What needs investors in infrastructure to know about the latest report on climate change.
The most recent report of the IPCC is now out, and it is not pretty: It is not pretty: “Widespread, rapid and intensified climate change [impacts].”
Michael Mann, climate scientist, sums up the recent findings in three main areas: 1. The “hockey stick” of rising global temperature has been maintained at unprecedented rates; 2. The impact is more widespread and more severe weather events are now being carried out; and 3.
At this point, none of this will be a major surprise to many professional investors in infrastructure. Many institutional investors with whom I am speaking are already fully aware of the megatrend in climate change affecting their markets, and that is why so many institutions move their investments away from fossil fuels to renewable fuels.
Although this change is highly evident for project financing in the field of power generation, investors also have to heed the IPCC’s warning about all other infrastructure categories. Due to the rapidly increasing climate change effects, investors are no longer able to think the same way about their long-term infrastructure assets.
Iceland can be a helpful case study. The country is known for its past transition to a large hydropower and geothermal grid mainly powered by fossil fuel. It is set for politicians as an example. Because of its large-scale low-cost, renewable electricity and geothermal heating systems, major industries such as aluminum smelting and now crypto-monetary mining have moved into Iceland. As the world changes to more sustainable energy sources, Iceland seems to be in an advantageous position.
Yet, as I heard on my recent visit to the country in person, climate change is indeed posing serious threats to the economy of the country. The famous glaciers of this country are in full retreat covering large parts of the island. This already has a small impact on tourism, with tour operators reaching the glaciers much longer than they were only a decade ago, but it could have a major effect over time.
There are also a few less evident impacts of the glacier melt. As one article described two years ago even at the time, the melting of the glacier had an impact on the fishing industry of the country.
The glacial melt has significant hydropower impacts, more directly relevant for investment in infrastructures and anyone planning to rely on low-cost, renewable electricity for a long term. When people think about Iceland, geothermal power generation pays attention, but the majority of power comes in fact from hydropower. And the massive glacial melts overwhelms the hydrodams of the country so that the potential power is not fully utilized… and yet in a few decades, the loss of glaciers is expected to result in lower water flow levels and threaten available electricity supply. By 2200, all glaciers are expected to be lost and the hydropower capacity available will stay at 1990. Indeed, another study concluded that “within the turn of the century, the regression in their glaciers will make Iceland’s hydropower plants inertial, reducing overall power generation by over 70%.” And, of course, the forecasts are even more accelerating than previously expected before the IPCC report today.
Iceland thus becomes a microcosm of caution for investors in infrastructure. Firstly, it is impossible to predict linear or easy the impacts on electricity generation projects. Even a decade from now, what appears to be an advantageous long-term project may not be today. Certainly, as most large projects are planned, over longer periods of time. Planning and planning for such investments are now very difficult.
Second, the climate change will have a significant effect on all infrastructure, not only electricity generation projects. The above-mentioned port impacts are a clear example, but extreme weather events will also affect any kind of project. Think of all the effort made to relocate industrial activities to Iceland in the search of cheap, renewable power when hydropower is no longer cheap.
Iceland is no longer so advantaged to switch to a more sustainable world economy, with fishing, tourism and cheap renewable energy all under threat from climate change.
Flexibility and resilience will become increasingly important for infrastructure investors. And in the following decades it would be possible to benefit from smaller, more distributed infrastructure. The distributed production will deal with the multi-decadal climate effects more easily than the large, centralized plants for 50 years. On an island like Iceland the fact that their economies depend on long supply chains (food, fuel, etc.) also becomes more obvious, so efforts like indoor agriculture can also bring resilience.
What the IPCC report shows today is that we are already in a period when climate change will have fast impacts on economies and infrastructure, and this will unfortunately be non-linear and hard to predict. As the example of Iceland shows, this will have an important, and sometimes contraintuitively, effect on the infrastructure asset class. Climate change is a strict energy issue and other categories of infrastructures still work as usual, as if they were not affected. The investors in infrastructure must ensure that they do not think about it in a siloed way. And investors should also think about how they can better incorporate distributed, flexible and resilient approaches into their strategy and allocation.
