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Fabrice Rossary
Chief Investment Officer, SCOR Investment Partners
 

This article is an opinion article and does not constitute investment advice or recommendations. Neither the author nor SCOR Investment Partners assume any liability, direct or indirect, that may result from the use of information contained in this opinion article.
 

The late 18th century theory that the geometric progression of population would outstrip the arithmetic progression of food production is obviously not really a concern today, even if the world’s population has increased from one billion to more than seven billion in the interim. Malthus was a strong believer that natural catastrophes and human disasters could correct the imbalance between food supply and population growth. He was also convinced that higher levels of food would lead to higher levels of population, with supply creating demand. This reasoning could be applied to any item other than food if we consider the supply to be limited. When production factors are supposed to be at least partially fixed, the capacity of supply to address growing demand leads to the law of diminishing returns. One of the key theoretical answers to this problem has been Ricardo’s competitive advantage theory, which made a strong case for an economic system based on free-trade, international flows and specialization. Indeed, technological progress and globalization have provided above-average historical growth.
 

Nevertheless, with climate change and the Covid-19 crisis, it is now obvious that the negative externalities created by this economic structure are starting to outweigh its advantages. For decades, Keynes’s response to the Monetarists - “in the long run we are all dead” - could easily have been applied to the way those externalities were considered. But with global warming things are accelerating, and we are already one degree above pre-industrial levels. We are reaching a critical phase where the oceans have never absorbed so much heat (93% of global warming is absorbed by the oceans). Over the long term, natural catastrophes are expected to be more frequent and more severe, especially secondary peril events. The rise in mean sea level is now forecast to reach between one and two meters by 2100 compared to the period 1986-2005. Given that 20% of the world’s population lives less than 30km from the coast, the economic consequences are expected to be extremely material. By 2050, 300 million people are expected to be impacted by major coastal flooding each year, which raises the issue of the insurability of certain perils/regions.
 

With growing concerns from the population, political pressure to tackle the environmental crisis should lead to the implementation of more coercive policies, which will bring additional costs. According to “the Energy transition risk stress test for the financial system of the Netherlands” conducted by the DNB in 2018, taxes and restrictions on high emission technologies could generate costs leading to a general economic slowdown, combined with higher inflation. In a scenario where the effective carbon price reaches USD 100 per tonne, modelling has shown an economic impact on the Dutch economy of -1.3% for GDP and +2.1% for the HICP in the first year, and -3.2% for GDP and +2.3% for the HICP in the second year. Despite those costs, the energy transition is critical for the Netherlands, where just one meter of sea elevation could lead to the physical disappearance of most of the country.
 

However, we are not all Dutch, and change takes time. We should not expect a complete U-turn from a global to a local economy. While consumers are intellectually aware of these challenges and supportive of change, they don’t seem ready yet to pay more for the same product, or to consume less. In 2018 and 2019, the French “Yellow Jacket” movement illustrated this contradictory behaviour.
 

The pressure for change should continue to grow, but in the current economic crisis environmental actions have been put on the back burner by policymakers. Interestingly, one of their first actions has been to provide emergency financing packages to avoid bankruptcies and unemployment, such as those given to airlines and auto companies, but without asking for significant balancing actions in terms of sustainable policies.
 

In the long term, sectors using fossil fuels as an input or an output are expected to suffer, and heavily indebted companies will face debt restructuring and default. But for the time being, states are injecting money to keep them afloat, with an allocation of capital driven by political and social concerns rather than pure financial rationality.
 

Hence, it is becoming increasingly likely that more drastic coercive actions will have to be implemented at a later stage, and the negative impact on GDP could be far more pronounced than expected.
 

In the aftermath of this economic crisis, asset owners and fund managers should take the driving seat vacated by governments to further promote and finance the energy transition, by excluding certain sectors, adopting a best-in-class approach and/or allocating capital to promising sectors. The adoption of an ESG policy is no longer considered an additional constraint or a marketing tool, and its full integration at the heart of the investment process should be pursued along with quantitative and qualitative assessment. If, as we expect, these more holistic strategies deliver superior returns, they should attract more capital, and a virtuous cycle could begin.