Investors Start Thinking About Underpricing of Climate Risk

The Financial Times has a long article, even by “Big Read” standards, on the fact that investors are finally starting to fret about the looming financial downside of bad climate outcomes. But those of you who read Lex in depth: how investors are underpricing climate risks in full will be troubled by the lack of imagination about how bad the downside could be. Albeit the stakes are vastly higher, but it’s as if you were transported back by time machine to 2007 when it started to come out that rating agencies has not allowed for the possibility of a nation-wide decline in housing prices in their models for subprime debt.

Now admittedly this is progress of sorts since the 2006-2007 IPCC reports. In 2006, at the instigation of the UK Treasury, Sir Nicholas Stern published the so-called Stern Review, which sought to estimate the economic costs of climate change. To make a very long story short, Stern had to use what many regarded as unrealistically low discount rates (0.5%) to make seriously bad climate impacts, generally seen then as not occurring until after 2100, to be worth bothering about now.1

This conclusion reflects several fallacies: the first that climate change downside should not be put in an investment framework but an insurance framework. With any sort of properly-priced insurance, the average buyer pays way more than the expected value of the bad event happening to them. That is because the price of catastrophic outcomes is very high, at least life-changing if not life destroying.

Even though AOC has fallen out of favor, the argument she makes that health care should not be a market good should apply to preserving the environment from disaster.

To draw the analogy further, US military experts were already warning the Pentagon in the early 2000s (as in before the Stern Report) of greatly increased international instability due to climate change, both to mass migration as cities and mega-cities in low-lying areas are made uninhabitable by storms and sea level rises (Bangladesh for starters) and greatly intensified competition for resources, particularly potable water. We got a taste of how suddenly things could go chaotic with the Arab Spring revolts, triggered by price increases in food and cooking fuel. Those were merely domestic upheavals. What happens with far more acute stresses and far bigger numbers of desperate people, who as AOC notes merely in price terms for health care, will do anything to survive?

But the path towards bad outcomes is incremental, over decades if not centuries, with innumerable decisions and actions all paying into the degradation….all taking place in a market system which doesn’t price in those costs. So in effect, we all get paid via wages higher and prices lower than they would otherwise be to destroy the planet.

The second fallacy is the failure to consider tight coupling, as in events or shocks will propagate across a system too quickly for them to be interrupted. That does not even mean that they have to happen quickly in real time, just too quickly for the cascade to be interruputed. Many of the systems of the modern world are tightly coupled, such as many electrical grids (particularly ones in America) and supplies of critical goods (recall how the Puerto Rico hurricane led to a protracted shortage of IV bags because a factory there was the dominant producer). In an odd way, the US/NATO conflict with Russia and US escalation with China is accidentally forcing some industries to get ahead of the problem but leading them to somewhat deglobalize and focus more on less risky regional supply chains. But what happens when regular floods and sea level rises imperil sewage treatment plants in the coastal area of the US? Imagine the cascade of events if that (more like when) that becomes a widespread issue.

The third fallacy at work is that tails are fat. Tail events are far more likely and more extreme that people who live in Mediocristan believe. And those risks are higher in systems with a lack of safety buffers. For instance, Jared Diamond and others have argued that the Mayan civilization was ecologically precarious, and successive droughts led to famine. How many years of widespread food shortages could most societies take?

Now to the Financial Times story. Now that very bad environmental outcomes could start appearing in the 2040 to 2050 timeframe, as oppose to the “Oh, what, me worry?’ after 2100 scenarios, some investors are taking notice. Mind you, this story is intended to be extremely sobering, but as indicated above, I suspect many will find it to be weak tea. Some key snippets:

The big danger is of a “climate Minsky moment”, the term for a sudden correction in asset values as investors simultaneously realise those values are unsustainable.

So far, businesses and investors have paid less attention to the physical effects of climate change….

The article then describes how the Singapore sovereign wealth fund engaged Cambridge Econometrics and Ortec Finance to perform an analysis. The big findings:

The net zero forecast results in cumulative returns over 40 years at 10% lower than baseline. The “failed transition” projection of temperatures 4C higher than pre-industrial levels by 2100 finds returns are 40% lower than baseline.

The analysis flags food output as a major source of risk. I am surprised that it does not give pride of place to the resource set to come under acute pressure first, potable water (you’ll see how it address that shortly). Nevertheless:

It is doubtful that this study considered the knock-on effects of scarcity, which is that producing countries start hoarding so as to have buffers to prevent distress at home in case their output flucuates. In addition, it contains other simplistic cheery ideas, like as global warming progresses, farther north areas will have longer growing seasons than now, so crop production can shift northward (from a northern hemisphere persepctive).

While that likely will happen, the problem is that on average these areas will be less productive. Sunlight is weaker in farther north and south latitudes. The same factors that make these regions not so good for solar energy also makes them less productive for photosynthesis.

Next the article turns to water:

Agriculture accounts for about 70 per cent of freshwater consumption globally, although in regions such as Asia it can be higher. Already 2bn people(opens a new window) lack access to clean, safe drinking water. By 2030, demand for freshwater is forecast to exceed supply by 40 per cent(opens a new window).

There again is more here than meets the eye. Most of the solutions to water shortages involve energy use, such as desalination or other water purification means. So solving the water problem will work against the “reduce energy use” imperative. And the problems are already becoming acute. In Panama, there may not enough freah water to keep the Panama Canal levels high enough for regular ship passage and supply local farmers. I had seen articles suggesting Panama desalinate water for use by farmers, but other stories depict that as unrealisti. From Agence-France Press, Drought-hit Panama Canal must ‘adapt or die’ as water levels drop, in early August:

The canal relies on rainwater to move ships through a series of locks that function like water elevators, raising the vessels up and over the continent between the Atlantic and Pacific Oceans.

However, a water shortage due to low rainfall has forced operators to restrict the number of vessels passing through, which is likely to result in a $200 million drop in earnings in 2024 compared to this year, canal administrator Ricaurte Vasquez said…

If the drought and resulting restrictions continue, Vasquez fears shipping companies will “opt for other routes.”

This includes the Strait of Magellan — a natural passage at the tip of South America between the mainland and the Tierra del Fuego archipelago…

The lack of rain has also increased the salinity of the lakes and rivers that make up the canal’s watershed — which also provides water to three cities, including the capital Panama City.

“Every time we open the gate that leads to the sea, seawater is mixed with fresh water,” said Vasquez…

“We have to keep that level of salt water within a certain range, because the water treatment plants do not have desalination capacity,” he added.

The dwindling freshwater cannot be replaced with sea water — as used by the Suez Canal which connects the Mediterranean with the Red Sea — as this would require massive excavations.

The analysis then considers flood risk…but oddly the impact only on manufacturing, not flooding of major cities and mass migration:

In fairness, the Financial Times story proper does think to include displacement, but in a bizarrely unimaginative manner:

Globally, the movement of people away from hard-hit areas is likely to be on a far bigger scale. More than 20mn people a year on average have been displaced by extreme weather-related events since 2008. By 2050, as many as 1.2bn could be uprooted by climate change, according to the Institute for Economics and Peace think-tank.

Florida will be first to go:2

The article discusses mitigations, ranging from the aforementioned desalination, dykes and improved crop science to how the holiday industry could adapt.

And at the very end of this very long piece, the pink paper does inject a suitably sober note. One might wonder why the bit we boldfaced was not mentioned earlier on:

Yet many models also omit factors that could make the outcomes far worse than predicted. Many assume that climate change does not slow gross domestic product growth. They do not take account of mass migration. Climate tipping points, such as thawing permafrost or an ocean circulation collapse, are rarely included.

More fundamentally, the past is an unreliable guide to the future. Modellers typically use a quadratic function to plot the relationship between damages and temperatures. Some 2 per cent of output would be lost at 3C of warming, while 8 per cent of output would be lost at 6C of warming, according to Nordhaus’s 2016 model. There is great uncertainty about the potential effects of such large rises, but even so the credibility of those predictions looks weak.

It makes more sense to conduct a reverse stress test, argues a new report(opens a new window) from the UK’s Institute and Faculty of Actuaries. This involves working backwards from an as-yet undefined temperature at which the world’s economy would plausibly cease to function. Using this logic, the report’s authors suggest that half the world’s GDP could be destroyed as early as 2070.

There is a cavernous gap between such cataclysmic forecasts and the modest impacts anticipated by pension funds and listed companies in their climate risk reporting….

There is growing unease that existing climate models may be providing a false sense of security.

Gee, ya think? This closing bit epitomizes the official response to climate change: too little, too late.


1 This is no surprise to anyone who has done financial modeling. Unless interest rates are super low, anything that happens more than 15 years out is worht pretty much zero once you discount it back to the present.

2 Lyrics to Jay Leonhardt’s Goodbye Miami:

Carbon monoxide is spewing from cars
It blots out the sun, it blots out the stars
Heating the atmosphere scientists say
Melting the icecaps away.
As the ice melts, it is not surprising
The oceans are ever so steadily rising
Steadily rising through high tide and low
Florida will be first to go.

Goodbye Miami, goodbye Lauderdale
Pass me a bucket, pass me a pail
Old folks and condos are up to their knees
With the wind and the salt and the sea.

Goodbye Miami, goodbye Sarasota, the
Gulf Coast now reaches Pierre, North Dakota
Tampa is dampa than ever before
And Key West ain’t Key West no more.

They’ll be no need to worry about air pollution
When you’re up to your neck in a saline solution.
The tide she comes in and she lingers about, but the tide
She don’t want to go out.

Print Friendly, PDF & Email


  1. marcel

    Now is good moment to (re)read Steve Keen’s criticism of ‘economics’, especially the neo-liberal variant: a 4°C-raise is optimal, 87% of the economy does not depend on climate change, etc.
    It would be hilariously wrong, but the guy got a “Nobel” for it, and it wounded up in the previous IPCC reports.

      1. DFWCom

        Yes, and I seem to recall Keen recounting that the ‘calibration’ point for the quadratic damage function (you can hardly use the term without rolling your eyes, can you?) was a market research survey done, back in the day, in the US, in which people were asked to select how much they’d pay for a natural setting. I think it was $2,000.

        And that number was extrapolated to the end of life as we know it.

        And was awarded a Nobel Prize in economics.

    1. Henry Moon Pie

      Keen is in good form in this roundtable discussion from 4 days ago titled, “Unlearning Economics.” Hagens moderates, with Keen, Raworth, Josh Farley, an ecological economist and Jon Erickson, the same. Both Farley and Erickson were on Hagens’s doctoral committe at Vermont, so they know each other well.

      It’s a great discussion, and Keen’s biting sarcasm about his “orthodox” colleagues is very funny. Nordhaus gets mentioned, of course.

  2. John

    oh for the good ol’ days when Rick Scott forbade discussions of daily flooding of Miami streets so insurers wouldn’t stop insuring Florida properties! And the touching belief in human innovations expressed by Rubio and Miami’s mayor.

  3. Ignacio

    Regardless investors and rentiers start taking notes on the risks of climate change they will always be reactive on it and try at heart to protect their assets and portfolios. They will just do their best to hoard those remaining assets less affected by climate change. So, may be this is not good news for the rest of the world.

    1. tegnost

      “…try at heart to protect their assets”

      Pondering borrells comment about “garden” and the proliferation of biological warfare labs makes me wonder if the plan has religious undertones…

      1. Frank Dean

        Once the climate “Minsky moment” is reached, “investors” undoubtedly anticipate that geoengineering measures previously rejected as too risky (or simply insane) will be welcomed with open arms. Everything will come up roses in their diversified portfolios.

  4. jefemt

    Smartest guys in the room! Bonuses on the house, with a chaser of Stock Options!

    Hard to turn a large ship quickly. First off, the crew has to be on the ship, and in accord, and working together toward a common goal that has been cogently crafted, perhaps by the team of seasoned mariners themselves. Then, as sports coaches like to say, one needs to create time and space. Whoops…

    I remember thinking stuff was getting real when Amory Lovins was re-directed from soft energy paths to start work for Empire’s Military. For some reason, I was naively hopeful. Now I realize he was co-opted, broght in house, marginalized and put on a shelf, I envision him being in the limitless US warehouse featured at the end of Spielbergs Indiana Jones arc of the Covenant.

    the only solace, and it is not a balm, is that we all live on the same closed loop, and we all are on that same ship, relying on it. Even Jeff Bezos and Lauren Sanchez!

    1. DFWCom

      Even harder when the ship is sinking and everyone’s in the bar assuming someone else is pumping the bilges.

      1. Henry Moon Pie

        For as in the days before the flood they were eating and drinking, marrying and giving in marriage, until the day Noah entered the ark, and they knew nothing until the flood came and swept them all away…

        Matthew 24:38-39.

        It’s a little freaky how that old verse sounds so contemporary.

        1. marku52

          HMP, did you link to “Breaking Together”.? I’m about half way through it, I guess there is nothing I did not know, but it does put it all together in one place.

          Prepare to “Dance in the Ruins.” Coming right up

          Thanks for the link to it.

          1. Henry Moon Pie

            I am waiting for my library to get it after I’ve requested it. Bendell is a fascinating guy who seems to be practicing what he preaches. He must be a case where WEF Young Leaders indoctrination didn’t take, at least permanently.

            His Deep Adaptation worldview is a standout among many different ones that people are working on.

            I just listened to an upbeat discussion on Vicki Robin’s “What Could Possibly Go Right?” podcast with Doug Rushkoff. When Rushkoff gets into how the hippies, beginning with Leary, were his models, and how the hippies were right, Vicki, who was a hippie, really waxes eloquent. I always find Rushkoff funny, and with Vickie feeling her oats, it was an conversation that inspired some laughter and smiles.

            I look forward to reading Breaking Together soon, and I’m very glad you’re enjoying it.

            1. marku52

              It was really good up until the philosophy chapter, where MEGO.

              You will probably take in in stride.

              I wonder who mentioned it, it was definitely someone in the commentariat.

    2. some guy

      The Roman galley ship slaves and the Roman galley ship captain may have been on the same galley ship.

      But they were not ” in the same boat”.

      At what point would the galley slaves chained to the oars decide that if they could do something to make the galley ship sink with the assured death of the captain and all his officers along with themselves . . . at what point would they do whatever they could to MAKE the whole galley ship sink?

      MISOP . Make It Sink On Purpose.

  5. Synoia

    The focus appears to be on sea level rise as the leading climate calamity. However one wonders if the leading calamity is fire, possibly coupled with a change in rainfall patterns.

    Currently the major calamities do appear to be heat and fire and changes in rain fall patterns, not sea level rise. This does not mitigate the effects of sea level rise, nut it dose introduce a much faster path to global famine and a civilization collapse.

    Increasing patterns of fire will certainly affect out food much faster than relatively slow sea level rise.

    A good hard look at the crop fire damage in Canada would provide information.

    1. Henry Moon Pie

      I guess they thought the drama of a flooded Miami or Manhattan would get people’s attention, but it turned out that the other effects have caught up and surpassed sea level rise. The article from Neuburger posted today does a good job of getting at the core issue, and it’s energy imbalance. From my perspective, that’s a relativistic way of saying there’s too damn much energy collecting in the Earth. That excess energy gets expressed in lots of ways: fires, floods, droughts, heat waves, but excess energy doesn’t “hurt” the Earth, it just means that Earth is going to be hurting us as it tries to dissipate that excess juice. And we keep pumping it full of more. Crazy. Hard rain a gonna fall.

    2. digi_owl

      Heat for some, storms for others.

      The simplest model of our planet is a pot of water on a hot plate.

      Those high and low pressures the meteorologists talk about? Those are like the bubbles in the water as it heats. Anyone that has cooked anything has noticed that as the heat increases so also do the size and density of bubbles.

      Long before the poles fully melt the planet will be ravaged with hurricanes, tearing apart the infrastructure that globalists take for granted.

    3. Spider Monkey

      Rising carbon dioxide levels will benefit plant and tree growth immensely. Many trees have a inverse 1 to 1 relationship between levels of CO2 and water usage during transpiration.

      Couple that more efficient use of agriculture and you’ll see total global land use for agriculture peaked nearly 2 decades ago but how many more people are there? (20% more).

      Total arable land in the US has been stagnant for decades yet we have an increased population. That is because land is much more productive than it use to.

      It’s hard to understand someone’s stance on famine here unless of course you take that stance of somebody who thinks we are facing peak oil and/or phosphorus.

      1. some guy

        . . . ” Rising carbon dioxide levels will benefit plant and tree growth immensely. ”

        Except in the occasional odd cases where the global warming caused by those rising carbon dioxide levels does things like reduce the ferocity of bug-killing winter weather to the point where the new kinder and gentler winter weather no longer kills certain bugs the way it used to. For example, the failure of weaker winters to kill bark-beetle numbers down to tolerable levels in the last few years has allowed bark-beetle plagues to kill many trees in parts of the West which they didn’t do so effectively back in times of more effective bug-killdown winter temperatures.

        Here’s an article about that. The failure of bark-beetle killdown in recent milder winters is mentioned a few paragraphs down from the top of the article.

        I guess those rising levels of carbon dioxide won’t be benefiting the growth of those trees immensely any more. Or even benefitting the growth of those trees the least little bit. Those trees are too dead to notice the rising levels of carbon dioxide around them, thanks to the bark beetles which killed them due to the global warming brought to their neighborhood by those rising levels of carbon dioxide.

        Nice try, though.

        1. Spider Monkey

          My main point was the likely hood of famine seems unlikely if you understand the yield increases in crop production. There are other serious issues like persistent herbicides that could be way more serious than changes in the weather. Regardless though if the issue was immediate we would be adding more farmland to offset lost crop production on net, but that’s not happening because we don’t need to.

          Carbon fertilization is a real thing, only time will tell whether it will offset the impacts from drought or bark beetle like you said. Keep in mind bark beetles are also tree species specific.

          I’m more worried about direct impacts on forests like Brazil cutting down their rainforest.

          “The study suggests that even as warming threatens forests by fueling drought, insect infestations, and wildfires, rising CO2 levels mean that tree-planting is an increasingly cost-effective method of fighting climate change, as the same number of trees can sequester more carbon, said Brent Sohngen, an environmental scientist at Ohio State University and coauthor of the study.”

          “From a quarter to half of Earth’s vegetated lands has shown significant greening over the
          last 35 years largely due to rising levels of atmospheric carbon dioxide, according to a new
          study published in the journal Nature Climate Change on April 25. An international team
          of 32 authors from 24 institutions in eight countries led the effort, which involved using
          satellite data from NASA’s Moderate Resolution Imaging Spectrometer and the National
          Oceanic and Atmospheric Administration’s Advanced Very High Resolution Radiometer
          instruments to help determine the leaf area index, or amount of leaf cover, over the
          planet’s vegetated regions. See NASA’s website at feature/

      2. Henry Moon Pie

        “more efficient use of agriculture”

        Here’s what your “more efficient use of agriculture” is accomplishing, in combination with global warming, in the longer term:

        1) disappearing topsoils;

        2) declining organic matter, crucial for absorbing and retaining and then releasing moisture, in topsoils;

        3) disappearing pollinators;

        4) depleting water resources.

        You mention concerns about oil and phosphorus. Your “more efficient” agriculture requires ten units of energy inputs for one unit of energy output (food is energy too). This is in contrast to the pre-“efficient” agriculture that produced ten units of energy for one unit of input. The “efficiency” is a reduction in human labor. Moreover, industrial agriculture is heavily dependent on nitrogen fertilizers, most of which comes from hydrocarbons as we learned at the beginning of the war in Ukraine and the subsequent embargoes and boycotts. Peak phosphorus is a concern, especially when the quality of the phosphorus deposits is consider along with the cost of removing contaminants you wouldn’t want where you’re growing food.

        On top of all these agricultural concerns, fish production is critical for the supply of animal proteins globally, especially in the Global South. One side effect of “efficient agriculture” is the spread of ocean dead zones created by fertilizer runoff. Ocean acidification, caused by excess CO2 in the atmosphere, and ocean warming are two additional threats to the human food supply derived from ocean and fresh water fisheries.

        So there are real threats to the food supply in the near and medium term.

        1. Spider Monkey

          Disappearing topsoil, as mentioned in your article linked is from bad agricultural practice, not climate change. The 60 years of topsoil is a common argument, but it misses the point that for much of the world, soil for agriculture is built (man made over generations) it doesnt necessarily exist outright and naturally like the plains of the midwest. See Western US or Yemen as examples. We can convert other lands to agriculture if needed.

          All my emphasis is, is much of the immediate problems faced by agriculture are not necessarily climate change related. We have serious pollution concerns which I believe are much more immediate. You are right to suggest those are also a result of more efficient agriculture. Those could cause a famine condition in the future, we are currently not close to that right now though on net. As for now, climate change is causing an immediate benefit to plant life globally as evidenced by NASA’s reviews of density of vegetated lands over the last several decades. Carbon Fertilization is real, which from my admittedly narrow viewpoint seems entirely absent from the climate change discussion.

  6. Mikerw0

    How does one possibly expect an industry that spends the vast bulk of its time and energy focused on the asset price (stock and bond) movements due to quarterly earnings ever possibly consider structural changes? Ever.

    1. Henry Moon Pie

      So did the goal get changed somewhere along with way? People like to talk about Reagan in that regard, or maybe push it back to the Powell Memo.

      Or is it just the same goal this system has always had, but taken to an extreme, maybe Friedman and Greenspan, with Rand smiling behind them, were the culprits?

      One thing is clear. We have to change the damn goal.

      1. marku52

        I think it is the same system as ever, it’s just now we’ve run out of new places and ecosystems to rape.

        1. juno mas

          Yes, the capitalist system worked fine in the US Post War (WWII) period but as the population grew, along with income and technology (autos, TV, computers), consumption/pollution has overwhelmed the planet.

          With resource scarcity comes price hikes; and now food and gasoline is too expensive for the proletariat to be part of the game.

Comments are closed.