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July 26, 2023

‘Flawed’ climate analysis is putting pension funds at risk, says Carbon Tracker

Drought leaves a reservoir at 10% of capacity. The Carbon Tracker report warns that models used by some economists substantially underestimate the dangers and damages of global warming (Photo: Mauricio Zina/Bloomberg)
Drought leaves a reservoir at 10% of capacity. The Carbon Tracker report warns that models used by some economists substantially underestimate the dangers and damages of global warming (Photo: Mauricio Zina/Bloomberg)

By using different assumptions to scientists on the effects of global warming, climate economists are underestimating the risks these could have on the financial system, says the think-tank.

Pensions are at risk from the huge disconnect between what scientists expect from global warming, and what investors and financial systems are prepared for, says a report from the think-tank Carbon Tracker and Steve Keen, professor at University College London.

The report, “Loading the DICE against pension funds”, says many pension funds use investment models that predict global warming of 2C to 4.3C will have only a minimal impact on portfolios – even if scientists warn that warming should be kept below 1.5C to avoid the worst impacts of climate change.

The report’s title refers to the “dynamic integrated climate-economy” model created by Nobel laureate William Nordhaus. Climate Tracker says that, according to the DICE model, “in the absence of global warming, global GDP in 2220 would be 21 times higher than in 2025”.

Those optimistic investment views are formed, says the report, because climate economists use “scientifically false assumptions” to determine the potential impacts of climate change and ignore the likelihood of “tipping points” that would accelerate economic damage.

A tipping point is where an environmental threshold – such as the melting of ice sheets or destruction of the Amazon – is passed, that would have disastrous knock-on effects and potentially create feedback loops that amplify these effects. Research published at the end of June suggests such a point of no return may not be far away. 

Such “flawed analysis” has “effectively compromised the risk management and investment decisions” for pension funds, central banks and governments with respect to climate change, and what to do about it, says the report. 

“Any analysis or stress testing which attempts to apply the work of these economists on climate change to real-world issues, such as portfolio choice and prudential regulation, will inherit its underlying problems and will, therefore, substantially underestimate the dangers and damages,” it adds.  

“To ensure that the world moves into a new climate secure energy system, it is crucial pension schemes send the market the right investment signals,” Carbon Tracker founder and director Mark Campanale said in a press statement. “Flawed climate risk models are used throughout the financial system, lulling economic decision makers, from pension funds to central banks, into a false sense of security.” 

A paper published in May 2023 by the University of South Wales Sydney in Australia reached a similar conclusion regarding the stress-testing regimes of banks and financial regulators. 

You can read the full Carbon Tracker report here.

A service from the Financial Times