2020’s run up in renewable energy and some EV stock valuations has been unhinged meteoric, and at least a decade in the making. A friend recently asked “maybe this is what pricing in the energy transition looks like?” He’s probably right. I couldn’t help but also wonder what pricing in the climate transition looks like?

The Biden administration seems poised to issue an executive order requiring companies to report GHG emissions and climate risk. With the Senate in Democratic hands, it also looks like some form of Sen. Elizabeth Warren’s proposed Climate Risk Disclosure Act of 2019 (S.2075) will be seriously considered. The bill directed the SEC to issue rules requiring every public company to disclose: (1) direct and indirect GHG emissions, (2) the amount of fossil fuel-related assets it owns or manages, (3) how its valuation would be affected by climate change, and (4) its risk mitigation strategies related to physical risks and transition risks. There’s a lot to unpack there, and the impact of such a law on shareholders would be dramatic. These disclosures also stand to cause knock-on shifts in the insurance industry, mortgage availability, and significantly impact local and state economies.

The GHG reporting framework is probably most straightforward, as similar systems have been implemented elsewhere and many companies are already tracking their emissions (it’s unclear how this might apply to a firm’s foreign supply chains, but that really isn’t the point of this post so I’ll stop the thought here). Accounting for overall fossil fuel reliance might be a bit trickier, and attaching a social cost of carbon—estimating economic damages per ton of GHG emitted—is bound to generate a political firestorm. All are likely be viewed as informative steps toward implementing a carbon tax system. A carbon tax, no matter how heavy or light, would certainly affect firms’ bottom lines. If physical climate risks get tied directly to firm valuations, however, impacts across the economy will be challenging to predict, and no doubt massive. This is the multitrillion-dollar question.

The reality here in the U.S. is that we can’t seem to even peacefully agree that our elections are fair. In this tinderbox of a political environment, and with an economy that’s as precarious, I doubt we’ll see any near-term order for accurate, forward-looking disclosures of physical climate risk. It should happen, I just don’t think it will. There’s insufficient agreement as to precise climate risks or the timeline for realizing those risks, and the political and economic shocks from these disclosures would be massive. To illustrate, imagine two identical public companies, except one is headquartered and heavily invested in property, plant, and equipment (PPE) along the gulf coast in Louisiana, and the other is based in Minneapolis and heavily invested in PPE throughout the state of Minnesota. Under prospective new reporting requirements, the Louisiana firm is required to disclose significant current—and increasing—risks of flooding and storm damage to its properties. Their ten-year outlook estimates insurance and repair costs many times higher than that of the Minnesota firm. Further, they’re required to lower projections for the value of their real estate. Their required mitigation strategy, in order to avoid a devastating blow to their stock price, relies heavily on hoped-for federally-funded floodwater diversion and floodwall infrastructure, which looks increasingly uncertain. All else equal, the Minnesota firm should have a far easier time finding long-term investors, whereas the Louisiana firm might be hard-pressed to raise any capital at all. With these kinds of risks coming into general awareness, the accompanying regional economic impacts would be crushing, and the political and economic fallout stands to be explosive. The big problem is that this wouldn’t only affect companies in these extreme cases, it would impact many utilities, farmers, banks, REITs, and major companies across oil & gas, materials, and consumer products sectors. Firms across the economy would see assets stranded, shareholder’s equity destroyed, and they’d face impossible hurdles to raising capital. Livelihoods would be in question, 401ks would get upended.

This market upheaval is going to happen. We can either start a government-led transition now, or else mother nature will dictate terms for everyone later. I’d opt for the earlier and less-panicked transition. But in America we’re known for doing the right thing only after we’ve exhausted all other possibilities. What seems like a promising mandate probably won’t be given adequate teeth, so I expect it won’t bring retail investors any hoped-for clarity about long-term climate risk. Maybe we’re a decade away from a strong mandate, hopefully less. I expect we’ll first see exchanges outside the U.S. mandated to incorporate climate risk, and if that happens, trust that institutional investors everywhere will take notice. Institutional investors may then pressure U.S.-listed firms for similar disclosures, or simply bypass them and hire consultants to do the assessments themselves.

In a previous post I discussed how setting yourself up for the clime ahead means investing in things that will retain or increase value. Although we can’t know climate change’s effects with certainty, and it doesn’t appear that we’ll soon get better clarity through mandated disclosures, we can still make educated bets—screening investments for companies with assets, consumer bases, and productive capacity in particularly well-positioned regions or industries. My fictitious ETF, CLME, might not only exclude companies that are invested in or reliant on high risk areas—maybe I’d set it up to have selectively inclusive criteria. Since I can structure this any way I want, I won’t just exclude the worst-positioned companies, I’ll only include the best.

I’d look for companies involved in the energy transition (I.e., nuclear, renewables—and I’d include a diversity because the road to success in renewables is littered with the large, heavily-indebted corpses of the corporate fallen). I won’t address whether they represent a good value at the moment, but I’d eventually want them in my ETF. Additionally, I’d include local firms — micro or small cap banks, utilities, and food distributors operating in regions expected to fare well, as well as timberland, farmland, or diversified REITs heavily invested in these regions. In the U.S., the ETF would target firms heavily invested in the Pacific Northwest, the Upper Midwest, parts of New England, and Alaska. Internationally, it would target Canada, Scandinavian countries, Iceland, Western Europe, Australia, and New Zealand. Russia could also be a great target for agricultural investments, if you trust whatever you’re buying.

I’m maintaining CLME at Strong Buy for the clime ahead.