Managing climate risk

Governments should consider policies that maximise investment opportunities in a low-carbon future

John Hewson

Economics and finance, Environment & energy | Australia

1 November 2015

Climate change risks can be measured and managed, and require urgent government attention, writes John Hewson.

I am in Paris to attend a meeting of the OECD concerning some of the financial issues/risks of the essential transition to a low carbon world.

This is a very significant, longer-term policy challenge, especially for a country such as ours, with a heavy dependence on fossil fuels.

Yet we hear very little discussion of this – indeed, it was almost excluded from the political agenda, as Abbott ran hard in opposition against a carbon tax, as well as the supporting architecture introduced by Rudd/Gillard, and did all he could to stall the development of renewables as a source of power.

All we got were vague and misleading statements, such as “coal is good for humanity”, and approvals/encouragement of new coal mines.

This was a grossly irresponsible strategy, when the world has committed to try to limit global warming to 2 degrees Celsius this century, which means that some 75 per cent of known, global, coal reserves will need to left in the ground.

This prospect clearly will have significant consequences for our economy and society, dependent as we are on coal as a major exporter, and with many regional communities and jobs potentially at risk.

Abbott did however announce an emissions reduction target of 26-28 per cent by 2030, as our national contribution to the UN Paris climate meetings due in December, which will hopefully see an agreement to limit emissions globally, to hold global warming to the 2 degree target.

While our target is only about half what was recommended by the Climate Change Authority, it will still require a very significant adjustment, with very real consequences for growth, investment and jobs.

Moreover, we have been given no idea how this target would be achieved, how the transition would be managed, and at what cost. Given that both sides of politics are still struggling to explain how they would achieve the 2020 target of just a 5 per cent reduction in emissions, clearly much needs to be explained.

The world is moving rapidly, and we are being left behind, even though we have something of a competitive edge in wind and solar resources, and in the development of alternative technologies.

When I think back to the climate change policy that I took to the 1993 election – which I am sure few read, being distracted by the GST- that called for a reduction in emissions by 20 per cent by 2000 off a 1990 base, I reckon we’ve lost the best part of 30 years in exploiting our competitive advantages, and carefully managing the essential transition.

It is now almost too late to avoid very significant fallout in the coal industry and related sectors. The Turnbull Government, hopefully with bi-partisan support of the Opposition, needs to spell out the detail of this transition in what might be called a de-carbonisation plan, also funding the process of re-location and re-training, and so on.

However, the risks, and the management task are not just specific within the fossil fuel industries. Our biggest financiers, and asset owners – especially superannuation funds – are heavily exposed to climate risks, to the risk of a climate induced, global, financial crisis.

There has been a significant global movement (a movement unequalled since the anti-apartheid movement) to encourage divestment from fossil fuel companies, and it is now having some real success with investors engaged in divestment managing a total of some US$2.6 trillion in assets.

The divestment from fossil fuels can no longer be ignored by policymakers.

As climate policies drive the transition away from fossil fuels to less carbon-intensive technologies and practices, some assets will become “stranded”, that is, unable to recover their investment cost as intended, with a loss of value for investors.

Of course, divestment is not the only possible policy response from these financial institutions. Active engagement and financial hedging are others, but the managers of superannuation funds, for example, have a clear fiduciary responsibility to manage these risks, which necessitates a much longer-term, more structural, strategy than just leaving it to asset managers that are focused and remunerated on short-term performance.

Hence there are some very real challenges for the Government and policy authorities as to whether to force disclosure of the risks being run by banks and funds, hoping to drive them to manage those risks more effectively.

Stranded assets are an inevitable consequence of good climate policy, yet investors are still ill-informed of the transition and its financial consequences.

Governments may also want to consider policies that would minimise value destruction and maximise investment opportunities in low-carbon alternatives.

Hank Paulson, ex US Treasury Secretary at the time of the GFC has said that the risks of a climate-induced global financial crisis “dwarf” the sub-prime risk that precipitated the last GFC. Mark Carney, Governor of The Bank of England has said recently that “a wholesale reassessment of prospects, especially if they occur suddenly, could potentially destabilise markets”.

These are risks that can be measured and managed, and require our governments’ attention as a matter of urgency.

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