TUTORIAL: Economics Basics
What Can We Expect?
There is still discussion over exactly what will happen if the Earth continues to heat up, or if the Earth is truly heating up at all, but this is not an article aimed at the ins and outs of that debate. Instead we will look at some of the most commonly cited effects of global warming and what they could mean to investors in the future if they come to pass.
According to the Intergovernmental Panel on Climate Change, there are five effects that we can reasonably expect to see as a result of continued global warming. They are:
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Some of these events may happen over long periods of time, while others could strike suddenly. Any of them will cause economic loss on a wide scale should they come to pass. Next let's examine five risks that - while not absent from the corporate horizon today - may take on new twists as they become increasingly costly to protect against in a future with unpredictable climate shifts.
Five Emerging Risks to WatchIn addition to general concerns such as higher energy costs and property loss from bad weather incidents, companies could also face increased risks that a major supplier won't be able to provide base goods and services, or that a major shortage in one or more raw materials leads to a hyperinflation scenario where costs skyrocket and corporate profits evaporate. Companies can often hedge against major price changes or other business risks by trading in derivatives, but even their pricing is determined by simple volatility assumptions that could be proved terribly inaccurate in one fell climate swoop. Let's look at some of the emerging risks in greater detail:
- Agricultural RiskThis risk could be the result of many scenarios described above; most crops have a specific list of needs and climate factors that must be met to grow. And because food is an absolute necessity, any shortages will lead to severe price increases and eat away at the discretionary income for ordinary consumers. Globalization may become a strong ally here; as an economy develops more trading partners, it can partly diversify against this risk. For example, if a nation in the far-Northern Hemisphere were exposed to increasingly warmer temperatures, it might partially become a new major exporter of agricultural goods to nations that previously could sustain their own consumption.
In extreme cases, agricultural risks like widespread flooding could even lead to population migration, which would put simultaneous strains on several different economies. (To learn more, check out The Globalization Debate and What Is International Trade?)
- Energy RiskIf carbon taxes, market-based carbon trading or the like is implemented, energy costs could rise dramatically. It may become relatively cheaper to create or purchase alternative energy for both businesses and individuals. However, this will come at loss of short-term profitability or disposable income. (For information about carbon credits and trading, read Carbon Trading: Action Or Distraction? and Can Business Evolve In A Green World?)
The fact that worldwide crude oil demand is steadily increasing paves the way for higher prices for our current sources of energy as well. Because energy is a major cost component for almost every industry, the list of those affected will be large. Opportunities will exist, however, for energy companies that can produce low-cost power or serve areas where higher temperatures lead to more demand for cooling. (To learn what less oil means to investors, check out Peak Oil: What To Do When The Wells Run Dry.)
- Property RiskThis will affect various industries in different ways, but all will be affected if higher property/casualty insurance becomes widespread. Insurance costs are already on the rise in certain geographic areas seen as high risk, and these trends will continue. Property-based industries like travel, REITs, hospitals and retail will face markedly higher risks. In extreme cases insurers may withdraw coverage altogether for certain areas. This could force some businesses to shut down completely. Private and government residences also face increased insurance costs, which could lead to lower investment-based real estate activity in some densely-populated areas of the globe. (To protect your own property, check out Insurance Tips For Homeowners.)
- Litigation RiskIf regulations on carbon-based emissions become more stringent, we will see more litigation against major offenders to the environment. Obvious targets include the major carbon-emitting industries, like energy, forestry, transportation and agriculture. Litigation concerns will linger over companies regardless of the outcome of specific cases, and could cramp asset and stock market valuations that are based on a long-term estimate of cash flows.
- Risk to Climate-Based IndustryTourism revenue is typically skewed toward coastal areas and temperate climates. Many of these areas are at the highest risk to be affected by major weather incidents and broad global warming. Future projections for travel could be adjusted downward well in advance of actual events, which could affect a wide swath of companies who make money on tourism, such as hotel operators, airlines, cruise lines, restaurants and entertainment providers. (To learn more, check out Taking Global Macro Trends To The Bank.)
Highlighting these risks isn't meant to scare you away from investing in companies that face them. Rather, the goal is to make you aware of what may happen, so that you can identify those companies that show leadership in preparing for these scenarios, whether it is by measuring carbon emissions, sourcing alternative energy or funding other green projects. Many companies will be able to succeed (and even thrive) by finding innovative solutions to mitigate these risks.
It is the insurers who will pave much of this road - they will set the pricing for the ability to ensure against the risks mentioned here, or they may choose not to at all. The broad investment community will also be casting millions of votes regularly in the form of industry and company stock valuations, access to the credit markets, and mutual fund flows. Companies with poor operating histories toward the environment may get depressed earnings multiples in the market, as the perceived ability to generate earnings in the future will be questioned. (For more reading on the economic benefits of going green, check out For Companies, Green Is The New Black.)
Parting ThoughtsBy fostering initiatives they might otherwise have shunned, companies can create their own insurance policies by promoting public goodwill and creating new potential sources of revenue to make up for losses in other business areas. Citizens - and the governments that represent them - can help spur innovation by pledging themselves to combat climate change and support initiatives that do so.
by Ryan Barnes
Ryan Barnes has over 10 years experience in portfolio management and investment research, covering equities, fixed income and derivative products. Barnes has worked with Merrill Lynch, Charles Schwab, Morgan Stanley and many others as an institutional trader, and maintained AIMR compliant performance for a diverse set of high-net-worth investors. Barnes is currently working as a writer and financial modeling consultant specializing in capital appreciation and hedging strategies, and is the editor of EpiphanyInvesting, a website devoted to finding long-term success in the stock market.
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