Lender’s Guide for considering Climate Risk in Infrastructure Investments

Published: 11th April 2018 10:16Last Updated: 11th April 2018 17:17
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Port of Los Angeles, California, USA.

Introduction

This short Guide* emerged from ongoing discussions among participants of the Global Adaptation & Resilience Investment Working Group (GARI) during 2017. GARI is a private sector, private investor-led initiative that was announced at Paris COP 21 in 2015. It is a partner of the UN Secretary General’s A2R Climate Resilience Initiative. The working group has brought together over 150 private and public investors, bankers, leaders, and other stakeholders to discuss critical issues at the intersection of climate adaptation and resilience and investment with the objective of helping to assess, mobilize, and catalyze action and investment. GARI has convened more than eight times during 2016 and 2017, and has underscored the continuous interest of the private sector and specifically, private investors, in investment and climate adaptation and resilience.

This Guide is meant to respond to questions that have emerged in various fora – including within the GARI meetings – specifically from banking institutions and infrastructure investors. Many of these questions build off work by the Task Force on Climate-related Financial Disclosures (TCFD) and related efforts to understand and consider enhanced disclosure requirements. Such discussions within the GARI and elsewhere have highlighted the need to break down in a clear, tangible manner the ways in which physical climate risks might affect key financial aspects of prospective infrastructure investments that credit officers and investment decision-makers within a bank consider. This Guide is meant to be responsive to and provide a framework for questions about how to link revenues, assets, and costs with potential project vulnerability because of physical climate risks. Enhancing understanding of these risks is a necessary step for banks better to understand and manage these risks in their pipeline of investments, and may also provide important insights for managing such risks in their portfolio.

This Guide includes ten “snapshots” of infrastructure sub-sectors provided to illustrate how investment and credit officers might think about weather and climate-related risks and opportunities when appraising a new project or corporate loan, when evaluating an equity investment in infrastructure, and/or when managing a portfolio of infrastructure investments. These snapshots are not exhaustive and do not present all the ways climate risks may arise for an infrastructure project. Rather they are meant to be illustrative only, and to provide an approach for the lender/credit officer to think about how climate risk may manifest in key financial drivers of projects, which may in turn impact their investment.

*Download the full guide from the right hand column.

Key findings (abridged)

The guide details 10 'snapshots' of infrastructure sub-sectors as examples of how loan and credit officers might think about physical climate-related risks when appraising a new project or corporate loan or when evaluating an equity investment. The key findings of each of these snapshots are summarised as follows:

1. Airports.

Revenues

  • Temperature (Acute): Extreme heat makes the air above runway tarmacs become less dense, which can impact the aerodynamic performance of airplanes and/or weight of passenger/cargo carried loads.
  • Temperature (Chronic): An increased number of extreme-heat days may lead to chronic heat-related disruptions if airport infrastructure is not designed to enable uninterrupted air traffic (e.g., investments in longer runways may mitigate incidents of heat-related disruptions, but costly).
  • Storms (Acute): Airport facilities and fixed infrastructure may be damaged by excessive precipitation and/ or flooding during acute precipitation events impacting availability of infrastructure.
  • Precipitation & Flood (Chronic): In some locations, nuisance flooding may cause chronic disruption to airport facilities and infrastructure thus affecting their availability and revenue generation.

Costs:

  • Temperature (Acute): Increases in operating expenditures to address occurrences of extreme temperature.
  • Temperature (Chronic): An increased number of extreme-heat days per year may impact overall cost and budgeting components of airport infrastructure.
  • Precipitation & Flood (Chronic): Contingency and recovery costs may increase and/or become more frequent and penalties may be payable if operating standards under concession are violated.

Assets:

  • Tangible (fixed assets, e.g., buildings, infrastructure): Frequent disruption and damage to an airport could lead to a decrease in value of an airport’s tangible assets . Conversely, airports with enhanced infrastructure adapted to climate change and that mitigates weather impacts may realise increased tangible asset value/valuation.
  • Intangible (e.g., goodwill, brand): Frequent climate-related disruption of operations may affect an airport’s brand and reputation, as well as service ratings by consumers and airlines.

2. Marine ports.

Revenues:

  • Temperature (Acute): Extreme temperature events can cause disruptions to marine shipping and/or marine passenger traffic from which port revenues are derived.
  • Temperature (Chronic): Gradual temperature increases may melt ice along shipping routes, thus extending shipping/cruise ship seasons and/or eventually opening new routes, which may increase traffic and provide revenue opportunities for ports in certain locations.
  • Storms, Precipitation & Flooding (Acute): Given locations in coastal zones and other low-lying areas, ports face increasing risk of regular inundation due to hurricanes, cyclones, and typhoons. Port facilities may be damaged by excessive precipitation and/or flooding during acute precipitation events impacting the availability of infrastructure.
  • Flooding & Sea-level Rise (Chronic): In some locations, nuisance flooding—temporary inundation of low-lying areas during exceptionally high tide events or floods that result from storm surges—may cause chronic disruption to port facilities, affecting service availability and revenue generation.

Costs:

  • Temperature (Acute): Maintenance expenses may increase due to needed asphalt repairs.
  • Temperature (Chronic): Depending on the location and type of traffic/cargo, an increased number of extreme-heat days and gradual temperature rise may escalate ongoing costs for maintenance if port traffic increases due to extended shipping/cruise ship seasons and changed trade flows.
  • Storms (Acute): Contingency and recovery costs may increase and/or become more frequent and penalties may be payable if operating standards under concession are violated.
  • Flooding & Sea-level Rise (Chronic): Port infrastructure may have to be raised due to continuous flooding and sea-level rise.

Assets:

  • Tangible (fixed assets, e.g., buildings, infrastructure): Frequent disruption and damage to port infrastructure could lead to a decrease in tangible asset value.
  • Intangible (e.g., goodwill, brand, copyrights): Frequent climate-related disruption of operations may affect a port’s brand and reputation, as well as service ratings by vessel operators and other customers/clients.

3. Gas and oil transport and storage.

Revenues:

  • Temperature (Chronic): Increasing temperatures can affect the storage of volatile oil and gas products in tanks and increase safety hazards.
  • Storms (Acute): Flooding can dislodge and lift oil and gas storage tanks which can cause a loss of petroleum and piping breaks. High wind speeds can also lead to buckling of metal fuel storage tanks (particularly if they are not full). Flooding can also cause damage to underground storage tank systems, including the buoying up of tanks which are partially full or empty, water entering the tanks and displacing product, failure of underground piping from groundwater pressure or debris, and damage to electrical systems from extended contact with water.
  • Precipitation and Water Stress (Chronic): Fuel transport by rail and barge can be affected when water levels in rivers and ports drop too low, such as during a drought, or too high, such as during a storm surge.
  • Combination of Hazards: Flooding, wildfires and icy conditions affect roads, railroads and other fuel transportation networks that move oil, coal and liquefied gas.

Costs:

  • Temperature (Acute): Warmer temperatures can result in more icebergs and ice movement, which in turn can damage barges transporting natural gas and oil. At the same time, decreasing sea ice could also generate some benefits; warmer temperatures are expected to improve shipping accessibility in some areas of the Arctic Basin, including oil and gas transport by sea.
  • Temperature (Chronic): Thawing permafrost in Alaska, Canada, and Russia will reduce the availability of ice road transportation and require companies to invest in other forms of transport infrastructure, such as all-season roads.
  • Precipitation & Flood (Chronic): These hazards could lead to increased remediation, recovery, and repair costs to address the loss/leakage of petroleum products.

Assets:

  • Tangible (fixed assets, e.g., buildings, infrastructure): Aging infrastructure is more susceptible than newer assets to the hurricane-related hazards of storm surge, flooding, and extreme winds, and retrofitting this existing infrastructure with more climate-resilient technologies is a long-term task which may require significant capital expenditures. More importantly, capital invested today into future oil and gas production is at risk of being stranded or wasted, and shareholders may not get the returns they have modeled for.
  • Intangible: Frequent climate-related disruption of operations may impact companies’ brand and reputation. Their social license to operate may also be challenged due to failure to respond adequately during extreme events, or to maintain levels of service set by regulatory requirements.

4. Power transmission and distribution.

Revenues:

  • Temperature (Acute): Extreme heat events may decrease the performance of substations and transmission equipment, for example by causing disconnections and reducing the level of performance in energy transformation in substations.
  • Temperature (Chronic): An increased number of extreme-heat days may lead to chronic heat-related disruptions if T&D infrastructure is not designed to enable uninterrupted operation.
  • Storms (Acute): Extreme weather events can cause damage to transmission towers, substations and transmission lines. In addition, heavy rain and floods can lead to transmission towers collapsing, and floods and water stagnation can submerge substations.

Costs:

  • Temperature (Chronic): Taking into account the effects of temperature changes on thermal power plant efficiency, transmission line capacity, substation capacity and peak demand, a higher temperature scenario requires additional peak generation capacity and additional transmission capacity, or a greater demand-side response at peak times.
  • Storms and Precipitation & Flooding (Acute): In order to manage extreme weather-related risks, increased operating expenses and capital expenses for adaptation measures may be required. This may include pruning and managing trees near T&D lines, installation and maintenance of underground power lines, which are more resilient to floods and storms but more expensive, research and development of distribution loss reduction technologies, and infrastructure hardening measures.

Assets:

  • Tangible (fixed assets, e.g., buildings, infrastructure): Expanded generation and T&D infrastructure/ assets built to accommodate distributed energy resources from renewables can create new climate- related exposures that need to be evaluated. The assets’ value could be impacted as changes in operation practices to meet levels of service, changing customer needs, or regulatory requirements reduce the asset’s life.
  • Intangible (e.g., goodwill, brand, copyrights): A utility company’s brand and reputation may be negatively impacted during long power outages caused by extreme weather, as customers face inconvenience, discomfort, anxiety, lost economic activity, food spoilage, etc.

5. Wind based power generation.

Revenues:

  • Temperature (Acute): Functioning and/or efficiency of certain equipment/components may be negatively affected by temperatures outside of rated conditions. Although wind turbines are typically designed for extreme temperatures, batteries used for storage can become less efficient, as extreme heat can affect battery chemistry causing degradation while very low temperatures can slow chemical reactions and impair battery ability to deliver current.
  • Temperature (Chronic): Although inconclusive, evolving research suggests that wind power may decrease in some regions of the world as global temperatures rise.
  • Storms, Precipitation Flooding (Acute): Depending on the location and nature of wind power infrastructure, increasing intensity and frequency of storm events, storm surge and flooding pose risks affecting availability and revenue generation.

Costs:

  • Temperature (Acute and Chronic): Costs may increase if higher-heat rated batteries are substituted for those that are unable to withstand extreme temperatures.
  • Storms, Precipitation & Flooding (Acute): Recovery costs may increase and/or become more frequent due to damage from storms and flooding. Depending on the location and nature of wind power infrastructure, increasing intensity and frequency of storm events, storm surge and flooding can cause physical impacts, such as compromised integrity of pilings, both onshore and off, as well as corroded parts. Penalties may be payable if operating standards under concession are violated.

Assets:

  • ​Tangible (fixed assets, e.g., buildings, infrastructure): Wind turbine condition is a key factor affecting asset value. Degraded turbines can negatively impact asset value while installed assets that have more rigorous heat and weather ratings may have higher value.
  • Intangible (e.g., goodwill, brand, copyrights): Frequent climate-related disruption of operations might change the wind energy’s brand and reputation, as well as the rating of overall service by the clients.

6. Telecommunications.

Revenues:

  • Temperature (Acute): Increases in temperature and higher frequency, duration, and intensity of heat waves create an additional burden on keeping equipment cool in exchanges and base stations, resulting in increased failure rates and impacting service delivery.
  • Temperature (Chronic): Increases in mean temperature increase the operating temperature of network equipment over a period of time, leading to malfunction or premature failure if it surpasses design limits, affecting service delivery.
  • Precipitation & Flooding (Acute): Acute heavy precipitation can result in some transmitted signals not being received clearly or at all. Reduction in service delivery can also occur due to increased storm-related damage to above-ground transmission infrastructure.
  • Precipitation & Flooding (Chronic): Increased precipitation and humidity can affect the radio spectrum on which wireless communications rely. Some services may also require increased transmission powers in order to withstand poorer weather without experiencing an outage.
  • Storms (Acute): There is often increased demand for services during extreme weather events, such as for emergency communications and for teleworking.

Costs:

  • Temperature (Chronic): Increased temperatures in winter may reduce the cost of space heating in assets such as exchanges, creating a cost-saving opportunity. Reduced snowfall lessens the impact on transmission infrastructures requiring less upkeep or maintenance and reduced operational expenditures.
  • Precipitation & Flood (Acute): Decreased precipitation over time can lead to land subsidence and heave, which can reduce the stability of telecommunications infrastructure both above and below ground.
  • Precipitation & Water Stress (Chronic): Decreased precipitation increases seasonal water scarcity, reducing the amount of water available for cooling of assets. Increased dry spells increase the risk of fire which can damage assets, particularly in rural locations. Changes in humidity lead to changes in patterns and rates of the corrosion of equipment, requiring more frequent maintenance or replacement, leading to new dehumidification requirements and incurring associated costs.
  • Sea-Level Rise (Chronic): Rising sea levels affect the operation of data centers and service centers upon which telecommunications rely, and is likely to increase the cost of maintaining levels of service and asset performance by investing to address physical risks.
  • Combination of hazards: Telecommunications rely heavily on continuous power supply. Acute weather events can cause disruption of power supply, which would increase the cost of energy supply. Increased frequency and intensity of extreme weather events make it difficult for employees to get to work or for maintenance employees to access infrastructure, particularly in remote transmission networks, increasing recovery costs and compromising service.

Assets:

  • Tangible (fixed assets, e.g., buildings, infrastructure):Extreme events as outlined above may lead to a reduction in asset life as a result of increased maintenance costs and higher depreciation rates due to damage; a rise in asset renewal rates will increase capital expenditure budgets. On the other hand, operators that invest in climate proofing may increase the value of their assets.
  • Intangible (e.g., goodwill, brand, copyrights): Frequent climate-related disruption of telecommunications service might negatively impact an operator’s brand and reputation, causing customers to switch providers. On the other hand, operators who continue to provide excellent service during extreme weather events may gain reputational advantage.

7. Data centres.

Revenues:

  • Temperature (Acute): Extreme temperature events can lead to increased demand for cooling during heat waves, causing power failures in local transmission grids due to excessive loads, which can affect the delivery of data center services.
  • Temperature (Chronic): Potential increased revenues for data centers located in cooler regions as some companies choose these locations to reduce the need for active cooling.
  • Combination of hazards: Flooding of buildings can cause damage to operational equipment and potential loss of data, whether due to increased river flood risk, sea-level rise, groundwater or increased risk of flash flooding due to heavy precipitation.

Costs:

  • Temperature (Acute): Increased average temperatures and the greater frequency of heat wave events put additional burdens on cooling equipment, leading to the deterioration or failure of equipment and more frequent maintenance/repair. Increased energy demand during heat waves can result in power outages, which can affect the delivery of data center services and increase the costs of energy supply.
  • Temperature (Chronic): Increases in average temperatures and associated humidity can affect baseline design parameters, for example, the loss of ambient cooling potential. On the plus side, companies can achieve cost savings from energy efficiency initiatives in data centers resulting in reduced operational efficiency and greater component failure rates.
  • Storms, Precipitation & Flooding (Chronic and Acute): Flooding of buildings and assets can cause damage to operational equipment and increased maintenance costs.
  • Water stress: Data centers require enormous volumes of water to cool their high-server-density spaces, which is making water management a priority for operators. During periods of drought, water supply is restricted.

Assets:

  • Tangible (fixed assets, e.g., buildings, infrastructure): Extreme events as outlined above may lead to a reduction in asset life as a result of increased maintenance costs and higher depreciation rates due to damage; a rise in asset renewal rates will increase capital expenditure budgets.
  • Intangible (e.g., goodwill, brand, copyrights): Frequent climate-related disruptions to data center service might negatively impact an operator’s brand and reputation, causing customers to switch service providers. On the other hand, data centers which continue to provide excellent service during extreme weather events may gain reputational advantage.

8. Commercial real estate.

Revenues:

  • Temperature (Acute): With projected increases in the frequency of heat waves, people are likely to visit public places with air conditioning, especially during the hottest hours of the day.
  • Sea-level Rise (Chronic): As sea levels rise, people may be forced to relocate away from the shore, driving down demand for coastal commercial real estate.
  • Combination of hazards: Climate change is already driving people’s migration to lower-risk areas, and this trend may increase in the coming decades, resulting in shifts in the supply and demand of real estate markets. Frequent extreme events may result in diminished property value over time.

Costs:

  • Temperature (Chronic): As temperatures rise, the need for cooling in order to maintain/increase the attractiveness of assets may increase, resulting in higher levels of energy use.
  • Water Stress (Chronic): Water and energy efficiency requirements are becoming stricter in many regions of the world, and compliance with such requirements may lead to higher and/or additional expenses for asset owners.
  • Storms (Acute): The greater frequency and intensity of storms are likely to lead to higher insurance costs for assets, particularly those that are located in flood-prone areas. Storms and other extreme weather events are also likely to damage commercial infrastructure, and the costs of recovery may rise as storm severity and frequency increase.

Assets:

  • Temperature (Chronic): Rising temperatures are likely to increase the demand for air conditioning and other cooling systems or features such as cool roofs. Increased uptake of cooling features or systems that are also energy-efficient may result in higher levels of capital expenditures for the owners and/or managers of commercial real estate such as health facilities.
  • Water Stress (Chronic): In regions where water availability or accessibility is projected to decrease, real estate managers may have to make significant investments in water treatment facilities in order to maintain the viability of their assets.
  • Sea-level Rise (Chronic): The managers and owners of coastal properties are expected to face increased risk of flooding as sea levels rise.
  • Storms (Acute): Extreme weather is anticipated to become more severe and therefore more disruptive. Infrastructure located in high risk regions may be increasingly prone to physical damage and, potentially, complete loss, which can have dramatic effects on asset values held on the balance sheet.
  • Combination of hazards: The attractiveness and valuation of assets in particularly vulnerable regions may be impacted, for example those in low-lying coastal areas that face high levels of risk from sea-level rise or flooding, or areas that are expected to see significant increases in temperatures and/or more frequent high heat events.

9. Healthcare.

Revenues:

  • Temperature (Acute): As rising temperatures lead to more heat waves, poor air quality and heat stress may result in more emergency room visits and hospitalizations.The influx of patients is more likely to result in additional revenue for non-hospital healthcare facilities, but could result in bad debt and failure of payment for hospitals with emergency room facilities.
  • Storms (Chronic): Hospitals located in low-lying areas and close to coastal bodies of water face increasing risk of regular and permanent inundation from hurricanes, cyclones, and typhoons. This may result in the disruption of business supplier services, leading to loss of adequate patient services and care.
  • Precipitation & Flooding (Acute): With increasingly varying precipitation patterns, facilities and fixed infrastructure are more likely to be damaged and inundated by excessive precipitation and flooding. These can include nuisance flooding, where there is a temporary inundation of low-lying areas during exceptionally high tide events or floods that result from storm surges.

Costs:

  • Temperature (Chronic): Hospitals may face an increase in operating expenditures to address extreme temperatures, regulatory requirements, changes in costs of supply/materials, disruptions to supply chains, and limitations in regulatory agreements and licenses to operate regarding their ability to pass costs on to customers.
  • Combination of hazards: More intense extreme weather events may result in increased operating expenditures, including prevention measures, as well as contingency and recovery costs after events. In addition, facilities may be obliged to pay for higher insurance premiums due to the increased risk of flooding.

Assets:

  • Water Stress (Chronic): Medical facilities often have a back-up water source to mitigate potential issues related to the supply, quality, or capacity of traditional sources.
  • Sea-Level Rise (Chronic): Hospitals located in low-lying areas and close to bodies of water face increased risk of flood damage to physical assets and infrastructure, and regular or permanent inundation from nuisance flooding, storm surge, or seasonal inundations, leading to escalating damage costs. In some cases, this risk may be extreme and facilities may need to be relocated, while in other cases facilities may be forced to invest in protecting infrastructure.
  • Combination of hazards: Extreme events may result in increased unplanned capital expenditures to address disruptions to operations and physical damage to infrastructure and equipment, regulatory requirements, changes in costs of supply/materials, and disruptions to supply chains.
  • General: Hospitals and other facilities could see changes in the value of an organization’s assets, or the acquisition or sale of assets, as a result of temperature and climate-related risks and opportunities.

10. Sport and entertainment.

Revenues:

  • Temperature (Acute): Athletes’ performance and health are highly dependent on weather conditions. As temperatures rise, open-air stadiums may become less attractive than covered or retractable-roofed stadiums.
  • Temperature (Chronic): Temperatures are expected to increase throughout the 21st century and this trend may have negative impacts, both on athletes’ performance and health, and on associated sporting event profitability, as event attendees may not be willing to attend events in higher temperatures. As a result, some cities and venues may become less attractive locations to host events.
  • Sea-level Rise (Chronic): Coastal sports venues are at risk of permanent flooding due to sea-level rise, especially in low-lying areas.
  • Water Stress (Chronic): As water supply becomes increasingly scarce, support for water sports (or sports that are water-intensive, such as golf) may be affected as water use is prioritized for more critical uses. Water shortages and drought may also result in an increased demand for synthetic surfaces.
  • Combination of hazards: Increasingly severe weather events are likely to result in more frequent cancelation of sports events and structural damage to sports facilities, disrupting revenue generation.
  • General: Climate hazards such as heat waves and extreme weather events are likely to increase the occurrence of sporting event cancelations, potentially leading to declining revenue streams. A study estimates that a venue with greater than a 10% possibility of event cancelation due to weather and climate hazards would make the venue an unviable choice, and that by 2085 the vast majority of 543 cities (outside of western Europe) will face a high risk of event cancelation.

Costs:

  • Temperature (Acute): Extreme temperatures are expected to affect the temperatures of outdoor pools, a critical element for athlete performance, requiring aquatic facility owners to invest in technologies such as pool blankets to help maintain water temperature at reasonable cost.
  • Temperature (Chronic): Indoor venues will likely see a rise in electricity expenses, given that higher temperatures will increase the need for air conditioning to maintain environmental conditions that are conducive to athletes’ performance and attractive for event attendees. In addition, the rising demand for air conditioning and increasingly strict regulations regarding energy use may require greater investments in clean (e.g., solar) energy and result in higher energy costs.
  • Combination of hazards: Increasingly frequent and intense weather events may result in event delays and/or cancellations. Given that the organization of a major sporting event can cost millions of dollars, cancellations can represent enormous losses. Because of these impacts, it is likely that facility owners will see an increase in insurance costs.

Assets:

  • Temperature (Chronic): Temperature can impact a number of sports infrastructure, including stadiums, sports arenas, and ski resorts. For example, snow availability for winter sports may no longer be sufficient in the future in many locations to support revenues or asset values of corporations that own ski resorts, as as snow levels decrease.
  • General: Because many cities around the world will not be suitable for hosting major sports events in the coming decades and beyond due to extreme heat, flooding, and other climate change-related impacts, sports venues that currently exist in such cities are at risk of losing value.