Global warming: a systemic risk

Global warming: a systemic risk

26-09-2016 | Insight

Global warming will become worse, before it hopefully becomes better, says Chief Economist Léon Cornelissen.

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Speed read

  • Climate change will impact politics, macroeconomics and financial markets.
  • The world will only slowly reduce its dependency on fossil fuel.
  • Thus positive benefits of new low carbon economy will take longer to materialize.

“The scientific consensus is that global warming will become worse, before it hopefully becomes better”, says Léon Cornelissen, Robeco’s Chief Economist. “One reason for optimism is the fact that heightened global concerns surrounding this phenomenon have now resulted in the ambitious COP21 Paris Agreement.”

“Global warming“, he adds, “also implies global ‘weirding’, i.e. more extreme weather events. This not only means drought like those recently experienced in Australia, where meteorologists had to search for new colors for their weather maps, or the summer wildfires of Siberia and the current drought in California.”

“But it could also mean – somewhat paradoxically – more severe winters as a consequence of a seasonal change in the path of the so-called ‘jet stream’ or a southerly bend in the Gulf Stream which is currently responsible for the mild sea climate in northwest Europe. Climate change will have an impact on politics, macroeconomics and on financial markets”, according to Cornelissen.

Impact on expected returns

What will global warming mean for expected returns on asset classes? “The most significant physical impacts of climate change will become evident in the second half of this century”, says Cornelissen. “But the consequences for forward-looking asset markets could become apparent far earlier. When future expectations in terms of climate change are adjusted, markets and prices will reflect this, possibly long before the physical changes of global warming make themselves felt.”

“The macroeconomic impact of climate change will be heavily influenced by the environmental policies pursued. It is impossible to calculate the impact with any degree of certainty, but of course we can sketch very rough and highly stylized scenarios.”

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Most benign scenario

“The most benign scenario consists of a rapid shift from a fossil-fuel based world economy to a low-carbon one. This will demand a tremendous investment in new capital infrastructure, research and development and new business models. The shift will be costly and lead to a short-term period of high volatility and slow growth. According to HSBC, nearly half the coal and oil assets will become stranded (essentially worthless)”, according to Robeco’s Chief Economist.

‘Nearly half the coal and oil assets will become stranded’

How could such a scenario best be achieved? “A combination of a global carbon tax, the introduction of carbon budgets, a hefty increase in investments in low-carbon technologies and an end to investments or subsidies for fossil-fuel extraction could do the trick”, replies Cornelissen. “Yet a more plausible scenario is a world where past trends basically continue, with temperatures rising by 2-2.5˚C by 2100. The world will succeed in slowly reducing its dependency on fossil fuel. The flip side is that it will take longer before the positive benefits of the new low carbon economy will start to accrue.”

Silver linings

Meanwhile, are there any silver linings at the horizon? “An international study suggests that the seasonal ‘ozone hole’ which forms over Antarctica every spring has shrunk by an area equivalent to the size of India since 2000. This improvement can be attributed to the gradual decline in the use of atmospheric chlorofluorocarbons (CFCs) as a direct result of the Montreal Protocol of 1987 (30 years ago), which committed the world to rapidly phase out CFCs”, says Cornelissen.

“Ironically, it was the decisive leadership of the free market enthusiasts Ronald Reagan and Margaret Thatcher that generated extensive new restrictions on industry. We have saved the planet once, so let’s do it again, the Financial Times recently noted referring to this successful example in the fight to tackle climate change.”

“We have saved the planet once, so let’s do it again”

One of the greatest market failures known to man?

“For an economist it is tempting to describe climate change as one of the greatest market failures known to man. There is no effective price on carbon to reflect the external effects of the ever higher atmospheric concentrations of carbon emissions that increase climate risk. Moreover, these risks will largely be borne by future generations. Still, it is far too early to despair. The fact that thirty years ago effective steps were taken via an international agreement to dispel the ozone crisis, also give us hope for the future.”

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