To that end, in 2019 the U. S. Commodity Futures Trading Commission (CFTC) formed the Climate-Related Market Risk Subcommittee, and tasked it with producing a report to consider what climate-related risks might be; examine whether adequate information about climate risks is available; identify any impediments to evaluating and managing climate-related financial and market risks; ask whether the market can do a better job of integrating climate-related scenarios and use them to stress-test investments; incorporate disclosures of climate risk into financial and market risk assessments and reporting; identify how risks can be managed and disclosed in order to protect the stability of the financial system; and ensure that information about climate-related financial and market risks are internalized into the market.

“[Episode #135] – Internalizing Climate Risk” of The Energy Transition Show

I recently discovered Chris Nelder’s The Energy Transition Show podcast, produced by the XE Network. On 25th November 2020 he hosted Bob Litterman, a founding partner of Kepos Capital, and the Chairman of the Commodity Futures Trading Commission’s Climate-Related Market Risk Subcommittee. He also serves as a member of the Board of Directors of the Options Clearing Corporation. 

The CFTC recently established a Climate Risk Unit. That was preceded by the release of a report from the Climate-Related Market Risk Subcommittee titled “Managing Climate Risk in the Financial System” which I recommend.

And of course, that’s the problem today with respect to climate, we’re not prepared for the worst case scenario. We don’t know how bad it might be. And we have to think about extreme but plausible outcomes. And what that means is rather than a slowly rising price, it’s way too late for that. We have to slam on the brakes and be prepared for whatever comes at us. And the brake, of course, is the incentive that we create to reduce emissions. So the longer we wait, the worse the situation is. You can think of the risk as being summarized by what is the highest average temperature change in the future climate. In other words, the temperature today globally averaged relative to historic temperatures is an increase of about 1˚C, and scientists have for a long time talked about 2˚C is really where we start to get into dangerous territory. Well, first of all, we don’t really know. It’s not like there’s a bright line at 2˚C, but in any case, where we are today is about 1˚C of warming. And inevitably, no matter what we do, the warming is going to continue for decades into the future. If we were to what I call slam on the brakes today by creating strong incentives to reduce emissions, we might be able to get to net zero by 2050. That’s what we’re hoping to do. And so until then, we’re increasing the amount of warming in the atmosphere. It takes another decade or two past that net zero to where we come to a new equilibrium. And the amount of heat escaping from the earth at that point becomes balanced with the amount of heat that’s coming into the earth. And so that might be 2070. And right now it looks like in that scenario, the best case, the warming will peak at about 1.7 or 1.8˚C. Now, here’s the really dangerous thing. For every three years that we wait to impose those incentives to reduce emissions, to slam on the brakes, the inevitable maximum temperature increases by about one tenth of a degree C. So if we’re at 1.7˚, inevitable temperature rise today, then in another 10 years we’ll be at about 2˚C and then, you know, if we wait longer than that, it continues to increase at that rate. And so the risk is just increasing very dramatically with every year of delay that we continue today. That’s why the response is inevitable. But the risk is increasing for every year of delay.

Bob Litterman