Global Economic Issues, Local Business Disruption

By Christina P. O’Neill

 

After an active storm season in 2013, followed by a tenacious cold snap last winter that paralyzed much of the country, New England’s economy has begun to see price tags for climate change. Add to that, the significant changes in the nation’s energy market, as vast supplies of natural gas are making the United States more energy-independent (and in the process, creating a new generation of boom towns in middle America).

Our region faces many environmental stressors. New Hampshire is becoming warmer and wetter, with fewer snow-cover days, earlier ice-melt days and resultant changes in spring runoff. Vermont faces much of the same dynamic, particularly in the Lake Champlain region. Rhode Island’s predominantly coastal economy will face rising water levels and increased shore erosion and flooding. Massachusetts has many of the same problems, as evidenced by the rapidly changing coastline on its National Seashore, with difficult implications for coastal real estate.

Massachusetts has seen firsthand the disruptions created by climate change and the energy market. Two liquid natural gas terminals in Everett, built in anticipation of the need to import foreign supplies, sit idle. And global competition from China decimated the business of once-promising Evergreen Solar, heavily funded by the state.

Both of these developments have had significant local impact on their host communities. Climate change and the energy markets need a new set of risk-establishing standards that move away from historically-based models – in other words, what got you here won’t get you there.

Boston Common Asset Management, a national investment firm that specializes in sustainable and responsible global equity strategies, recently released a report titled “Financing Climate Change: Carbon Risk in the Banking Sector,” taking a comprehensive look at these market forces as experienced by the world’s biggest banks, and giving pointers on how to reduce the attendant risks. Big banks in the U.S. have largely been disintermediated from the finance process for high-carbon industries, with those loans taking the form of corporate bonds or securitized bank loans; they are more involved in the process in emerging markets elsewhere. But much of the report’s decision-making pointers can also be utilized by small and mid-sized banks for their more local lending activities.

Among the study’s pointers are environmental risk factors:

Credit risk assessment and loan pricing that do not take into account the effects of unpredictable or extreme weather. Conversely, weather extremes can also present climate-related business opportunities.

Changing regulatory environments. The report notes that in 2013 alone, more than 30 countries passed new national legislation to regulate or restrict carbon emissions. Current estimates of an energy company’s value are based on the assumption that most of its reserves will be fully used. If we transition to a low carbon economy, these fuel assets will become stranded, impairing the ability of companies to repay loans.

Legal risks. The tobacco and asbestos industries have been made to pay for longstanding public-health problems linked to their products. The report suggests the possibility that high-carbon industries may have exposure to a similar legal action in the future.

Reputational risk arising from shifts in consumer sentiment. Global, multigenerational protest campaigns that cut across socioeconomic and cultural divides can lead to account closures and declines in new business, and can undercut employee morale.

Uncertain demand for high-carbon fuels. Declining prices for renewable energy relative to fossil fuels will make the field of energy provision more competitive, complex and uncertain, the report notes; such market forces are unlikely to have been properly factored into historically-based loan loss models.

Misalignment of banker incentives. Banker compensation needs to be aligned with long-term goals, not just the short-term rewards from origination fees and transaction revenues. Environmental risk assessment should be conducted before, not after, the crafting of a deal, the report advises, and the bank should determine whether a particular client relationship is in line with its long-term strategy.

The report urges banks to conduct regular stress tests to model the effects of bad weather; to rebalance their portfolios in view of risks from climate change; consider legal and reputational implications of investments; and reassess loan pricing to correlate to changes in consumer behavior, including potential shifts in demand for high-carbon fuels.

 

Christina O’Neill is editor of custom publications for The Warren Group.