Climate Change Is Real: The Investing Implications

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In the fall of 2007, my family and I were awakened early in the morning and forced to evacuate our home due to raging wildfires burning out of control near our home in southern California, fanned by winds gusting to over 100 miles per hour. Unlike many of our neighbors, we had time to gather a few things before we escaped. We left seriously doubting that we would return to find our home still standing.

After nearly a week we were allowed back into our neighborhood. Fortunately, our home survived with only minor damage. Many of our friends and neighbors were not nearly so lucky. Just within our church community, 70 families lost their homes. Our town lost roughly 400 homes. We live with “fire season” every year. But the problems and the risks have grown consistently over the 21 years we have lived in San Diego and they will continue to grow, largely on account of climate change.

According to nearly all working scientists in the field and the various organizations representing America’s best scientists, climate change is a fact. On September 20, 2016, 376 members of the National Academy of Sciences, including 30 Nobel laureates, published an open letter to draw attention to the serious risks of climate change.

There is vanishingly little scientific dispute that climate change is very likely caused by the emission of greenhouse gases from human activities and poses significant risks for a range of human and natural systems. As these emissions continue to increase, further change and greater risks will ensue. These risks include rising temperatures, extreme weather, and the problems caused or, more typically, exacerbated by them.  

Without belaboring what is remarkably clear, temperatures have risen significantly. 

Click to enlargeSource: NASA

Click to enlargeSource: NASA

No serious climate scientist believes that sea level will rise less than a meter this century unless we get off fossil fuels with great haste. Many forecasts are much grimmer. At least 20 port cities will be seriously exposed to coastal flooding risks in the coming decades including Mumbai, Calcutta, Ho Chi Minh City, Shanghai, Bangkok, Tokyo, Miami, Alexandria, and New York (as Hurricane Sandy demonstrated in 2012).

With major impact weather events becoming more and more common, it is exceedingly difficult to ignore the increased and intensifying storms, droughts, cold snaps, heat waves, wildfires and disease that inevitably follow from climate change and which are causing devastating damage and disaster-related losses, according to organizations like the National Oceanic and Atmospheric Administration and the Intergovernmental Panel on Climate Change. It also means more agriculture-related problems and more variability in weather patterns. Even oil companies acknowledge the facts of climate change and its human causes.

If you don’t want to believe scientists directly, then believe the highly profit-motivated insurance industry, which was the first major business sector to acknowledge the effects of climate change and to seek to deal with that risk in a systematic fashion.

Just two weeks before Hurricane Sandy slammed onto the New Jersey shore, German reinsurance giant Munich Re issued a major report in which it linked the risks of severe weather events to human-caused, or anthropogenic, climate change. Global insurance leader Allianz actively lobbies for worldwide, binding carbon emission targets and has designed various insurance products to deal with climate change risk, such as catastrophe bonds and micro-insurance. Swiss Re also has a product line that is explicitly geared toward climate-change risks.

Or perhaps you’ll be influenced by our military. The Pentagon describes climate change as “an urgent and growing threat to our national security.” A major Pentagon-commissioned study asserts that climate change is a greater threat to national security than terrorism. The Department of Defense calls climate change a “threat multiplier” in that it has the potential to exacerbate conflict and thus increasingly threaten national security. Just this past September, 25 military and national security experts — including former advisers to multiple Presidents of both major parties — issued a new report warning that climate change poses a “significant risk to U.S. national security and international security.”

Despite the science, our forecasts about the future based upon the science may well be seriously flawed because our human ability to forecast the future is so notoriously poor. However, when an activity raises significant threats of harm to human health or the environment, precautionary measures should be taken even if the future is uncertain. In this context the proponent of a threatening activity should bear the burden of persuasion. If they cannot do so — by establishing that climate change is not a substantive risk — then we should act as if climate change is a major risk to our lives and health. This approach is particularly appropriate, as Nassim Taleb points out, because the extent of the threat and the risks are so high. As Taleb explains, we should readily use a headache pill if it is deemed effective at a 95% confidence level but assiduously avoid such a pill if it is established that it is “not lethal” at a 95% confidence level.

As a consequence, at the Paris climate conference in December of 2015, the United States was one of 195 countries that adopted the first-ever universal, legally binding global climate deal. The agreement sets out a global action plan to put the world on track to avoid dangerous climate change by limiting global warming and is often described as President Obama’s leading environmental achievement.

But there is a dedicated group of climate change “skeptics” who insist either that climate change is a myth or that its risks are overstated. That cadre is led by the President-elect of the United States, Donald J. Trump. Mr. Trump has claimed that the “concept of global warming was created by and for the Chinese in order to make U.S. manufacturing non-competitive” and that it is a “hoax.” He has also said he would “cancel” the Paris accord and promised to repeal the regulations that the Obama Administration put in place to reduce carbon emissions from power plants. Mr. Trump has said he wants to repeal all federal spending on clean energy and has also said repeatedly that he wants to abolish the Environmental Protection Agency.

Even so, Mr. Trump has also consistently asserted that his views generally are negotiable. He has indicated a softening of his climate position since the election. Away from the political arena, when his personal money is on the line, he has even applied to build a sea wall to protect one of his golf courses from “global warming and its effects.” So what the new administration might do in this regard is anyone’s guess.

Still, there is precious little reason to expect that Mr. Trump will go green. But irrespective of any position his Administration ultimately takes, since causation is such a difficult matter to ascertain to everyone’s satisfaction (and especially to the asserted satisfaction of those whose financial status is threatened by climate change), there will be some kind of debate about this issue for the foreseeable future.

So What’s the Investment Play?

The reality of climate change doesn’t mean that there’s a trade to be made, especially if and where the U.S. government does nothing about it. Jeremy Grantham has addressed the issue directly: “Global warming will be the most important investment issue for the foreseeable future. But how to make money around this issue in the next few years is not yet clear to me.”

However, in September, the world's largest asset manager, BlackRock, said that all investors need to factor climate change, and the investment needed to halt it, into their future risk-assessments. The firm also argued that "curbing carbon emissions requires significant spending on green infrastructure and a reduction in fossil fuel subsidies. This creates large investment opportunities in areas that attract capital or industries at risk of disruption." I agree.

With the possible exception of the inverting demographic pyramid, I expect climate change to be the dominant investment challenge and opportunity of our time over the long term. But I don’t expect it to play out quickly. For most traders, an actionable item is one that can and should be undertaken right now and is expected to pay off essentially right away. But no matter how often I point out that lunch tomorrow is not a long-range plan, I don’t seem to get heard all that often on this point. What I offer is an action item that will almost surely pay off in the longer term for those with the necessary patience based upon any reasonable interpretation of the available data. The climate is changing and those changes will have to be dealt with sooner or later.

The “skeptics” and even governmental opposition conceptually do not trouble me in the least. As Bruce Chadwick put it, “if your investment horizon is long enough and your position sizing is appropriate, you simply don’t argue with idiocy, you bet against it.”

Investment opportunities in this area fall into two general categories. Climate mitigation focuses on reducing greenhouse gas emissions while climate change adaptation refers to actions taken to address the risks and opportunities associated with the physical effects of climate change such as changes to temperature, rainfall and ecosystems.

I remain unconvinced about the investment opportunities available with respect to mitigation. Since entrenched energy interests have a strong economic incentive to delay governmental initiatives towards climate mitigation, since climate “skeptics” are likely to oppose such initiatives, since the Trump Administration will likely deny the need for any such measures, and since it remains decidedly unclear which approaches will succeed (even assuming the “correct” approaches currently exist), Grantham’s uncertainty is well placed in this regard. BlackRock’s advice with respect to risk assessment holds, but there isn’t a clear affirmative investment thesis to promulgate.

A Suggestion on Investing
However, we can avoid arguing about the causes of climate change — which are fraught with political peril — and simply put our money to work in companies that deal with the consequences of climate change while avoiding those entities and regions with the most to lose. Thus the better investment opportunities exist in climate change adaptation. Adaptation efforts include improved infrastructure design (Hurricane Sandy clearly demonstrated the fragility of our energy infrastructure), more sustainable management of water and other natural resources, modified agricultural practices, and improved emergency responses to storms, floods, fires and heat waves. Infrastructural improvements include sea walls, dykes, tidal barriers and detached breakwaters – like the project Mr. Trump wants to undertake at his Ireland golf course.

Since these improvements may have unintended and damaging side effects, perhaps by displacing erosion and sedimentation, for example, we might also consider “softer” accommodation options that involve restoring dunes or creating or restoring coastal wetlands, or continuing with indigenous approaches such as afforestation. Given Mr. Trump’s clear commitment to major infrastructure spending generally, reiterated in his victory speech on election night, this general approach has the added benefit of being broadly consistent with expected policy.

Other accommodation options include warning systems for extreme weather events as well as longer-term measures such as improving drainage systems by increasing pump capacity or using wider pipes. Of particular interest ought to be food technologies that are resistant to heat, drought and flooding. Water needs provide opportunities in adaptation strategies for water conservation, storm water control and capture, resilience to water quality degradation, preparation for extreme weather events and diversification of water supply options.

Harsher and more widespread droughts will lead to a strain on communities and farmers that need fresh water. At the same time, rising sea levels will affect coastal regions, potentially leading to an increase of salt in ground water. So-called desalination technology has largely been a non-starter to this point; venture capitalists may want to re-think that. Other water recycling approaches are also promising. Further opportunities exist with respect to innovations in dealing with infectious diseases and pest control, weather forecasting technologies and more efficient irrigation systems.

Because the facts (and the science) are inexorable, society is going to have to adapt to higher temperatures and rising sea levels. Obviously, it’s much cheaper to deal with climate change before a crisis hits than after a city has been flooded. But there is no reason to believe or expect that we will have the public policy sense to do so. Moreover, green-energy technologies are still too speculative for the type of call I’m making here. The obvious investment priority is in adaptation technologies that will prepare and help us to deal with effects of climate change.

It is a highly speculative play. It is a very long-term play. But it is the right play. Our warming atmosphere and rising sea levels have inevitable consequences. Investment in climate change adaptation is the most important hot action item of our time.

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