The Rise of the Climate Consultant
As the SEC asks for climate risk disclosure, an industry blooms
Dan Rice thought he knew more than most investors about weather and climate risk. As a managing director of BlackRock's (BLK) $1-billion Energy & Resources Fund (SSGRX), he uses weather forecasts to gauge heating demand that moves the oil and coal markets. In 2009, as climate change became a more pressing issue for U.S. businesses, he grew concerned about the coal companies in his portfolio; he wondered if climatologists knew something he didn't. Rice commissioned Atmospheric & Environmental Research (AER), a Lexington (Mass.) consultancy in to synthesize the climate literature. After he sat down to read AER's 35-page report, he says, "I was humbled by how little I know—and how much uncertainty there is in the existing science."
Rice belongs to a growing pool of market players who are boning up on their climatology. Although the fate of climate legislation in the Senate is uncertain at best, some companies are snapping to attention because of a mix of federal action and historic weather calamities—the kind scientists say are likelier in a warmer world. Flooding in early May killed 30 people in the Southeast. The East Coast braved two "once-in-a-century" snowstorms in two months. This decade is the hottest in recorded history. Despite intense opposition, the Environmental Protection Agency is moving ahead with carbon regulations. And in February, the Securities & Exchange Commission urged public companies to disclose material risks from climate change. Pension funds, state treasurers, and nongovernmental organizations asked the SEC to act because, they said, climate risk is changing business. The SEC's "interpretive guidance" creates no new regulations; instead, it suggests how existing rules might apply to climate.
Demand for expertise is growing. On May 25, Ernst & Young released a survey of 300 companies, 70 percent of whom expect to boost outlays on climate-related initiatives in the next two years. British research firm Verdantix puts the U.S. climate consulting market at $4.1 billion, rising to $5.7 billion by 2014. Five years ago this business was a blip, says Greg Holland, a senior scientist at the National Center for Atmospheric Research, which advises insurers and offshore energy firms, including Chevron (CVX) and Royal Dutch Shell (RDS). Today companies such as AER—a unit of insurance information company ISO—have climatologists and risk experts on staff.
Next to the oil spill, the SEC's move will turn out "to be the biggest event in the next 12 to 18 months," says Jeffrey A. Smith, who runs the environmental practice of Cravath, Swaine, & Moore. Disclosure, he says, isn't just measuring a carbon footprint. It means rethinking strategy—and confronting fuzzy 21st century risks. The oil spill and climate are related in this sense: Business doesn't account well for rare events. The Gulf disaster is a so-called black swan, an unlikely catastrophe of incalculable cost—which is a good analog for climate predictions.
Rice and his peers make a living by betting on known risks and rewards. Rare events don't make it into the equation. Rice says a fund that hedged a decade ago against the possibility of an offshore blowout wouldn't have had oil stocks—or customers. "You'd be correct, but it doesn't do you any good," he says.
Rice didn't sell coal stocks after reading AER's report—"not because we love coal, but we love coal stocks because they appear to be overly discounting the negative headlines." He can't bet other people's money today on weather events in the 2030s. As SEC disclosures say, past performance is no guarantee of future results. The same might be said for the earth's operations.
The bottom line: Assessing climate risk is difficult, but a $4 billion consulting industry is emerging to meet a growing need for expertise.