Placing a dollar amount on the impact of unmitigated greenhouse gas emissions, the London School of Economics (LSE) on Monday released a new report warning that $2.5 trillion of the world’s financial assets are at risk if the Earth’s temperature increases 2.5°C by 2100—and under a worst-case scenario, losses could reach as high as $24.2 trillion, obliterating the global economy.
“There is no scenario in which the risk to financial assets are unaffected by climate change—that is just a fiction,” said lead author Professor Simon Dietz, an environmental economist with LSE’s Grantham Research Institute on Climate Change and the Environment.
“It makes financial sense to a risk-neutral investor to cut emissions, and even more so to the risk-averse,” Dietz added.
The study, published in the journal Nature Climate Change, employs an integrated assessment model to tally the direct destruction of assets by extreme weather events, such as increased temperatures and drought, in addition to the overall economic slowdown predicted on a hotter planet as a result of mass human displacement.
According to the model, “the expected ‘climate value at risk’ (climate VaR) of global financial assets today is 1.8 percent [or $2.5 trillion] along a business-as-usual emissions path.”
However, there is a one percent chance that the VaR could reach 16.9 percent, or $24.2 trillion, which researchers note “would constitute a substantial write-down in the fundamental value of financial assets.” In other words, total market mayhem.
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The silver lining, however, is that because much of that risk lies in the “tail,” substantially reducing greenhouse gas emissions to limit global warming to 2°C “substantially reduces the climate VaR.”
Even when the researchers factored in the costs associated with reducing emissions, Dietz said, “we still find the expected value of financial assets is higher in a world that limits warming to 2°C.”
“This means risk-neutral investors would choose to cut emissions, and risk-averse investors would be even more keen to do so,” he added.
In the wake of the Paris climate agreement, when global leaders pledged to keep global warming beneath 2°C, there has been growing attention on the economic impact of climate change: from the global campaign to divest from fossil fuels and the bankruptcy of the coal industry, to revelations that multinational oil giants have purposefully deceived investors, as well as the general public, about the risks of greenhouse gas emissions.
“Our research illustrates the risks of climate change to investment returns in the long run and shows why it should be an important issue for all long-term investors, such as pension funds, as well as financial regulators concerned about the potential for asset-price corrections due to an awareness of climate risks,” Dietz said. He added that, as the first comprehensive economic model on climate change, the study “should be seen as one of the first words on the topic, not the last.”
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