Carney, global warming and deep risk: James Saft

September 30, 2015

Sept 30 (Reuters) – Global warming is a source of
unprecedented deep risk for investors, with no easy answers.

Like wars or confiscation, global warming may be best
thought of as a source of “deep risk,” a term coined by investor
William Bernstein to describe those risks, unlike a cyclical
stock market crash, from which an investor may not be able to

Bank of England Governor Mark Carney on Tuesday urged
insurance companies and others to get out in front of those
risks, arguing that “once climate change becomes a defining
issue for financial stability, it may already be too late.”

Carney called for more transparency about the carbon
intensiveness of firms, as well as cautioning that insurance
companies and others face potentially huge liabilities from
severe weather, drought and disorder. Carney also warned that 20
to 33 percent of global fossil fuel reserves could prove to be
“un-burnable” as a result of regulation, imperiling the value of
an industry which comprises about a third of all global equity
and fixed income assets.

Speaking to a group – insurance companies – which must think
in decades, his call is a tall order. For individual investors,
even those saving for a retirement or bequest in the distant
future, global warming is an even more difficult puzzle.


Carney argued that making carbon use transparent “allows
skeptics and evangelists alike to back their convictions with
their capital.” That formulation ignores that most investors
aren’t so much skeptics about global warming as doubtful of
their ability to anticipate how it might play out in financial

Take the concept of stranded assets in the energy industry.
That analysis depends on many things, chiefly that the world
will decide to adhere to a “carbon budget” to cap global
warming, resulting in policies which will make the stranded
petrochemicals uneconomic. That’s certainly possible, and
arguably desirable, but is a political outcome outside the scope
of most investors to anticipate.

If we look for a read-across from other harmful industries,
the idea that they will be starved of capital and collapse or do
poorly as a result of regulation should give investors seeking
to de-carbonize their portfolios little comfort.

A prudent investor in 1964, when the U.S. Surgeon General
first labeled tobacco harmful to health, might have concluded
that cigarette company assets too would be stranded. Tobacco
shares, however, have outperformed the U.S. equity market by an
annualized 4.5 percentage points – a huge margin – over the past
115 years, according to data from Credit Suisse and the London
Business School.

Energy and gambling stocks have a similarly strong track
record, perhaps because investors have to be induced with high
risk premia to take on the burden of tight regulation and
potential confiscation.

Putting one’s money where one’s principles are is admirable
and requires no commercial justification, but a bet on a carbon
budget is a risky one, in and of itself.


One potential reaction investors may have to global warming
is to decide to take less risk. The classic playbook would be to
“tighten up” like a poker player facing a tough table with few
chips: you try to make smaller, surer bets and preserve capital
for what you hope will be better times ahead.

Global warming, unfortunately, is a potential disaster of
such scope that taking on less risk may actually backfire. The
classic way to lighten up on risk would be to sell equities and
buy safer assets, chiefly government debt. Yet governments
themselves may be first in line to absorb the costs of climate
change, which might both reduce tax revenues and create new and
pressing public spending burdens.

Consultants Mercer, in a 2014 report on climate change, make
the point that traditional asset allocation approaches are
ill-suited to the issue, as they seek to optimize portfolios
based on historic data on risk, return and correlation among
asset classes.

As with its effect on government debt, global warming may
upend much of these assumptions. How best to react is extremely
unclear, though it may be possible to take precautions about
sources of risk, like liability, while making small bets on
sectors like timber and agriculture which may rise in value.

Carney turns an apt phrase, calling global warming “the
tragedy of the horizon” because its remoteness and
unpredictability can easily lead to inaction. For investors, the
problem is, if anything, more difficult, as they not only have
to make assumptions about what will happen with the climate, but
about the speed and shape of the policy reaction, something that
is both everyone and no-one’s job.

Most will do very little at first, and then everyone will
try to do the same thing at more or less the same time.
(At the time of publication James Saft did not own any
direct investments in securities mentioned in this article. He
may be an owner indirectly as an investor in a fund. You can
email him at and find more columns at

(Editing by James Dalgleish)

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