Water stress is the main medium-term climate risk for Europe’s biggest economies

This piece is produced by S&P Global Sustainable1, S&P Global’s single source of essential sustainability intelligence to navigate the transition to a low carbon, sustainable and equitable future. The heaviest rainfall to hit western Europe in a century caused flash floods and killed more than 188 people in July — […]

This piece is produced by S&P Global Sustainable1, S&P Global’s single source of essential sustainability intelligence to navigate the transition to a low carbon, sustainable and equitable future.

The heaviest rainfall to hit western Europe in a century caused flash floods and killed more than 188 people in July — stark evidence that rich, western countries are vulnerable to extreme weather events linked to climate change. But a new S&P Global Sustainable1 analysis reveals that water scarcity presents a potentially even greater risk for Europe’s residents, businesses and investors.

According to S&P Global Trucost data, water stress is the biggest climate-related risk facing many parts of Europe three decades from now. That could trigger droughts and potentially affect European food producers and beer brewers who rely heavily on agricultural products. Such shifts, in turn, would change the risk profile on businesses and have a knock-on effect on banks, insurers and investors.

“It’s a new normal we are experiencing,” says Swenja Surminski, climate scientist at U.K.-based Grantham Research Institute on Climate Change and the Environment, in an interview. “It means more extremes and more long-term shifts, so that’s heat, drought, sea level rise and flash floods.”

Major climate-related risks in 10 European countries

A new report by the U.N.’s Intergovernmental Panel on Climate Change (IPCC) found that heavy precipitation has increased across northern Europe since the 1950s, with a high level of confidence that it is linked to greenhouse gas emissions resulting from human activity. Heavy precipitation has also increased in western and central Europe, and in eastern Europe, though any links to human contribution in those areas are more tenuous. If the average global temperature increase was to hit 1.5 degrees C relative to pre-industrial levels, the IPCC scientists said they had “medium confidence” that heavy precipitation and associated flooding in Europe would intensify.

At the same time, the IPCC concluded that there has been an increase in agricultural and ecological drought across the Mediterranean (medium confidence in the human contribution) and in western and central Europe (low confidence in human contribution). This is of concern for heavy water users, such as the agriculture industry. In recent years, cargo barges on the Rhine River in Germany have also faced loading and transportation issues because of critically low water levels.

“This has implications for a number of different companies in the region — not only for credit ratings, but also how they manage climate-related risk,” S&P Global Ratings analysts wrote in a May report.

According to Trucost data for the 2030-2050 period, of the 10 studied countries, Greece, Italy, Spain and Belgium are the most exposed to the five physical risks in aggregate. On a scale of 1 to 100, where 100 is the maximum physical risk, Greece scores nearly 70, while Italy and Spain are each around mid-60.

Listen to this episode of ESG Insider, a podcast hosted by S&P Global Sustainable1, to learn more about the climate risks Europe faces

Some of the bigger consequences of climate change, such as water scarcity, may not always capture investor interest because they unfold over longer periods of time, can be more diffused in their impact, and aren’t always the subject of newspaper headlines. Flooding will continue to be a major risk factor in specific parts of Germany, Belgium and other countries, while issues such as water stress is a risk across a large swath of the European continent, notes Trucost analyst Rick Lord.

Of the 10 countries in the analysis, Greece, Italy, Spain and Belgium are most exposed to water stress between now and 2050, followed by Germany, France, Hungary and the U.K. Water stress refers to the combination of both reduced water availability (rainfall) and increased water demand (population, industrial and agricultural use). So even in parts of Europe where rainfall might increase as a result of a warming climate, more water demand could trigger water stress.

Heat waves are also expected to be worrisome, with France somewhat more exposed than other countries in the analysis.

Trucost measured the exposure of the 10 European economies using a moderate scenario for projected temperature increases for the 2020-2050 period. The 10 countries were picked for the size of their economies, and for their geographic location in Europe. Such estimates have limitations: climate models have a level of uncertainty because of the assumptions used. Trucost used spatial resolution to measure the physical risk exposure, and that analysis will be sharpened as more detailed data becomes available.

Both climate researchers and financial institutions were surprised by the scale of the recent floods in Europe. “The losses were bigger than we thought,” Berenberg insurance analyst Michael Huttner said in an interview. “These floods are shocking for two reasons. One is that they are unusual, and the second is that they come close on other floods we saw… at the end of June.”

Berenberg estimates the recent European floods will cost the German reinsurance industry between $2 billion and $3 billion. The overall impact of the flooding will be larger if other affected areas of Germany, such as Saxony, and other countries, such as Belgium, are factored into the calculation, Berenberg said in a note published July 19.

A calculation by the German Insurance Association put the losses between €4.5 billion to €5.5 billion (or roughly $5.3 billion to $6.5 billion, using the exchange rate on Aug. 11, 2021).

Such climate-related consequences on physical infrastructure aren’t limited to Europe, of course. Data from the National Aeronautics and Space Administration, EM-DAT (which compiles the International Disaster Database) and the U.N. shows that since the 1960s, greenhouse gas emissions, temperatures, the number of weather-related disasters and the resulting economic damage have all been rising together, according to a May 2018 report published by Schroders.

A separate analysis by the German asset manager, based on insurance costs, found that “capital-intensive sectors operating in more vulnerable parts of the world face the biggest impact, while companies that have asset-light business models are least exposed,” Schroders economist Irene Lauro said in an interview. Companies in areas such as oil and gas, basic resources, real estate, and travel and leisure are most exposed, while tech and healthcare companies are least exposed to physical risk, Lauro added.

So what can countries and companies do to mitigate the physical risks? According to many climate scientists, the answer is: Adapt. The concern is that this need to re-jig corporate infrastructure, adjust global supply chains and protect other physical assets is currently more talk than action.

“Globally speaking, there’s a huge adaptation gap between what is technically possible and what is being done, and that applies also across Europe,” says Surminski of Grantham Research Institute. “There are very few countries that have a specific and dedicated adaptation plan or program in place with targets and clear strategies. They are still stuck in [the stage of saying] let’s understand the risk” instead of shifting to a mindset of climate adaptation.

The IPCC report states that the most immediate adaptation step is for the world to sharply cut emissions of two major greenhouse gases, carbon dioxide and methane.Not surprisingly, this will be the focus of the big COP26 climate change meeting being held in Glasgow, U.K. in November. In the words of the conference organizers: “At COP26 we need to work together to enable and encourage countries affected by climate change to protect and restore ecosystems, build defenses, put warning systems in place and make infrastructure and agriculture more resilient to avoid loss of homes, livelihoods and lives.”

This piece was published by S&P Global Sustainable1 and not by S&P Global Ratings, which is a separately managed division of S&P Global.

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