The underpriced climate risks?

Economic impacts of climate change have been modelled in many ways, though uncertainties related to outcomes remain high. General macroeconomic uncertainty increases the difficulty of modelling. Country level economic impacts will vary depending on e.g. geography and related natural phenomena. Company level impacts are even more complex due to, for example, global supply chain locations, various transition risks and individual market impacts.

It is also estimated that climate risks are underpriced in capital markets. Pricing climate risks and opportunities is a huge task, requiring knowledge of natural and socioeconomical phenomena and it needs to start by increasing information. As per Inderes’ principles we decided to introduce some key findings related to climate economic impacts to start democratizing information also on this area.

At a global level, climate GDP impacts are estimated to be huge

According to IPCC (Intergovernmental panel on climate change) estimates, global warming with current policy set-up will continue on a path to above 2°, close to around 3°.

Source: VTT Technical Research Centre of Finland, the Finnish Ministry of the Environment, and Climateguide.fi 

SwissRe has estimated that warming of 3.2° would impact global GDP by around -18% by mid-century. Regional and country level variation is estimated to be broad.

Source: Swiss Re Institute

Geography, as well as social, natural and economic differences explain the variations in GDP impacts to a large extent. Although Finland, and more generally the Nordics are expected to manage the negative impacts of climate change relatively well compared to other countries, climate economic impacts are global.

For example, we are already witnessing climate related changes, such as heat waves and drought, in Southern Europe. Lack of rainfall during the first 4 months of 2023 in Spain has impacted around 80% of crops and caused serious losses to olive oil and fruit agriculture. It is estimated that there will be an impact on fruit and crop prices in Europe further accelerating the ongoing inflation.  

Opportunities arise from climate investments

Complexity always generates opportunities. According to IPCC’s sixth assessment report, average annual investments required in 2020-2030 to mitigate climate change to a level of 1.5 or 2° Celsius warming, are three or even up to six times greater than today. In other words, there are business opportunities for many new emission reducing and efficiency increasing businesses across all sectors.

Whether those businesses will become scalable and profitable, mitigating climate change and increasing social welfare is largely in the hands of international politics. European Industrial Plan and US IRA are examples of recent initiatives, which are supporting the green transition but also building trade barriers. To navigate through the climate transition era requires not only setting company targets and assessing potential mitigation technologies which would decrease emissions. It also requires understanding potential new financing opportunities, and navigating the political playing field and timing commercialization accordingly.

From an investor’s point of view the topic is rather complex due to the scope of issues that need to be considered. Many things related to climate risks and opportunities are topics that cannot be evaluated without understanding broader macroconomic development or company specific circumstances.

At Inderes we have taken the first steps towards further democratizing information related to climate. We have started to monitor what climate targets will require from companies (started with OMXH15) and how that is linked to companies’ business strategies. This is the beginning, and we hope that more discussion on climate targets, risks and opportunities will also help to valuate climate risks when making investment decisions.  

Main sources used for the article: IPCC 6^th assessment report, SwissRe: Economics of Climate change, no action not option, McKinsey global institute: Climate risks and response: Physical hazards and socioeconomic impacts; Reuters, NASA observatory; Spain browned by drought

The author of this article, Karoliina Loikkanen, is head of ESG solutions at Inderes. She has an extensive background on ESG issues and is passionated to develop the dialogue between investors and companies on ESG further.