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Investors have a vital role to play in managing climate change risk for infrastructure and building long-term climate resilience. To make a real impact, they need to tap different types of technology and financial innovation.
Climate change is an existential threat to the long-term resilience of the energy, transport, communications and social infrastructure that supports social and economic activity. In the past, the owners and financers of such infrastructure could assume its operation in relatively stable climate conditions where severe weather events occur but follow predictable patterns. That assumption is no longer valid.
As a result, strategic and financial investors—key actors in infrastructure development — are grappling with the complexity of managing climate change risk for such assets, which typically have a long-term investment horizon. A key part of the solution is ensuring infrastructure assets have physical and financial resilience built in — and this is where investors need help from new technologies and from more innovative risk transfer solutions.
Climate change is already exacting a substantial economic cost to societies. Aon estimates that weather disasters attributable to atmospheric change (such as tropical cyclones, flooding, drought and wildfires) caused US$268bn of economic losses globally in 2020, 10% above 21st century average . In the 21st century the annual losses have been rising inexorably, with damage from cyclones and flooding increasing at an accelerated pace (see chart).
Projecting future losses is complex but, says David Bowcott, global director – growth, innovation & insight at Aon’s global construction & infrastructure group, there is little doubt about their upward trajectory, given the near certainty that temperatures will continue rising for the foreseeable future under even the most benign of scenarios.
Global cumulative economic loss by peril, 2000-2020
Note: The figures on the right of the graph are the cumulative totals of losses from 2000 onward. Source: Aon, Weather, Climate & Catastrophe Insight — 2020 Annual Report.
Electricity networks, roads, ports, fibre-optic cables and other infrastructure assets are susceptible to damage in extreme weather events just as residential and commercial buildings are. Degradation — to roads and railways, for example, from extreme heat or rising water levels — also reduces the availability of such assets and negatively impacts on the returns for the investors.
Beyond the assets themselves, damage to such infrastructure has added social costs when, for example, gas or electricity supply is interrupted, roads buckle, Internet traffic slows or stops, and hospitals or schools shut.
Whether through sudden, catastrophic damage or gradual degradation, the costs incurred by investors in infrastructure can be considerable, in the form of higher-than-expected capex or opex. There is also a threat to the asset’s future revenue generation, and thus to the anticipated returns for investors. These are additionally put at risk if an asset, such as a gas distribution network, is itself contributing to climate change and needs to be retired earlier than planned. “No investor wants to be stuck with a stranded asset,” says Ginette Borduas, head of ESG and sustainability at Meridiam, a Paris-based investment and asset manager.
For all these reasons, says Carmela Mondino, head of ESG and sustainability at Partners Group, a global private markets investment manager, “we need to do what we can to mitigate the damage to, or improve the climate impact of, our assets.”
The above explains why investors are increasingly looking at climate change through a risk management lens. “We analyse investment opportunities to assess how we manage ESG (environmental, social, governance) risks and how we maximise each project’s contribution to the UN Sustainable Development Goals,” says Ms Borduas. “We also want to influence how each asset is designed and made more resilient.”
Building resilience into infrastructure assets is indeed the most effective means of managing climate change risk, according to Carol Lemmens, global advisory services leader at Arup, a British engineering services firm. Such resilience can have physical dimensions and financial dimensions, both of which protect investors. Technology innovation is integral to building both forms of resilience.
“It all revolves around data,” says Mr Lemmens. “We increasingly have infrastructure that gives us insights, which help us monitor it and steer it in the right direction.” Smart sensors allied with advanced data analytics provide such insights, showing engineers as well as investors and insurers how assets perform under extreme conditions.
Such capabilities, says Mr Bowcott, are giving rise to the ‘digital twin’. This is a computer model that, fed by continuous data feeds, mirrors the as-built asset. “It is a living digital capture of the asset that shows how different components of it are operating under different weather conditions,” he says. The twin simulates how weaknesses are developing or are likely to develop, allowing remedial efforts to be undertaken to address them.
The same data and technology-driven capabilities are enabling investors to model infrastructure performance, both in the design stage via design simulations and during the asset’s life via tools like IoT sensors, with a higher level of certainty than ever before. Such capabilities can also be used to build more financial resilience into infrastructure projects, an effort in which insurance has a role to play.
Investors in infrastructure are looking to the insurance market to help transfer some of the financial risk relating to climate change. As part of this, says Ms Mondino, insurers need to be able to creatively price the risk of extreme weather events.
The convergence of digital twin technology and advanced modelling based on machine learning, believes Mr Bowcott, is making this possible through informed underwriting. Already used in retail forms of insurance to adjust premiums, he expects insurers to use this capability to “underwrite projects more thoughtfully”. By allowing insurers to reward with lower premiums those projects having greater physical resilience, it will give investors greater confidence in investing for a longer term, says Mr Bowcott.
Innovation in technology is also creating potential opportunities for investors in the battle against climate change. Some revolve around the emergence of new classes of infrastructure. For example, as the adoption of electric vehicles grows, significant investment is required in charging infrastructure to support public buses, commercial fleets and private transport. Others relate to the de-carbonisation of energy, such as gas-to-grid, which involves injecting biomethane gas into existing gas networks. “We have to start thinking about what to do with these pipelines once natural gas is phased out,” says Ms Mondino.
Mr Lemmens foresees investment opportunities emerging around the conversion of gas infrastructure to transport hydrogen. “North Sea oil rigs, for example, which are otherwise likely to become stranded assets, could be converted to support green hydrogen production,” he says. “Existing rig-to-shore pipelines could transport the hydrogen, and gas distribution networks could bring it into homes for applications such as cooking and heating.”
“In the meantime, investors need to access all available tools to build resilience into existing and future infrastructure,” says Charlie Garrood, Aon’s EMEA head of infrastructure for M&A and transaction solutions. “This will enable them to determine their susceptibility to climate change, analyse its longer-term financial impact across their portfolios and allow them to mitigate against such impact with a clear risk management plan. This will ultimately help protect their returns whilst enabling their assets to reliably support social and economic activity in the face of the disruptive effects of climate change.”