Preparing for Catastrophe: Is your global warming portfolio ready for rising sea levels?

A Worse[sic]-Case Scenario

I believe that a large part of global warming denial is fear: fear that if we acknowledge that global warming is happening, we will be morally obligated to do something about it, and that the problem is too large for us to do anything effective. I also believe that denying the problem is certain to render us all ineffective in dealing with it.

But getting over our global warming denial is not the only obstacle in our way to dealing with it. Global warming is already happening. and future temperature rises are already inevitable given the continuing effects of global warming gasses already released in the atmosphere. Depending upon our actions today and over the next decade, we will effectively choose between a planet that is uncomfortably warmer than it is today, and one which is much too toasty for even the Russians (who some economists predict will be net beneficiaries of global warming ) to be happy about it.

That’s my belief. If it makes me sound like a raving lunatic, so be it. As an investor and investment advisor, I see my job as having an opinion that differs from the consensus, being correct in that opinion, and investing in such a way that I will make money for myself and my clients if I am correct. As long as I am correct more often than not (or realize my mistake before I’ve lost too much money), I’ll actually make more money the fewer other market participants agree with me.

I gave an example of this when I discussed how to prepare your portfolio for Peak Coal, on the assumption that while the production of coal may not peak in the next decade or two. rising demand may nevertheless drive price spikes that create investment opportunities. I’m personally not certain when peak coal will happen, but I’m fairly confident that most investors are too complacent about it, and that is reason enough change the allocations of a diversified portfolio.

Investors Believe What they Want to Believe

Since people tend to deny ideas that are just too scary, a consequence of global climate change that I expect most investors are under-prepared for is a massive (15+ foot rise) in sea level rise due to the melting of either the Greenland or West Antarctic ice sheet. From casual conversations, I note that Al Gore got a lot of flack for even bringing up this possibility in An Inconvenient Truth. despite the fact that he was careful not to do more than raise the possibility, as opposed to predicting it.

We don’t know if those ice caps will melt suddenly, or, if they do, when it will happen. We do know that their melting has accelerated in recent years. and I believe that society has massively underestimated the danger, because a 15 foot sea level rise (let alone a 20 or 40 foot rise) is just too horrific for most people to think about. Given our propensity towards psychological denial, I feel confident that the markets are underestimating the chances sea level rises large enough to seriously disrupt large coastal cities. Note that I’m not saying we will see such a sea level rise in my lifetime; rather that the probability of such a rise is currently underestimated by most market participants, and that this complacency is likely to be reflected by a relative overvaluation of investments which stand to lose from such a rise, and an undervaluation of investments that might gain.

If we can identify the exposure of individual securities to the risk/opportunities of sea level rise, we should then underweight our portfolio to investments which stand to lose, and overweight towards investments which stand to gain. This begs the question: Other than coastal real estate, which investments are which?

One environmental activist friend of mine asked me about using the Chicago Mercantile Exchange’s new housing futures or options to effectively short real estate prices in coastal cities. While this may be a good strategy to hedge against further implosion of the current housing bubble. these derivatives all expire within one year, which even I feel is much too short a horizon to hedge the risk of rising sea levels. In addition, given mass flooding from a rise of sea levels, there is no guarantee that the very indices that the futures are based on would not be changed to only reflect the values of real estate in higher lying areas, which would probably increase in value as people moved to higher ground.

Holding back the Flood

On Earth Day, Marc Gunther reported on an idea to come out of a Goldman Sachs conference on the business of climate change: dikes. If sea levels were to rise even a foot over the next couple years, that would require massive new barriers to protect existing structures from the ravages of the sea. The companies who build those dikes are likely to profit handsomely as soon as the need is recognized. I’m not an expert on the construction industry, but my impression is that it is fragmented and most of the companies are privately held. However, makers of the equipment and materials necessary for shoreline reinforcement may be easier to find, such as companies in the cement industry such as Cemex (NYSE:CX .) Another likely beneficiary a dike building boom would be Caterpillar (NYSE:CAT ), given their leadership in earth-moving equipment. CAT has the added benefit of being a company which is actively lobbying for meaningful greenhouse gas regulation, which I pointed out in my article on blue chip companies involved in alternative energy .

On the downside, one loser would be any owner or operator of seaside resorts, such as Club Med (CLBXF.PK .) When considering an investment in any REIT. I would make sure to check their portfolio of properties, and avoid ones that have excess exposure to oceanfront or low-lying properties. On the other hand, REITs and other real estate firms focused on areas where people are likely to flee (my own Denver, for instance) might stand to gain.

Conclusion

Given the massive uncertainties in predicting the probability and timing of large sea level rises due to melting ice caps. I don’t advocate buying or selling any company solely because of the risks or rewards which would be a consequence of rapid sea level rise. I do, however, advocate considering the possible effects of sea level rise on any investments you currently own or are considering buying. Managing risk is essential to long term superior results, and ignoring a risks in the hope that that they will go away is an excellent way to lose your shirt.

DISCLOSURE: Tom Konrad and/or his clients have positions in the following stocks mentioned here: CAT.

DISCLAIMER: The information and trades provided here are for informational purposes only and are not a solicitation to buy or sell any of these securities. Investing involves substantial risk and you should evaluate your own risk levels before you make any investment. Past results are not an indication of future performance. Please take the time to read the full disclaimer here.