Sun | Mar 7, 2021

Walter Molano | The unintended costs of global warming

Published:Friday | February 14, 2020 | 12:18 AM
A Uniper coal-fired power plant and a BP oil refinery and chemical plant are at work in Gelsenkirchen, Germany, on Wednesday evening, December 4, 2019.
A Uniper coal-fired power plant and a BP oil refinery and chemical plant are at work in Gelsenkirchen, Germany, on Wednesday evening, December 4, 2019.


The environment is one of the most polemic topics of our day.

From the New Green Deal to the Australian wildfires to the impassioned declarations of Greta Thunberg, there is plenty of fodder for vitriol and debate.

There have been countless studies detailing the costs associated with global warming, analysing the impact of climate change as well as the costs associated with the shift away from carbon-based fuels. Rising sea levels will be disruptive to tidal basins, such as Buenos Aires and Montevideo. It will also impact coastal cities, such as Panama, Rio de Janeiro, Guayaquil and Cartagena.

Fortunately, most Latin American capitals will not be affected. Spanish colonists established their capitals in areas with large indigenous populations. These were located in High Plains, where the weather was more temperate, without mosquitos carrying tropical diseases and with an abundance of potable water due to the orographic effect.

In contrast to North America, where most of the economic activity occurs in low-lying coastal areas, Latin American economic activity tends to be in the interior. This limits the amount of damage that can result from rising sea levels.

That is not to say that the countries will not be affected by other climatic changes, such as droughts. But, some initiatives to stem global warming will have an insidious impact on the asset class.

ESG, which is a short form reference to issues related to environment, sustainability and governance, is one of the growing themes of the financial world. Although ESG seems new, it started more than 15 years ago, and it has been gaining traction over the last few years. The three words outline the guiding principles to create a business environment that is more socially responsible.

It may seem like a lot of fluff, but it has made its way into the mainstream. Two years ago, the European Commission began mandating ESG guidelines for pension funds. Given that pension funds are the largest investing bodies on the planet, they are having an important impact on global economic decisions. The energy sector is a good example.

Fixed investment in the global oil and gas sector plunged 40 per cent in 2014, and it has not recovered, even though oil prices climbed and stabilised. Some analysts argued that this was due to looming concerns about peak oil. However, an important factor could be the internal pressure being exerted by pension funds on corporate boards.

Pension funds are the biggest investors in the energy sector. It is also no coincidence that many oil companies, from Shell to Exxon, are trying to reinvent themselves. Last year, Norway’s sovereign wealth fund said it would divest US$1 trillion in oil and gas exploration.

Even though individual state leaders may rail against climate change and make moves to resign from global climate agreements, the ESG movement is taking matters into its own hands. The movement is not relegated to a handful of socially responsible European countries. Pension funds in Chile, Colombia and Peru have adopted ESG guidelines. The movement has cut across the insurance industry, which is also incorporating ESG parameters into their investment plans. As a result, the ESG movement will eventually affect all issuers.

Some issuers have already started taking note. Late last year, the Ukrainian energy company, DTEK, issued a €325 million green bond to finance new solar and wind farms. The new issue was quickly snapped up, even though the Ukranian government had defaulted on its sovereign just a few years before.

Given the proliferation of ESG mandates by buy side institutions, there is an insatiable demand for assets. In fact, a new universe of ESG rating agencies are cropping up that will add a whole new dimension to the credit analysis process. Names, such as MSCI ESG research, Sustainanalytics, REPRISK, CDP and Vigeo Eiris are some of the leading names in the field.

Just as the Basel accords created a demand for high yield bonds, by allowing a framework for financial institutions to legally hold a new universe of previously-unimaginable risky assets on their books, the same will be the case with ESG-rated assets.

In order to comply with regulatory mandates, financial institutions around the world, starting with pension funds and insurance companies, will need ESG-rated assets. The universe will eventually expand to other buy side areas, such as private banking, mutual funds and hedge funds.

As a result, global warming is having a more important effect on the emerging world and our asset class. It may be about to turn it on its head.

Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.