ESG In Pills - February 2024
Top story
Hedge Funds Reap Record Returns Amidst Climate Uncertainty
In a striking turn of events, hedge funds such as Tenax Capital, Tangency Capital, and Fermat Capital Management that invested in insurance-linked securities, notably catastrophe bonds, outperformed traditional investment strategies to post record gains. Catastrophe bonds, or "cat bonds," are a type of insurance-linked security that allows investors to assume the risk of natural disasters on behalf of insurance companies. In exchange for potentially high returns, investors accept the risk of losing their capital should a predetermined disaster occur. This investment strategy, capitalizing on the unpredictable nature of climate events, enabled these funds to secure exceptional profits amidst a volatile climate backdrop.
The surge in cat bond performance can be traced back to a series of strategic bets placed by investors on the absence of contractually defined catastrophes, a gamble that paid off handsomely in 2023. This surge was a rebound from previous years where natural disasters like hurricanes had dampened returns. The backdrop for this success was set by an increasing frequency of natural disasters, underlined by hurricane Ian's devastating impact on Florida in 2022, leading to a significant shift in the insurance market as companies sought to offload more risk onto the capital markets. This adjustment was further amplified by the inflation-driven rise in rebuilding costs, setting the stage for a record issuance of cat bonds, totalling $16.4 billion for the year. “I can’t tell you if there’s going to be a hurricane or earthquake this year, obviously,” said Hagood of Nephila Capital. “But what I can tell you is spreads are near historical highs in the sector. So broadly speaking, we believe the market is being well paid for the risk.”
The backdrop of this investment boom is the undeniable influence of global warming on weather patterns, which has necessitated adjustments in risk modelling and increased interest in secondary perils like wildfires and severe storms. These emerging risks present new opportunities and challenges for the cat bond market, with recent expansions including cyber-catastrophe bonds reflecting broader concerns around digital security threats.
This strategic shift towards incorporating climate risks into investment models reflects a growing acknowledgment of the profound impact that global warming has on weather patterns and, consequently, on financial markets. The interest in so-called secondary perils, such as wildfires and severe storms, highlights an area of both concern and opportunity, signalling a shift in the industry's approach to managing and distributing risk.
As the financial sector continues to grapple with the challenges posed by climate change, the success of cat bonds in 2023 serves as a stark reminder of the urgency to align investment strategies with the path to limiting global warming to 1.5 degrees Celsius. This alignment not only represents a prudent risk management strategy but also underscores the critical role of the financial industry in supporting broader efforts to mitigate climate change and promote resilience in the face of increasing natural disasters.
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Chart of the month
The data scientist Hannah Ritchie cuts through the doomsday warnings to explain the behaviours that will have the biggest impact in reducing your carbon footprint - and on why there’s plenty to feel hopeful about.
Environment
NYSE Retracts Proposal for Natural Asset Companies
The New York Stock Exchange (NYSE) recently rescinded its plan to introduce a new type of publicly traded entity dubbed "natural asset companies" (NACs), following widespread backlash from various sectors. Initially filed with the US Securities and Exchange Commission, the proposition aimed to create a market for companies focused on managing and restoring natural assets, such as farmland and parks, for ecological benefit. However, concerns over potential land exploitation, restriction of traditional land uses, and the influence of foreign investment led to significant opposition. Critics ranged from farmers and mining companies to political figures and conservative media, all voicing fears over the implications for land rights and economic activities. In response to the feedback from regulators and the public, the NYSE, in collaboration with the Intrinsic Exchange Group (EIG) who proposed the idea, decided to withdraw the initiative. Despite the intention to bridge a financing gap for biodiversity restoration, estimated at up to $824 billion annually, the NYSE acknowledged the need to reassess the approach. This decision underscores the complexities of integrating environmental conservation goals within the financial markets and highlights the challenges of balancing ecological preservation with economic and property rights.
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Federal Court Endorses Willow Oil Project
A recent federal court ruling in the US has granted ConocoPhillips the green light to proceed with the Willow oil development project in Alaska, igniting a contentious debate on environmental preservation and energy production. The Willow project, estimated at $7.5 billion, is set to produce around 180,000 barrels of oil per day from a 600-million-barrel reserve, marking a significant advancement in the National Petroleum Reserve-Alaska. Critics argue that the project's approval contravenes national environmental laws and Biden's climate commitments, with the Interior Department and the Fish and Wildlife Service facing scrutiny for their environmental impact assessments. While ConocoPhillips champions the project as a model of responsible energy development, promising substantial benefits for Alaskan communities, opponents vow to appeal the ruling, emphasizing the dire need to align national energy policies with climate goals. Beyond environmental issues, this case also underscores the looming risk of stranded assets, as projects like Willow could become economically unviable in a rapidly transitioning global energy market focused on sustainability.
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UNDP and Pegasus Capital Advisors Boost Climate Investments
The United Nations Development Programme (UNDP) and Pegasus Capital Advisors (PCA) have inked a Memorandum of Understanding, marking a significant step toward amplifying investments in climate resilience and nature-positive initiatives in emerging economies, Least Developed Countries, and Small Island Developing States. This strategic alliance is set to mobilize over USD $1 billion in grants and investments by 2025, focusing on vital sectors such as food systems, water management, clean energy, and waste reduction. The partnership will focus on deploying blended finance mechanisms, including guarantees, loans, and concessional finance, to facilitate resilient and sustainable development projects. This ambitious collaboration between UNDP and PCA represents a forward-thinking approach to addressing the dual challenges of climate change and biodiversity loss, underscoring the critical role of public-private partnerships (PPPs) in achieving global sustainability goals. PPPs are crucial in transitioning to a 1.5 degrees future, as they distribute the risks and rewards between the public and private sectors, reducing the financial risk for investors, which in turn can stimulate more private investment into critical but potentially high-risk areas like climate resilience and sustainable development.
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Social
Climate Change Fuels Africa's Worst Cholera Outbreak in Years
The Africa Centres for Disease Control and Prevention links the continent's most severe cholera outbreak in three years to climate change, highlighting that adverse weather conditions escalate the disease's risk at a quicker pace than elsewhere. The situation is exacerbated by floods in the Democratic Republic of Congo and other parts of southern Africa, which strain health infrastructures, hinder access to clean water and sanitation, and displace populations. Jean Kaseya, the director general of the Addis Ababa-based Africa CDC, emphasizes that cholera in Africa is intricately connected to climate change. The past year has seen outbreaks in over a dozen countries, resulting in hundreds of deaths, from rural Zambia to South Africa's capital outskirts. Despite Africa contributing minimally to climate change, it disproportionately suffers from its impacts. Treatment challenges are compounded by low immunity levels, inadequate vaccination, and a global shortage of cholera vaccines, with Africa needing up to 80 million doses but only a fraction available. The Africa Centres for Disease Control and Prevention's link between the continent's worst cholera outbreak in years and climate change underscores a global concern: adverse weather conditions, exacerbated by climate change, are not only elevating health risks in Africa but are also impacting health beyond the continent. From extreme heat stressing the heart and mental health to increased air pollution and the spread of infectious diseases, the effects of climate change on health are profound and widespread. This situation highlights the urgent need for comprehensive strategies to mitigate climate change's health impacts, reflecting a global challenge that extends far beyond Africa's borders.
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Challenges and Pathways Greening UK Farms
British agriculture stands at a crossroads, challenged by the necessity to harmonize elevated environmental standards with the realities of global trade. Environment Secretary Steve Barclay's unveiling of initiatives, including a new food labelling scheme to spotlight UK standard produce and increased environmental farming payments post-Brexit, aims to nudge both producers and consumers towards more sustainable practices. However, this optimistic vision is clouded by concerns from the farming community and experts, who argue that the UK's agricultural sustainability ambitions are undermined by the influx of cheaper, lower-standard imports. Since Brexit, the government has struck deals with?Australia,?Mexico and Canada, raising fears meat such as pork and beef produced to lower animal welfare and environmental standards will be imported into the UK. These imports not only threaten to transform eco-conscious British food into a premium commodity but also question the government's commitment to supporting local farmers in their transition towards greener practices. The discourse calls for a cohesive strategy that includes robust support for farmers transitioning to environmentally friendly methods, as well as equitable trade policies. Such a multifaceted approach is crucial for ensuring a just transition.
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British Wind Farms Overstate Power Output
Many of the UK's wind farms, operated by leading European energy corporations, have consistently reported higher power output forecasts than actual, imposing extra millions in costs on consumers annually, market records and discussions with power traders reveal. This issue stems from Britain's outdated electricity network, which struggles on windy days, leading to excess power that risks grid overload. The grid operator is then forced to compensate certain firms to reduce production, a practice known as "curtailment," which incurs significant costs. An investigation, involving analysis of 30 million records from 2018 to mid-2023, found that 40 out of 121 wind farms exaggerated their expected output by at least 10%, with significant overstatements leading to estimated unnecessary consumer costs of ￡51 million ($65 million) since 2018. Despite the challenge in predicting wind, evidence suggests that some operators may deliberately inflate their forecasts to increase compensation. The situation has sparked calls for regulatory investigations and highlights the need for improvements in the UK's grid infrastructure to accommodate the growing reliance on renewable energy sources without imposing undue financial burdens on consumers.
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Governance
Exxon’s Legal Battle
In a ground-breaking legal action, Exxon Mobil has taken to a Texas court to block a climate change proposal from being presented to its shareholders, marking a first in the company's history. The proposal, championed by activist investors including Arjuna Capital and Follow This, demands Exxon to establish ambitious climate targets, specifically aiming to reduce emissions from the consumption of its products (Scope 3). Exxon, standing as the sole Western oil giant without such goals, dismisses the proposal as detrimental to shareholder value, driven by what it sees as an extremist agenda. The assignment of the case went to a judge known for conservative rulings. This legal challenge not only underscores the escalating tension between Exxon and a segment of its investors over climate issues but also raises significant concerns over the rights of shareholders. By seeking to sideline the climate proposal, Exxon is testing the boundaries of investor influence, posing crucial questions about the role of shareholder decisions in steering corporate strategies on environmental responsibilities. This dispute emerges amidst broader scrutiny over the commitment of major asset managers to climate goals, and reflecting the desires of investors, with firms like BlackRock Inc. and State Street Corp. facing criticism for their frequent opposition to green resolutions, deeming many proposals to be “over-reaching, lacking economic merit, or simply redundant”. “Voting on shareholder resolutions is a key lever for institutional investors to hold companies to account on their commitments,”?Felix Nagrawala, research manager at the London-based non profit ShareAction that led the investigation, said in an interview.?
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Climate Lawsuit Pose Trillions in Liabilities
Research from the Oxford Sustainable Law Programme, featured in Science, reveals a pressing oversight in how investors and regulators calculate climate-related financial risks. It highlights the potential for polluting companies to face trillions in damages due to climate lawsuits, a factor currently underappreciated in financial risk evaluations. With 2,485 climate lawsuits filed globally, the financial threat to major carbon emitters is escalating, exemplified by Chevron's liability risk of up to $8.5 trillion, overshadowing its past profits significantly. The study criticizes existing frameworks, such as such as the International Sustainability Standards Board (ISSB) and The Network for Greening the Financial System (NGFS), for assessing climate risks for lumping legal risks with transition risks without adequate detail, underestimating the comprehensive impact of climate litigation. It proposes a new framework for assessing climate litigation risks, including market-impact analysis and qualitative analysis, to better represent the true financial risks companies face. The research underscores the importance of integrating legal reasoning with financial and climate science analyses for governance, aiming to guide policymakers, investors, and companies towards a more informed understanding of climate risk exposures. This approach is vital for ensuring more sustainable investment decisions and governance strategies, acknowledging the profound implications of climate litigation on financial stability and corporate accountability.
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MP Quits Over Oil Policy Clash
In a bold move that has sent ripples through the UK political landscape, former Conservative minister Chris Skidmore announced his resignation from Parliament, citing deep opposition to the government's push for further oil and gas exploration. This decision comes as a direct challenge to Prime Minister Rishi Sunak's recent bill advocating for new oil and gas licenses, a move Skidmore deems harmful to the environment and future generations. His departure not only triggers a potentially transformative by-election in Kingswood but also signals a significant moment of political contention, highlighting the growing rift within the Conservative Party over environmental policies. For investors and businesses, Skidmore's resignation underscores the increasing importance of sustainable practices and the potential risks associated with continued fossil fuel dependency. As the debate over energy policy intensifies, market participants should anticipate shifts in investment trends towards greener alternatives, reflecting a growing consensus on the need for a sustainable economic future. 2024, in fact, is poised to be a watershed year for the enactment of ESG regulations. This evolving landscape urges a strategic reassessment of energy investments in alignment with global climate objectives and regulatory changes.
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Events
GreenBiz
Feb. 12-14, 2024
Phoenix, Arizona
Economist Impact
March 4-6, 2024
London, UK
Economist Impact
March 11-13, 2024
Lisbon, Portugal
Reuters Events,
March 26-27,
New York City, US
February 2024, issue XXVVV. Previous editions can be found on LinkedIn or the Oxford Business Review website. All information in this article is personal and does not represent the point of view of any company.