Financial risks to companies and investors associated with climate change will become more important in the coming years as countries look to decarbonize their economies. New government regulations, such as air pollution targets and carbon pricing, technological breakthroughs that make new resources competitive, such as solar power and shale oil, threats to infrastructure from climate conditions and public opposition to investment in fossil fuels can all contribute to the risk of stranded assets – assets that suffer unanticipated or premature write-downs, devaluations or conversion to liabilities due to climate change and other environment-related risks. On February 1st, the Inter-American Dialogue hosted a panel of experts to discuss how these economic and financial risks related to climate change will affect Latin America.
A long-term investment outlook that considers climate risk is crucial for Latin America, especially in terms of infrastructure investments. Infrastructure projects have very high upfront costs, which are paid back over the 30-60 year life of the asset. If governments and companies do not invest in climate resilient infrastructure now, they risk incurring huge costs if expensive assets become stranded, noted Amal-Lee Amin, Climate Change Division Chief at the Inter-American Development Bank. Amin presented findings from the bank’s recent report, “Stranded Assets: a Climate Risk Challenge,” which looks at potential systemic risks to the financial sector from climate change, how low-carbon development could result in stranded assets and how investors are managing portfolios to mitigate environment-related risks.
Latin America’s vulnerability to climate change makes these climate-resilient investments all the more important. The region is one of the most vulnerable to extreme weather events like flooding and droughts, and as a result many Latin American countries are already seeing the fiscal impacts of climate change. In El Salvador these losses have already totaled 3% of the country’s GDP, said Amin.
Budget constraints across the region will continue to necessitate important levels of private sector investment and public-private partnerships in the coming years. In order to mobilize this private sector investment it is imperative to price in climate change-related risk, noted Amin, but these risks remain very difficult to quantify. The Financial Stability Board’s taskforce on climate-related financial disclosures recently released a report outlining guidelines for voluntary disclosure of climate-related risks, but there is still no clear metric for how to quantify those risks and accurately report them to financial investors. Bob Litterman, Founding Partner at Kepos Capital, argued that a rapid shift in investor preferences could come sooner than many expect if the right incentives are put in place, particularly a tax on carbon.
However, market signals regarding decarbonization remain mixed, noted Nancy Meyer, Associate Director of Climate Strategy at IHS Markit. Though the Paris Agreement established strong incentives for the rapid shift to a low-carbon economy, the US government’s opposition to climate action and efforts to roll back emissions regulations send opposing signals to the global market. Meyer also pointed out that there are multiple paths to reach the 2 degree Celsius temperature increase limit that the Paris agreement aims for, including scenarios in which some of the world’s energy consumption still comes from fossil fuels over the next 30 years.
These issues are being discussed widely in the global energy and climate context but have not been explored extensively in their application to Latin America. Considering the scope of the risk, however, these issues will surely become a growing concern throughout the region.