The uncertainty surrounding future regulation on climate change and related issues in Australia has made it difficult for investors and companies to value the impact of climate change.
Regulation has the scope to increase costs or to drive new product opportunities, reduce or increase the size of existing markets, create new markets or render some markets or products obsolete.
Technology shifts driven by government policy could lead to significant changes in markets, which could be positive for some firms and industries, while negative for others.
For the remainder of this article I will flesh out some of the opportunities and risks for some major asset classes for Australian superannuation investors.
Listed equities
Gross domestic product (GDP) growth is not the only determinant of equity growth. There are a multitude of social and financial factors in particular that influence equity growth and these can differ by sectors and countries quite significantly.
However, it is fair to conclude a decline in GDP growth as generally predicted from a climate change perspective is not a positive for equities in aggregate.
Australia will need to adapt to higher costs generally. The higher costs will be primarily the result of increased energy costs and higher basic food prices. Despite this, global demand for commodities is projected to continue to rise dramatically in the coming years.
This will be driven partly by developing countries, partly by the need to repair and build new infrastructure to cope with the changing environment and partly by the drive for innovation in certain sectors.
This is positive for Australia as a net exporter of commodities and a country rich with natural resources. As a result, we believe that despite the potentially negative impact of climate change policies on dominant sectors, such as coal and iron ore, the outlook is relatively positive for Australian equities.
The impact on equities globally will differ among sectors and geographies. The economic impact will vary depending on global climate change policies and the price of resources, such as coal and iron ore.
Europe has been addressing energy and related issues for a number of years and is arguably better placed to deal with the negative economic impacts of climate change, than say the United States, in the coming years.
The impact will also depend on the response by companies to climate change and specific regulation and policies. Simply because a company or a sector is a high emitter of greenhouse gases, it does not necessarily follow that the company will be negatively impacted on by climate change policies and regulation.
We believe it is important fund managers are considering issues such as climate change, policies and carbon pricing when assessing companies. Superannuation funds need to determine the process fund managers use to price potential risks of climate change and how possible opportunities are sourced.
Infrastructure
Infrastructure, by definition, exists to support the social and economic activities of society. When these activities change, the impact can be quite significant, both positively and negatively.
Positively there may be opportunities to invest in renewable energy assets, natural gas distribution networks, transport infrastructure and other climate-friendly infrastructure assets. In addition, this sector has traditionally been viewed as a solid inflation hedge, given a sizeable amount of the revenue is pegged to inflation.
Some of the more traditional areas of infrastructure do not face such a positive outlook from a climate change perspective. Airports are linked to climate change through their symbiotic relationship with the airline industry, which is emission intensive.
The potential impact on airports is threefold. A carbon price on aviation emissions may result in changes to passenger numbers due to the direct impact on the cost of air travel.
The indirect impact of reduced economic growth (GDP) as a result of climate change may decrease discretionary travel. Finally, due to physical changes in the environment, for example, the continued bleaching of the Great Barrier Reef, passenger growth may fall and travel routes may alter.
This is unlikely to be a direct issue for a number of years, but passenger growth should be monitored.
Toll roads may be an area of concern, but there has been limited indication to suggest this to date. Given the emissions produced by cars, coupled with continued high oil prices, traffic numbers may decrease.
Research has generally predicted energy costs and climate awareness are only likely to impact on discretionary travel. It is unclear whether there will be additional investment in rail and other public transport infrastructure to aid in reducing society’s reliance on cars, although this makes sense.
There are a number of opportunities in the renewable energy sector. These too are not without risks due to the early stage of the sector, particularly in Australia.
There will be a number of technologies that may benefit greatly from climate change, however, predicting which technologies and renewable alternatives will be adopted depends on a number of factors that tend to be outside the control of investors, such as regulation, subsidies and the price of carbon.
There may also be elements of the supply chain, such as energy services companies, that may benefit, depending on the industry dynamics, but these are yet to be identified.
Water saving and recycling technology is another potential growth area. Historically water infrastructure has lacked appropriate capital expenditure and this may present attractive investment opportunities.
Some parts of Europe are now facing more severe water shortages and investment in water storage infrastructure is required. In Australia there will be increased demand for a host of water saving, recycling and other water management technologies, which should support growth in the sector.
Property
The property sector has witnessed increasing numbers of concerned occupiers as governments and large institutions aim to lease energy efficient buildings. These changes in attitudes may negatively impact on the valuations of properties unable to comply with energy efficiency standards.
Rental values for less efficient commercial sites may fall and have a negative impact on valuations and the transferability of these energy-inefficient buildings in the near future.
The changes to legislation and consumer preferences will most likely lead to accelerating obsolescence for some assets and portfolios.
However, in response to the increasing obsolescence of buildings, investment in development properties may be stimulated and the building sector more broadly may experience higher demand for services.
Conclusions
Investors should engage with fund managers on climate change issues to discuss how the climate change analysis is incorporated into their investment process. This is too large an issue to ignore.
It is important to understand how fund managers price and assess risk and how this is incorporated into the valuation process across all asset classes.
Adequate consideration and analysis of risk will ensure there is limited downside to investors. Every fund manager is likely to view and analyse the potential impacts of climate change differently.
As demonstrated by this article, there are numerous uncertainties and no one approach to analysing climate change is necessarily appropriate. However, in our view, ignoring the issue is likely to have far worse consequences over the long term.
Ed Smith is Frontier Investment Consulting senior consultant.
