Weather events have a material impact on corporate earnings. How can this risk be managed?
Extreme weather is common around the world. Research from the European Academies' Science Advisory Council (EASAC) shows the number of floods and other hydrological events have quadrupled since 1980 and doubled since 2014.
This rise comes at a large economic cost. EASAC’s research reveals that economic losses due to thunderstorms in the US doubled from US$10bn in 1980 to US$20bn in 2015, for example.
Elsewhere, 2013 flooding in Central Europe cost the countries impacted US$18bn in total. Moody’s expects that losses from the devastation caused by Hurricane Irma and Hurricane Harvey in 2017 will exceed US$150bn.
There is clear evidence that extreme weather negatively impacts corporates. In fact, new research by S&P Global Ratings suggests that climate risk and severe weather have a meaningful impact on corporate earnings.
S&P’s research, conducted in partnership with Resilience Economies, found that 73 companies (15%) on the S&P 500 publicly disclosed an effect on earnings from weather events in 2017. The large majority reported a negative impact.
However, only 18 quantified the effect. Those that did say weather had a significant negative impact on their earnings reported an average materiality of 6%.
Complexity is highlighted as the main reason so few companies quantify the risk. S&P cites the airline industry as an example, where the cost of delays due to weather depends on location, time, class of aircraft, and the value of passenger time.
S&P expects the number of companies reporting on and quantifying the impact of weather events to increase. This is because investors are increasingly interested in understanding what it means for their holdings.
Also, initiatives such as the Financial Stability Board's Taskforce on Climate Related Financial Disclosures (TCFD) are looking to build a framework on climate-related risks to help increase understanding and to standardise disclosures. More than 250 companies have signed up to support the TCFD's recommendations so far.
Reporting on and quantifying climate risk will have far-reaching consequences for companies. For instance, S&P indicates that it may lead institutional investors to build climate risk factors into their portfolio selection processes, thereby placing greater emphasis on climate when directing investments.
Climate may also have implications on ratings. According to S&P, 65% of the 43 rating actions it took between July 2015 to August 2017 where climate factor was a key driver were downgrades. Further contributory factors could be that more companies are becoming vulnerable to climate change and severe weather events, but few are proactively mitigating the effects on either earnings or credit ratings.