J.P. Morgan Is Thinking About Climate Tipping Points

How does the market price an existential risk: nuclear warfare, AI takeover, or global pandemic of unprecedented proportions? In short, it doesn’t. At the end of the world, your assets are irrelevant. 

Most corporate executives and investors have approached climate tipping points the same way—and for understandable reasons. Tipping points, events where climatic conditions change rapidly and irreversibly, are too distant and too difficult to model. 

But tipping points, however unlikely they seem, don’t have to end the world to reshape it. And they may finally be starting to get their due in the private sector, thanks in part to the rise of geopolitical risk and the wide range of unprecedented disruptions that have rocked the economy in recent years, reminding us that old assumptions may not be as reliable as they once were. 

“People are dealing now with geopolitical risks at a level that they haven't in a while,” says Sarah Kapnick, J.P. Morgan’s global head of climate advisory. “And, like geopolitical risks, these are nonlinear risks that they're starting to figure out how to account for.” Companies with board members who have national security and environmental expertise are best able to connect the dots, she says.

In a new J.P. Morgan report which I got an exclusive first look at, Kapnick lays out a framework to understand and respond to the risks of climate tipping points. While banks regularly publish on climate risks, the assessment of tipping points is something new. Right now, only the most forward-looking investors and firms have begun to incorporate tipping points into their business models and operational considerations. But as time goes on sophisticated firms will need to establish an approach for thinking through these questions, or risk facing costs—whether slowly or all at once. 

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The science underpinning tipping points has been widely understood in climate communities for decades. Continued destruction of the Amazon rain forest, for example, could trigger “dieback,” where the entire ecosystem converts into a savannah, with hard to predict ripple effects. The Atlantic Meridional Overturning Circulation (AMOC), a system of currents that regulate weather conditions in North America and Europe, could weaken as the planet warms, triggering a quick shift in climatic conditions. Scientists are currently debating whether we have already crossed a tipping point with the world’s coral reefs, which are dying amid climate stress. 

But, despite how scary these things sound, economists have long struggled to incorporate the risk into modeling and firms had no real way to account for them. The late Harvard economist Martin Weitzman captured this dynamic with what he called the “dismal theorem”: the worse the outcome, the less equipped we are to address it. At the same time, he argued that we should be willing to pay a very high price to avoid tail-end risks, effectively buying an insurance policy. 

That may work at a society level, but it doesn’t resonate at a firm level where CEO tenures are typically measured in years not decades and the stock price is determined by quarterly returns. Kapnick’s report, however, begins to offer some insight that does resonate. And instead of calling on companies to take radical action unmoored from financial realities, she suggests that they build capacity to understand their vulnerabilities to a world post-tipping points. 

Critically, she puts tipping points into the language of business. She uses a discounted cash flow model to evaluate the cost of a future, post-tipping point flood in immediate terms. Kapnick shows that over the short term, the present value of future damages remains relatively manageable. Consider a flood that would cause $1,000 in damage each time it occurs but is so rare that it has just a 0.2% chance of occurring in any given year in the base case without accelerating climate change. In that scenario, a company might expect $30 in present-value damages over 30 years. If a climate tipping point hits midway through that window, the same analysis produces over $1,600 in present-value damages. In other words, once firms are thinking over a 30-year horizon, these risks start to look financially significant.

So how to navigate this risk? The recommendations vary. Venture capital should seed technologies that will become more relevant once a tipping point occurs. Policymakers need to set the rules of the road to protect supply chains from disruption. Pension funds and family offices with long time horizons must map the risks in their portfolios. 

Investors who are thinking in these long-term ways and likely to use that knowledge in their pricing of assets are what Kapnick calls "high conviction pricers.” Those assessments are likely to affect debt, where downside risk is more important, before equity, where upside opportunity outweighs risks.   
But we don’t need a tipping point to actually occur to have tipping points shape pricing. As awareness and alarm grows, and the time horizon for potential costs moves forward, more and more institutions will begin to price tipping point risk. “It’s not just about the physical risk and the loss,” says Kapnick. “It’s about how the information flows through the system and what those responses are, which can happen before the actual physical climate events.”

Once markets begin to treat tipping points as decision-relevant rather than theoretical, repricing may come suddenly, unevenly, and across asset classes in ways that reward firms that prepared early. 

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