Can infra development ride the wave of climate risk?

Climate adaptation remains an ill-defined subject. The EDHEC Climate Institute recently held its EC-EIB Adaptation Days conference, and delegates lamented that climate adaptation is often conflated with climate mitigation. The case for net zero is well accepted: that the world must decarbonise or face the consequences of a three-to-five-degree Celsius increase in global average temperature by 2100 relative to pre-industrial levels, in a worst case scenario.

But where adaptation differs from mitigation is that it need to happen over a much shorter timeline. Nicolas Schneider, a senior research engineer-macroeconomist at EDHEC Climate Institute, notes in a recent article discussing his work on modelling the economic impact of climate change, “It is widely acknowledged that mitigation strategies are likely irrelevant over a mid-century horizon.” In other words, the premise of climate adaptation is that, over the next 25 years, the incidence and severity of extreme weather and climate shocks will increase substantially. 

For instance, a study published by the European Commission in 2022 projects economic losses from natural disasters to increase at least two- to three-fold in the EU by 2050. And for Schneider, even this is a charitable estimate. He argues that estimates of the impact of climate change on GDP are too low. If an analysis accounts for small-scale variations in localised climatic exposure and intra-country economic heterogeneity, aggregate losses start looking greater.  

Varying appetite for climate adaptation amongst developers

Adaptation to climate risk is not always revenue-generating for energy and infrastructure developers. Rather, its value lies in how it limits the losses tied to climate change, be they operational delays, or mounting maintenance and insurance costs. The more time passes, the more frequent and expensive these losses become. So the projected lifespan of developers’ assets will shape the extent to which adaptation figures as a priority.

Infrastructure investors, thinking as asset owners, tend to be more proactive when it comes to adaptation. For example, Vincent Gerritsen, head of UK and Europe at Morrison, suggests that infrastructure investors have already begun calculating the cost of adaptation relatively to the cost of inaction. He says: “Damages attributable to a lack of climate resilience serve to price climate adaptation. Once there’s a price, there is a basis to develop an investment case.”

New infrastructure investments do not currently invite the same kind of investment. Rather, the former is still more geared towards risk transfer via insurance, whilst the latter towards direct adaptation measures. For investors due to reach the end of their investment in particular assets soon, insurance solutions will likely remain the more economical safeguard against climate-related loss than a costly retrofit. Despite the near certainty that premiums for natural catastrophe will rise, the annual rate of policy-renewal may still offer investors sufficient breathing room to stomach any increases in the immediate term. 

Retrofits, on the other hand, require architectural, engineering, construction and project management expertise, little of which is yet sufficiently professionalised or at scale. As has been the case with many of the technologies of the climate transition, bankability for the private sector will hinge upon revenue support from governments. 

But with many nations overleveraged, and hardly short on competing policy objectives, rallying the necessary political will may yet take some time. Indeed, as a senior financier active in the climate transition sector said when asked about the state of their retrofit pipeline, “That’s a tricky one. We’re not seeing much of it at the moment. Bolting new infrastructure onto an existing plant is never straightforward.”

By contrast, it is more possible to make infrastructure climate resilient when it is greenfield and adaptation requirements are fulfilled at the point of project design. Whether it be a matter of selecting a suitable, low-risk location, or factoring in sufficient flexibility so modifications can be made as the climate emergency evolves, implementing adaptation is much easier before any concrete has been poured. And for the investor about to commit themselves to a project for the long haul, the draws of future-proofing are more urgent.

Governments can incentivise adaptation through regulation and data sharing

Large and small energy and infrastructure asset owners need to feel equally the need to future-proof. As one financier’s comments acknowledge, there is currently a disparity in how decisively larger corporates are acting on their exposures compared to the smaller ones. 

In their words, “There is a slight tendency for multilaterals and governments to overcomplicate things. It’s not beyond the wit of man to say, ‘okay, we need to factor in raised elevation’, or ‘we need to build barriers.’ Granted, from a planning and engineering perspective, smaller corporates may not know where to start. But within the larger, more sophisticated corporate space, people are very clued in on this and are tapping into the relevant engineers, consultants and advisers to help them along the way.”

Piling up regulation will not always be the most quick and effective way to make changes happen. Yet the EU has shown through legislative measures like the Corporate Sustainability Reporting Directive (CSRD), obliging firms to disclose the steps they are taking towards adaptation, that governments can address inaction in ways other entities cannot.

And there is yet more for governments to do, especially around the democratisation of the data tools that would allow corporates to reckon with their vulnerabilities in the first place. Banks equally stand to gain from this, as the European Bank Authority (EBA) flags the lack of uniformity in data granularity and assessment methodologies across institutions when estimating banks’ exposure to elevated physical risk.

For Roman Roehrl, a climate specialist at the EIB, the unavailability of these tools is a significant barrier to adaptation. He says, “In the past, I haven’t seen particularly strong models for estimating damages in monetary terms. However recently progress has been made. Stakeholders may need to get more used to planning on the basis of such loss models.” 

Insurance offers parallel pressure 

But should governments delay or falter in pushing for adaptation, insurance may still function as a parallel lever. The particular strength of insurance in this regard is that its incentives are financial, and they can incentivise owners of both brownfield and greenfield infrastructure.

As natural catastrophes become increasingly commonplace and their occurrences start to jar with their ‘black swan’ classification, insurance has responded by upping premiums, reducing coverage, and, in some cases, retreating from markets entirely. For instance, a 2024 report published by Howden and Boston Consulting Group forecasts a 50% increase in insurance premiums for physical risks and natural catastrophe protection globally by 2030, reaching $200-250 billion.

If the decision of insurers State Farm, Allstate and Chubb to scale back or withdraw from California’s property markets following January’s wildfires is anything to go by, infrastructure developers may have to grapple with the prospect of stranded assets in chronically vulnerable areas in the near future. In the Californian case, the risk once assumed by the private sector has been in large part transferred to the state-mandated FAIR Plan – but after registering a loss of around $4 billion from the Eaton and Palisades Fires, additional funding has had to be requested. Public-private (re)insurance schemes the world over can only be pushed so far.

But as data modelling improves and insurers have more of a handle on the risks, eventually it is reasonable to expect them to stay in the market and offer the more comprehensive coverage that insurance programmes of last resort cannot. Then the case for adaptation will make itself felt amongst infrastructure providers, as the premiums offered will be higher for projects that have invested little in adaptation measures. 

For such market-driven incentivisation to function robustly, governments might need to enforce a universal commitment to adaptation amongst competing insurers to prevent predatory pricing. They might also have to avoid plugging the climate insurance gap artificially via price controls on premiums which distort the true nature of the underlying risk. But as Karina Whalley, head of public sector at AXA Climate, acknowledges, a winning formula has yet to be found: “How to set policy that actually incentivises adaptation without disrupting the price signalling of the insurance market? I don’t think anyone has an answer to that yet.”

As for addressing pre-existing clients whose vulnerabilities are more baked in, insurers have also been innovating their offerings to support them to build back better. Parametric insurance, for instance, which grants payouts automatically based on pre-defined climate conditions being met (e.g., wind speed, hail size, water level, etc.) encourages adaptation, in that it is not contingent on loss. 

Unlike indemnity-based insurance, a payout could result without significant losses being suffered – or, alternatively, a near-parameter event might lead to significant damages but no compensation. Implementation of adaptation measures will more likely keep policy holders in the first category and spare them from the second.

Private sector participation can jumpstart the retrofit pipeline

Governments and the private sector have a shared interest in adaptation. On the one hand, governments wish to get the ball rolling for essential public infrastructure in particular, but do not wish to shoulder the cost alone. Meanwhile, the private sector can generate returns through delivering climate adaptation projects.

A promising pilot project is the Haliotis 2 wastewater treatment facility located along the French Riviera in Nice, France. Operated by Eau d’Azur, a company owned by the association of municipalities Metropole Nice Cote d’Azur, Haliotis 2 in fact constitutes a brownfield renovation. Via a €170 million ($199 million) loan from the EIB, the project will expand upon a previous plant, built in the 1980s, to service a greater share of the region’s population: up to 680,000 people. 

Various climate mitigation and adaptation measures have also been planned, such as recalibrated flood protections safeguarding the site from marine submersion or storm surge over the next 100 years. Solar energy capabilities of 475MWh/year have also been factored into the design, as well as biomethane generation capacity of 43GWh/year through the treatment of sludge produced during the water filtration process. It is claimed that the renovated plant will be able to produce four times the amount of energy that it consumes today. 

The wastewater treatment technology itself will also be improved upon, with new systems capable of eliminating nearly 90% of microplastics from the plant’s output. Private sector expertise has been employed, with contracts signed with SUEZ Water to help realise the project.

Haliotis 2 constitutes a clear case of infrastructure needing to occupy a particular area. The original plant was built alongside the coast in service of the city, and it cannot now be easily relocated for treating the wastewater of communes extending beyond Nice itself. Diverting wastewater further inland would be a highly costly endeavour. 

A renovation carried out in phases has saved the state the cost of relocation and simultaneously permitted it to maintain operations throughout the redevelopment. It may also serve as a useful opportunity for the public and private sector to settle on a viable blueprint for brownfield adaptation. 

The formula 'adaptation is an opportunity' may sound trite at times. But as projects like Haliotis 2 attest, the adaptation drive may afford developers and governments alike the rare chance to rethink how some infrastructure operates at a fundamental level, and in ways that are not solely confined to the remit of adaptation.

The Proximo perspective

It is sometimes difficult to communicate the urgency of climate adaptation investment. Sea walls built to guard against severe floods will necessarily not be used a lot of the time, even if climate change makes such natural disasters more likely. 

Adaptation infrastructure can be costly and the case for investment in this infrastructure may not be apparent until an extreme weather event occurs, at which point it is too late to act. Developers, lenders, and insurers are all likely to have some exposure to climate risk and must begin to accord it the proper space in their due diligence processes.

With so many moving parts, essential to adaptation’s success will be the ability of all relevant stakeholders to communicate effectively. As Emmanuelle Nasse-Bridier, currently an independent senior consultant for climate adaptation and blended finance, indicates, “The way forward is to engage all stakeholders at the local level - corporates, farmers, local governments, communities - in a collective adaptation process: working together to define a shared vision for their territory, co-designing a local and concrete adaptation plan (both short- and medium-term), and piloting its implementation.” 

Nasse-Bridier was also formerly the executive director of Meridiam’s The Urban Resilience Fund (TURF). TURF’s €20 million catalytic capital fund focuses especially on project preparation, with an emphasis on developing countries.

Pilot PPPs like Haliotis 2 may also offer a template for climate adaptation projects, particularly when it comes to collaboration between the private and public sectors. MDBs can certainly help to advance this collaboration, having encouraged foregrounding climate risk when it comes to new projects. As the EIB’s Roman Roehrl points out, “When you go to a bank, you’re not typically there to talk about your vulnerabilities, right? However, the risk reduction is the opportunity.”

Such a shift in mindset will almost certainly have to take place across the global project finance market. Says Roehrl, “We are really right at the precipice of making the adaptation drive a reality. This explains why suddenly many more people, even in the corporate and financial space, are finally starting to talk about adaptation. It is on the cusp of viability.”