"Last week, in the wake of the publication of the Stern report, the public debate over climate change shifted gear. From a debate about the science to a debate about the economics. From concern about the causes and consequences of climate change, to analysis of the financial costs of action versus inaction. From focus on ‘the environment’ to focus on the economy, energy and security. This is a debate that the insurance and financial services industry, and the ABI in particular, has been leading. It is now a debate that we need to turn from words into actions - by government, by the private sector and by individuals.
Today, I want to begin by setting out the conclusions I draw from the Stern analysis. I then want to focus not on the risks, but the opportunities for the financial services sector over the next decade, and how government can create the policy frameworks, domestically, and internationally, that make markets work in the public interest.
Nicholas Stern is an economist not a scientist, and I would not boast that I am either, but it seems to me there are some very clear conclusions that can be drawn from his work and the science which underpins it.
- Atmospheric carbon dioxide levels are now higher than at any time for at least the last 740,000 years. As a result, the earth has warmed by 0.7 degrees since 1900.
- Rising greenhouse gases will push many of the great eco-systems of the world towards irreversible decline or ‘tipping points’.
- And the effects will be on people as well as nature. ‘Business as usual’ could cause economic consequences greater than the two world wars and the Great Depression put together. That is why people say c limate change is the greatest long term threat faced by humanity.
Stern focuses on how difficult it will be to stabilise CO2 equivalent concentrations at 450 parts per million, and how dangerous it is to get anywhere near 550 parts per million which is around double pre-industrial levels of greenhouse gases. Stabilisation in this range means at least a 25 per cent cut in global emissions, and this must be our minimum goal. For richer countries, this would mean a cut of 60 per cent or more. I believe this as a matter of self-interest, not just moral duty.
The argument is simple.
The technologies exist to reduce energy demand, increase efficiency and develop low-carbon electricity, heat and transport. Climate change is not insoluble.
Investment in these technologies is manageable at around 1 per cent of global GDP – about the same as we spend globally on advertising.
Early and gradual action will be far more cost effective than sudden and late action. Action by individual countries need not place firms at a competitive disadvantage.
The policy challenge is to develop the mechanisms that recognise the economic cost of greenhouse gas emissions in future decisions and promote adaptation to the greenhouse gases we have already emitted. We need institutions and markets adequate to a problem global in scale, long term in its causes and consequences, and uncertain in terms of its impacts.
Those three factors – global reach, long term decision-making, and managing uncertainty – are characteristics that define the work of the financial services industry, particularly insurance. Your investments, particularly in pensions and insurance are long term in nature, and will be affected by our ability to stabilise the climate. The UK may make up just 2 per cent of emissions but the city and the financial services sector are responsible for shaping a much larger proportion of global investment. When our major financial institutions speak, companies and other financial institutions around the world take notice.
Today I want to focus on our responsibility to shape and lead these global markets.
Opportunities
The transition to a low-carbon economy will involve the biggest restructuring in how we live and work since the industrial revolution.
For the financial services sector, a number of opportunities are emerging.
First, the UK has the opportunity to become the leader of a global carbon market. Trading on global carbon markets is now worth over $10 billion, four-fifths of which is made up of the EU Emissions trading scheme. The amount of carbon traded globally increased 44-fold between 2004 and 2005. The most actively traded emissions exchange, ECX, which is located and cleared in London, deals in more than twice the volume of its nearest competitor. If markets were established in the top 20 emitting countries, the carbon market would grow by 400%. The investment flows to developing countries generated by scaling up the Clean Development Mechanism could also grow rapidly.
It is absolutely vital that the EU Emissions Trading Scheme is strengthened as the nucleus of a global carbon market and I address this below.
Second, new opportunities to invest in low-carbon technologies will emerge. The IEA World Energy Outlook, published today, with kits emphasis on low carbon infrastructure investment b etween now and 2030, is relevant here. Renewable energy generation is currently worth around $38 billion globally pet year, and grew by 25 per cent in 2005. This average rise conceals even sharper growth pockets. The global installed capacity of solar photovoltaics rose by 55 per cent in 2005, wind power by nearly 50 per cent, and biofuels by 15%. The markets for low-carbon energy products are likely to be worth at least $500 billion per year by 2050, and potentially much more, with research commissioned by Shell Springboard suggesting a global market of $2 trillion dollars.
It is important that government provides the right leadership for these technologies – investment, regulation, procurement – and I address this later.
Third, new markets in green financial products are likely to open up, The creation of Energy Performance Certificates rating the energy efficiency of homes could spur green mortgages that factor in energy efficiency into payments, or link finance to energy improvements. Travel insurance companies could begin to offer offsetting services built into their insurance offers, and the offsetting market could begin to generate critical mass. Financial innovations could emerge to support adaptation in the developing world. For example, new index-linked insurance products are available for farmers in India that makes crop insurance viable and lets people make decisions that would otherwise be perceived as too risky.
Government has a responsibility not to pick winners but to create the right framework.
Fourth, providing green financial products could be a new source of comparative advantage. Growing consumer pressure for green investment could see a growth in green pensions where a proportion of funds are invested in low-carbon technologies and all investment factors in environmental concerns. The Jupiter Ecology Fund has outperformed conventional investment funds by 23.5% over three years, proving that environmental sustainability and financial security can go hand in hand. Consumer and investor pressure on companies is being facilitated by greater transparency over companies environmental impact. For instance, the Carbon Disclosure Project is now supported by 225 investors with collective assets under management of $31.5 Trillion.
The challenge for government is not to do the work of financial institutions, but instead to offer the clarity and consistency that helps them to thrive. There are four areas I want to address in particular.
Government framework
First, investment will flow into climate change mitigation and adaptation but only if there is a clear framework for investment. The role of Government must be to tackle the market failures that distort investment in energy efficiency and low-carbon technologies.
For the past 150 years, we have emitted greenhouse gases without thought to the cost these gases are imposing on future generations or the developing world. Those who have produced pollution have not faced the full cost of their actions. If we are to channel investment into a low-carbon economy, we must begin to put a price on carbon dioxide and other greenhouse gases, equivalent to the damage these gases will cause.
The mechanisms for doing this include a combination of emissions trading, taxation, and in some cases, regulation. Let me say more in particular about emissions trading. Our ambition must be to create a global carbon market, building on the European Union’s emission Trading Scheme. The EUETS is still in its infancy. But already it covers nearly half the emissions within the EU. As set out last week in the EUETS vision statement, we need to look at how to improve and extend the scheme in future phases:
Securing its long term future beyond 2012 so that investors have the confidence to invest
Extending its coverage to include aviation, and, potentially, surface transport
Improving the mechanisms for allocating permits, for instance through more auctioning, and the setting of caps that are consistent with our long term goals for C02 emissions.
Linking it to other emerging emissions trading schemes around the world, such as the recently announced Californian scheme.
Putting a price on carbon rectifies the main source of market failure.
But carbon pricing alone will not be sufficient to drive investment at sufficient scale and speed. There are other barriers to global action to meet the challenge, and government needs to play its part in overcoming them.
The second part of our strategy is to increase the level of investment in R&D to ensure a diverse range of low-carbon technologies emerge, and support technologies that a further from the market and require deployment support. That is why earlier this year we created the UK Energy Technologies Institute, a public-private partnership, that will potentially generate £1 billion of investment over the next ten years; £550m is already on the table, half from Government and half from the private sector. It is also why, as set out in the Energy Review, we intend to reform the Renewables Obligation to ensure it provides more support for technologies furthest from the market such as off-shore wind. Together with the Climate Change exemption for renewable electricity, the Renewables Obligation is worth £1 billion a year from 2010.
Third, carbon pricing and technology support must be combined with other policies that address barriers to changing behaviour and investment. These market imperfections include lack of information, up-front capital costs, and transaction costs. We are trying to address each of these issues.
As a Government, we need to lead by example. We have already committed to moving the Government estate to Carbon neutrality by 2012. But we also want to use the £150 Billion spent on procurement to drive market transformation, and enable the more rapid development and scaling up of technologies.
We are also helping consumers, businesses and investors have more information and feedback on the environmental impact of their decisions. That is why we are promoting real-time metering and energy performance certificates for homes, better labelling on products and appliances, or, as I said earlier, carbon disclosure for investors.
In some cases, particularly where the credibility of emissions trading is being established and there is a need to avoid technology lock-in, regulation can be an effective tool. In particular, it has role in eradicating the most polluting products, and communicating to a global audience the scale and pace of ambition. For instance, changes in building regulations since 2002 have increased the energy efficiency of new homes by 40 per cent. In the recently published EU Energy Efficiency Action plan the Commission has said they will use the Eco-design Directive to adopt minimum energy performance requirements for 14 priority product groups, with special attention to be paid to standby switches.
The fourth area is adaptation. The science shows that there are already unavoidable impacts from climate change as a result of the damage already done. We have a dual task. To invest in mitigation to avoid the costs of adaptation spiralling, but also to begin to adapt the way we live to the unavoidable warming already in train.
Adaptation will be particularly critical to the developing world. They will suffer the greatest threat from climate change, despite having contributed least to it. In some cases such as Bangladesh, it will massive changes to housing, flood protection, and agriculture. A global framework must include long term investment in building the resilience of developing countries, and ensuring developing policy and planning takes into account adaptation. With the nature of risk changing, insurance markets are beginning to adapt. For instance, in India, a weather insurance initiative launched in India in 2003 by a group of companies called BASIX has grown from 230 farmers in one state to 6703 customers across six states by 2005, and is developing a wider interest in weather related insurance.
But adaptation will not just be needed in the developing world. All countries will be affected. Flood risk presents, a major threat to people in England. That is why over the past decade funding has increased from £307m per year in 1996-7 to £580m in 2005-6, a real terms increase of 35 per cent, and a total expenditure of £4 billion.
Government recognises the important role the insurance industry plays in managing flood risk and in promoting understanding and debate about the effects of climate change. We have welcomed the ABI's Statement of Principles on Flooding and Insurance which provides homes and businesses at risk with important reassurance that insurance will remain available subject to Government's own actions to manage that risk. This agreement between Government and the ABI was renewed at the end of last year and I have every intention of working to make sure we honour our side of the bargain. We commited to continuing to invest in flood risk management measures so as to maintain outputs, including having evidence based discussions on future funding needs; reducing the probability of flooding for a substantial number of properties; strengthening the land use planning system in relation to flood risk; communicating flood risk effectively; and developing an integrated approach to urban drainage that alleviates the risk from sewer flooding and flash flooding.
We are doing all this - I would highlight that we are on course to increase the protection for over 100,000 properties in the SR04 period; that DCLG are about to launch a new strengthened PPS 25 on flood risk; and that we will shortly be announcing the pilot areas for our integrated urban drainage work.
I fully understand the concern among insurers about reduction in the Environment Agency’s 2006-07 flood resource allocation from £428 million £413 million. But Govt is still maintaining overall investment above the level assumed when we signed up to the Statement of Principles. I am pleased that the capital budget, which delivers improved flood defences, has not been cut. Future funding will be a matter for the CSR but we have analysed the evidence carefully in a zero based review of flooding spend and we are engaged with HMT now on what would be an appropriate level of public investment for the next CSR period. I am also interested in looking at possibilities for a longer term investment strategy and how we might get it delivered in the most cost effective way. Ian Pearson and I look forward to talking to the ABI about these issues at the end of November in our annual stocktake of progress.
I appreciate the fact that this country has a unique partnership between the insurance industry and government in relation to flood protection, and over the next year, as part of CSR07, we are determined to do further work on the investment needs and priorities for flood protection. I recognise the importance of flood protection at home, and it will not be neglected.
Conclusion
The WWF have calculated that if all countries consumed the natural resources that we do in the UK, we would need three planets to support us. Our goal must be to move to a one-planet economy, to one-planet living. To achieve that every part of society will have to change in fundamental ways. Consumers, businesses, investors and Government.
In that project the insurance industry has a lot to teach us. You are by definition long term and global, and you recognise risk. The rest of us need to do the same, and act accordingly."
[Source: DEFRA web site - Crown copyright 2006]