Unaccounted Risks of Extreme Weather Events Could Lead to Economic Crash

A study reveals that despite increased awareness among investors, climate risks from extreme weather events remain unaccounted for in financial markets. Lack of knowledge of this risk could lead to an economic recession in the future. Another study also revealed that extreme hot weather leads to a decline of stock values, illustrating that while climate-related risks may be recognized in some local businesses, it is also underpriced.

The study, "Energy Finance Must Account for Extreme Weather Risk," was authored by Paul Griffin, an accounting professor at the UC Davis Graduate School of Management. Griffin warns that if the markets do not improve its accounting for climate, it could lead to recession.

He cited instances like excessive high temperatures in the US and Europe last summer disrupted agriculture, harm human health, and economic growth. Pacific Gas and Electric Company (PG&E), an American Investor-Owned Utility which provides natural gas and electricity to approximately 5.2.million households in California had to shut down its delivery during fires and weather conditions that could trigger a fire.

Extreme weather event also threatens other services such as water delivery and transportation were also disrupted consequently affecting businesses, families, cities, and region, and putting a strain on local and broader economies.

Yet despite the obvious risks of extreme weather events to the business, investors and asset managers barely relate physical climate risks to company market valuations. Reports of the value of lost properties are most often reported, but there is limited information on how business is doing. These threats to business could disrupt the entire economic system, Griffin noted in his article.

A striking example of which is in the United States, U.S. oil refineries are located on areas that are either exposed to sea-level rise and intense storms, constant flooding, or in the case of energy company's transmission lines, are in arid areas that are vulnerable to wildfires.

Given these, risk factors such as climate-vulnerable location, insurance coverage on such risks, costs of litigations, sanctions and even loss of business from property destroyed need to be assessed. The climate litigation risk already included in the prices of energy stock would prove insufficient.

Weather-related climate risks are recognized but are underpriced

A separate study from the University of California, Davis, revealed that episodes of extremely hot weather in the South and Southeast America decreased the market value at an average of more than $17 million a month after incidences of heat events.

The study, which aimed to examine and quantify the impact of physical climate risk on the corporate market, revealed that equity markets experienced a 0.42 percent loss in the first 20 days after the beginning of a heatwave and about 0.68 percent in longer heatwaves. Investor losses increased to 1.38 percent.

Firms most exposed to the heat lost 1 to 2 percent of their market value. The study also revealed of more negative response from investors in the most recent years of the study period and an increase in the volatility of returns after the first day of a heat event. This result led researchers to conclude that although weather-related climate risk are being incorporated by investors in pricing future equity returns, assessment of climate-risk is still underpriced.

Paul Griffin, who is also a part of this study team warned that continued underpricing of extreme weather climate risk could have devastating future market consequences.