From Paris to Pandemic: How climate risk and policy uncertainty shapes fossil and clean Energy commodities

Abstract

How do climate-policy uncertainty and climate shocks affect systemic risk within clean and fossil-fuel energy markets? Could more advanced connectedness models help reduce this risk? This study investigates these concerns through the dynamic interconnections between climate risk and the leading energy commodities: natural gas, crude oil, and clean energy. Employing innovative text-based climate uncertainty indices capturing natural disasters, global warming, international summits, and U.S. climate policy, we apply the frequency-Quantile VAR model to unveil the asymmetric spillovers across time horizons and return quantiles. Our results show that events like the U.S. withdrawal from the Paris Agreement and the 2024 U.S. presidential election, significantly enhance interconnections among both renewable and conventional fossil-fuel energy markets. We also find that climate-policy uncertainty stemming from U.S. climate policy and international summits, consistently transmits risk in the high quantiles, driving both short-term volatility and long-term structural repricing in the energy commodity market. Our findings are useful guidelines for traders, portfolio managers, and policymakers aiming to hedge against tail risks and adapt to a decarbonizing global economy.