Effects of climate change on Financial Sector
Abstract
Burning hydrocarbon e.g. fossil fuel emits carbon dioxide and other greenhouse gases like methane. Nature has its own ways of absorbing these green house gases. But since Industrial age we have been emitting green house gases at a higher rate than the capacity of nature’s sink. These green house gases trap heat, affecting the environment and ecosystem in numerous ways.
Figure [ 1 ]: Historic Atmospheric CO2 Concentration (ppm) for 1,000 Years
The preindustrial carbon dioxide concentration in atmosphere of around 280 ppm has risen to current level of 386 ppm. The Intergovernmental Panel on Climate Change (IPCC) project CO2 concentrations in 2100 ranging from 540 to 970 ppm. This will lead to an increase in temperature of 1.5 to 5.8 degree Celsius. Due to this rise in temperature sea level will increase by 0.09 to 0.88 meters because of thermal expansion and loss of ice from glaciers and ice caps. This will upset the finely balanced global climate system causing ever increasing number of extreme weather events like storms, draughts and floods. Rapid action has to be taken to reduce this GHG emission so as to protect our environment, ecosystem, socio-economic and political stability of several countries.
In this article an effort has been made to identify the effects of climate change on macroeconomics, capital markets and financial and actuarial sectors.
The Essay on Greenhouse Gases Global Climate Increase
Greenhouse gases are important in maintaining Earths habitable climate. These greenhouse gases must fall within a narrow range. Too much of any of the greenhouse gases can induce climatic changes, in particular, global warming. Of the greatest concern are the anthropogenic sources of greenhouse gases because they are steadily increasing in concentration in the atmosphere, and therefore increasing ...
Effect of climate change on Financial Industries
Climate change will lead to uncertain extreme weather events in future. It will affect the socio-economic balance of human societies, trade and commerce, availability and allocation of capital, corporate strategies and financial policies of Governments.
Sectors with Potential Physical Risk
The sectors which are very sensitive to climate change are Agriculture, Forestry, Fisheries, Healthcare, Insurance and reinsurance and Real Estate.
Insurance, Re-Insurance, Life Insurance and Pension
Climate change will bring to geographic and demographic changes in various parts of the planet. Mortality and morbidity will be affected by milder winters, increased temperature spreading tropical diseases and pests and extreme weather events. Life insurance and pension industries use financial models based on financial assumptions on the links between economic variables, such as investment return, interest rates, inflation, and salary increases, which have historically been stable. In post colonial era we have lived in a time of steady economic growth and prosperity. In UK’s perspective, The UK Chartered Institute of Insurers predicts that weather related damage will be larger than economic growth by 2065 (Nick Silver, May 2003, The Actuary).
The insurance industry will be the first to bear the cost of such unprecedented events and will be passing the liabilities to the common people in terms of increased premium.
Sectors with Potential Regulatory Pressure
After the Copenhagen Summit, Governments all over the world have come to political agreements, at least morally, that climate change is a reality and we should take action to nullify its effects. As per the Copenhagen Accord and other announcements from the Governments around the world there will be an effort to ‘control’ GHG emissions. Hence, the industries responsible for creating GHG emissions will be asked to take the first steps. The industries which will be affected the most by modified policy norms are fossil fuel power generation, oil and gas extraction and refinery, manufacturing requiring high amount of energy, chemical, cement, ceramic and glass, paper pulp, Transportation etc.
The Term Paper on Climatic Change Man Climate Earth
I. SUMMARY: This paper looks at the controversial issue of climatic change. In particular, it develops the question of if and why earths climate is changing The roles of man, naturally occurring trends, and earths cycles are considered, and an outlook for what can be expected in the near and distant future is given. The uneasiness of modern man arises from a rupture between himself and nature that ...
Asset Liability Management
Asset Liability Management is very crucial to the financial business as most of the assets and liabilities translate into medium to long term cash flow projections. Typically, a bank lends funds over a period of 20 years. A life insurance company receives regular premiums for periods of often higher than 30 years to guarantee over the mortality or the morbidity (invalidity) of an individual. A pension fund receives contributions from individuals aged 18 to 60 and will invest these contributions into assets so that it is able to provide adequate retirement for these individuals at retirement age. (Impacts of Climate Change on Financial Institutions’ Medium to Long Term Assets and Liabilities by Louis Perroy, 2005).
Climate change will change the input variables of several assumptions on which these industries stand.
New Opportunities: CDM Projects
As IPCC, UNFCCC and Governments around the world is trying to find solutions to control GHG emissions and several industries are finding opportunities in this. ‘Cap and Trade’ policy has enabled companies in developing countries to import technologies from developed countries. This has made some projects economically profitable which were not otherwise.
Several CDM projects are being implemented which will offset GHG emissions created by the industries in the developed countries. The most frequent project types include Wind Power Generation, Hydro Power Generation, Thermal Power Generation from Animal Waste, Green Transportation System, Sewage and Wastewater Management, Landfill Management, Bio-fuels, Power Generation from Bagasse etc.
Revenue Streams of CDM Projects
CDM projects earn revenue in two ways
1. Revenue from Business Operations
2. Revenue from ‘Carbon Credit’ or CER (Certified Emission Reduction)
There are many projects which would not be economically feasible if there were no ‘Carbon Credit’ e.g. thermal decomposition of HFCs, flaring of methane from urban waste dumps, capture of N2O from nitric acid manufacturing process etc.
The Essay on Climate Change Carbon Dioxide
Weather changes all the time. The average pattern of weather, called climate, usually stays pretty much the same for centuries if it is left to itself. However, the earth is not being left alone. People are taking actions that can change the earth and its climate in significant ways. Carbon dioxide is the main culprit. The single human activity that is most likely to have a large impact on the ...
There are several projects which have multiple carbon layers e.g. a Municipal Solid Waste Management project claims CERs for captured methane and for generating energy by replacing potential usage of fossil fuels.
Cost of CDM Projects
CDM projects are registered with UNFCCC. Submitting proposal, Validation, Monitoring and Verification processes are very costly. The costs depend upon the amount of CERs claimed over the period of seven to ten years.
13,000
38,000
16,500
10,000
34,000
53,000
PDD
Validation
Initial
Monitoring
Ongoing
Verification
By
DOE
Ongoing Annual Monitoring
Pre-Registration
CDM Costs
Post-Registration
CDM Costs
US$
51,000
67,500
77,500
111,500
164,500
PIN
Figure [ 2 ] Cost of a typical CDM project (Source: Carbon Credit World).
Standard terminologies as per UNFCCC have been used in this figure. Assuming a 10-year project, recurrent costs discounted at 3% annual rate to express in present-value terms. Registration costs, Administration Fee and Adaptation Fund Levy not included.
Opportunities for Financial Intermediaries
The documentations, execution, finding CDM partners, addressing legal issues and managing securities and certificates require experts in the financial field. These needs have created a different industry including CDM consultancies, Investment Banks and Carbon Funds. World Bank has taken an initiative to start a carbon fund called “Prototype Carbon Fund”. Carbon funds raise funds from CDM partners from developed countries and invest in CDM projects in host countries.
Climate Exchange
Climate exchange is a place where the CERs are traded. Already European Climate Exchange and Chicago Climate Exchange are quite maturated and volumes of daily trade are satisfactory. In India there will be a new climate exchange, called “India Climate Exchange” with the help of Chicago Climate Exchange. Advisory board for the same has already been formed, chaired by Dr. Rajendra K. Pachauri.
Concluding Note
Climate control has poised risk over the future businesses; as well as opened up windows of opportunities for new businesses. Innovative financial instruments based on CER securities will be coming in near future. It has also opened up opportunity for CDM consultancies and carbon funds. In future there has to be specialised financial services to manage the changing risk of future businesses.
The Essay on Global Climate Change And The Kyoto Protocol
Pakistan has the fifth largest population country worldwide contributes only 0. 4% of world’s greenhouse gas emissions. Regardless of its low contribution, global climate change in Pakistan has resulted in irreversible destruction with remarkable environmental, social and economic effects including natural ecosystems and forest resources of the country. Kyoto protocol framework convention on ...
(In the next issues I will be writing about the mechanisms of CDM projects and related financial instruments)
