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Why it could be smart to bet on climate change

The derivatives market has existed long enough to indicate that betting against the consensus climate models doesn't pay.

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Traders who specialise in weather derivatives have to be more attuned than other finance professionals to what's really going on with the planet's climate.

A TIPPING point for governments in aligning their policies with the science of climate change won't be brought about by students demonstrating. It will come from a shift in investor sentiment.

Data shows that even if investors don't flag environmental cataclysm as a major concern or even express scepticism about it, there are some who bet consistently and successfully on the scientists being right.

Conservatives are on the whole still sceptical about climate change, particularly in the US. Many investors are conservative. As one finance professional told Uppsala University researcher Brett Christophers for a recently published study of institutional investor attitudes towards climate change, oil and gas analysts are generally not building climate risk into their models. There is zero chance that any of these groups are going to divest from oil or gas companies any time soon. You still get investors in the US who don't believe in climate change. These guys honestly couldn't give a stuff.

Dr Christophers' study, based on interviews with executives at investment firms with more than US$1 billion under management, showed that these financiers weren't interested in selling their fossil fuel assets, didn't see productive ways of incorporating climate change into their models and, if they did see it as a risk, then saw it as merely one of many.

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That led him to conclude that environmental lobbyists and progressive politicians wouldn't sway the investment crowd until it saw a clear financial return in adjusting for climate change. As things stand, sustainability plays a minor role in investment decisions, as was made clear in a 2018 study by asset management firm Schroders Plc.

The "show me the money" attitude is natural, but another recent paper highlights at least one part of the financial community that's taking climate science seriously.

Wolfram Schlenker and Charles Taylor from Columbia University looked at the US market in exchange-traded weather derivatives for 2002 through 2018, comparing the way investors priced temperature expectations for a particular month with climate scientists' temperature forecasts based on the impact of human activity.

They found something approaching full agreement between the traders and the white coats. They wrote: "The observed annual trend in futures prices shows that the supposedly efficient financial markets agree that the climate is warming. At least so far, climate models have been very accurate in predicting the average warming trend that's been observed across the US. When money is on the line, it is hard to find parties willing to bet against the scientific consensus."

That's probably an over-optimistic conclusion. The market for weather ETFs and options is small and illiquid. Billions of dollars of such derivatives are traded over the counter - they are used mainly in the reinsurance business, given that about 30 per cent of the US economy is estimated to be directly affected by the weather.

But weather derivatives is still a niche area for major investors. Traders who specialise in these instruments have to be more attuned than other finance professionals to what's really going on with the planet's climate. There's no reason for climate sceptics to go out of their way and make contrarian bets on barely liquid contracts.

Nevertheless, investors should pay more attention to what's going on with weather derivative pricing. The market has existed long enough to make it clear that betting against the consensus climate models doesn't pay. This should have broader implications. If the derivatives market is bearing out these projections, divesting from fossil fuel stocks and looking for more sustainable opportunities should be viewed as reasonable strategies. WP