«More and more assets have a terminal value of zero»

Spencer Glendon warns about the effect of climate change. Markets aren't pricing the risks correctly. Investors need to rethink fundamental assumptions.

Spencer Glendon does not paint a rosy picture. According to the climate specialist, Florida is heading into a catastrophe. Not only homeowners on the Keys will be affected, but owners of bonds as well. But the consequences of climate change are not only evident in the Sunshine State. Airlines and oil companies also have to adjust to a new world, according to Glendon – as do all investors.

Mr. Glendon, the glaciers are melting, the sea level is rising, and it is getting hotter. What does climate change mean for investors?
It means that many of the assumptions that investors have are going to be violated.

Like what?
For example, that all 50 states in the US are similar to each other and can be treated in similar ways.

Can’t they?
Take Florida for example. Florida is built on porous limestone – coral reefs and shells that have been crushed over time. Due to the rising sea level, the saltwater penetrates the porous rock and salines the freshwater supply. At the same time, the rising sea pushes water into the sewer system. That’s why Miami is flooded by the sewers and not by the beach.

What does this mean for Florida?
Parts of Florida will have financial difficulties. People today still take out mortgages with a maturity of thirty years. Those mortgages are contingent on being able to get insurance. But insurance is only offered one year at a time. So you have annual insurance as a condition for 30-year mortgages. Insurance can stop anytime. As soon as the insurance stops, the mortgage is in default.

Does it affect the municipalities?
At present, all of them seem to be able to borrow fine. Nobody’s asking about what’s going to happen over the next ten years. Rating agencies for example did not ask Miami a single question about climate change when Miami issued a bond to build a convention center. Nobody asked on the call. Nobody asked on the roadshow. All of the plans for Florida are based on the idea that the population of Florida will grow. If growth slows down enough, Florida will go bust, because all of the fiscal projections will be wrong. At the same time, they need to invest in infrastructure. In Miami Beach, they may be able to do it, because people are rich, but every other place in Florida is not rich. The non-rich places are going to have terrible fiscal problems at the same time as the rest of the country stops lending money to them.

How soon will this take place?
This shouldn’t take very long. The financial markets will close for the municipalities. When that happens, how do you get a mortgage in a place where the city can’t borrow money?

Are other states better prepared for rising ocean levels?
The government of North Carolina has made it illegal to enact building codes for planning using climate science. All assessments have to be based on past data only. So you can ask yourself if the rest of the country should be underwriting North Carolina’s infrastructure when they’ve done nothing to prepare themselves, and they willfully have chosen not to use a reliable source.

Are other states also ignoring science?
The governor of Florida made it a punishable offense to use the term climate change in the Floridian government. Many cities in Florida now have a plan because they have to have a plan. They don’t have a choice. There are floodings every day. To say that it’s not happening is to deny reality. But the state government continues to behave as if it’s not happening and the federal government and even Florida’s representatives are having a tough time admitting that it’s happening.

What about the plan of the city of New York to expand Manhattan to protect itself against rising tides. Will it help?
Sure it will help. New York City should be applauded. It has a plan, and the plan is informed by science. But one thing to remember is: it’s New York City’s plan. It’s not the nation’s plan.

Are markets aware of those risks?
Investors are totally unaware of those risks.

How will climate change affect markets?
If the world becomes uncertain, nobody will lend money for 30 years or more. Long-term interest rates include inflation risk, but they don’t include a climate risk nor an instability risk.

Where else do you see misperceptions in the market?
Take India for example. People accept that Europe and Japan won’t grow and that the US will grow slowly, but they still expect a high global growth rate because India is going to expand by 7% forever. But India is already losing working days due to heat. Over the next ten years, parts of India will be uninhabitable because of the temperatures. It will be too hot and humid for the body to effectively cool itself by sweating.

What needs to be done?
We need to have zero emissions. It’s really simple. It may sound hard, but it’s straightforward. We understand it, and the only variable that matters is one that we control. We couldn’t be luckier. And it might cost around 3% of GDP.

What do investors need to do?
They need to beg for regulation.

Beg for regulation?
Yes. If you think that markets are a great idea, then you should want them regulated so that they continue to exist. Because if we wind up in a world of climate-induced violence, it won’t be a market economy. Capitalism is not the most obvious outcome when you have a catastrophe.

What regulation are you talking about?
We need to find all kinds of ways to get to zero emissions, for example have better building codes, and produce less waste. You could simply have manufacturers being held responsible for all the stuff they produce. In the 1970s there were protesters in the US and Congressional hearings about how much garbage there was. And it was quite clear that manufacturers were going to have to take back their packaging. But then they went on a big lobbying campaign to turn it into a problem of the consumer. It’s challenging to see markets embrace regulation. Business doesn’t really care if you change the rules. Business will adapt. Markets are how we currently organize a lot of things. But the longer we wait, the more we’re going to wind up with forms that are much more authoritarian.

What assets are most affected by climate change?
The director of a superannuation fund from Australia asked me how I thought about their investment in Qantas. I said I’m worried about the investment in airlines because of politics. When you have a substantial carbon tax, air travel will go back to being only for the rich. Australians have internalized the idea that everybody gets to leave Australia all the time. And what’s going to happen in the future is that only the wealthy Australians are going to get to be able to pay for their fossil fuel supply. So it’s not the politics of burning carbon that bothers me. It’s the politics of excluding most people from the privilege of leaving Australia. Maybe a good investment cash-wise, but how does it look politically?

That doesn’t sound well for airlines.
Europe is full of all of these cheap airlines. Those are all going to go away.

How soon?
I don’t know what the next year or the next two years or five years are going to be. But there are more and more assets that have a terminal value of zero. And having a benchmark investment and a set allocation – including something that eventually is going to zero – is probably a bad policy.

Like what assets?
At some point, oil companies are going to be worth zero. Because we will use far less oil or we won’t be using oil at all. And the last people to exit the oil market won’t be public companies. It will be government entities, like the one from Saudi Arabia. They have the cheapest oil. You don’t need an oil price of zero to get oil companies going out of business.

Do you expect benchmarks to change?
It doesn’t make much sense, that a pension fund would have a dedicated allocation to an industry that has a terminal value of zero. That’s a norm that could change in finance that would change the availability of capital. Most of the money that’s invested is passive.

How soon might these benchmark-changes take place?
It might happen in a couple of years.

What other assets have a terminal value of zero?
Coastal real estate, for example. Its value might be fine for the next 20 years. But if the terminal value is zero, buying a house in Florida with a mortgage of twenty years doesn’t make much sense. It might be better to rent. Its value is on a pathway to zero. Will it take 20 years or 50? That’s not clear. I think it’s probably faster than most people think.