LSEG Insights

What Canada can teach investors about underpriced physical climate risk

Claire Hugo

Senior Analyst, Sustainable Investment Research

Fannie Serrano

Sovereign Climate Analyst - Sustainable Investment Research

Around the world, 2023 saw climate- and weather-related records tumble. As the human and economic costs of climate change continue to rise, investors are reconsidering their exposure to the physical impacts of global warming – and are braced for rising transition risks as governments are forced to respond.

This echoes the findings of the latest edition of our Net Zero Atlas, which examines G20 countries’ climate targets, mitigation strategies and physical risk exposures. For the first time, the report systematically assesses national adaptation plans of G20 countries. Although 19 G20 governments have published strategies or plans for adaptation, few investors are yet systematically examining them.

These adaptation strategies will become critical as climate change exacerbates physical risks – even in a 1.5-degree scenario. But despite these intensifying impacts, the report shows that adaptation planning is in its infancy. Investors are taking note. Heatwaves, wildfires and floods become more common, and countries face rising costs both from extreme weather and from efforts to adapt to a changing climate.

Canada: facing climate impacts

Last year’s wildfire season in Canada illustrates this point. Temperature anomalies, 10-15°C above normal during Spring 2023 in northern Canada, were a key contributing factor to an unusually long wildfire season lasting from May to September.

Annual area burnt in Canada (Mha)

In its worst wildfire season on record, 18.5 million hectares of Canada’s forests burned – an area twice the size of Portugal, and some six times the 10-year average. Different from the deadly wildfires in Hawaii that cost around a hundred lives, it caused few human casualties. Nonetheless the impact was devastating. Tens of thousands of people were evacuated, including 70% of the population of the Northern Territories. Timber production, tourism and oil and gas production were all affected, with an early analysis of the fires' economic impact estimated at a 0.3-0.6 percentage point hit to the country’s third-quarter GDP. The health costs are potentially enormous: one researcher estimated costs of C$1.28bn related to pollution from forest fires over four days in June, in just one Canadian province.

The impacts could be felt across national boundaries, with New York blanketed in an orange haze from the wildfire smoke in June. For three days, the city’s air pollution reached levels considered as “hazardous”, impacting the health of people hundreds of miles away from the fires.

While exceptional, such wildfires could become less so as the world continues to warm. This also demonstrate the unnerving feedback loops that climate change can trigger. The 2023 fires sent more than 1.7Gt of carbon dioxide (CO2) into the atmosphere, nearly three times Canada’s average annual emissions, contributing further to accelerate atmospheric warning. The growing wildfires have already turned the massive Canadian boreal forests from a carbon sink (which sequesters CO2) into a source of emissions.

Canada’s wildfires are just one example of how physical risk is not only an issue for smaller developing countries or island states but will also increasingly affect G20 countries. As our Net Zero Atlas report shows, Brazil’s agricultural sector is vulnerable to drought. China’s megacities are at risk from extreme temperatures, affecting labour productivity and human health. Germany faces more large-scale floods. Some regions in India are now exposed to temperature episodes that test lethal levels. The United States could see significant movement of people away from southern and western coasts in the face of increasingly intense and frequent hurricanes. 

Despite these risks, efforts to mitigate climate change are not in line with globally agreed goals. The report uses Implied Temperature Rise calculations to assess the alignment of countries’ climate change policies with the global effort to hold the average temperature rise to below 1.5°C. It finds that G20 countries’ plans to reduce emissions by 2030 are collectively aligned with 2.6°C of warming (see the Net Zero Atlas report for the full methodology). This is only marginally smaller than the 2.7°C alignment calculated in last year's report.

Factoring this into decision making is an opportunity for investors. Physical impacts of a changing climate could lead policymakers around the world to redouble efforts to reign in global emissions. As large-scale adaptation finance emerges, it will create demand for trillions in both public and private investments over the coming decades.

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