Monday, December 17, 2012

Where are the climate change investments? A Carbon Based Original

    Markets can fall prey to inefficiencies or fail altogether. The annals of investment are replete with tales of visionary investors who find ways to exploit these failures.      Climate change, in addition to being a global emergency, is also a market failure.  In the words of climate economist Nicholas Stern in 2007, "Climate change is the greatest market failure the world has ever seen, and it interacts with other market imperfections."

    So where are the investors who are profiting from exploiting this failure?  In fact, their numbers are small, and so far their performance has not attracted other asset managers. 

    One disadvantages is that investors in climate change do not have need politicians committed to the right policies.  As Stern put it, "The first is the pricing of carbon, implemented through tax, trading or regulation. The second is policy to support innovation and the deployment of low-carbon technologies. And the third is action to remove barriers to energy efficiency, and to inform, educate and persuade individuals about what they can do to respond to climate change."

    Investments in the right actions face a political headwind. Instead of a concerted three-pronged push, would-be climate investors face virulent obstruction from conservative politicians.   These politicians and their fossil fuel backers work indefatigably to thwart all measures to price carbon. They do their utmost to thwart any large-scale post-carbon investing -- witness the near-criminalization of renewable energy at the hands of congressional Republicans.  They spout fossil fuel propaganda unabated even though governments and businesses pursue hundreds of small improvements in energy efficiency, and a majority of Americans believe climate change is real.

    Hostility from politicians and lobbyists is not the only obstacle. Psychology and cognitive habits place another barrier in the way of investing profitably in climate change action.

    Most people rarely notice long-term, lumbering problems for a number of cognitive and psychological reasons.  Their time horizon is too short. The climate signal emerges too slowly from the noise to command investors' attention.

    Traders, for example, operate in the briefest of short runs, and for them, climate change has hardly any existence at all. They buy securities, hold them for just a moment. 

    Investors work with a time horizon of three months to a year.  But even this somewhat longer field of view is the blink of the climate's eye. 

    Some asset managers defy this tendency, focusing on climate and renewable energy as investments, but most other investors quickly lose interest. 

    The time horizon problem even bedevils insurance, the one industry that cares the most about climate change right now.  Insurers have an immediate and obvious stake in reducing climate risk, since clients' disaster losses determine how profitable they are. 

    A growing number of property and casualty firms are focused on climate change. They are cutting their own emissions, taking climate into consideration in their portfolios, spelling out and communicating the risks of climate change, and even trying to influence policy. 

    Does this mean we should put our money in climate-savvy insurers?  Sometimes the industry does well, but the nature of the risk business prevents them from reaping extravagant payoffs. 

    The time horizon of insurers is one year -- policies are renewed every twelve months, usually in January.  Their judgment of their portfolios' risks only needs to be correct enough for a year. 

    Skill at assessing risk is only one part of the insurance business. The other half is investing. Insurers invest the premiums they take in, resulting in some of the largest asset pools in the world.  Their bias is conservative and short-term, since they might face large losses that could force them to unwind their portfolio in a hurry. In short, an insurer that has an acute understanding of climate risks has a better chance for staying in business, but it won't perform like a boom stock.

    Between the difficulty of thinking long term and fierce political opposition, sound climate investing has languished. That's alarming because all of us have a stake in stopping greenhouse gas emissions and reducing the harshness of its impacts. It should be profitable to do so.

Dunes at Gran Canaria, shot by Marc Ryckaert (MJJR), Wikimedia Commons, under the Creative Commons Attribution 3.0 Unported license

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