Climate risk

Climate is not just a question for the planet. For an investor, it is also a financial risk, with a price.

In two thousand fifteen, the Governor of the Bank of England summed it up: the tragedy of the horizon. The damage comes beyond decision-makers' horizon.

Two main risks are distinguished. The first is physical: floods, droughts, heatwaves.

A flooded factory stops. A harvest burnt by drought does not sell. A warehouse that is too hot is costly to cool.

And this risk also hits individuals. A house in a flood zone becomes dearer to insure, and sometimes harder to sell.

The second is transition risk: the rule that changes, sometimes overnight.

In France, since January two thousand twenty-five, a home rated G can no longer be let on a new lease.

For the owner of a poorly insulated home, that means work to pay for, or rent that disappears. One law, and a property's value changes.

The extreme case is called stranded assets. Things that were worth a lot, and will be worth almost nothing.

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A study published in Nature in two thousand fifteen put numbers on it. To stay below two degrees, a large part of known reserves would have to stay in the ground.

About a third of the oil, half the gas, and more than eighty per cent of the coal.

Yet these reserves are counted in the companies' value. If they are never extracted, that value is partly fictional.

That leaves the tool economists agree on most: putting a price on carbon. The polluter pays.

Europe launched a carbon market in two thousand five. Industrial firms must hold an allowance for each tonne of C O two emitted.

The number of allowances is capped, and falls over time. Those who pollute less can sell their spare allowances.

But the start was chaotic. Too many allowances had been handed out: in two thousand seven, their price fell almost to zero.

After several reforms, the price rose again. In February two thousand twenty-three, it passed one hundred euros a tonne for the first time.

Say a factory emits one hundred thousand tonnes a year, and must buy all its allowances. At twenty euros a tonne, the bill is two million.

At one hundred euros a tonne, ten million. If it earned fifteen million before carbon, its profit falls from thirteen to five million.

The twist: the same price ruins the polluting factory, and enriches the one that invested to pollute less. One's risk is the other's advantage.

So for the investor, the question is not only moral. A heavy emitter carries a bill that can grow.

The price swings also remind us of one thing: this bill depends on political decisions, which can change.

For you, three simple questions. Where are your assets? Which rules could hit them? And who pays for carbon in your investments?

Climate is not yet read well in balance sheets. But it always ends up getting in.