Nevil Chamberlain’s claim in September 1938 that his agreement with “Herr Hitler” had achieved “peace for our time” is one of the dramatic historical interludes that modern people look back upon with wonder.
How could so few at the time see that – rather than buying England a durable peace – giving Germany a green light to annex Czechoslovakia added fuel to the fire of Hitler’s ambition that would within a year spark the conflagration of the Second World War?
I believe that this week will prove similarly impactful in retrospect when viewed with a generation’s worth of hindsight.
Figure 1. PG&E Headquarters (Wikimedia)
For this week saw what is arguably the first bankruptcy of an S&P 500 firm due to the effects of Global Warming: Pacific Gas & Electric PCG.
Reuters reported on Monday that PG&E – a regulated utility that serves roughly 5.2 million households in central and northern California – was preparing to file for bankruptcy protection due to “potentially crushing” liabilities stemming from its equipment’s role in starting several of the enormously destructive fires of summer 2018.
PG&E, which was trading for over $48 per share just before Thanksgiving, closed yesterday for $6 and change – nearly a 90% drop in a space of less than three months.
Figure 1.
Future investors will look back on these three months as a turning point, and wonder why the effects of climate change on the economic underpinnings to our society were not more widely recognized at the time.
Read back through my article Investments That Ignore Climate Change Just Burn Money. In 2012-2015, California struggled through an intense drought, which was, according to NOAA climate scientist Eugene Wahl and colleagues, the most severe period of drought in this region since at least 1571. Since the end of that drought, California has experienced five of the 10 largest fires in its history, including the deadliest fire in the state’s history: the Camp fire that razed Paradise.
Climate scientists may equivocate about the degree to which Global Warming is contributing to these fires until more detailed research is complete, but for an investor who is used to making decisions based on incomplete or ambiguous information, the warning signs are flashing red.
Granted, this is not the first time for PG&E to declare bankruptcy, so one might question the operational competence of the firm’s managers. (PG&E’s most recent prior bankruptcy was much less prompted by a natural disaster, unless one considers a shambolic deregulation process coupled with the maleficence of Enron’s energy trading desk to be forces of nature.) And it is true that PG&E’s bankruptcy appears to be “strategic” – essentially providing the company room to renegotiate the terms of power contracts signed when oil was trading at $130 / bbl.
Despite the firm’s potential operational weaknesses and / or the possibility it is using an especially hardball strategy to reduce production costs, there is no doubt in my mind that Global Warming’s thumb rests on the scale of PG&E’s decision to declare bankruptcy.
The ripples that will propagate out from the sinking of PG&E will probably be small. A few providers of solar power to PG&E’s grid will likely have some problems making ends meet. Kinder Morgan KMI is a pipeline provider for PG&E’s natural gas, so may have a few quarters of reduced earnings and weak guidance.
But the Reuters article linked above hints at the possibility for much wider and more important potential impacts in the future:
In a regulatory filing, [PG&E] questioned whether it could continue to operate in the years ahead as a so-called investor-owned utility by being exposed to [the risk of catastrophic fire-related risk].
If PG&E were to become a state-run entity – the alternative implied by the quote above – the risks of fire damage would not go away. They would simply be spread over the entire taxpaying base rather than over a limited group of share owners. That diffusion of risk would cause ripples in bond markets – bond yields would rise to account for the added risks.
Now imagine these sorts of ripples spreading outside of California. After years of a stable, low interest rate environment, governments and corporations are up to their necks in debt. Increasing liabilities and rising rates would have the potential to place strains on government bond issuers and reduce the cash flows available to the equity holders of indebted corporate issuers.
I was surprised listening to a recent interview with European wealth manager Anthony Deden, when he said that he kept most of his clients’ uninvested funds in gold rather than in a “risk-free” bond portfolio, as is “normal” for most asset managers.
“I’d rather own assets that are not someone else’s liabilities,” he explained. In the new normal of climate change investing, his radical approach to asset allocation may, I believe, come to be seen as common sense.