EDHECinfra Paper
It’s Getting Physical

Some investors in infrastructure could lose more than half of their portfolio to physical climate risks by 2050.

This research note shows that the physical risks created by climate change are not limited to a distant future for investors in infrastructure, some of whom could well lose more than 50%of the value of their portfolio to physical climate risk before 2050 in the event of runaway climate change. Moreover, the average investor will also lose twice as much to extreme weather, mostly in OECD countries, compared to a low carbon scenario.

The numbers are significant: over the past two decades, institutional investors have increas-ingly allocated capital to private, mostly unlisted, infrastructure companies like toll roads, airports, power plants and pipelines. infraMetrics tracks a universe representing approximately USD4.1 trillion of enterprise value and USD2.2 trillion of market capitalisation at current market prices in 25 key markets.

Floods and storms are the most common types of climate-related events, but extreme temper-ature events are also on the rise as global warming increasing their frequency and intensity. If climate change speeds up, these trends are also forecast to become more frequent and more severe.nUsing a very granular database of asset-level physical risk estimates and financial data, we find that the impact of runaway Climate Change on the value of infrastructure investments before 2050 is significant. We also find that if no serious measures are taken, financial losses from physical risk (which are never zero) would be twice as high than in a low carbon scenario, for all investors.

In this note, we describe our approach to measure baseline physical risks (today) and how physical risks would materialise from that baseline in different climate scenarios in terms of their impact on cash flows and discount rates at the asset level. We also look at how physical risks, despite being asset specific, are not easily diver-sified for most investors, some of whom could have a high concentration of such risks in their portfolios.

Our research shows that the cost of physical risks within the “Current Policies” scenario repre-sents, on average, 4.4% of the total NAV of the assets in our reference database by 2050. The average maximum loss is -27% and we see that the effect of extreme climate events is negative across all sectors, impacting the NAV of transport (-10% on average with a maximum of -97%) and the energy and water resources sector (-7% on average, with a maximum of -40%).

Moreover, most investors in infrastructure hold a few individual assets and therefore have potentially high concentration in physical risks. Investors who hold direct stakes in infrastructure assets, be they fund managers or asset owners, usually have fewer than 20 investments. The average asset owner typically has fewer than 10 direct stakes. As such, when an investor finds themselves exposed to the riskiest assets in the same portfolio, losses can mount to 27% in the orderly transition scenario and to 54% in the “Hot House” scenario.

2050 is still 30 years away and past the investment horizon of investment funds, but many are now exposed to much longer-term investments. Moreover, the next generation of funds will pick up the same assets.

Climate change risks are already material for a number of investors in infrastructure assets even if these are located in developed economies. This challenges the intuition of many investors that these risks would impact first and foremost the poorer populations of the global south. Instead, the reverse is true: more value will be destroyed in places where more valuable assets exist. It should also be noted that our loss estimates can be considered very conservative in the light of the very limited impact of physical risk on the economy implied by the scenario used by the Network for Greening of the Financial System (NGFS). A ‘too little, too late’ scenario, by which emissions keep rising and climate change happens faster, would show a rapidly decreasing value of infrastructure assets due to their loss of future revenues, itself the result of a less active economy, mostly due to chronic heat.

This focus on the materiality of the physical risks allows climate risk to be seen not solely as the result of a public policy decision but as a reality that, without action from all stakeholders, including governments, will have a very signif-icant impact on the value of investments.

EDHEC Infrastructure & Private Assets Institute
2023 (August)