DAVIS, Calif. — The next Great Recession could come on the heels of an extreme weather event, due to the fact that the risk of disruptive physical weather is not accounted for in financial markets. Researchers from the University of California, Davis warn that the worldwide financial market needs to plan for weather risks or face extreme correction.
Without accounting for this risk, average energy investors have no way of knowing if the next extreme weather event will start a sudden market correction.
“If the market doesn’t do a better job of accounting for climate, we could have a recession — the likes of which we’ve never seen before,” says lead author Paul Griffin, of the UC Davis Graduate School of Management, in a university release.
Griffin’s research indicates that too much “unpriced risk” makes the energy market uncertain.
“Unpriced risk was the main cause of the Great Recession in 2007-2008,” Griffin says. “Right now, energy companies shoulder much of that risk. The market needs to better assess risk, and factor a risk of extreme weather into securities prices.”
For example, the extremely high temperatures in the United States and Europe last summer caused serious damage; disrupting agriculture markets, harming or killing people, and stunting economic growth. Extreme heat can also disrupt energy delivery, as seen in Northern California, when a power company shut down their power grid while huge wildfires raged this year.
Extreme weather can also shut down water delivery services and transportation, which negatively affects businesses, families, and entire communities. This disruption also strains local and regional economies. Some regions never recover.
“Despite these obvious risks, investors and asset managers have been conspicuously slow to connect physical climate risk to company market valuations,” the study reads. “Loss of property is what grabs all the headlines, but how are businesses coping? Threats to businesses could disrupt the entire economic system.”
Energy markets are particularly susceptible to disruption because of where energy infrastructure is located in the United States. U.S. oil refineries line the Gulf Coast, which is exposed to rising sea levels and extreme storms. Refineries in Northern California are exposed to coastal flooding. Also, most energy transmission infrastructure is located in dry, arid areas that are vulnerable to wildfires. Energy companies are insured against infrastructure damage, but it’s unclear if their policies will cover massive, sudden damage because of weather events.
Climate risk models developed by some firms help predict future weather conditions based on the rate of climate change, but as the weather becomes more extreme, it becomes harder to predict.
The study is published in the journal Nature Energy.