A systems view of climate change

Climate change may well be the most pressing environmental issue facing the world but, says Al Gore, it represents just one part of a system of sustainability issues that will profoundly affect investors

The best long-term investors, including Warren Buffet, now realise that climate change can materially impact company returns. As the issue has risen up the corporate agenda, capital markets are becoming more proficient at pricing in some of the most immediate impacts it can have on company profitability. However, there are second order risks and opportunities related to climate change that go beyond carbon emissions exposure – risks and opportunities which are equally material, yet often overlooked. We must be careful not miss some of the more significant longer-term implications of climate change for business, and therefore for investors.

One of the challenges of integrating sustainability factors, such as climate change, into equity analysis has been the measurement issue. Only after several years of development do we now have pricing mechanisms and government-supported trading markets such as the EU Emissions Trading Scheme to help address the external costs of carbon dioxide emissions. Even without a regulatory federal framework in the US, voluntary markets, such as the Chicago Climate Exchange, are emerging, as are mandatory state-level initiatives such as the Regional Greenhouse Gas Initiative. These market mechanisms increasingly enable companies to calculate project returns with the price of carbon dioxide fully integrated.

What is happening with carbon is a sign of things to come with other ecosystem services, as markets begin to monetise and allow for the trade of things such as conservation credits, wetlands, and biodiversity habitat. These markets are being pioneered by a fresh breed of investors such as New Forests, the Global Environment Fund and Wetlands Inc.

To truly understand the implications of climate change for investors, one must understand the related issues of ecosystem services, water security, public health, urbanisation, migration, and even poverty. These linked challenges may collectively affect returns in ways completely different to what we’ve seen in the previous hundred years, and merit a new way to think about the longterm operating environment for business.

Consider access to water, for example. The Himalayan glaciers on the Tibetan Plateau have been among the most affected by climate change. These provide more than half of the drinking water for 40% of the world’s population; seven Asian river systems originate on the same plateau. With global water consumption doubling every 20 years, 48 countries are expected to face chronic water shortages by 2025, which will put up to 3 billion people in “water-stressed” situations. If water becomes a strategic resource like oil, companies with water treatment capabilities (such as access to desalination technology) will play an important role in the provision of clean water for a growing population.

Consider disease migration. Some 30 so-called new diseases have emerged over the last 25–30 years. The relationship between human species and the microbial world of germs and viruses is more threatening when there are warmer winters, warmer nights, and less stable climate patterns. One example is West Nile virus, which entered the US on the eastern shore of Maryland in 1999 and within two years crossed the Mississippi.

"To truly understand the implications of climate change, one must understand the related issues of ecosystem services, water security, public health, urbanisation, migration, and even poverty"

Two years after that, West Nile virus spread across the whole of the country. Climate change is accelerating the rate of disease migration, which in turn puts pressure on public health systems and infrastructure in developed and developing countries alike. Companies that are considering future scenarios for disease migration demonstrate superior management quality in their ability to adapt to a changing global context for business.

Also consider urbanisation and migration. Roughly half of the world’s 6.5 billion people live near coastlines, increasingly threatened by sea level rise together with more violent storms. For example, certain projections of flooding in Bangladesh would leave up to 20 million people as “climate refugees”. Hurricane Katrina, which displaced hundreds of thousands of Americans, showed us that this is not only a developing country concern.We may need to rethink the types of investments that will be needed for sustainable urban design in light of such a rapidly changing climate.

Paradoxically, many of the regions most vulnerable to climate risk are the same regions that multinational companies depend upon for their just-in-time production (in the case of Asia), for their services (in the case of India) and for many other natural resources (in the case of Latin America). Wall Street and the City forget that a portion of their wealth is generated by the sweat equity of often disenfranchised people living in these fragile climate areas.

The bottom line is that climate change cannot be viewed as a singular issue. But rather, it must be viewed as part of a system of sustainability issues that can affect the long-term operating environment for business and therefore investment returns.

Al Gore is the chairman of Generation Investment Management, a London-based asset management company, and a former vice president of the United States of America. E-mail: info@generationim.com