When will firms begin spending on local weather adaptation? | USAEMALL.com

Welcome back. This week’s glorious warm weather in London is a pleasant surprise to many; less so to those who have been keeping an eye on the latest climate data. A publication last week from the EU’s Copernicus service showed that, in 21 of the past 22 months, the average global temperature was more than 1.5C above pre-industrial levels.

Time for companies to start serious investment in climate resilience? Who stands to make money if they do?

CLIMATE ADAPTATION

The mismatch in climate adaptation spending

For some years now, many global companies have been displaying an odd self-contradiction. While they claim to recognise serious climate-related risks to their business, they’ve taken very limited action to tackle them.

See, for example, a survey of companies published by the European Investment Bank last year. Sixty-six per cent of EU businesses polled said they faced threats from the physical impacts of climate change, yet only 22 per cent had an adaptation strategy.

A behavioural economist could point to several possible explanations for this mismatch. Humans tend to show a “status quo bias”, sticking with established practices simply because they’re established. We exhibit “herding behaviour” — meaning we’re less likely to invest heavily in climate adaptation if our peers aren’t.

Perhaps the most significant cognitive bias, according to the late Nobel laureate Daniel Kahneman, is the “optimism bias”. Even if you can grasp intellectually that you and your peers face a risk, you’re likely to underestimate the chances of it biting you. Business leaders, Kahneman noted, were particularly likely to demonstrate this kind of thinking.

But a growing chorus of voices from the financial sector has been arguing lately that spending on climate adaptation could be poised to take off — and that well-positioned companies and investors will be in line for big rewards.

On Monday, the London Stock Exchange Group published new research which found that “companies with exposure to adaptation solutions” generated total revenue of $1tn last year.

You can be forgiven for thinking that number sounds a bit high. The companies in question mostly sell products and services for which climate resilience is only one part of the value proposition. “Green building” revenues comprise $424bn of the total, according to LSEG. Water infrastructure — which has an important role to play in climate adaptation, but would need investment in any case — accounts for a further $94bn.

Investors looking to build a strategy around climate adaptation have a growing range of more closely focused start-ups to explore, as I wrote recently. But for those who want to deploy larger sums along these lines in the public markets, things look more challenging.

Analysts at Jefferies have had a go at tackling this problem by building an international set of 115 listed companies with a significant level of exposure to “adaptation solutions”. Those companies had outperformed the iShares Global Clean Energy exchange traded fund by 53 per cent over the prior five years, Jefferies said in a January note to clients.

But that’s more of a reflection of clean energy share price slumps than of a roaring trade in adaptation. The adaptation-linked basket of companies almost exactly matched the performance of the MSCI World index over five years (its absolute return was just 0.1 per cent lower).

Perhaps that’s not surprising, given that this basket included a hugely diverse range of companies, many of which gain a fairly small share of their revenue from anything that can reasonably be called an “adaptation solution”. They include Google parent Alphabet (which has developed software to help forecast floods), Home Depot (which sells products that can be used to make homes more resilient), and military giants Lockheed Martin and Northrop Grumman (which sell analytics systems to address wildfire risks).

This doesn’t mean there won’t be serious money made from climate adaptation. Attention to this area is certain to grow as expensive disasters, such as the recent floods in Spain and fires in Los Angeles, play out.

Government action is likely to catalyse investment — notably in the EU. European Commission president Ursula von der Leyen has put new emphasis on climate adaptation and resilience in her second term, tasking commissioner Wopke Hoekstra to develop a major policy package on the subject. Jefferies analysts suggest that adaptation investment is likely to prove less vulnerable to political backlash than spending on the energy transition, partly because the local benefits are more obvious.

In a paper this month, JPMorgan climate advisory head Sarah Kapnick argued that companies should view this area as “not just a risk management tool, but . . . also . . . a strategic investment opportunity” that could give them a long-term competitive edge.

Electric utilities have been taking it particularly seriously, noted Kapnick, who was previously chief scientist at the US National Oceanic and Atmospheric Administration. So they should, following a disastrous series of fires that led to the 2019 bankruptcy of electricity provider PG&E, after a court found its ageing infrastructure had contributed to the blazes. PG&E, now out of bankruptcy protection, has just won a credit rating upgrade from Moody’s thanks largely to its “continued improvement in mitigating wildfire risk”.

Good for PG&E. For now, most businesses with an existential climate disaster still in their hypothetical future, rather than in their painful recent past, are proving much slower to act. Kahneman would have been utterly unsurprised.

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