Category: climate risk

The Green Futures Index: How to Rate the World’s Climate Progress

If the world is to hit ambitious climate goals over the next ten years and avoid the worst effects of climate change, we need huge shifts in our economy. This means mass uptake of renewable energy, rapid decarbonization policies and the development of sustainable economies.

There are signs this is happening, the pandemic has seen the oil industry hit hard in 2020, losing 40% of their revenues due to a huge drop in demand. In turn this helped greenhouse emissions fall 7% (relative to 2019). But the fossil fuel industry still made US$ 1.5 trillion in revenues over the same period, five times total investment in renewables which indicates the scale and difficulty of transitioning to a sustainable, climate friendly economy.

At the same time there is an appetite for change across governments, the corporate sector and the public. But how should this progress be measured, the new MIT Sustainable Green Futures Index attempts to do just that. The Index rates 76 leading countries on their progress and ability towards building a low carbon future. The index measures countries across five pillars; carbon emissions, energy transition, green society, clean innovation, and climate policy.

It is probably no surprise that European countries dominate the top of the index with 15 of the first 20 places. Iceland is the leader, followed by Denmark – both countries renowned renewable energy and climate policy leaders.

Norway is third in the table thanks to measures such as leading the adoption of electric cars and rapid transition to a low emission economy. However, Norway remains a major oil exporter and contributor to other countries carbon emissions, which may be reflected in its poor score in the green society pillar.

The energy transition pillar was dominated by African countries; Ethiopia, Angola, Uganda and Cameroon are all leading a move to clean energy.

Much of the continent has seen rapid adoption of solar and wind energy. Ethiopia has been in the news thanks to its construction of its monster dam near Sudan and conflict in the Tigray region but its Green Climate Resilient Economic Strategy has been in place since 2011 and has led the way in promoting a clean future.

Morocco is also prominent in the Index as an African country which has pioneered clean innovation. Morocco made an early decisive shift toward renewables, lacking the oil or gas reserves of its neighbours (such as Algeria) it grasped the future with both hands.

Now the country is on track to have a 52% renewable energy share by 2030. The Moroccan Agency for Energy Efficiency has become a centre for expertise – it hopes it can promote and share expertise on renewable energy across Africa.

The green society pillar is driven by preserving the environment, recycling levels as well as meat and diary consumption. Singapore tops the pillar thanks to its advanced recycling program and low use of meat and dairy.

New Zealand despite being a high performer overall is last in this category thanks to its high meat consumption and lack of green buildings plus a poor recycling rate.

New Zealand does top the Climate Policy Pillar, which is the most important element contributing 40 percent of the total score. This pillar measures countries climate ambition as determined by the national determined contributions (NDCs), as well as the effectiveness of the policy frameworks that will deliver these targets.

Policy is also defined as the development of carbon pricing measures, sustainable agricultural policies and the so called “pandemic pivot” – in other words what do stimulus packages offer towards decarbonisation such green infrastructure and transition. Denmark and France excelled in this pillar. Denmark’s recovery program placed EUR 5 billion to make homes more energy efficient.

While each pillar can contain some interesting results, it is the overall index score which counts. There is no real surprise that the countries at the bottom of the chart are the so called climate abstainers.

These are typically fuel exporters like Saudi Arabia and Russia who have consistently blocked climate initiatives. We can probably expect these nations to delay meaningful change until it is too late.

Arguably the most critical countries are those which will drive global decarbonisation due the size of their economies and emissions. Right in the middle of the table (40th Place) is the US, it should and must improve this position under the new Biden Administration.

China sits just below the US at number 46. While the country is a leader in renewable technology it also remains heavily dependent on coal. But China should now feel the pressure from the US to up its climate game.

India is perhaps surprisingly just outside the green leaders at 21 in the table overall given its high carbon emissions, but it partly makes up for this thanks to its rapid uptake of renewable energy, primarily vegetarian diet and ambitious climate policy.

The Green Futures Index will help judge the relative performance of nations in the drive to decarbonise and develop sustainable economies. In time the Index could become a well known benchmark like the World Bank’s Doing Business Survey.

Decarbonisation and sustainability will become a growing factor in judging whether to invest or even broker alliances with other nations (climate diplomacy). As the world faces climate breakdown understanding who the laggards and the heroes are will be ever more critical.

Climate Risk: A New Frontier for the Corporate Sector

For millennia climatic factors have threatened humans. Farmers have been at the mercy of droughts, storms and floods. Harsh climates such as rainforests, deserts and tundra have shaped human development forcing people to move or adapt.

The modern world appeared to offer some deliverance from harsh climatic conditions. People can build huge cities in the desert or snow thanks to central heating, air conditioning and modern technology. Infrastructure can now be built to withstand extreme weather and technology such as early warning systems can effectively assist in managing disasters.

But now the steady but certain onset of climate change has changed these old assumptions. The world’s rapidly changing climate throws up a host of new risks and uncertainties. Climate change can be understood as a giant lens, which magnifies existing risks making them more frequent and more deadly.

Hurricanes have always posed a threat to humans, climate change will make them stronger and more regular.  The deadly effects of droughts have been around for millennia, but climate change and overuse of water supplies is already shrinking places like Lake Chad, the Aral Sea and many other lakes and rivers.

Rising sea levels will drown mega cities like Jakarta, Mumbai and Shanghai. Despite billions being spent on sea defences, the sea will eventually simply overwhelm urban areas, forcing people inland. The destruction of so much infrastructure will dwarf previous economic losses.

Climate risk is the impact of the environment on humans. For many years we have been concerned with our impact on the environment and infrastructure, pollution and all the other activities of humans will damage the environment. The world’s fast changing climate over the next few decades will make profound changes to our existence.

Climate Risks

  • Higher sea levels as ice sheets melt and oceans warm.
  • Stronger and more frequent cyclones, typhoons, and extreme weather.
  • Drought and famine, higher temperatures & lack of rain will result in mass crops failure.
  • More deadly wildfires, with higher temperatures and drier weather this provides the conditions for fire.
  • Flooding, this seems to be in contradiction with drought, but more unpredictable and sudden heavy rainfall is likely, creating the conditions for devastating floods.

Organisations must now face up to climate change and act to preserve the planet as well as their themselves.

Below I explain climate risk and how it will impact businesses and organisations. I look at how the Task for Climate related Financial Disclosures (TFCD) framework can help banks and other organisations identify how they will be hit by climates risk.

Topping the Global Risk Charts

Authoritative think tanks such as the World Economic Forum placed climate related risks in the top four places of the top ten risks in their landmark 2021 global risk report.

Extreme weather, failure on climate action, natural disaster and biodiversity loss were selected by respondents as the key long-term risks facing the world.

For both businesses and individual’s climate change is often viewed a slow burn threat that always appears to be in the future and that will happen to someone else. Some detractors claim that organisations will be able to adapt to the new conditions.

Companies that fail to act on climate change will face a major backlash from investors, the public and consumers.

Firm’s emissions and supply chains will be identified in close detail for risk. Labels that detail the carbon footprint of products like food labels measure sugar and fat could become a feature of new products.

Companies still require consistent, reliable data on climate risk to finance climate resilient projects and to price climate risks correctly. There are also opportunities for firms that act to identify climate risks. These firms can gain advantages over rivals and pre-empt many threats and even offer products and services for a decarbonising world which faces huge unprecedented threats.

How Climate Risks will materialise

Shrinking ice sheets in the Arctic, Antarctica and the “third pole” the Himalayas where glaciers are melting. Shrinking glaciers in the Himalayas endanger the two billion people that rely on the glacier fed rivers. The melt of the glaciers will reduce the flow of the rivers cutting available water for agriculture and for dams.

The result will be a crash in agricultural productivity and in heavily agricultural economies like India and Bangladesh, as well as much of sub-Saharan Africa this will lead to widespread social unrest, migration and political anger.

The shrinking of ice sheets in the poles will feed sea level rises. Many of the world’s mega cities have exploded in size but will with little thought or preparation towards changes in sea levels.

Shanghai, Karachi, Dhaka, Miami are just a few of many cities threatened by rising seas. Jakarta the already sinking into the sea and the Indonesian government are looking at moving the nation’s capital to a new purpose-built city.

The Risk Multiplier

None of these risks are new, humans have dealt with them for millennia, but climate is best viewed as risk multiplier. It will increase the number and size of these climatic risks.

How far and fast climate risk will impact us is partly down to how fast humans can stop carbon emissions and therefore runaway climate change. Right now, there are signs that mitigation efforts or decarbonisation are taking hold.

Renewable energy continues to fall in cost and investment in the sector continues to grow. But the oil and gas sector’s hold over the energy sector is strong and modern economies remain wedded to oil, at least for now.

The increase in global temperature appears to be minor, ranging between 1.5 C to 4 C. However, it is important to consider this is an average and many critical areas (such as the Antarctica) warming much faster than the average. Even small temperature changes can lead to a catastrophic impact.

The effects of climate risk can be non-linear, so a 1 C temperature increase may reduce crop yields by 5%, but a further 1 C increase in temperature may see a dramatic fall in yields.

However, there are other emitters of greenhouse gases such as agriculture (particularly cows), deforestation and transport. It will take major political change and technological advancement to decarbonise these sectors.

Even if carbon emissions stop or peak now, we will all face unprecedented climate change and all the devastation that goes with that. The longer carbon emissions continue, the worse the risks we will face.

How Should Companies Act?

For companies it means two things: First they need to do more to reduce their own emissions which is the central plank of the 2015 Paris Agreement. Reducing emissions will mitigate climate change slowing the rate at which climate changes.

Secondly: Organisations need to consider their own exposure to climate change. The impacts described above will affect entire societies but will also hit companies and organisations in a variety of different ways.

Climate risk is fast growing discipline. The Intergovernmental Panel on Climate Change (IPCC) outlined many of the climate risks faced by world in various reports.

The Task Force on Climate Related Financial Risks (TCFD) was created in 2017 to create a framework for banks to assess the climate risks they face. Above all the TCFD was set up to make banks realise that climate is a financial risk. Companies and banks could lose billions if they fail to take climate risks seriously.

For manufacturers considering their investments, existing factories will be emitting carbon in 10, 20, or 30 years’ time, Decisions need to made now to cut emissions or companies will be left with outdated infrastructure designed for a fossil fuel world.

Planning new investments and projects should be viewed in the context of changing climate. When water shortages, desertification and sea levels rise become the norm, companies need to adapt to this reality. Within a decade all major companies will report on climate risks.

Climate risk will intensify and compound existing threats and twisting them into tangible threats. Climate risk can broadly split into two areas: Physical climate risk and transition risk.

What are the Hurdles?

Climate risk is making waves in the corporate sector leading firms scour their portfolios for climate related risk. It has taken a time for organisations to understand, accept and implement the principles.

For many businesses’ climate risks are too far in the future, are too uncertain, others many feel they can mitigate against the risks. For most businesses planning 2,3 or 4 years ahead is the norm.

Beyond that time frame risks become too abstract and difficult to predict. Companies are often dealing with a raft of urgent issues so the problem of climate change can seem distant and unimportant.

Applying the TCFD

How can my firm discover its climate risks ?

Financial organisations can apply the TCFD principles, in practice this is difficult, given it is such a new set of principles in a new area of risk. But over time its application will become easier as firms become more experienced and skilled at applying the principles.

How does the TFCD work?  

The TCFD was driven by Mike Bloomberg, founder of the financial information firm and ex-Mayor of New York.  The framework is a set of recommendations and principles which will allow organisations to understand and measure the concentrations of carbon related assets in portfolios and the financial sectors exposure to climate risks.

Many banks and financial institutions have signed up to the principles. However, it is not yet clear how it will work in practice. Whether there will be a unified approach and standardisation or will organisation diverge and use their own approaches.

The TCFD process includes a disclosure of climate related risks. They should be adoptable by all financial organisations, which will provide useful forward-looking information, will focus on the risks and opportunities related to a low carbon economy and that recommendations should have a financial impact.

There are four pillars:

Governance

Disclosures around climate related risks including the role of management and the board.

Strategy

This should disclose the actual and potential impact of climate related risk and opportunity. Describe the impact on climate risk on the organisation’s strategy, financial planning and overall resilience.

Risk Management

This should identify the organisation’s processes for identifying and assessing climate related risks. It should also describe how these are integrated into overall risk management.

Metrics and Targets

This should disclose the metrics used by the organisation to measure climate risk. Disclose scope 1,2 and 3 greenhouse emissions and describe the targets used to manage climate risks as performance against these targets.

Scenario Planning

The TCFD also recommends scenario analysis, this provides the “what if” analysis which can help a firm tease out what might happen in a significantly warmer world, or one where there is rapid transition. Scenarios are not predictions, but rather a plausible narrative of what might realistically occur.

Physical Climate Risk

Climate change is predicted to result in more extreme weather, rain, typhoons, as well as longer term conditions such drought, flooding and sea level rise. None of these things are new, but what will change is the intensity of impact.

The devastation caused by these changes will result in political instability, economic damage and migration as people move in search of better conditions. This can be internally or across borders. Although poorer less resilient countries will be hit harder, more developed cities such as Shanghai, New York and Hong Kong will be under threat from sea level rise.

Water stress could spark conflict in places such as North Africa and Iraq. As droughts and water shortages become more common, problems with food supply and production will result.

Drought, water shortages and crop failures are as old as time, but the speed at which they happen will be shocking. Mass migration started by long term collapse of countries especially in the Middle East, Africa and South Asia will send millions of people in search of food.

Physical climate risks can be divided into two types, acute and chronic:

Acute physical climate risks:

  • Extreme heat/heatwave
  • Flood
  • Drought

Chronic Risks

  • Higher long term temperatures
  • Lower rainfall
  • Drier climate

Some examples of physical climate risks impact on businesses:

  • Supply chain interruption and damage from extreme weather
  • Higher insurance costs due to high risk of assets being damaged
  • The recommendations should lead companies to be able to identify what assets in their portfolio are threatened by climate risks. For example:
  • A power plant which relies on rivers and streams for cooling may find that if the river dries up and the average temperature rises the cooling system does not work and the factory is untenable.  
  • Rising sea levels will mean many ports are unusable as the ocean engulfs the infrastructure due to rising sea levels, any new infrastructure should take this into account.
  • For an agribusiness reliant on food products, more frequent droughts will reduce crop yields making the business less profitable.
  • Along with physical climate risk there so called second order impacts meaning that one impact will result in further often unpredictable events and impacts:

Some examples of second order impacts:

  • Droughts and famines will result in millions of migrants as marginal land in hot countries becomes arid wasteland.
  • Many coastal towns, cities and communities become untenable due to sea level rise and flooding (Florida & Jakarta for example).
  • Poorer more vulnerable communities/countries will be hit hardest as they have fewer resources, and less ability to adapt to a changing climate.
  • Ecosystem collapse which will result in fish or food supply failure.
  • Communities in hurricane zones are devastated with ever more frequency making their existence untenable.
  • Crop failures due to a failure of rains, excess heat or even pests (able to breed faster due to increased temperatures) could result in shifts in the food chain, food price increases for some and starvation for others.
  • Epidemics – rising temperatures will make it easier for disease to spread, making the spread of viruses and diseases more likely.

Transition Risk

Transition risk is the threat that policy shifts around climate change will result in losses for companies and banks. As economies decarbonise to mitigate against climate change, what is the risk to your firm. Germany closing its coal plants is a transition risk for the owners of the coal plant.

In oil dependent countries like Saudi Arabia the risk is probably lower as the government will stick with fossil fuels for longer. But energy is not the only sector at risk, changes in technology are also a factor.

The move from petrol cars to electric will see many car companies change production models. However, not all will be successful and doubtless go bankrupt. This shift is already visible, Tesla which makes exclusively electric vehicles is the world’s most valuable car manufacturer by market capitalisation.

Other disruptions could be the move towards vegan diets which is already threatening meat processors and farmers. Other shifts driven by social change could be tricky to predict but could include a widespread boycott against flying or at least people cutting back on flying (the covid pandemic could accelerate this by making remote meetings the norm).

Somee examples of transition risk are:

  • Early write of equipment due to policy changes
  • Increased compliance costs due changes in law and policy
  • Falling demand for carbon intensive products
  • Increasing costs due to rising input prices in water, fuel and other raw materials

Disorderly Transition

Transition can be orderly or disorderly. An orderly transition is a well-planned decarbonisation of the economy with the broad backing of society, government, and the private sector. Germany is a good example, the government has steadily shifted its power production towards renewable energy.

Disorderly transitions will be seen where countries that have stuck with fossil fuel dependent economies.The country is then faced with a need to decarbonise very quickly to meet obligations under the Paris Agreement, national legislation, or peer pressure from other countries.

This could well translate into geopolitical risk as sectors of the economy such as coal mining are threatened and unable to adapt, they collapse resulting in energy shortages.  

Geopolitical Risk and disorderly transition

Countries that fail to meet decarbonisation objectives will be put under pressure by those countries that have achieved their goals. As climate risks intensify, the political pressure on the worse greenhouse gas emitters will grow. Naturally a blame game will emerge where developing countries will accuse developed ones of carbon debts and hypocrisy.

This could escalate as the carbon sinners; countries that continue with deforestation or expanding fossil fuels use and those who have decarbonised. As climate risks engulf the globe the pressure on sinners will become acute.

Already politicians and others launch political attacks on Bolsonaro and Trump due to their lack of environmental credentials. While Trump could afford to largely ignore them, Brazil faces its trade deal with the EU being derailed thanks to disregard of the environment.  

Climate Risk Analysis

Climate risk means each organisation will analyse their assets for physical and transition risks. This can be a time consuming process using climate models or policy analysis to identify risks, but also taking into account time scales and the criticality of asset locations. Assets with a short tenor do not pose so much of a risk, whereas those with a 20-year life span are far more likely to be impacted.

Locations such as distribution hubs or HQs are likely more critical to companies’ operations than a small branch office. Therefore these key locations should be analysed for climate risk ahead of less critical locations.

Eventually organisations should analyse their assets for exposure of both physical and transition risk and quantify that in their financial statements. For many this will involve a painful and frank analysis of their company. For those will heavy exposure to climate risks – this could involve major losses or at least a reduction in the value of the firm.

The key objective of the TCFD is to ensure that banks avoid investing in assets with climate risk.

The TCFD outlines some key principles for effective disclosures.

Principles for Effective Disclosures

1 Disclosures should represent relevant information.

2 Disclosures should be specific and complete.

3 Disclosures should be clear, balanced, and understandable.

4 Disclosures should be consistent over time.

5 Disclosures should be comparable among companies within a sector, industry, or portfolio.

6 Disclosures should be reliable, verifiable, and objective.

7 Disclosures should be provided on a timely basis.

Climate Opportunities

Climate risk is a significant risk for companies and the analysis should consider and mitigate against these risks. For the most resilient and nimble firms there will be opportunities.

Adaptation measures

Some countries and regions may see benefits, such as wine growers in the South of England to Russian farmers who may enjoy longer warmer growing seasons. While overall the risks of climate change will outweigh the benefits, there will be advantages for some.

Resource efficiency

By reducing the amount of material or energy used in production and distribution processes companies can save a great deal of money, as well as curb emissions. Innovative ideas such as using electric vehicles, retrofitting buildings, embedding circular economy ideas, introducing LED lighting can all assist the transition to a low carbon future.

Products and Services

By offering low carbon products and services companies can enhance their competitive position against rivals. Any product that reduces emissions whether this is because of local production, low energy consumption or reduced materials has the potential to be attractive to consumers who increasingly favour goods that do not damage the environment.

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