Climate Scenario Analysis for Enterprise Risk Management is a sound solution for addressing the complexities of climate risk. The Climate Service (TCS) assesses scenarios based on different representative greenhouse gas emissions concentration pathways (RCPs) to provide actionable insights on business strategy for diverse industries.
As increasingly unstable conditions emerge from the global impacts of climate change, businesses are entering a more dynamic playing field. Property damage from natural disasters, disruptions to raw materials sourcing, shifts in public policy and opinion, and unstable market conditions are all salient climate risks, which enterprises have largely overlooked in their strategic planning.
Assessing business risks and opportunities related to climate change requires sophisticated data analysis, a long-term future orientation, and agility. Effectively responding to climate risk will likely become a key differentiator among enterprises of the future.
Fortunately, there is considerable alignment among the most widely adopted business sustainability reporting frameworks, and the insights businesses disclose in their non-financial reports can inform business strategy. For instance, the Task Force on Climate-Related Financial Disclosures (TCFD) and the Carbon Disclosure Project (CDP) both recommend scenario analysis and the disclosure of physical and transition financial risks.
The TCFD was established by the Financial Standards Board (FSB) in 2015, and it has gained widespread adoption worldwide. It is now mandatory in New Zealand and the UK, and the United States Securities Exchange Commission is accepting public comments on whether to implement mandatory reporting under TCFD.
The CDP is an international non-profit collecting data on key climate change impacts related to forests, water security, and supply chains. More than 8,000 companies worldwide report under CDP, and institutional investors accounting for hundreds of trillions of dollars in assets depend on its data. It holds the largest collection of voluntarily disclosed climate change data.
Scenario analysis, which involves comparing best- and worst-case scenarios based on specific assumptions, is a long-standing approach to strategic planning. In the climate risk context, scenario analysis depends on assumptions related to physical risks, such as natural disasters, flooding and drought, as well as transition risks including policy changes, reputational impacts, litigation, market conditions, and technology.
Assessing these specific moving parts in a business context can be a daunting task. For many companies, “…scenario analysis [is] one of the most challenging aspects of meeting supervisory expectations,” according to a commenter in the recent Climate Financial Risk Forum (CFRF). Companies also have a lot to gain from conducting these seemingly cumbersome analyses.
Scenario analysis helps businesses take more of a proactive rather than reactive stance towards the complex impacts of climate risk. Aligning business strategy with the insights gleaned from scenario analysis can unlock future-aligned opportunities and improve the long-term viability of business operations.
Climate risk scenario analysis identifies the financial impacts of short-, medium-, and long- term physical and transition risks and opportunities for at least two climate warming scenarios. TCS often assesses these time periods according to different decades, spanning the 2020s-2030s for short-term, the 2050s for medium-term, and the 2090s for long-term insights.
The Climanomics® Platform uses two representative concentration pathways (RCPs) for net atmospheric GHG emissions to provide the anticipated physical risk and transition risk contexts to understand the financial impacts for the different scenarios.
How should business managers interpret this data in relationship to their own assets and operations? “It starts with a question,” says Joseph Lake, Chief Operating Officer at TCS. The guidelines of TCFD encourage an exploratory approach to scenario analysis, in which businesses are encouraged to ask “what ifs” of critical importance to their business.
For a server data farm, which depends on cool temperatures for optimal performance, extreme heat at a certain facility location might become a central concern. In this case, the business should look at how much and how fast temperatures will rise, and how this will impact the facility in their scenario analysis.
The company can then probe business strategy considerations such as how to source the energy under those conditions, whether to move the facility to a more optimal location, or what technologies and infrastructure the business could invest in to mitigate or adapt to the temperature rise.
For real estate investors, the price of climate change is expected to reach trillions of dollars in economic losses due to physical risks such as sea level rise, storms, and wildfires impacting different regions. By conducting scenario analysis, these impacts become far easier to analyze and incorporate into investor strategies. Investors can also include indirect market effects like future insurability, liquidity, and rental market growth as considerations for their strategic approach.
While assessing individual assets may sound feasible, the real challenge with scenario analysis is getting this level of granularity across the entire global operations, holdings and investment portfolios of large enterprises. Even for smaller enterprises, the complexity of the data science involved in climate risk scenario analysis may be beyond the existing capabilities of the company.
The Climanomics® platform offered by TCS not only handles the complex data analysis required, it quantifies climate risks in financial terms. By compiling the financial risks associated with climate change impacts in a comparable, consistent format, the problem becomes more tangible for members across an entire organization. Presenting climate risk in numbers rather than impacts helps communicate the importance of mitigating and adapting to the risk in a language decision-makers speak.
Ultimately, the aim of conducting a scenario analysis is to produce actionable insights. Without translating climate impacts into clear financial terms, there is no strong basis for teams across an entire organization to take action. The level of data analysis required to establish reliable figures for climate risk, however, is immense.
The Climanomics® platform processes terabytes of data compiled from public sources and proprietary asset-level data to analyze entire business asset portfolios. The quantification incorporates the physical risks for specific locations around the entire world, and the likely policy shifts and market dynamics that accompany different warming scenarios. It achieves granularity for assessing individual assets, and it provides overarching snapshots that reveal the portfolio-wide patterns of risk.
In our work with some of the world’s largest enterprises, the results of most scenario analyses show a small fraction of business assets face the most noticeable financial risk. In line with the Pareto Principle, roughly 20 percent of the assets experience the most risk, while the other 80 percent are not as much of a priority for resilience investments. Identifying exactly which assets require the most attention is a key benefit of using the Climanomics® platform to assess risk.
Different scenarios will reveal contrasting forms of climate risk impacting assets in financial terms. For example, scenario analysis often reveals a somewhat converse relationship between physical and transition risks. Business as usual without significant greenhouse gas emission reductions leads to mounting physical risks, while global climate action increases the level of transition risks for business operations. Having the opportunity to compare how these risks will likely play out based on different RCPs helps businesses make informed decisions.
In short, the Climanomics® platform “puts a price on climate change,” says Joseph Lake, COO of TCS. “It thus enables all departments to quantify, communicate, and embed climate risk into virtually every facet of a company’s operations - essential for risk mitigation and planning in the face of the greatest challenge of our era.”
Another benefit of scenario analysis is the role it plays in preparing robust reporting. The Climanomics® platform aligns with TCFD recommendations for disclosing physical and transition risks for different scenarios in the short, medium, and long-term. Companies which are reporting under TCFD for the first time often start by undergoing a gap analysis to determine their existing reporting alignment with the recommendations of the framework. Scenario analysis
Likewise, the CDP questionnaire on water security calls for disclosure of many of the same details, so preparing a scenario analysis as part of your non-financial report can improve your CDP score. Overtime, the CDP has increasingly stringent criteria to meet for achieving A-list status, and it recently heightened its criteria for sector-specific data. This is where comprehensive TCFD-aligned reporting and the asset-level of granularity offered by the Climanomics® platform can earn an enterprise a spot on the CDP’s leadership index, a highly attractive distinction for investors.
As sector-specific reporting becomes more common, here are a few insights for sectors with significant climate change risk exposure. Additional sectors with uniquely impactful climate risk conditions include real estate and financial institutions.
Common food and beverage products which derive from crops in tropical regions increasingly face the risk of crop failure due to effects as wide-ranging as extreme heat and longer rainy seasons. For example, the rising temperatures could cause coffee growing regions to diminish by 50% by 2050. Climate change also causes climatic regions to shift, so regions not traditionally suitable for coffee, like Nicaragua, could become growing regions.
In its work with one of the largest multinational food and beverage corporations, TCS analyzed how climate change is impacting 20 specific crops and more than 2,000 assets to assess how its supply chain could be impacted by both direct and indirect impacts of climate change. This helped the company anticipate and assess issues as diverse as non-resilient crop replacement to the risk to the headquarters facility located in an area with expected sea level rise.
In working with clients whose complex supply chains pose analytical challenges, TCS provides custom approaches to preparing actionable insights. The level of analysis reveals risks and opportunities at the business unit, region, and asset owner which helps assess the overall business structure in terms of climate risk.
London’s Heathrow airport shocked the world with its 2010 3-day closure due to snowfall right before Christmas. The closure caused British Airways to lose 50 million pounds ($69 million). Further weather-related closures came in 2013, when it cancelled 400 flights. The airport has now invested in improved equipment and facilities for preparing the airport for increased snow and ice during winters.
Due to aviation’s inherent sensitivity to weather conditions, the CAPA Centre for Aviation reports aviation industry climate impacts such as “reduced aircraft performance, changing demand patterns, potential damage to infrastructure, loss of capacity and schedule disruption” are areas to assess within business strategies.
TCS helped a major international airline with strategic planning, route planning, hub locations, and traveler preferences in order to anticipate fluctuations in demand due to changing weather patterns and extreme heat.
The pandemic revealed how critical the internet is for maintaining ongoing business operations remotely, and we’ve come to expect the internet’s reliability. Yet, the data centers where we store our files in the cloud may not be as resilient as they seem.
For instance, the fiber infrastructure connecting the data centers and internet service providers are vulnerable to flooding and storms, especially in coastal regions. By 2030, “771 point of presences (PoPs), 235 data centers, 53 landing stations, 42 IXPs will be affected by a one-foot rise in sea level,” according to a study revealing some of the vulnerabilities of technology infrastructure to sea level rise.
Companies operating data centers are at a critical juncture in terms of planning for a resilient internet. Understanding the climate risk in financial terms is the next step for technology infrastructure firms to prepare for the critical climate impacts we now face.