The Paris Climate Conference is underway, and the announcements, pledges and statements of leadership are starting to roll in, and some of them are fairly impressive. In the opening day alone, Bill Gates and a powerful list of fellow billionaires announced the creation of the Breakthrough Energy Coalition, aimed at accelerating the pace and scale of affordable, clean energy solutions. This is significant in part because it is a commitment by private investors to finance projects just past the R&D stage and bring them to commercial viability, helping them avoid the “valley of death” that exists between basic research and full commercialization. For the transition to a low-carbon economy, this kind of capital, invested at this stage in the commercialization process, will be critical. Other announcements that focus on our collective ability to mitigate future emissions included a global alliance launched by India and France to mobilize $1 trillion for solar power, and of course the World Bank’s launch of the Carbon Pricing Leadership Coalition, a group of government and business leaders who are actively supporting the adoption of carbon pricing to help lower emissions.
This is a lot of hope just a few days into the CoP. Indeed, it seems that regardless of how the negotiations go over the next week and a half, there is momentum from all corners – business, finance, and policy – to step up the pace of mitigation efforts. This is great news.
But before we get carried away by the potential, let’s not forget that we are now in the unenviable position of having to adapt to at least a 2˚C warmer world and possibly more if the ambition governments have set out in their INDCs is not ratcheted up in subsequent years. In addition to scaling up our mitigation efforts, we also must scale up our resilience. And fast.
But what is fast? And how do we scale up resilience?
In a blog post earlier this fall on why Paris matters for our understanding of climate risk, I made the connection between countries’ INDCs and greater clarity for investors on the risks posed by climate change in the future. Since October (when the INDCs were due), many organizations have analyzed how much these plans collectively will impact warming over the next century, including MIT, UNFCCC, Climate Action Tracker, International Energy Association (IEA), London School of Economics and others. Perhaps most helpfully, the World Resources Institute (WRI) analyzed all of these analyses and found that the INDCs put warming by the end of this century in the range of 2.7˚C – 3.7˚C, depending on the modelling assumptions.
So, it seems we have some work to do even in the best-case scenario, notwithstanding the significant momentum building and finance flowing to scale up clean energy solutions. We now have a quantifiable range of warming within a predictable period of time.
The time horizon is now
Mark Carney, governor of the Bank of England, famously called our inability to address climate change the “tragedy of horizons,” meaning that there is no direct, immediate incentive to address climate change today. Those incentives don’t exist for consumers, for policy makers or for the markets. In fact, inherent in the challenge of addressing climate change is the fact that we will not know for sure the extent of climate risk until it is upon us, and at that point it will be too late. For investors, clean energy is a growing business, and private finance sees the opportunities. On the other hand, investors do not yet have a handle on how to incorporate climate risk into investment decisions.
With Paris and the INDCs, things may have changed. We now have a fairly good estimate of future warming, based on our ambition today. It is our responsibility to plan and invest against this information.
Many are concerned about this risk, including the World Bank to the U.S. Department of Defense, who agree that climate change is the ultimate threat intensifier to overall development and security. For the investment community, climate change likewise brings the potential to intensify risks to returns and sustainability of investments.
So how can we translate the science and the collective ambition into something meaningful so that investors can start making decisions that incorporate climate risk? How do you measure and then price in this risk so we are building in – or, better yet, locking in – resilience to what we can reasonably expect to happen given the collective ambition of the INDCs? Can we put a value on climate risk that is useful for investment decision making? Can we develop the equivalent of a climate-risk rating?
The CAU – or shall we call it the “Koh”?
Recently, a colleague from the finance industry, Jay Koh, posted a blog on the need for a common metric for measuring climate risk. Jay is a managing director of Sigluer Guff, a private equity firm in NY, and previously the chief investment strategist for OPIC. He is asking these very questions and argues that while a price on carbon is good for driving investment decisions that will mitigate against future emissions, we do not have an equally compelling and simple way to quantify climate risk that would allow us to build resilience into our investments. This, he argues, requires a Climate Adaptation Unit, or CAU.
What would go into such a unit is as complex as climate models themselves. Having one single unit of measure to represent climate risk in all its forms – be they increased frequency of extreme events, coastal flooding, health risks, heat risks, water stress or risks to food production – seems quite a challenge. As Jay notes, “Climate risk is multi-faceted, and adaptation needs will be both local and specific as well as global and common. Measuring adaptation requires understanding the baseline to change from and the target to move to. Designing a climate adaptation unit and practically measuring it would be challenging. But these challenges can be met.”
The good news is that people are already looking at various aspects that could contribute to a CAU (or shall we call it a “Koh”?). Many in the insurance and re-insurance industry are looking at climate risks in the context of weather modelling. S&P has issued reports on the risks to sovereign and corporate credit ratings posed by climate change. NOAA and NASA have extensive data about the physical side of climate risk.
Why do we need a “Koh”?
Of course, a “Koh” does not have to be simply a measure of risk. It can also reflect a measure of resilience. Like a price on carbon, quantifying and translating climate risk into financial terms will go a long way to help investors make better, more resilient decisions. It would help businesses make more relevant and resilient capital investments, and it could, in the long run, translate into lower costs of capital.
As a reflection of resilience, it may also provide a common metric for responsible investing by orienting an investment’s risk to the impacts from climate change around expected warming.
With an agreement in Paris, the INDCs, and the benefit of highly sophisticated modeling, it may well be possible to develop a “Koh.” Today, the world is nearly 1˚C warmer than 20th Century averages, and the probability of risks from climate change at 1˚C of warming versus 2.7˚C or even 3.7˚C of warming are very different. Having a Koh might be a good first step to help incentivize investors and get the finance flowing so we can build in resilience to the future we are collectively creating.