Climate risks and the decarbonisation era

Understanding climate risk in business is essential for navigating safely through the decarbonisation era. Whether climate change has been at the forefront of your business strategy for decades, or you’re still uncertain if your business is adequately prepared, this article presents three good reasons why businesses should be actively responding to climate risk now.

Action to help mitigate the climate crisis has a long history. From the First Earth Summit in Stockholm (1972), through the Earth Watch programme established by UNEP (1979), the founding of the Intergovernmental Panel on Climate Change (IPCC; 1988), and into the era of climate change action via Kyoto (1997), Copenhagen (2009), Paris (2015), and most recently, Glasgow (2021), world governments are increasing regulation and mandates in this space. Importantly, this climate change action will not end any time soon.

It is unequivocal that climate change is impacting on every human system. Social, political, economic. All are interconnected and all are affected. Needless to say, human actions and human-induced climate change have already changed the face of most environmental systems beyond natural states. These impacts on human and environmental systems continue to increase non-linearly. The wealth of information from the IPCC (most recently in the AR6 reports on the Physical Science Basis, Impacts, Adaptation and Vulnerability, and Mitigation of Climate Change) is indisputable.

Which means that climate change action will continue into the future and will follow one of two routes. Potentially, global decarbonisation is successful, climate change impacts are mitigated, and climate change policy eases. Maybe. Much more likely is that even with decarbonisation underway, climate change impacts will continue to worsen and climate policy action will become more stringent in efforts to limit warming as far as possible.

Which route is your business banking on?

Current climate change impacts and existing climate policy action is already forcing climate risk towards the centre of strategy and planning. Until global decarbonisation is successful, with no significant evidence to suggest it is on the horizon, future climate change and climate policy action is going to exacerbate climate risks for businesses. Which raises the first good reason for businesses to respond to climate risk now:

Climate risks are impacting businesses now, through physical climate change impacts and transition impacts from decarbonisation efforts. What’s more, climate risks to businesses will exacerbate over time until decarbonisation goals are met.

So how do climate risks, physical and transition, impact businesses? More importantly, how do businesses respond and navigate through the risk and regulatory landscape?

One important truth about climate risk is that risks are spatially and temporally non-uniform. This is to say, physical and transition risks will impact different businesses differently depending on where their facilities, operations, and value chains are located about the globe; and risks will change over time depending on the physical climate and socioeconomic pathways that unfold into the future.

Likewise, climate risks will have variable impacts on businesses in different industries and sectors, too. A key part of this relates to the evolving regulatory landscape that seeks to engage increasing parts of the global economy with decarbonisation efforts.

The scope and remit of climate-related policies and regulation has been growing for decades. From tax incentives to support energy transitions, protocols for cutting greenhouse gas emissions, and climate litigation supporting compliance, to legislation driving mandatory climate-related financial disclosures.

When it comes to climate risk, a single international body stands out as the driving force behind national uptake of legislation focussed on improving understanding of the financial risks related to climate change. The Task Force on Climate-related Financial Disclosures, better known as the TCFD, was established in 2015 by the Financial Stability Board and has since released a growing body of literature and guidance to improve understanding of climate risk, to help integrate climate risk management into business strategy, and to support climate-related financial disclosures.

Nations who have announced uptake of TCFD-aligned mandatory climate-related financial disclosures include New Zealand, Switzerland, Hong Kong, Singapore, and China, in addition to the G7 nations (Canada, France, Germany, Italy, Japan, the UK and the US). Importantly, the US Securities and Exchange Commission have made progress in pushing through a climate-related disclosures ruling and adoption could be as early as 2023. Leading to the second good reason for businesses to respond to climate risk now:

Governments are building climate risk into legislation as mandatory climate-related financial disclosures. Businesses need to engage with climate risk in order to maintain regulatory compliance.

There are many more benefits to understanding climate risk beyond regulatory compliance. Indeed, the second half to understanding climate risk is understanding the opportunities that the decarbonisation era will bring.

Businesses have been pursuing cost reduction strategies that incorporate energy efficiencies, savings from emissions reductions, and accessing green capital with lower borrowing costs. Beyond reducing costs, benefits from decarbonisation include new market and revenue opportunities with the (potentially exponential) growth of industries that are vital for delivering the low-carbon transition.

Ørsted is regarded as a key example of a company to have completed an incredibly successful low-carbon transformation, which simply wasn’t thought plausible at the time. In 2006, the Ørsted group (back then, a merger between six energy companies) had a power and heat production mix that was 85% fossil fuel (coal, oil, and gas). In the one and a half decades to follow they transitioned from fossil fuel reliance to a world leading renewables company, and have been able to deliver on the opportunities this new energy balance provided. Since going public in 2016, Ørsted share prices have increased by over 200% (over 400% pre-COVID). In comparison, oil and gas growth over the same period was 0% to 50%, depending on the index observed.

Climate-related opportunities exist across all sectors. Emissions intensive industries have the potential to make some of the biggest contributions in the decarbonisation era, and the size of the associated opportunities is commensurate. Yet all industries are capable of benefitting from the global transition to low-carbon, which raises the third good reason for businesses to respond to climate risk now:

Opportunities for businesses are extensive, and they are available now. Policy makers, professionals, and consultants are on hand to help businesses realise these opportunities and transform their business cultures whilst doing so.

Our Climate Risk and Resilience Team specialise in climate risk and opportunity advisory services, including risk assessment, scenario analysis, financial impact modelling, and disclosure compliance. If you would like to talk to someone further about any topics raised in this article, please contact us.