It’s Getting Hot in Here: Assessing the Risks of Extreme Heat in the US
Key findings
- Although U.S. companies face lower physical-risk costs compared to global averages (2.7% vs. 7.5% of market capitalization in present value terms), over half of these costs may be heat-related amidst rising temperatures and higher humidities.
- Certain industries, like hotel resorts, may face additional demand-side impacts like changes in tourist traffic, but their specific location may determine whether a hotter summer improves or hurts business prospects.
- Limited company disclosures on physical risks mean that investors may have to rely on leveraging geospatial analysis to assess physical-risk exposure.
As the world continues a 14-month streak of recording the hottest months on record, chronic heat is emerging as a physical climate risk widely affecting companies and governments alike.[1] Combined with high levels of humidity,[2] chronic heat is causing stress on workers and driving the need for adaptations to existing working conditions, particularly for outdoor labor.[3]
Across asset classes ranging from equities to real assets, investors exposed to industries dependent on outdoor-labor productivity (e.g., construction, agriculture, tourism) will need to navigate their portfolio holdings' management of worker safety and labor productivity.
For investors looking to assess the exposure of their holdings to heat-related risks, it helps to see how the risk is broken down at various levels including country, sector and company. Perhaps the level that can provide the most insights, however, is at the asset level.
Heat-related risks in the US — an increasing trend in severity and potential costs
Applying this asset-level geographic approach to companies' asset locations in the U.S. (as shown in the first exhibit), we note that even in a 2 degrees C warming scenario, extreme heat shows a distinct increasing trend compared to other physical hazards.[4] From a potential costs perspective, the U.S. constituents of the MSCI ACWI Investable Market Index (IMI) could see the present value of extreme-heat-related costs increase from USD 370 billion[5] in a 2 degrees C warming scenario to USD 770 billion in a 3 degrees C warming scenario, accounting for over half (53%) of all costs related to physical hazards.[6]
Extreme heat shows a distinct trend relative to other hazards
Data as of Aug. 7, 2024. Hazard percentiles indicate a company's hazard exposure relative to the constituents of the MSCI ACWI IMI. The average change in hazard percentiles refers to the difference between 2023 and 2050 under the 2 degrees C climate scenario for all locations of constituents of the MSCI ACWI IMI. Positive change indicates greater exposure in the future. Source: MSCI ESG Research
Present value of costs related to physical hazards in the US
Data as of Aug. 19, 2024. The MSCI Climate Value-at-Risk Model estimates that U.S. constituents of the MSCI ACWI IMI face total costs from physical hazards of USD 830 billion and USD 1.5 trillion under the 2 degrees C and 3 degrees C temperature-rise scenarios, respectively. Source: MSCI ESG Research
Workers and regulators have started to recognize the increased risks and to demand action. Multiple U.S. labor unions organized nationally around "heat week," while the Occupational Safety and Health Administration in July 2024 proposed an initial set of heat-protection regulation for workers.[7] The proposed regulation includes two heat-index thresholds of 80 degrees F (26.7 degrees C) and 90 degrees F (32.2 degrees C) that start with requiring access to drinking water, rest breaks and acclimatizing new workers with gradually increasing workloads, to mandatory 15-minute breaks and monitoring for heat-related illnesses.[8] But temperature is just one part of the picture. Layering other factors such as humidity, wind speed, cloud cover and solar radiation means that labor productivity may start being affected for heavy physical labor at a daily maximum outdoor temperature of just 77 degrees F (25 degrees C).[9], [10]
Asset-level insights of hotel resorts show widespread heat risks
Data as of Aug. 30, 2024. This includes 15 enterprises that were constituents of the MSCI ACWI and part of MSCI GeoSpatial Asset Intelligence as of August 2024 with 81 assets designated as resorts. Change in exceedance days is calculated as the difference between 2023 and 2050 under the 3 degrees C NGFS REMIND Current Policies scenario. Source: MSCI ESG Research
In addition to planning for the labor side of risks related to extreme heat, certain assets like hotel resorts may also see a direct impact on consumer demand. Resorts that capitalize on winter activities may see shorter profitable seasons, while higher temperatures may lead to harmful second-order effects like disruptions to rail and air travel,[11] or in some cases, rising water temperatures above safe levels for swimming.[12]
We looked at a selection of 81 hotel resorts in the U.S. owned by constituents of the MSCI ACWI Index, to see how regional variations in risk exposure emerged. On average, these locations would see a 16-day increase in days above where the maximum outdoor WBGT exceeds 25 degrees C under a 3 degrees C warming scenario. While every corner of the U.S. is expected to see an increase in heat-exceedance days by 2050, the highest increases are projected to be observed for resorts in Hawaii, across the southeastern U.S. and over much of the eastern half of the U.S. However, in areas like the Great Lakes (e.g., Michigan, Minnesota, Wisconsin), Pacific-Northwest (e.g., Washington and Oregon) and surrounding the Rocky Mountains (e.g., Colorado and Utah) where temperatures are currently more moderate and the effects of humidity less pronounced than in other parts of the U.S., a case could be made that over time they could benefit from a longer summer season — some Scandinavian cities have recently seen new peaks of tourism during hotter summer months.[13]
Leveraging geospatial intelligence gives investors the tools to engage
While initiatives like COP 27's Sharm El-Sheikh Adaptation Agenda and legislation like the EU Corporate Sustainability Reporting Directive aim to increase company disclosure on physical climate risks, investors need not wait to assess their investments.[14] Comparing the hazard exposure of assets across current and future warming scenarios can give investors an immediate (high exposure currently) and long-term (largest change in risk exposure over time, or crossing a specific threshold) physical-risk profile.
This understanding of risk can empower investors to ask companies what potential adaptation measures, ranging from risk-transfer mechanisms (i.e., insurance), risk-reduction measures (e.g., adopting new technologies or processes or even changing locations of operations) or diversification strategies may be most appropriate.
1 “July 2024 Global Climate Report,” National Oceanic and Atmospheric Administration, Aug. 12, 2024.2 We refer to extreme heat as the daily mean indoor wet-bulb globe temperature (WBGT), which differs from air temperature because it accounts for other atmospheric variables including humidity, wind speed, solar radiation and cloud cover. It is a common indicator of heat stress in direct sunlight felt by humans.3 Wojciech Szewczyk, Ignazio Mongelli and Juan-Carlos Ciscar. “Heat stress, labour productivity and adaptation in Europe – a regional and occupational analysis,” Environmental Research Letters 16, no. 10 (2021).4 Based on a 2°C REMIND Orderly temperature scenario, aligned with those recommended by the Network for Greening the Financial System (NGFS). We observed the largest average increase in hazard percentiles for extreme heat between current and 2°C levels among U.S. constituents of the MSCI ACWI IMI. Hazard percentiles indicate a company's hazard exposure relative to the constituents of the MSCI ACWI IMI.5 To estimate costs from extreme heat, we derive sector-specific productivity loss functions from labor-productivity loss per labor type and the labor-intensity profile of each Nomenclature of Economic Activities (NACE) sector. Furthermore, we estimate two types of vulnerability reduction. For work done indoors, we reduce the vulnerability to zero because we assume that environmentally controlled conditions (i.e., the prevalence of air conditioning) will not change with climate change. For all other kinds of work, we consider a vulnerability reduction factor due to acclimatization, where we apply this factor uniformly across all timesteps and NACE sectors because people acclimatize quickly. The vulnerability to chronic weather extremes is also lower in regions where these events are frequent and the local businesses are experienced in dealing with the consequences. For the full methodology of how we compute risks for extreme heat, please refer to “MSCI Climate VaR Methodology Part 4 - Physical Climate Risk,” MSCI ESG Research, August 2024 (client access only).6 The MSCI Climate Value-at-Risk Model estimates that in a 2°C temperature-rise scenario, U.S. constituents of the MSCI ACWI IMI face a present value of USD 830 billion worth of costs related to physical hazards. These costs could go up to USD 1.5 trillion based on the emissions trajectory of current emissions-mitigation policies. As of Aug. 19, 2024, there were 2,237 U.S.-domiciled constituents in the MSCI ACWI IMI with a combined market capitalization of USD 55.5 trillion. The entire MSCI ACWI IMI (8,717 constituents, USD 109 trillion of market capitalization) faces a range of USD 5.6 trillion worth of costs (USD 1.6 trillion from extreme heat) in the same 2°C scenario. These costs could go up to USD 8.2 trillion under current policies (USD 3.3 trillion from extreme heat).7 “Union campaign pressures companies to adopt OSHA heat rule,” E&E News, Aug. 14, 2024.8 “The U.S. has a plan to protect workers from heat. Employers are fighting it,” Washington Post, July 11, 2024.9 The threshold used to assess extreme heat is defined as the daily mean indoor WBGT of 20°C, which implies a daily mean outdoor WBGT of 23°C and a daily maximum outdoor WBGT of 25°C as per Dirk Lauwaet et al., “A New Method to Assess Fine-Scale Outdoor Thermal Comfort for Urban Agglomerations.” Climate 8, 6 (2020).10 Chloe Brimicombe et al., “Wet Bulb Globe Temperature: Indicating Extreme Heat Risk on a Global Grid,” GeoHealth 7, (2023).11 “It's heat wave season. That's bad news for your flights,” Washington Post, June 14, 2024.12 “Florida's ocean water temperatures are high. But are they too hot for you to swim?” USA Today, July 28, 2023.13 “Extreme heat is changing where and when we vacation,” NBC News, July 7, 2024.14 The Sharm El-Sheikh Adaptation Agenda sets a target to have 2,000 of the world's largest companies to develop actionable adaptation plans by 2030. “Taking Stock of Business Efforts to Adapt to Climate Change,” World Economic Forum, December 2023.
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