Managing climate risks in 2020: how are businesses responding?

Author Sally Cook, Dr Nick Wood, Dr Peter Holt

Date May 2020

Energetics’ fourth podcast was a conversation between two of Energetics’ climate risk experts who approached the question of how businesses are managing climate change in 2020, from different angles. Dr Nick Wood is an expert in the physical risks of our changing climate. Sally Cook, a leading climate strategy and policy adviser, with a background in corporate finance, works with large businesses and government clients on the transitional risks associated with responding to climate change. In the podcast, each described the recent responses they’ve seen from businesses to climate change risk management and reflect on the impacts of COVID-19 and the catastrophic bushfire season.

The critical importance of resilience

Australia’s response to COVID-19 has demonstrated a lack of resilience in the economy. We are realising the fragility of ‘just-in-time’ global supply chains and the need to retain a domestic manufacturing capacity for a range of essential products. This is particularly relevant, as Nick noted, because pandemics are a symptom of a stressed natural environment, and as such, they could become more frequent in the future. As a result, Australia and the world over, will need a more defined strategic response and dedicated resources, which in turn may have implications for globalisation. For business COVID-19 has highlighted both where their vulnerabilities lie and how quickly change can occur across a market.

Interestingly, throughout the response to the pandemic to date, Sally commented that business is continuing to seek advice on how to understand and manage their climate related risks better. This work is typically driven by boards and senior management using the Taskforce on Climate-related Financial Disclosure (TCFD) framework. She states, “we're finding that drive from the top is providing very effective pressure and tone, which is then flowing through to an organisation's priorities. Boards are seeing their peers disclosing in public reports as well, which has created a ‘race to the top’ and is materially improving disclosures and ensuring commitment to the process.”

The other driver of climate risk assessments is increasing concern about sovereign risk. The bush fires have highlighted what climate change looks like in a developed economy. For global capital markets, they are alert to the need to consider the longer term credit risks.

Nick added, “We’ve observed through our work with credit rating agencies, investors and super funds, that everyone's ‘on notice’. The worst outcome would be that somebody decides that Australia's 20 year credit horizon is not very good. While serious as a national economic impact, a drop in credit rating is probably more politically serious. Credit downgrades driven by climate events and related outcomes such as falling levels of tourism, have a compounding effect.”

The power of scenario analysis: for understanding climate change – and pandemics

Many businesses use scenario analysis as described by the TCFD to understand future divergent pathways and how these might impact their business. Sally noted, “Businesses are considering aspects like macroeconomic trends. For example, GDP growth and wealth are changing significantly as a result of the impacts of COVID-19. Going back two or three months, before the virus started, a pathway that considered lower GDP growth, less globalisation and general fragmentation of the world was unlikely. Now it looks more like a scenario that, at least in the short term, will drive different possible pathways.”

Businesses that have used scenario analysis are, in Sally’s view, ahead of the curve and many are coming to understand that the TCFD process is not just useful for external disclosure but can support strategic decision making. “The process can provide insights into where your business is vulnerable. Possible tipping points indicate when a certain scenario is becoming more likely.”

Using climate science in scenario analysis

As acceptance grows that climate change is occurring, using climate science within scenario analysis can enable businesses to consider questions such as, what is the climate going to be like in 10 years’ time? How is our business going to be impacted? Could we develop a new product or service that will be needed in a climate-impacted world? Scenarios help inform these answers and provide insights in developing a strategic response.

In terms of using different scenarios based in climate science, while there are levels of certainty applied to climate parameters like temperature and rainfall in southern Australia due to macro climate processes, for example, there are other areas of the country where there is greater uncertainty. However, as Nick pointed out, both offer decision useful insights. Where there is significant uncertainty, identifying the worst outcome and then determining whether precautions are needed, will prompt thinking about how resources can be allocated. He says, “until now, key resources have been allocated to economic growth, but the pandemic and the recent climate events have shown that more resources need to be directed towards resilience.”

Global warming is locked in for around at least 20 years

Nick stated in the podcast, “The current view of science is that we have locked in warming for around 20 years. It is only after 2040 that changes in the emissions scenarios make a difference. The outcomes are different across climate variables: continental scale temperature changes carry a high level of confidence, while changes in behaviours of cyclones have a high degree of uncertainty. So an amount of climate change is locked in. How that manifests is more uncertain.”

What does that mean for markets and policy settings?

Sally stated, “I think it's important to reinforce that there is an element of bipartisanship in our current policies and there is a nominal carbon price. Knowing this, makes some of the drivers for decarbonisation less of a stretch and less uncertain than they might be otherwise. The TCFD assessment process provides a good understanding of what might need to happen politically in the short, medium into longer term. The TCFD guidelines have been adopted relatively quickly and achieved traction with boards and senior management after years of climate deadlock at the national level.”

Sally added, “So, I think change can happen very quickly when the drivers are there. What comes out of the negotiations on Article 6 of the Paris Agreement will have a significant impact on the rate of decarbonisation. The interesting thing about COVID-19 will be whether it constrains that process, not just from a diplomatic point of view but also in terms of commitments and the willingness of governments to pursue their Paris targets and strengthen them over time.”

Nick said, “We lost a decade of climate change action because the governments around the world chose a fossil fuel based economic recovery following the global financial crisis. What we understand now is decarbonisation must be done very quickly – we cannot waste another 10 years. Following COVID-19, we cannot choose another fossil fuel driven economic recovery because the world will be in trouble. The speed of change that we would need to adapt the economy in 10 years’ time would be beyond what we could achieve.”

In addition, the economic slowdown resulting from COVID-19 lockdowns worldwide has provided a glimpse into a different future. We have seen clear skies and breathed clean air. The clean energy alternatives to fossil fuels can deliver a better quality of life as well as being the economically advantageous option, as arguably 10 years ago, low carbon technologies had not achieved the commercial maturity we see now in 2020. A clean energy based recovery, it also an approach that younger generations wish to see.

Sally reflected, “To a certain extent, the transformation of the economy relies on new businesses, new industries and new ways of doing things. The optimist in me says that if we end up with some businesses that don't survive the pandemic, that could be a good thing for transformational type activities and for opening up new, innovative ways of thinking.”

Questions for businesses to consider

Sally advised, “Businesses need to think about their vulnerabilities - their exposures, their risks and the opportunities that may arise across different future scenarios. They really need to challenge their own internal thinking. The pandemic has shown us how quickly things can change - the scale of the response from governments around the world has been unprecedented. Businesses need to understand how different scenarios could materially impact them and try and to fold that into strategic planning.”

Questions include, what do you want to be in 10 years’ time, how are we going to attract investment and capital? In 10 years’ time, will we be doing things that are economically and socially useful? How should we inform our investors and stakeholders about the decisions we are taking? How will we manage emerging risks and opportunities? (Certainly, Energetics is seeing some businesses considering climate risks in acquisitions, divestments and how they approach the market).

Nick’s final comment was, “Businesses and their boards need to understand that there is no normal anymore. Climate change has taken a system that has been stable for 2000 years and destabilised it. We are seeing changes that have not been seen before. That’s the biggest lesson and it is not yet well understood.”