How extreme temperatures may affect Chinese companies

May 19, 2023 09:35

Last year, China suffered its most intense heatwave, with nearly one billion people experiencing temperatures exceeding 35°C. This year, the China Meteorological Administration has warned that more extreme weather conditions may occur. With climate change accelerating, extreme and abnormal weather patterns are becoming more frequent, raising questions for investors around potential company and sector impacts.

Which sectors may be most at risk to heatwaves?

According to the latest report from the Intergovernmental Panel on Climate Change (IPCC), the average global surface temperature for 2011–2020 was 1.1°C above 1850–1900 levels. And as global temperatures continue to rise, further changes in weather and climate extremes are projected, resulting in escalating damages.

For China specifically, more than one quarter of the country is expected to face medium-to-high or high risk from physical climate impacts under a 2°C warming scenario.

While overall exposure to physical climate risk is anticipated to increase for companies operating in China, sector-level impacts are not projected to be evenly distributed. To assess this, we took a hypothetical portfolio of companies, based on the MSCI China Index (as of March 2023), and determined variations in physical climate risk using MSCI’s Climate Value-at-Risk (VaR) model.

We found that extreme heat comprised 49% of the total potential loss from all physical climate risks in the hypothetical portfolio, the second largest hazard type following coastal flooding. The exhibit presents the potential losses from extreme heat for each Global Industry Classification Standard (GICS®) sector on a 1.5°C warming trajectory.

Potential losses from extreme heat varied considerably by sector

For the hypothetical portfolio, the energy and utilities sectors, with a combined 5% weighting, contributed 33% of the weighted extreme heat VaR, partly due to infrastructure disruptions, increased cooling costs and reduced productivity. By contrast, the consumer discretionary and financials sectors, with a combined weighting of 44%, contributed a much lower potential loss percentage (22%).

Not only does the extent of vulnerability differ across sectors, but the relative impacts each sector experiences are shown to change under different warming scenarios. Financials, telecommunication services and real estate, which may not be largely affected under an orderly 1.5°C transition, become some of the most sensitive to global warming with projected market value losses increasing ten-fold under a 5°C warming scenario compared to a 1.5°C warming scenario.

Where might a heatwave hit the hardest?

Another factor at play in economic losses due to extreme heat is location. To look at this, we retrieved the asset-level assessments of extreme-heat VaR and then aggregated them to assess worst-case potential losses (i.e., a 5°C warming scenario).

Potential losses from extreme heat are projected to vary by location

Under the 5°C warming scenario, we found companies domiciled in Beijing, Shanghai, Shenzhen and inland provinces such as Sichuan Province and Hebei Province are exposed to higher potential losses (dark red regions in the above exhibit). Within these areas, the assets located in the same single grid (smaller than 10,000km2) may face a combined potential loss over USD 2 billion by 2100.

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Siyao He: MSCI APAC ESG & Climate Research Analyst. Shuo Xu: MSCI China Research Analyst