Getting physical: assessing climate risks

A series of recent extreme weather events — from hurricanes and wildfires in the U.S. to heat waves in Europe and floods in Japan — have put a spotlight on climate-related risks. We offer a new set of tools for assessing such risks to portfolios.

Mapping the damage
Estimated climate-related impact on U.S. regional GDP, 2060-2080

Estimated climate-related impact on U.S. regional GDP, 2060-2080

Sources: BlackRock Investment Institute, with data from Rhodium Group, March 2019. Notes: The map shows the projected GDP impact in 2060-2080 on U.S. metropolitan areas under a “no climate action” scenario. Climate changes are measured relative to a 1980 baseline. The analysis includes the effect of changes in crime and mortality rates, labor productivity, heating and cooling demand, agricultural productivity for bulk commodity crops, and expected annual losses from coastal storms. It accounts for correlations across these variables and through time — and excludes a number of difficult to measure variables such as migration and inland flooding. See Rhodium Group’s March 2019 paper Clear, Present and Underpriced: The Physical Risks of Climate Change for further details on its methodology. Forward-looking estimates may not come to pass.

Advances in climate and data science now allow us to gauge the likely overall economic impact of climate-related risks on a localized basis. To illustrate, the heat map above shows that 58% of U.S. metro areas will likely suffer annualized GDP losses of 1% or more by 2060-2080 under a “no climate action” scenario. Among the likely losers: Arizona, the Gulf Coast region, and coastal Florida.

Here are our key findings:

  • We show how physical climate risks vary greatly by region, drawing on the latest granular climate modeling and big data techniques. We focus on three sectors with long-dated assets that can be located with precision: U.S. municipal bonds, commercial mortgage-backed securities (CMBS) and electric utilities.
  • Extreme weather events pose growing risks for the creditworthiness of state and local issuers in the $3.8 trillion U.S. municipal bond market. We translate physical climate changes into implications for local GDP — and show a rising share of muni bond issuance over time will likely come from regions facing economic losses from climate change and events linked to it.
  • Hurricane-force winds and flooding are key risks to commercial real estate. Our analysis of recent hurricanes hitting Houston and Miami finds that roughly 80% of commercial properties tied to affected CMBS loans lay outside official flood zones — meaning they may lack insurance coverage. This makes it critical to analyze climate-related risks on a local level.
  • Aging infrastructure leaves the U.S. electric utility sector exposed to climate shocks such as hurricanes and wildfires. We assess the exposure to climate risk of 269 publicly listed U.S. utilities based on the physical location of their plants, property and equipment. Conclusion: The risks are underpriced.
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A growing burden
Muni market share at risk of climate-related GDP losses, 2020-2100

Muni market share at risk of climate-related GDP losses, 2020-2100

Sources: BlackRock Investment Institute, with data from Rhodium Group, March 2019. Notes: We use the S&P National Municipal Bond Index to represent the muni market. The chart shows the estimated market value share of the muni market exposed to GDP losses of various magnitude through 2100 under a “no climate action” scenario. For example, roughly 20% of the market value of the current muni index is expected to come from regions suffering annualized average losses of up to 3% or more of GDP from climate change by 2060–2080. We use the upper bound of the 66%, or “likely,” range of losses to illustrate a plausible risk scenario.

Climate-related risks pose a threat to the economies – and creditworthiness – of many U.S. state and local issuers, our analysis shows. Our work with Rhodium Group shows a rising share of U.S. metropolitan statistical areas (MSAs) will likely be hit by climate change in the coming decades. Within a decade, more than 15% of the current S&P National Municipal Bond Index by market value would come from MSAs suffering likely average annualized economic losses from climate change of up to 0.5% to 1% of GDP. The impacts are projected to grow more severe in the decades ahead. See the A growing burden chart above.