Pricing the unthinkable: Investors struggle to plan for AMOC collapse

The AMOC has grabbed headlines recently after a new study warned that a collapse could come much earlier than expected, most likely in the mid-century, if current carbon emissions trends continue unabated. 

But preparing for the collapse of the Atlantic Meridional Overturning Circulation (AMOC) and other major climate tipping points is still unfeasible for investors, despite the urgency of the issue.

The collapse may even come as early as 2025, though this would be a highly unlikely worst case scenario.

Previously, Intergovernmental Panel on Climate Change (IPCC) models concluded that the collapse seemed unlikely to happen within the 21^st century.

The AMOC is a system of ocean currents that circulates water within the Atlantic Ocean, bringing warm water north and cold water south. This global process, which makes sure that heat and energy are distributed around the earth, contributes to the current climate.

The collapse of the AMOC would bring about “non-linear changes”, meaning that the impact on nature (biodiversity, ecosystems) and societies (human wellbeing, cities, companies, financial markets) will be highly unpredictable, according to asset manager Robeco.

Unpredictable consequences

“Due to the complex, non-linear, and unpredictable nature of the potential consequences, assessing how a full or partial AMOC collapse influences investment portfolios is not feasible, even more so because there are severe data limitations on how individual companies are dependent on the AMOC,” Robeco’s ESG-investment specialist Jan Anton van Zanten told Net Zero Investor.

Innes McKeand, head of strategic equities at the Universities Superannuation Scheme (USS) – the UK’s largest private pension fund by assets – said: “It’s difficult to model how AMOC behaves as things stand. A collapse would likely have enormous impacts, not least in significantly reducing temperatures in the UK and Europe." 

He stressed that "predicting when it might happen is exceptionally difficult, as is predicting the scale of the impact – will it be a partial collapse or a complete failure?”

McKeand continued that it may be that an AMOC collapse could have such an enormous effect on the global economy - not to mention the potentially devastating effect on people - that it might be considered a systemic risk, affecting the financial performance of all asset classes.

"It’s also possible that other global events (such as changes in similar ocean circulation systems elsewhere) happen simultaneously."

However, the collapse is avoidable. 

For this reason, the authors of the Nature paper argue that their findings “call for fast and effective measures to reduce global greenhouse gas emission”.

“Our predictions are based on a “business-as-usual” scenario,” said Susanne Ditlevsen, professor at University of Copenhagen, co-author of the study. 

“This means that we assume that greenhouse gas emissions will continue to grow as they have done up to now … The collapse can be avoided if we stop greenhouse gas emissions. It is urgent.”

Uncertainties

The difficulties in predicting both the time horizon and consequences of the AMOC collapsing signal more general problems when it comes to assessing climate-related physical risk.

USS’s McKeand shared the key challenges with Net Zero Investor:

Firstly, economic models use estimates of damage from historical events. These estimates may look precise, but are highly uncertain, even for similar businesses in the same location. 

Further uncertainty is introduced when trying to extrapolate these local impacts nationally or globally.

Secondly, climate models forecast over decade-long time periods, and can’t predict the weather (a short term phenomenon). 

So it is extremely difficult to use climate models to forecast a specific weather-related risk at a defined location at a specific time, he argued.

Furthermore  It’s challenging to model potential tipping points and interactions. For example, a period of high temperatures, then drought followed by heavy rainfall leading to mudslides. 

"It is much easier to model each of these factors separately than in combination," McKeand said.

Finally, physical risk in one location can have far-reaching impacts beyond the specific location, because of the interconnectedness of the global economy (e.g. in the supply chain). 

He singled out extreme temperatures in China, which present obvious risks to companies operating in China, but they could also result ultimately in a shortage of goods in Europe or the US.

Frustrated by the sensationalist treatment of AMOC, Ditlevsen wrote a blog on LinkedIn to set the record straight.

“Our estimates are more uncertain than what is reported in some parts of the press,” she said. “The AMOC has only been directly monitored for the last 20 years, which is not sufficient to evaluate if the fluctuations that we see are due to global warming or natural ... This would require evaluat[ing] the natural levels before global warming started. 

Ditlevsen added: "Our predictions are based on historic data from the last 150 years. This data is not ideal, [but] what we call a fingerprint of the AMOC.”

While scientific studies are often characterized by uncertainty and reservations, she still stressed that the collapse of the AMOC is likely to happen much earlier than initial expectations.

“More studies are needed to confirm or disprove our results,” Ditlevsen noted. “However, the data is sufficiently alarming to call for immediate action.”

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