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EXECUTIVE PERSPECTIVE: Climate change may trigger the next financial crisis

Jane Burston

04 Feb 2014

Financial markets have long been the preferred topic of the 2500 world and business leaders who gather annually at the World Economic Forum in Davos. Over the past few years, there’s been little room for anything else. As one Davos veteran said to me, the atmosphere has been so unsettled that one whisper of a percentage drop in the indexes would be enough to see the helicopters swooping in to speed executives back to the day job.

This year, a semblance of calm had returned. With the immediate crisis receding, different conversations were again possible – social entrepreneurship, sustainability and society were back on the menu alongside the staple diet of financial performance.

But as someone who works with climate scientists on a daily basis, I’m deeply concerned that even in Davos, the environmental movement is still just talking to itself and not to those who have the most power to do something about it. I’m not the only one with this concern. At the end of a day of meetings dedicated to climate change, head of the UN climate body Christiana Figures asked a packed room how many of them had been to multiple meetings that day with the same 20 people. Almost every hand went up.

The fact is that the people who can really influence this issue are still in different rooms, still talking only about financial markets, and still of the opinion that the warming world is someone else’s problem.

If we and they don’t do something soon, though, it will become their problem: based on what I heard in Davos, climate change has all of the right ingredients to trigger the next financial crisis.

The first of these ingredients is the issue of stranded assets. The Carbon Tracker initiative has calculated that if we are to give ourselves a reasonable chance of limiting global warming to 2 degrees, only 20% of the oil and gas reserves currently held by major companies can be burned unabated. In such a world, HSBC suggests that the share prices of such companies could be reduced by 40-60%.

Sure, that amount of money, while it would cause significant pain to pension holders across the world, isn’t of the same order as the mortgage products which triggered the crash. But it’s far from the only financial impact climate change will create.

The second ingredient of a potential financial crisis will be loss and damage arising from the increased number of extreme weather events climate change will bring. Speaking in Davos, UK economist Lord Stern, famous for quantifying the implications of delayed action on climate change, said that the impacts from climate change in scientific and economic modelling have been grossly underestimated.

What will these losses arise from? Whilst it’s incredibly difficult to predict exactly what will happen – especially on a regional scale – some things we can consider reasonably likely:

  • Increased costs of insurance. The UK Committee on Climate Change states that insured losses from flooding and severe weather events have cost an average £1.5 billion per year over the past twenty years. The Association of British Insurers estimates that increased losses could raise the cost of capital and increase the volatility of insurance markets, for example in a high emissions scenario (where carbon dioxide levels double) premiums in the US and Japan could increase by up to 60% due to the increased likelihood of storms and typhoons. In the UK, climate change “could increase the annual costs of flooding by almost 15-fold by the 2080s”, leading to potential losses of more than £22bn.
  • The need to adapt our infrastructure. If we manage to keep global average temperature increases to 2 degrees, we are likely to see sea level rises of between 0.3 meters and 0.6m this century.* If average temperatures increase by 4 degrees, the sea level rise by the end of the century will be by 0.5m to 0.8m. These rises, combined with very significant increases in the occurrence of future sea level extremes such as storm surges, will mean ports and coastal infrastructure will be challenged. Heatwaves and flooding will cause damage to roads and railways, such as stress-cracking of road surfaces and buckling of railway lines.
  • Lost productivity of land. Climate change means we will see more heatwaves. The variability of temperature is currently increasing twice as fast as average temperatures.  That means that even if we keep average temperature increases by the end of the century to 2 degrees more than now, a hot summer at the end of the century could be 4-5 degrees hotter than a hot summer now.  Based on previous experience, this means increasing livestock mortality and reduced yields, and not just in developing countries. The summer of 2003 in France and northern Italy was ‘only’ about 3.5 degrees hotter than last century’s average, but yields declined by 20-30%.  Drought could accentuate these impacts further – average yields in the US for maize and soy are predicted to decline this century by 30-80%
  • The loss of life. Increased heatwaves will also lead to loss of life. The Met Office reports that the 2003 heatwave in caused 2000 deaths in the UK. The World Health Organisation has calculated that climate change impacts including more extreme weather events, but also changed patterns of disease and effects on agricultural production, are already estimated to cause over 150,000 deaths annuallyand we have currently only experienced 1 degree of warming.

The third ingredient contributing to a financial crisis is that with increased costs and risk comes increased price volatility of key commodities. Thomson Reuters Lanworth analysis shows that the increase in summer night-time temperatures over the last decade in the northern hemisphere have led to a corresponding sharp decrease in world grain supplies, concluding that “under anticipated growing conditions, the present market environment of rising prices and volatility will likely prevail until population- and policy-driven demand abates or until production risk is somehow mitigated.”

Research by PWC shows that it is not just food that will be affected by price volatility. Extreme weather events will have an impact on transportation and logistics, including transportation of energy that will have a knock-on effect on the supply of other goods.

I’m not going to try to predict exactly how all this could wend together to trigger another financial crisis. But it’s clear that complex and interconnected factors with a cumulative major financial impact are present – just as was the case with the near collapse of the financial system just a few years ago. And on the evidence of Davos, it’s equally clear that the people who hold the purse strings aren’t looking at the problem – again.

One heavy-hitter from the financial sector, in a private session in Davos, spoke to this directly. In his view, the proper response of government to the financial crisis was to act hard and early; the biggest mistake in a crisis, he said, is to be too tentative. When challenged as to whether the same principle should apply to the climate crisis, his reply was that it was not for him to say – tackling climate change was not in his job description.

As the financial crisis unravelled, the Queen of England wrote to a group of senior economists to question why they had not seen it coming. Within a few years she’ll need to be getting her pen out again. But if the financiers can come to see it too, they could be the heroes who prevent it. They are the ones who are qualified to understand this threat as a whole, not just to see and measure the specific parts.

If they do not, they will soon find themselves once again the villains who have to find a way to clear up the mess. And this time, that will be a great deal harder – if not impossible. It is one thing to recapitalise an economy. It is quite another to recapitalise a planet.

For scientists the task must be to do more to make the financiers see it in terms they can understand. Because that high-profile financier was wrong. Tackling climate change is in his job description. We just need to stop talking to ourselves and make him see it.

* Editor’s Note: Ms. Burston will be following up on this article with a subsequent piece on the global repercussions for a half meter rise in sea level.

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