Climate-related risk refers to the potential negative impacts of climate change on an organization. It arises through a combination of exposure (associated with the climate hazard/driver) and vulnerability (how sensitive the operations and assets of an organization are to climate hazards or transition drivers).
What are climate-related risks?
Climate-related risks are typically grouped into two main categories: physical and transition risks.
Physical risks are associated with the impacts from physical climate hazards. They can be event-driven (acute) such as increased severity of extreme weather events (e.g., cyclones, droughts, floods, and fires) or relate to longer-term shifts (chronic) in climate conditions (e.g., sustained increased temperatures and sea level rise). Physical risks have financial implications either directly (e.g., through damage to assets) or indirectly (through supply chain disruption).
"Physical risks involve risks from climate change including risk to facilities and infrastructure, impact on operations, water and raw material availability and supply chain disruptions." - The Concept of Risk in the IPCC Sixth Assessment Report, p. 13.
Transition risks are associated with the changes required to transition to a lower-carbon economy. They reflect impacts relating to various drivers including policy and legal actions (e.g., climate litigation or changes in regulation), technology changes (e.g., development and use of emerging renewable energy technology), market responses (e.g., shifts in supply and demand for commodities), and reputational considerations (e.g., customer perceptions of an organization's contribution to mitigating climate change). Importantly, the IPCC adds "A key issue is the stranding of assets that may not provide the expected financial returns and may end up as large financial liabilities " (The Concept of Risk in the IPCC Sixth Assessment Report, p. 14)
What are climate-related opportunities?
As categorized by the TCFD, opportunities could arise in several areas:
- Resource efficiency: Reducing operating costs through efficiency improvements can result in direct cost savings over the medium- to long-term whilst also potentially reducing emissions.
- Energy source: Companies will need to transition their energy generation to low emission alternatives. Those that shift their energy usage, particularly those that shift early, towards these sources could reduce their annual energy costs.
- Products and services: Organizations innovating and developing new low-emission products and services can improve their competitive position and capitalize on shifting consumer preferences.
- Markets: Organizations may be able to diversify their activities and seek opportunities in new markets which could enhance their position in the transition to a lower-carbon economy.
- Resilience: Organizations that respond to and manage climate-related physical and transition risks will enhance their resilience.
How are future scenarios modeled?
A wide range of global warming futures are plausible, and a range of climate scenarios have been defined to account for this. These scenarios are based on different GHG emissions pathways and are not assigned a likelihood. Therefore, it is essential to assess at least two scenarios to account for this uncertainty. The selected scenarios should be contrasting (e.g., a low carbon and a high carbon scenario) as physical and transition risks will have greater impacts at opposite ends of the spectrum. It is also important for organizations to understand and be prepared for the implications of varying scenarios within the context of their operations.
Sources
- 'Reisinger, Andy, Mark Howden, Carolina Vera, et al. (2020) The Concept of Risk in the IPCC Sixth Assessment Report: A Summary of Cross-Working Group Discussions. Intergovernmental Panel on Climate Change, Geneva, Switzerland. Accessed at https://www.ipcc.ch/site/assets/uploads/2021/02/Risk-guidance-FINAL_15Feb2021.pdf.
- Recommendations of the Task Force on Climate-related Financial Disclosures. Accessed at https://assets.bbhub.io/company/sites/60/2021/10/FINAL-2017-TCFD-Report.pdf.