A changing climate

What to make of the growing frequency and intensity of extreme weather events

Well before Hurricane Florence hit the Carolina coastline, The New York Times called 2018 "the year global warming made its menace a reality."[1] Alas, recent heat waves, fires and flooding should have come as no surprise. As the Potsdam Institute for Climate Impact Research recently put it, "More and more people are suffering from increasing and often unprecedented extreme weather, both in terms of casualties and financial losses. (…) as warming continues, (…) our planet also runs a growing risk of crossing critical tipping points where major and largely irreversible changes to the Earth's systems are triggered."[2]

So, how should investors and asset managers react? Well, climate change can create opportunities as well as risks for long-term investors. The transition to an economy with much lower carbon emissions will be shaped not just by the increasingly visible real-world effects of climate change but also by changes in policies, technologies, consumer preferences and market norms. Higher taxes on carbon emissions and litigation, for example, can increase companies' operating costs or change the demand for their products and services. Technology development can make incumbent companies uncompetitive. Of course, there is no guarantee that policies to mitigate climate-related risks are suitable in every country or sector.[3] Essentially, climate-change risks and opportunities may be mispriced or incorrectly assessed by many investors. This suggests that the topic should best be approached with a combination of humility and an open mind. At DWS, this is precisely the approach we have taken for over ten years.

For instance, we recently asked investment professionals throughout our investment platform to assess whether, how and by how much their subsector of coverage will be impacted positively or negatively within one and within five years. Thanks to the assessments of our sector analysts across credit, high yield and equities, we were able to create an interrelationship map on the effects that climate change is having within and across different subsectors of the global economy. Already, this process has helped identify key topics affecting the future performance of many subsectors. These can range from structural changes in energy-generation business models to a reassessment of growth potential in the car industry. Other examples include the ability of utilities to maintain or expand margins and of insurers to sustain asset values and more broadly the impact on capital spending and innovation within and across subsectors.

The real surprises, though, come when you look into the specifics. Take utilities, for example. On the plus side, demand for renewable energy and distributed energy infrastructure looks set to continue to increase, as more and more industries are becoming more aware of their emissions footprint. This should be good news for electric utilities able to grow their investments in onshore, offshore wind and solar parks. The need to integrate these parks into the energy system is likely to entail a growing role for companies focused on the transmission and distribution networks. This may boost the capacity to capitalize on some of the opportunities offered by structural changes within the broader industry. Since climate change is not just the emission topic, we are likely to see its impacts in other subsectors of the utility space, too. Among water utilities, the growing lack of water availability in several regions looks set to cause more and more companies to invest in areas such as water desalination plants and to demand additional water services being offered by water utilities. Among utilities, there will likely be winners from climate change, as well as losers in areas such as thermal generation. Given the growing frequency and intensity of extreme weather events like flooding, heat waves and droughts, regulatory and technology changes aimed at combatting climate change look set to accelerate further, perhaps more so than markets think. At DWS, we are doing our best to be prepared.

Climate-Related Risks, Opportunities and Financial Impact

Source: Task Force on Climate-related Financial Disclosures (June 2017). Recommendations of the Task Force on Climate-related Financial Disclosures. Page 16: https://www.fsb-tcfd.org/wp-content/uploads/2017/06/FINAL-TCFD-Report-062817.pdf , DWS Investment GmbH

1. The New York Times - 10 August 2018, https://www.nytimes.com/2018/08/09/climate/summer-heat-global-warming.html

2. Potsdam Institute for Climate Impact Research: Stefan Rahmstorf and Anders Levermann, Preface to Mission 2020, April 2017. https://www.mission2020.global/climate-turning-point/

3. According to Climate Action Tracker no major country is on track to meet its international commitments from the 2015 Paris Agreement. https://www.nytimes.com/interactive/2017/11/06/climate/world-emissions-goals-far-off-course.html

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