Business economics: What are the financial implications of climate change?

One of the most significant and perhaps most misunderstood risks organizations face today concerns climate change. Although it is recognized that the continued emission of greenhouse gases will cause further warming, which could lead to severe consequences for the planet, the exact timing and severity of the physical effects are difficult to estimate, which makes the problem even more unique and challenging, especially in the context of economic decision-making. This difficulty causes many organizations to mistakenly seek long-term alternatives.

The potential impacts of climate change on organizations, however, are not just physical and do not only manifest themselves in the long term. To contain the disastrous effects of climate change in this century, nearly 200 countries agreed in December 2015 to reduce greenhouse gas emissions and accelerate the transition to a low-carbon economy. The promise implies moving away from fossil fuel energy combined with greater deployment of clean and energy-efficient technologies, which can have significant short-term financial impacts.

For many investors, climate change poses significant financial challenges and opportunities, now and in the future. It is estimated that the expected transition to a low-carbon economy will require around US$ 1 trillion of investments per year in the foreseeable future. At the same time, the risk-return profile of organizations exposed to climate-related risks can change significantly, as such organizations may be more affected by the impacts of climate change, climate policy and new technologies.

Indeed, a 2015 study estimated the value at risk, as a result of climate change, to the total global stock of manageable assets to range from $4.2 to $43 trillion between now and the end of the century. The study highlights that “much of the impact on future assets will come from weaker growth and asset returns across the pipeline.” This suggests that chain actors may not be able to avoid risk when exiting certain asset classes, as a wide range of asset types could be affected.

Thus, more efficient capital allocation and strategies should be considered. Organizations that invest in activities that may not be viable in the long term will be less resilient to the transition to a low-carbon economy; and its investors are likely to experience lower returns.

*Gibran Felippe is Professor of Risk Management in Agribusiness in the MBA courses at ISAE Escola de Negócios.

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