Svetlana Borovkova: Climate risk - what are the opportunities for investors?

1 augustus 2023

By Dr. Svetlana Borovkova, Head of Quant Modelling at Probability & Partners

Climate risk is firmly on the agenda of financial institutions. However, it is not all doom and gloom. While climate change poses significant risks to investors, it also opens up lucrative investment opportunities, as certain types of companies can benefit from climate change and climate risk regulations.

A current trend in asset management is thematic investing, which can be defined as identifying a global macroeconomic trend (e.g. climate change) and selecting companies positively exposed to this trend (i.e. those that stand to benefit from it). .

While some types of companies are obvious winners (such as renewable energy companies or electric vehicle manufacturers), other investment opportunities are less apparent, but just as interesting from the perspective of climate risk.

Emissions measurement and monitoring

One type of company is the one providing solutions for measurement and satellite monitoring of greenhouse gas emissions. Currently, a company’s reported CO₂ and other emissions are typically not based on precise measurements, but on wild guesses. This is why such self-reported emission numbers should always be taken with a pinch of salt. However, soon regulation will require companies to report their accurate, measured emissions. As soon as such regulation goes live, companies providing cost-effective emission measurement tools and services, especially low-cost sensors, will be poised to play a crucial role in the implementation of climate risk regulations.

Low-cost emission sensors offer real-time data, allowing businesses to identify emission spikes or anomalies quickly. This capability is particularly useful for industries that experience fluctuating emissions, enabling them to respond promptly. The market for emission measurement tools and services is likely to expand as climate change regulation expands. As more industries recognize the importance of tracking and reducing emissions, the demand for these solutions will grow, making companies providing such solutions attractive investment opportunities.

Once emissions are accurately measured and monitored, companies will face increasing pressure to reduce them. As this happens, firms offering carbon offsetting and emission reduction solutions will also see an increased demand for their products and services.

EV-related businesses

With a growing emphasis on reducing emissions from transportation, electric vehicle (EV) manufacturers are clearly well-positioned to benefit from climate risk. However, there are controversies that surround EVs, the biggest one being their reliance on raw materials such as cobalt, lithium and rare elements, which have been linked to grave environmental and human rights concerns. But as earlier generations of EVs are reaching the end of their lives, recovering and recycling valuable metals and rare elements from old batteries is seen as a viable alternative to harmful and environmentally damaging mining. So EVs’ associated industries (such as battery technology and battery rare metals recycling companies) are expected to experience significant growth and thus present interesting investment opportunities.

Other investment opportunities

There are other types of companies positively exposed to the climate risk investment theme. For example, providers of technologies for energy efficiency stand to gain from the efforts of businesses and households to reduce carbon footprint. Climate data analytics and consulting firms which help financial institutions and other businesses in understanding and mitigating their climate-related risks will also see an increased demand for their data and services.

The increasing frequency and severity of extreme weather events may drive higher demand for insurance coverage and hence an increase demand for insurance companies, particularly those offering climate risk insurance and products tailored to specific climate-related risks. The same events may lead to an increased demand for companies involved in building resilient infrastructure and disaster-proof construction, as well as engineering companies building dykes around countries exposed to rising sea levels.

Finally, I should also mention sustainable agriculture firms, companies providing water conservation and technologies facilitating the efficient use of water, as well as waste management and recycling firms promoting circular economy.

To conclude

It is worth thinking about climate risk not only in terms of dangers, but also in terms of opportunities. Approaching it within the framework of thematic investing will streamline your thought process and help you with the choice of the appropriate thematic investment portfolio.

Probability & Partners is a Risk Advisory Firm offering integrated risk management and quantitative modelling solutions to the financial sector and data-driven enterprises.

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