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Climate change and emerging markets after Covid-19

Foreword

The world stands to lose nearly half of its potential economic output by the end of the century. That’s the shortfall we face if we fail to make further progress on climate change.

Laurent Ramsey
Co-CEO Pictet Asset Management, Managing Partner Pictet Group
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But this is only an average. Emerging markets are at risk of faring even worse given their particular vulnerabilities to rising sea levels, drought and slumps in agricultural output.

It’s a bleak picture. But there are also reasons for hope.

The scientific consensus on climate change is becoming widely accepted, and governments, individuals and businesses have started to act. With the benefit of some clear thinking and careful planning, much more can be done. Particularly across the emerging world.

Everywhere, human ingenuity, technological advances and the understanding that comes from experience and education are all positive forces that will drive efforts to mitigate climate change and to help us adapt to its effects.

This paper by Professor Cameron Hepburn and his team at the University of Oxford Smith School of Enterprise and the Environment offers a deep and broad analysis of the risks and opportunities emerging economies – and the world more generally – face from climate change. Their insights are based on the latest economic and climate modelling techniques.

It is research we at Pictet Asset Management are proud to have sponsored. The dynamics this report describes will play a critical role for investors over the coming decades. The pace at which governments act will determine how capital should best be allocated, be it regionally or across asset classes.

 

Do you integrate climate change issues in your asset allocation?

Our responsibility as managers of our clients’ assets is to understand the forces that shape our world, not just during the coming quarter or two, but sometimes over lifetimes – indeed, this frames our pioneering thematic approach. It also underpins our commitment to investing in emerging markets, which, notwithstanding short-term fluctuations, represent the greatest potential for long-term economic growth. Just think of the enormous strides these countries have made over recent decades.

Such are the foundations on which Pictet has grown during the past two centuries. But as talented as our own analysts, economists and investment managers are, we recognise there is always more to learn. For nearly a millennium, Oxford’s academic community has created a well of knowledge that has profoundly influenced the course of humanity. Our own history suggests that we have also had some success in taking the long-term view. 

Which is why we have forged this partnership with Oxford’s Smith School. Thanks to their vast expertise in both environmental economics and emerging economies, 

Professor Hepburn and his team have produced insights here that aren’t available anywhere else.

Laurent Ramsey
Laurent Ramsey Managing Partner

And, extraordinarily, they’ve done so through the lens of one of the most traumatic global developments in modern memory.

Compounding the challenge of how to negotiate the long-term peril presented by climate change is a more immediate crisis – the Covid-19 pandemic that has ravaged communities around the world. As this paper makes clear, the vast fiscal and monetary packages governments continue to put in place to support their economies over the near term can also considerably help efforts to limit global warming over decades to come if invested wisely.

Thankfully, the worst-case outcome, that of failing to do anything more to prevent global warming than we already have, is unlikely. Governments, businesses and individuals have recognised the need for action and have put steps in place.

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Rather, the issue is: how much do we do? We can’t take for granted that all the effort will come from the developed world. Emerging countries are at risk of suffering disproportionately from the effects of global warming. And I think they are rising to the challenge – not least because taking measures is an investment that will often reap considerable rewards, and not just over the very long term.

In some areas, emerging economies are even well placed to take a lead. China already accounts for the lion’s share of photovoltaic cell manufacturing, is at the forefront of research and development and is one of the biggest adopters of the technology. Renewables combined with decentralised energy systems could help other emerging economies escape the need for massive investment in large networks. And as renewables become ever more cost effective, many of these countries could end up with cheaper energy than their developed rivals.

Some of the measures governments introduce, such as redirecting fossil fuel subsidies towards renewable energy sources, will be temporarily unpopular because they run counter to embedded interests. But the economic justification is clear. As the cost of power generated by renewables falls, fossil fuels will become ever less attractive. Great swathes of infrastructure devoted to fossil fuel production and use will be mothballed.

Ultimately, the work done by Professor Hepburn and his team leaves us hopeful. The challenges posed by climate change are huge. But they’re not insurmountable. And the emerging world has both its role to play and rewards to reap.

Download the full report

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Webcast with Professor Cameron Hepburn and Laurent Ramsey

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Costing climate change

Climate change will cause enormous damage to economies, especially in the emerging world. People in China could be 25 per cent poorer by the end of the century than if there were no further climate change if we do nothing more to slow the rise in global temperature. For Brazil and India the shortfall is likely to exceed 60 per cent, according to modelling by a team of environmental economists at Oxford University’s Smith School in a new report sponsored by Pictet Asset Management.

Globally, that deficit could reach some USD500 trillion – as a worst case, nearly half of the world’s potential economic output would be lost by the end of the century compared to potential in the absence of further global warming. But this impact won’t be spread evenly. Some of the world’s biggest emerging economies are at greatest risk, particularly if they leave the heavy lifting on slowing climate change to the developed world and do little themselves. Vulnerable to rising sea levels, drought and severe weather events, these countries need to take action to limit climate change.

Climate change could cost some USD
500tn
to economies globally by the end of the century.
Source: Climate Change and Emerging Markets after COVID-19 report, October 2020

Fortunately, they increasingly recognise that the effort will be worthwhile. Worldwide, people are aware of the challenges presented by climate change, understanding that it leads to a loss of biodiversity, more flooding, arid farmland, forest fires and the like. And so governments are being forced into action. Thankfully this now makes the worst case a relatively unlikely one.

But merely sticking to current policies doesn’t do enough either.  The loss in potential GDP per capita would be smaller, but not by much. At best the loss in potential GDP per capita might be reduced to 32 per cent from 46 per cent. And that’s without factoring in impossible-to-predict cascading effects where small incremental changes lead to a suddenly catastrophic outcome.

But were countries to act collectively, they could make up a significant chunk of that foregone output. That means action by developed and developing countries.

The Oxford team’s “current policies” scenario is that global warming would be some 2.8 degrees Centigrade above pre-industrial levels if efforts were limited to the richest countries, with 1 degree of that warming having already occurred. Should that temperature increase be cut to 1.6 degrees under an ambitious programme that included emerging economies, potential losses could shrink to a quarter or less.

GDP per capita impacts by country by 2100 by scenario
% change relative to SSP2*
Fig5e_website

High-Ambition Scenario: immediate climate action is taken by all countries, including in emerging-market economies, thus limiting the rise in global average temperature to 1.6°C above pre-industrial levels in 2100.
Current Policies Scenario: mostly follows current policy pledges, largely involving action by developed countries (2.8°C in 2100). 
Worst-Case Scenario: no action to mitigate global climate change (4.3°C in 2100).

* The Shared Socioeconomic Pathways (SSPs) are a family of five modelled socioeconomic pathways of global change that each draw on several plausible ways societies might evolve through the 21st century. SSP2: Middle of the Road consists of a world following a path in which social, economic, and technological trends follow historical patterns including growth inequality.

And right now, there is a unique opportunity for countries, rich and poor, to make radical progress towards limiting the likelihood of catastrophic climate change. The Covid-19 pandemic has been a huge global shock. Public health measures, such as lockdowns, have inflicted huge financial costs. Governments were quick to respond and have committed vast sums to economic recovery. In many cases it makes financial sense for this expenditure to be directed towards measures that mitigate climate change.

Download the full report

>



webinar

 


Webcast with Professor Cameron Hepburn and Laurent Ramsey

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Emerging woes

China and India are jostling for greater geopolitical influence, within the emerging world and beyond. Their ambitions are manifold. For instance, China aims to lead the world in AI technology, India to take China’s manufacturing mantle. But over the long run, they won’t achieve their aims through armed conflict on some high Himalayan glacier.

Rather, they’ll only do so by working towards the same goal of limiting global warming – and, along the way, will ensure the survival of the glacier they both claim.

A major, concerted effort at limiting how much global temperatures rise over the coming decades will pay significant dividends not just in China and India but for emerging economies generally. Were developed and emerging countries to work together in limiting global warming, they could roughly halve the loss in output they face by the end of the century compared to if there were no further climate change.

Emerging economies are much more vulnerable to rising global temperatures than their advanced counterparts. For instance, major cities around the world face annual losses of between USD300 billion and USD1 trillion in output from climate change-related sea level rises, according to modelling by Oxford University’s Smith School, in a report sponsored by Pictet Asset Management. China alone has 15 cities that risk losing as much as 4.7 per cent in GDP per capita per year from rising sea levels.

Sea-level damage
Average annual losses as share of GDP, %
Fig5c_website

High-Ambition Scenario: immediate climate action is taken by all countries, including in emerging market economies, thus limiting the rise in global average temperature to 1.6°C above pre-industrial levels in 2100.
Current Policies Scenario: mostly follows current policy pledges, largely involving action by developed countries (2.8°C in 2100). 
Worst-Case Scenario: no action to mitigate global climate change (4.3°C in 2100).

But this is not where China’s worries about global warming end. Temperatures in the country have been rising faster than the global average. Current projections are for a 13 per cent fall in the country’s crop yields by 2050 compared with 2000. 

Meanwhile, India stands to be one of the biggest losers from global warming, risking more than a 60 per cent shortfall in GDP per capita by the end of the century relative to if temperatures stayed the same. A hotter climate threatens the country’s productivity levels. Knock-on effects to education will prove a drag on the accumulation of human capital and thus economic development. Agricultural output will also decline. 

In Brazil, climate change will have a major impact on water availability – by the end of this century, two-thirds of the country will be classified as arid. This will hurt harvests and also energy production – hydro power accounts for some 60 per cent of the country’s electricity supply. Similar issues confront Mexico, Indonesia and South Africa.
Climate impact on agricultural GDP per capita, %
Annual growth impact in 2100 under three different warming scenarios
Fig6_website
High-Ambition Scenario: immediate climate action is taken by all countries, including in emerging market economies, thus limiting the rise in global average temperature to 1.6°C above pre-industrial levels in 2100.
Current Policies Scenario: mostly follows current policy pledges, largely involving action by developed countries (2.8°C in 2100).
Worst-Case Scenario: no action to mitigate global climate change (4.3°C in 2100).

Of major emerging market economies, only Russia is likely to benefit from rising global temperatures – at least, on the face of it. A melting Arctic would free more of Russia’s coastline, opening the region to trade and the exploitation of the region’s wealth of natural resources. But there’s a caveat. This doesn’t factor in the impact climate change would have on other countries’ demand for Russian goods. Subdued GDP elsewhere would very likely hurt Russian exports.

Download the full report

>



webinar

 


Webcast with Professor Cameron Hepburn and Laurent Ramsey

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EM giants step up

The Covid-19 pandemic has ravaged economies worldwide. Weak infrastructure and healthcare systems, dependence on commodities and tourism for income, and high debt loads have left emerging markets suffering disproportionately.

But looking beyond the short-term, prospects for these countries are hopeful. Vast fiscal and monetary stimulus have poured into the global financial system as governments everywhere look to mitigate the pandemic’s impact on their economies. A considerable proportion has been earmarked for infrastructure. Crucially, governments will be in a position to restructure their economies in ways that not only boost their productivity but are also environmentally friendly – to build back better. Indeed, in many cases the greener course of action is also the most economically sensible for emerging markets, according to a report by Oxford University’s Smith School sponsored by Pictet Asset Management.

Even before Covid-19, the green investment potential of emerging economies was huge. It’s estimated that the Paris Agreement has paved the way for some USD23 trillion in climate smart opportunities in emerging markets by 2030, according to the World Bank.

Climate-smart investment potential, 2016-2030
USD TRN, Total: USD22.633 TRN
Fig1d_website
Source: Climate Finance Leadership Initiative (2019). "Financing the Low Carbon Future: A Private-Sector View on Mobilizing Climate Finance".

So far, their performance has been mixed. Yet, there is political momentum, driven by a groundswell of popular support, for green recovery from Covid-19, in a way there wasn’t following past pushes like the 1997 Kyoto agreement. Government efforts are reinforced by and reflect a groundswell of environmental activism by both individuals, companies and communities.

Not that it necessarily needs new money. For instance, public subsidies for coal, oil and gas production and consumption amounted to roughly USD500 billion worldwide in 2019, compared to USD100 billion for renewables.

In many cases, this support is provided by governments of less developed economies in an effort to develop oil and gas fields or to keep their populaces happy with cheap energy. But just reversing those subsidies would make huge strides towards climate change mitigation. And would save tens of billions of dollars from becoming stranded assets.

Between USD5 trillion and USD17 trillion of assets are already at risk if governments decide to pursue a high ambition strategy of limiting warming to 1.6˚C. That’s the value of infrastructure and other assets that would have to be mothballed to achieve the lowest rate of warming in Oxford’s scenarios. Further investment into fossil assets only pushes the value of stranded assets higher.

The percentage of committed emissions and asset values associated with those emissions
By emitting sector, %
Fig3_website
Source: Tong et al. 2019

The green economy already makes up some 6 per cent of the global stock market, according to FTSE Russell.  For it to expand further, investments will need to flow beyond the power sector, which currently receives most low-carbon funding, to agriculture, transport and forestry among others.

The significant structural changes economies need to undergo to mitigate climate change will absorb large amounts of funding over a long period, but financing is also needed for the many smaller, cost-effective measures that can be taken to adapt to the rise in global temperatures. For instance, early warning systems for storms and heat waves are estimated to save in assets and lives ten times what they cost. In all, adaptation currently represents just 0.1 per cent of private climate finance flows.

There’s an inevitability about the shift towards greener investment. The economics are moving in that direction. The finance will follow. Governments and private investors are likely to heed the early signals and allocate capital accordingly. 

Download the full report

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Webcast with Professor Cameron Hepburn and Laurent Ramsey

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Video

In the thick of the global pandemic, it might be forgivable to lose sight of an even graver global threat: climate change. But there’s a clear inter-play between the two, as a new exclusive report commissioned by Pictet Asset Management from Professor Cameron Hepburn’s team at Oxford University’s Smith School highlights.

In the video below, Professor Hepburn explains why we’re all responsible for solutions to this potentially existential problem, whether we live in the developed or developing world. 

About the authors

Cameron Hepburn is Professor of Environmental Economics at the University of Oxford, and Director of the Smith School of Enterprise and the Environment. He also serves as the Director of the Economics of Sustainability Programme, based at the Institute for New Economic Thinking at the Oxford Martin School.

Cameron Hepburn
Professor of Environmental Economics at the University of Oxford and Director of the Smith School of Enterprise and Environment
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Cameron has published widely on energy, resources and environmental challenges across disciplines including engineering, biology, philosophy, economics, public policy and law, drawing on degrees in law and engineering (Melbourne University) and masters and doctorate in economics (Oxford as a Rhodes Scholar). He has co-founded three successful businesses and has provided advice on energy and environmental policy to government ministers (e.g. China, India, UK and Australia) and international institutions (e.g. OECD, UN).

His co-authors on this paper are researchers at Oxford University, Francois Cohen, Matthew Ives, Sugandha Srivastav, Moritz Schwarz, Yangsiyu Lu, Penny Mealy, Paulo Bento, Maffei De Souza and Luke Jackson.

Click here for more information on the work of Professor Cameron Hepburn

About the Smith School of Enterprise and the Environment

The Smith School of Enterprise and the Environment was established in 2008 through the generosity of Sir Martin and Lady Elise Smith, and their family, based on their belief that to address climate change and environmental sustainability, it is essential to bring business into the conversation.

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The Smith School seeks to apply relevant research with enterprise to shape business practices, government policy and stakeholder engagement. The Smith School is focused on teaching, research, and engaging enterprise and works with social enterprises, corporations, and governments alike. Its goal is to offer innovative solutions to the challenges facing humanity and the modern firm over the coming decades.

Its focus is on environmental economics and policy as well as enterprise management, financial markets and investment. It is housed in the University of Oxford’s School of Geography and the Environment, which is the top ranked department in the QS World University subject rankings. The Smith School works closely with Oxford's wealth of academics, with 1,000 researchers from the social sciences. Its staff also hold cross-appointments at the University of Oxford's Saïd Business School, the Oxford Martin School, and the Institute of New Economic Thinking.

The University of Oxford is one of the world’s leading academic research institutions, consistently at or near the top of global university rankings.

Find out more about the Oxford Smith School of Enterprise and the Environment by clicking here.

Download the full report

>



webinar

 


Webcast with Professor Cameron Hepburn and Laurent Ramsey

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