Of the major environmental, social and governance (ESG) issues, climate change has become one of, if not the most important area for investors, companies and financial regulators as well as a growing number of youth movements around the world. The importance of examining climate-related investment risk can be seen in the decline in the index value of coal-related companies over the past decade. Similarly, we have seen significant declines in share prices and investment write-offs from European utility companies. Both partly reflect the disruptive impact of increasingly cost-effective renewable technologies, such as wind power.
One of the challenges is that investors lack broadly comparable information on companies' climate-related financial opportunities and risks. Several initiatives are already underway, including one chaired by the Bank of England Governor Mark Carney and a consultation by the European Union. However, it is not necessary to wait for 'perfect' disclosures from companies to assess some of the risks and opportunities.
To take one example, 3.6 billion people worldwide are already living in potential water-scarce areas at least one month per year. By 2050, this could increase to 4.8–5.7 billion. More than 20% of today's global GDP is already produced in water-scarce regions. This could rise to 45% by 2050. The sectors most exposed to substantive water risks are consumer staples, utilities, energy and mining. Key data to assess climate-change risk on water availability in the food and beverage industry should include exposure to water-stressed regions, water-use intensity, spending on water conservation and the existence of water reduction and re-use targets. A special challenge comes from the still low visibility of water use in a companies' supply chains, particularly related to agriculture. Investment opportunities may exist in the industrial sector related to water stress, for instance companies involved in technologies related to water desalination or efficient-water use.
Another example concerns automotives, a sector in which information on the low-carbon transition risk is comparatively plentiful for regulatory reasons. Electric-vehicle penetration should continue to be an important emission-reduction priority. Thus, regulation for stronger corporate average-fleet emissions standards is likely to continue to strengthen, increasing the fuel economy of automotive companies’ new vehicles. However, heavy investments into the electrification of future cars may mean higher spending on research and development as well as capital expenditures which could dilute company earnings. Monitoring all factors affecting a company's average-fleet fuel economy should provide a good idea of the sustainability of business models.
Finally, the global industrial sector continues to be very exposed to the opportunity side of climate change. Clean technologies include wind, solar, water efficiency and electric vehicles as well as heating, ventilation and air conditioning. And, as already mentioned, the capital-goods sector is very exposed to the water theme. When it comes to water stress, agriculture accounts for 70% of the world's total freshwater withdrawal mostly through irrigation, but some 60% of this is wasted due to leaky irrigation systems and the cultivation of crops that are too thirsty for the environment in which they grow. Smart farming can help to minimize the application of fertilizers and pesticides. The use of site-specific weather forecasts, yield projections and probability maps for diseases can also help increase productivity. The capital-goods sector is also in a good position to profit from the trend towards energy efficiency. Technologies such as smart meters are being deployed in homes and offices to improve efficiencies in the areas of heat, noise and light as well as security.
Looking across the sectors, we recognize that we need additional disclosure from companies on their exposure to various climate-change risks. This is why we use our shareholder influence to encourage companies to improve their disclosure, to reduce carbon emissions and to improve resilience to physical climate change.
Share prices of coal miners and related businesses have fallen sharply. This partly reflects tighter regulation and advances in renewable technologies.
Source: Bloomberg Finance L.P. as of 2/26/19
European utilities have had a dreadful decade in stock markets, partly as a result of changing policies and growing concerns about climate change.
Source: Bloomberg Finance L.P. as of 2/26/19
1. Source: The Financial Times Ltd as of 6/28/17
3. The United Nations World Water Development Report 2018 as of 3/19/18
4. Influence is exercised via proxy voting, public appearances at Annual General Meetings and shareholder engagement.