What does extreme weather mean for investors and their portfolios?

The planet is on track to mark a climatic milestone in its meteorological history with scientists almost certain that 2023 will be the warmest year on record.[1] Indeed, we will be remembering the year for its series of extreme weather events across the globe – deadly heatwaves in Europe, devastating wildfires in North America and Australia, and widespread flooding across Asia.  These events, the severity of which is attributable to climate change[2], have impacted the lives of millions of people and caused yet-to-be fully calculated damages on infrastructure and businesses.

For financial institutions, 2023 should serve as a stark reminder that climate change must take a central role in any prudent risk management strategy. While most institutions do give some consideration to the physical impacts of climate change on their investment portfolios, this has largely been limited to potential risks over short-term horizons, with potentially more profound, longer-term implications receiving far less attention.

Acute physical risk refers to identifiable extreme weather events and how these occurrences may impact losses and the economy. It covers the insured/non-insured losses to infrastructure and physical assets during and after an extreme weather event, which in turn may result in unexpected investment losses.

The events of 2023 have served to reinforce the fact that different regions experience the impacts of acute physical risks in varying ways. This is due to a wide range of factors including population density, current infrastructure, and how each region is adapting and preparing for a future of increased extreme weather events.

Physical climate risk modelling, which uses a variety of climate change assumptions, demonstrates that the major cities of the world are likely to be uniquely impacted by the phenomenon over the short and long-term, depending on the factors described above. This is clearly evidenced by city-specific climate modelling exercises undertaken for Houston, London, and Dhaka.

Houston, United States, is a sprawling metropolis located in a low-level area prone to severe storms and hurricanes. Under hypothetical scenarios where the world is between 1.5°C and 2.8°C warmer by 2100, Houston is expected to suffer the effects of an increase in extreme weather events, particularly from hurricanes. The city has much to do to adapt its infrastructure and policies to be more climate resilient as it is anticipated that Houston will be significantly affected over the long-term.

Dhaka, capital of Bangladesh, on the other hand, is an example of a highly climate conscious city making great strides to adapt for a global warming level above 2°C by building more climate-resilient infrastructure and societal mindset. While the city will still experience extreme weather events such as cyclones, floods and heatwaves, the severity of such events on resilient infrastructure, and subsequently the economy, is anticipated to be much reduced.

The outlook for London, United Kingdom, falls somewhere in the middle of these two examples. Being a relatively low-lying city built on the banks of a major watercourse, flooding has always been a major risk. While the city has built flood-mitigating infrastructure, its future lies in the balance – being largely dependent on the extent to which storms, flooding and sea levels rise over the coming decades.

These three analyses highlight why it is vital that financial institutions not only consider the acute physical risks of climate change within their investment decisions but do so with a geographic lens as it is clear each city across the globe will be impacted differently. It is also essential that they understand how these extreme weather events may impact investment portfolios and, more importantly, how they can address this risk over short and long-term horizons.

In factoring in acute physical impacts into investment decision-making, financial institutions must consider the uncertain range in infrastructure damage projections – from benign to catastrophic – the likely outcomes of various global warming pathways, the impact of adopting resilient infrastructure, and finally the uncertainty as to when financial markets and investors will begin to price-in these impacts in their valuations.

To learn more about on how Ortec Finance can help you assess the impact of physical risks on your investment portfolio to enable a effective transition to net-zero please click here.

[1] 2023 likely hottest year on record; further spike expected with El Niño | UN News

[2] The global costs of extreme weather that are attributable to climate change