By Alan Hsu, Climate Strategy Portfolio Manager and Global Industry Analyst at Wellington Management
Few today would deny the impact of climate change on the planet.
Extreme temperatures, wildfires, droughts, floods and water scarcity: these and other damaging climate events are becoming more prevalent.
The Woodwell Climate Research Center was founded in 1985 not just to quantify global climate challenges through world-leading research, but to partner with stakeholders to bring climate research into arenas in which it could have a real-world impact. Woodwell has been ranked the number one global think tank by the International Centre for Climate Governance (ICGG) for each of the last four years.
In 2018, Wellington began a partnership with Woodwell to integrate climate science into asset management. Together, we started using quantitative models to better understand how and where climate change may impact global capital markets. We have developed investor tools and innovative analytical methods aimed at improving climate risk assessment and investment outcomes, modelling climate change impacts to directly inform investment decisions.
From an investment perspective, climate change creates risks, but it also creates opportunities. These opportunities lie in the need to develop resilient infrastructure and process changes across a multitude of industry sectors, countries and asset types, as well as responding to increased policy regulation and driving technological innovations.
Whether it’s wildfires in California, Texas winter storms or Australian bushfires, the problem with climate is two-fold: it’s not only changes in the physical landscape, but also an inability to prepare an adequate response for worst-case scenarios, even when the best of our science suggests these are highly likely.
A good example of this is in Chinese agriculture. China is among the world’s biggest producers of corn, soybeans and wheat, but our research shows that many of the regions where it grows these crops experience severe water scarcity, with 40% lying in the twentieth percentile for water scarcity risk globally. Data from Woodwell suggests that the likelihood of years when yields are down by 10% relative to historical levels will double for all crops by the middle of this century, with wheat showing the highest likelihood at 65%. It also predicts that drought will increase in severity along an east-west axis from Tibet through Chengdu and Hunan in central China, where drought conditions will persist up to 60% of the time from 2021-2050 onwards1. That means the incidence of drought conditions will have increased by around 80 months per decade relative to the 1971-2000 baseline. This will impact both China and neighbouring countries reliant on the Mekong River, which originates near Chengdu.
Surprisingly, the research shows an increase in flooding risk as well as water scarcity – in fact, the two phenomena are linked. A warmer atmosphere can hold more water vapour. So, when a storm forms, rain can fall in large quantities, with a drastic effect on an individual city. China is not prepared to manage extreme precipitation events. Roughly 70% of Chinese cities’ stormwater systems cannot properly deal with a one-in-five-year storm event. And we believe that, by mid-century, historical one-in-100-year and one-in-500-year extreme precipitation events are likely to occur with at least five times their historical frequency for most of China, especially east of Chengdu and in the northeast region.
So China must not only plan for a water-scarce world; it must also plan for flooding in many of its major cities.
What are the opportunities?
China is one example. But we’ve found that, around the world, increased levels of climate adversity in agriculturally productive areas will require ongoing investments in agriculture technology to boost crop productivity and crop resilience. The same is true for water infrastructure. Climate solutions related to water can be as simple as flow technology or as complex as smart water solutions that enable us to irrigate more intelligently, dispatch water more precisely and use it more efficiently. We believe that there is a wide opportunity associated with these themes.
We have also found that China also faces one of the highest threats of sea level rises. That’s the reason it is building what has been dubbed a new Great Wall – flood defences centred on the coastal regions of China to protect cities like Shanghai. This and similar projects bring with them an increased need for specific construction materials and flood infrastructure technology.
China and India are likely to be the two largest incremental sources of energy demand in future decades. For economies that are attempting to grow quickly, modernise and raise per-capita income, access to low-cost energy is key. Today, unfortunately, we still see a reliance on energy forms that we do not view as sustainable, including coal and to some degree natural gas. These countries face a conundrum: they must deploy vast amounts of energy while attempting to diversify their energy sources. It’s thus crucial that China, alongside India, is on a path to decarbonisation. From an investment standpoint, this plays into the growth of renewable energy sources globally, as well as alternative fuel use and the redesign of energy infrastructure to increase efficiency.
At Wellington, we are able to match our deep knowledge of renewable energy firms with insights from Woodwell’s climate science on whether local conditions favour wind or solar. This can help to inform our analysis of those companies when we engage with them on managing the productivity of their renewable assets. Blending that information with other fundamental research gives us a good sense of what might be the best regulatory outcomes. It also provides a much more complete picture of the risks and rewards of investment.
Taken as a whole, our research on climate change leads us to believe that many investors are overexposed to the risks stemming from climate change while being underexposed to the accompanying investment opportunities. That’s why Wellington offers a range of thematic funds from the Wellington Climate Strategy Fund to the Wellington Global Impact Fund that leverage our deep understanding of these and other sustainability issues.
To find out more, listen to the replay of our How we believe climate science can uncover investment opportunities webcast with Alan Hsu and guest scientist Dr Zachary Zobel from Woodwell Climate Research Center.
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