The great crash of 2023 made the聽2007 financial crisis look like聽a聽blip. It was triggered by US聽president Bernie Sanders聽signing emergency measures to聽slash carbon emissions. Investors started panic-selling stocks in fossil fuel companies. Trillions were wiped from the stock markets within days聽鈥� and聽hundreds of millions of people around the聽world lost their聽pensions.
Impossible? Not according to financial regulators, who are so concerned about the prospect of climate-related financial crashes that they are already taking action to stop them happening. They want all big organisations to start聽assessing and disclosing their climate-related risks.
鈥淭he whole point of this exercise is to avoid that kind of crash happening,鈥� says Michael Wilkins of credit rating agency S&P Global Ratings, a member of the Task Force on Climate-related Financial Disclosures, .
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Voluntary guidelines
But the guidelines are voluntary. They will work only if聽they are widely adopted, and the聽companies facing the biggest risks will be the most reluctant to disclose them. So can we really prevent a financial crash when we get serious about limiting global warming? Or does saving the planet inevitably involve a very bumpy economic ride?
The rapid warming of the planet poses two related threats to聽the financial system. There is the cost of physical damage inflicted by a changing climate, which is already high and climbing. For instance, insurance market Lloyd鈥檚 of London estimates that sea level rise due to聽climate change by a third, adding around $5 billion to the cost.
鈥淭he increase in the severity and the frequency of losses incurred due to climatic events such as floods, heatwaves and so聽on, let alone the damage caused聽by rising coastal waters, is聽causing billions and billions of聽losses to economies right now,鈥� says Wilkins.
The costs could rise so high that聽insurers either go bust or drastically limit what they cover.聽This could lead to existing聽properties becoming unsellable and a halt to further developments in at-risk areas. 鈥淲e聽believe absolutely as an insurance company that climate risk presents an existential crisis for the insurance sector north of 4掳C [of warming],鈥� says Steve Waygood of Aviva Investors, another member of the task force.
The second threat is the fact that the financial industry聽鈥� almost certainly including your bank and pension fund聽鈥� is betting heavily on things carrying on as they are now. They are investing in companies trying to聽find yet more oil and gas, in聽car聽firms with no plans to switch聽to electric vehicles, in real聽estate threatened by rising seas and more.
On paper, these investments are worth trillions. But their value depends on investor confidence in the status quo. If that changes, their value will plummet.
Low-carbon economy
The low-carbon transition will聽lead to the reallocation of a significant fraction of the world鈥檚 capital. If this happens suddenly, it could lead to 鈥渁 rapid system-wide adjustment that threatens financial stability鈥�, the Bank of England .
This is what happened in 2007, when it became clear banks had been making high-risk loans that would never be repaid. The end result, of course, was the worst crash since the 1930s and the loss of trillions of dollars of wealth as the value of stock-market listed firms was rapidly reassessed.
The danger could be more immediate than many think. In June, one real estate investment company started because there is no way to protect most of it against rising seas and storms. If enough follow suit, in the area will fall.
The risks are certainly worrying Mark Carney, governor of the Bank of England and chair of the聽Financial Stability Board, an聽international body that aims to聽identify and address financial vulnerabilities. It was the FSB that set up the , at Carney鈥檚 instigation. Already, institutions responsible for $25聽trillion in assets have said they聽support the initiative, including Barclays, Morgan Stanley and PepsiCo.
Ignoring the risks
Unsurprisingly, some in the fossil fuel industry dismiss the idea that they are exposed to any risks, let alone that they should have to .
For instance, a recent report from the Independent Petroleum Association of America claimed pension funds would 聽if they sold all their shares in oil聽firms. But the report is based on the assumption that oil companies will do as well over聽the next 50 years as they did聽in the past 50 years. That鈥檚 laughably absurd.
Last year, attacked the idea of a carbon bubble聽鈥� that the value of oil and gas companies depends on reserves that they will be unable to sell as we shift away from fossil fuels. It claims 80 per cent of the value of oil and gas companies depends on reserves that they will be able to sell in the next 10 to 15聽years.
However, the issue for fossil fuel companies isn鈥檛 just whether they will be able to sell their products in future; it鈥檚 whether they can make a profit.
The US is still using lots of coal, but since 2010, three of the top five coal companies have filed for bankruptcy. Cheap gas is killing coal鈥檚 profits in the US, and cheap renewables could do the same to fossil fuel profits globally聽鈥� even if聽they are only supplying a small proportion of overall energy.
Status quo
鈥淭he oil majors clearly have a聽vested interest in the status quo聽not being changed as far as disclosure is concerned,鈥� says Wilkins. But pretending the problem doesn鈥檛 exist will lead to far greater shocks down the line.
鈥淭he risk of panic is far greater,聽as we have seen with the聽credit crunch, when there is聽no information out there,鈥� says聽Waygood.
Disclosing companies鈥� exposure to climate-related risks is just the first step, however. Investors and companies need to act on these disclosures by taking steps to minimise the risks.
Oil companies have already found more reserves than future climate laws may allow them to sell. These firms must accept that they cannot keep growing and instead focus on downsizing to maximise revenue from their existing reserves, says Anthony Hobley of the Carbon Tracker Initiative, a think tank set up to highlight financial risks from climate change.
If they do, they could remain profitable and valuable for decades to come. 鈥淭hey have to聽go聽ex-growth,鈥� says Hobley. 鈥淭he growth mentality no longer applies in this new world.鈥�
Instead, fossil fuel companies are borrowing to find further reserves. According to a report in聽June, into 鈥渆xtreme鈥� fossil fuel projects聽鈥� those most likely to be targeted by climate action. These include coal mining and power plants, and oil from tar聽sands, the Arctic and deep offshore.
High risk
These sectors are already high risk. In 2015, Shell had to write off聽$2.6 billion after withdrawing from the Arctic, and another $2聽billion on a suspended tar sands project, for instance. .
鈥淭hey are betting on an increasingly risky house,鈥� says聽Johan Rockstr枚m of the Stockholm Resilience Centre, who studies sustainable development.
Then there is Donald the denier. President Trump鈥檚 attempt to turn back the tide on climate action in the US will probably have little effect on the country鈥檚 emissions, but it could delay the transition to a low-carbon global economy if lots of the developing countries that signed up to the Paris climate agreement scale back action too.
Any delay is bad news. A late and abrupt transition away from fossil fuels is much more likely to trigger a financial crash than a gradual one, according to a from the European Systemic Risk Board, set up in 2010 to try to avert financial crashes. 鈥淭he adverse scenario for the EU financial system is one of late adjustment, resulting in a 鈥榟ard landing鈥�,鈥� the report says.
Despite all these issues, Waygood thinks we can avoid another big crash. Few people predicted the credit crunch, he聽says, but this time lots of big institutions are saying there is a聽problem. The task force鈥檚 recommendations should smooth the transition, if widely adopted.
But investors still have to bet on聽what they think are the most plausible scenarios. There could be trouble ahead if lots of them get it wrong聽鈥� perhaps because of聽an unexpected technological revolution, like turning solar power into petrol, or some climate聽tipping point kicking in聽early, such as the Gulf Stream grinding to a halt.
Rockstr枚m is optimistic, though. 鈥淭here may be a sudden shock, no doubt, but there鈥檚 growing global preparedness,鈥� he聽says. 鈥淭here will be a quick bounceback.鈥�
But by a quick bounceback he means a recovery like the one after the 2007 crisis. To the millions of austerity-hit people around the world who are still suffering as a result of that crash, that鈥檚 not exactly comforting.
