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Welcome to the quarterly Schroders Green Macro Newsletter, where we present recent news, internal and external research on topics covering the economic impact of climate change, green energy transition, and natural capital.
In this newsletter we focus on rising physical risks and their impact on the investment and the economic outlook. We examine the implications of a warmer world given that many regions are set to see physical risks intensifying over the coming months. Recent floods in Brazil and Europe, droughts in America, extreme heat across Africa and Asia provide evidence that the economic impact of climate change can no longer be ignored.
In the news
World Meteorological Organization sounds the Red Alert
According to the latest report released by the World Meteorological Organization (WMO), there have been significant and alarming developments in various climate indicators. The report highlights that numerous records have been broken in relation to greenhouse gas levels, surface temperatures, ocean heat and acidification, sea level rise, Antarctic Sea ice cover, and glacier retreat.
2023 was the warmest year on record and the upward trend has persisted into 2024, with May marking the twelfth consecutive month of record warmth based on historical data. Global warming is now above the 1.5 °C target agreed in Paris in 2015. At the regional level, Europe has been warming twice as fast as the global average, becoming the fastest-warming continent, registering a record number of days with extreme heat stress in 2023.
Our view: The occurrence of monthly breaches of 1.5°C does not imply that the world has failed to meet the temperature target set by the Paris Agreement. The agreement's objective is to limit long-term temperature increases over a period of decades, rather than focusing on short-term monthly fluctuations. However, levels of greenhouse gases continue to climb at steep rates, meaning that a more persistent increase in global warming is likely, highlighting how urgent the need to prepare for a warmer world is. Until we reach net zero, the climate will continue to warm, breaking records and producing even more extreme weather events.
Global warming to intensify pressures on inflation
Changes in temperature and rainfall patterns severely impact agricultural output, with important implications for global food supply and prices. A recent empirical study by the European Central Bank shows that higher temperatures increase global food and headline inflation persistently over 12 months. This means that the initial spike in inflation is not offset by a decline in prices over the following year. The study finds that persistent upward pressures on annual food inflation of 1-3 percentage points per year as a result of higher projected temperatures could occur from 2035. These impacts vary across regions with generally larger effects expected in the global south.
Our view: Global warming is having a persistent impact on inflation via higher food prices, changing inflation dynamics, with important implications for future monetary policy. As “climateflation” becomes more relevant, challenges for traditional monetary policy frameworks will rise. If climate shocks can no longer be considered temporary, central banks will have to start taking global warming into account when making monetary policy decisions.
Climate damages are rising in the US economy – more to come
In 2023, the US witnessed a significant increase in climate and weather events, setting new records. These events had a widespread impact on people and infrastructure in the country, leading to the highest number of billion-dollar disasters ever recorded in a single calendar year. The number and cost of weather-related disasters have increased dramatically over the past four decades, with tropical cyclones having the most damaging impact on the economy. The upcoming Atlantic hurricane season is expected to have above-normal activity due to record warm ocean temperatures. Early seasonal forecasts from Colorado State University suggest Accumulated Cyclone Energy (ACE) – a measure of Hurricane season strength – of 210.1, a level which is 90% above the 1980-2023 average of 110 and 45% above the 2023 level. Recent analysis from the US Energy Information Agency (EIA) expects that the oil and natural gas industry is particularly at risk, as the concentration of oil refineries along the Gulf Coast makes them vulnerable to hurricane activity.
Our view: Evidence that climate change is having a toll on the economy is mounting. Extreme weather events cause direct economic losses through infrastructure damage, disruptions in labour, and losses in property values and agricultural output. Over the past decade, the total cost of climate disasters amounted to more than 1.2$ trillion to the US economy, representing 5% of US GDP. This highlights the importance of prompt action by policy makers to mitigate the risks associated with climate change. Higher investment in adaptation to build a more resilient economic system will also be critical to minimise disruptions while reducing the economic costs associated with climate-related disasters.
Droughts hitting hydropower generation in the US
Recent data for the US provide important evidence regarding the influence of droughts on energy supply. Analysis from the US EIA highlights that western US hydropower generation fell to a 22-year low last year due to severe drought conditions. The two largest hydroelectric reservoirs in the US, Lake Mead and Lake Powell, which provide water and electricity to millions, are at risk of reaching “dead pool status”. This occurs when the water level in the dams falls so low it can no longer flow downstream and power the hydroelectric power stations. The US EIA expects hydro production to continue to fall this year, estimating a drop of 12% from the previous year, with important implications for the energy system in the region. Hydro is also under pressure on a global basis. See external economic sustainability research section later on in the newsletter for more details.
Our view: The drop in hydropower provides further clear evidence of how climate change impacts the economy. Loss in electricity output could lead higher energy prices, at a time in which the US economy is still battling with above-target inflation. Switching to gas to replace the loss of hydroelectric output is set to worsen the climate crisis as it leads to higher carbon emissions, underscoring the importance to incentivise renewable energy production to help meet demand.
Climate change and the maritime sector
Due to climate-induced droughts, the Panama Canal Authority has been forced to restrict the number of daily transits since November 2023. Amid low water levels, transits in May were down by more than 30% compared to their 2021 peaks. The Panama Canal plays an important role in global trade dynamics, being a crucial trade route linking North Asia with the East and Gulf Coasts of the US. Approximately 14% of seaborne trade entering and exiting the US economy relies on this important waterway. Several Latin American countries are also highly dependent on the canal for their imports and exports.
Too heavy rainfall can also create disruptions to trade dynamics: high water levels on the Rhine River, a key artery that connects industrial centres and key trading hubs in Europe, forced the southern section to close for cargo ships due to safety concerns.
Our view: Water is vital to global trade with 90% of products moving around the world via oceans and waterways. Disruptions in key trading routes can have significant consequences for global trade. This can mean higher shipping costs and delays in transportation of goods, impacting industries that rely on timely delivery of raw materials or finished products. Delays can also result in higher inventory holding costs and potential production slowdowns. These increased costs can be passed on to consumers, leading to higher inflation, as further evidence of climateflation.
Our economic sustainability publications
Are we underestimating the impact of climate change? – June 2024
- Climate scientists are forecasting things will get a lot worse a lot sooner than many mainstream economic models predict.
There are growing concerns that current economics models, including those we use in our own 30-year return forecasts, may be underestimating the risks of climate change. This is because they only focus on the impact of global average surface temperatures on economic activity.
We introduce a new damage function that allows us to consider factors like tempeature volatility and extreme weather events - giving us a clearer picture of the shape of temperature distribution beyond the mean.
External economic sustainability research
Global Electricity Review 2024 - EMBER
- Due to severe drought conditions, hydropower generation experienced a significant decline in 2023, reaching its lowest level in the past five years.
The hydro deficit played a significant role in the global surge of fossil generation, as coal generation rose to compensate for the loss in hydropower, resulting in a 1% uptick in global power sector emissions.
Among the countries affected by droughts, which also experienced above-average demand growth due to heatwaves and increased cooling requirements, four economies stood out. China, with a substantial increase of 319 terawatt hours (TWh) (+5.9%), led the pack, followed by India (+100 TWh, +7.3%), Vietnam (+24 TWh, +23%), and Mexico (+12 TWh, +55%).
As global warming intensifies, we are likely to see more frequent droughts over the next decade, dampening production in the energy sector. This highlights the importance of speeding up the energy transition, as wind and solar can mitigate the loss in hydro, without compromising climate commitments.
Europe is not prepared for rapidly growing climate risks – European Environment Agency, 2024
- According to the first European Climate Risk Assessment, even under optimistic global warming scenarios, extreme heat, drought, wildfires, and flooding are set to intensify in Europe. This threatens the continent’s energy and food security, ecosystems, infrastructure, water resources and financial stability.
Southern Europe and low-lying coastal regions and European Union’s outermost regions are hotspots for multiple climate risks. It is estimated that economic losses from coastal floods alone could exceed €1 tn per year.
The assessment indicates that Europe's policies and actions to adapt are not keeping up with the rapidly increasing risk. Higher investment in preparing for a warmer world is needed, while supporting the expansion of green energy technology critical to limiting global warming.
What’s coming up
A new climate finance goal – from billions to trillions
COP29 has been dubbed the “Finance COP” as its main objective is to set a “new collective quantified goal” for climate finance. The road to COP29 will set more ambitious climate targets and will ensure that those targets translate into concrete and transparent actions that drive real change.
In 2009, developed countries made a commitment to transfer $100 bn annually to poorer nations starting from 2020. This financial support was aimed at assisting these countries in dealing with the escalating costs of climate disasters. This objective was met with a two-year delay in 2022. Much more investment is needed to reach net zero. Studies show that global climate finance of $9 tn a year is required by 2030.
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