors that lower overall emissions.
In 2023, investments in the low-carbon transition exceeded those in fossil fuels, reaching $1.8 trillion, and the International Energy Agency predicts peak fossil fuel demand and emissions will be reached within this decade, even without further policy commitments.
The European Commission’s roadmap to a 90% emissions reduction by 2040 shows a commitment to ambitious climate action. And following the example of the US Inflation Reduction Act, governments are realising the economic benefits of a low-carbon stimulus package in attracting inward investment.
This, in turn, is fostering sustainable development and spurring other governments to consider adopting similar low-carbon stimulus packages to reap the potential economic benefits.
Obstacles to limiting global warming
Current climate policies are nowhere near where they need to be to achieve net zero by 2050.
Furthermore, the continued absence of a radical shift in global climate policy each passing year contributes to more locked-in emissions and further hinders efforts to limit temperature rise.
Last year, some countries, such as the UK, rolled back policy commitments in the face of rising political pressure.
While investments in the low-carbon transition exceeded those in fossil fuels in 2023, reaching $1.8 trillion, this is still less than half of the annual investment required to reach net-zero emissions by 2050 and limit temperature rise to 1.5C.
In addition, as temperatures increase, we are drawing closer to the risk of hitting climate tipping points.
One example is wildfires, which increased in frequency worldwide in 2023.
It is estimated that global wildfires generated almost 8 billion tonnes of CO2 in 2023, with Canadian wildfires accounting for 22%. Greece experienced the largest wildfire ever recorded in the European region. This staggering figure is roughly equivalent to Europe and the US’s combined emissions from burning fossil fuels.
Given that wildfires are extreme weather events attributable to climate change, the projected increase in frequency will contribute further to emissions and act as a barrier to limiting temperature rises.
Implications for investors
The momentum and volume of decarbonisation activity will have a profound impact on the world’s future in both the short and longer term.
From an investor’s perspective, there will be cascading effects on the economy, including GDP impacts, inflation and asset class returns which will differ between countries and sectors.
For example, a tougher implementation of policies that aim to cease the use of fossil fuel technologies within a 20-year horizon may see more attractive investment opportunities emerging in the renewable-energy sector in the shorter term, in comparison with an implementation that takes 30 years.
The timing of impactful policy action will also probably result in different levels of physical risk impacts, as well as agricultural and productivity disruptions.
Given that these profound effects can lead to risks as well as opportunities, financial institutions and investors who seek to gain an understanding of the potential impacts will be positioned to make better-informed decisions.
How you can prepare
Future climate change and its effects remain inherently uncertain, but investors do have access to indicators of its trajectory and associated implications.
By acknowledging the range of possible climate futures, taking account of possible disruptive technological change, policy initiatives and other driving factors, ‘what-if’ climate scenarios can be utilised to conduct risk analysis and stress-test investment portfolios. The quantified insights describing the financial and economic implications generated from the analysis can then be translated into strategies that are robust and resilient.
Financial institutions operate in a world of uncertainty. Ultimately, by being prepared for different plausible climate futures, investors can not only effectively manage risk, but also remain ready to embrace the opportunities that will arise and contribute to building a resilient and sustainable future.
Sophie Heald is a senior climate specialist at Ortec Finance
