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The Changing Profile of Corporate Climate Change Risk
By Mark C. Trexler, Laura H. Kosloff Do Sustainability
Copyright © 2012 Mark C. Trexler and Laura H. Kosloff
All rights reserved.
ISBN: 978-1-909293-02-1
CHAPTER 1
Executive Summary
CLIMATE CHANGE HAS BEEN CHARACTERIZED as a business risk, at least for major greenhouse gas (GHG) emitters, for more than 20 years. Today, climate change and related risk variables (e.g. water scarcity and extreme events) increasingly rank toward the top of the business risk list published annually by the World Economic Forum.
Climate change can translate into business risks in a number of ways:
• Physical risk, including direct impacts of climate change on a company's operations, supply chains, and financial performance;
• Brand risk, including the impact of consumer and stakeholder perceptions on corporate competitiveness;
• Policy risk, including the impacts of climate change policy and regulatory mandates on a company's operations, supply chains, and competitive advantage;
• Structural risk, including the impacts of climate change-influenced market forces on the supply of and demand for a company's products and services; and
• Liability risk, including litigation or legislation that could assign corporate liability for GHG emissions, potentially retroactively.
Several of these risks can manifest themselves at both ends of the corporate risk management time-line, i.e. through measures undertaken too early and too aggressively, or too little and too late. Stakeholders routinely pressure companies in virtually every business sector to take corporate action on climate change, even before any regulatory regime is in place. Yet it is a rare investor indeed who willingly and explicitly accepts reduced corporate performance in the near term as a tradeoff for being better hedged against future climate risks. Corporate first-movers undertaking aggressive mitigation strategies can find themselves under pressure from shareholders due to short-term impacts on the bottom line, face competitive disadvantage if competitors do not pursue the same initiatives, and even incur brand risk for their efforts if public attention to those efforts leads to 'greenwashing' charges.
Companies therefore walk a fine line when it comes to managing potential climate risks – assuming they are actually aware of the risks. Playing it safe, much of the corporate action on climate change has taken the form of low-risk voluntary measures, including harvesting low-hanging fruit (e.g. energy efficiency). While that can lead to significant cost savings, it usually runs out long before a company is able to accomplish serious emissions reductions. More importantly, it addresses just one of the potential risks companies face from climate change.
For companies wanting to undertake more material risk management efforts, whether mitigation or adaptation-based, physical and policy uncertainties surrounding future climate change and climate change policy are a major challenge. Corporate efforts can be frustrated by societal risk management inaction on the one hand (resulting in delayed policies and more climate change than the company might have anticipated) or societal risk management actions that are more aggressive than the company might have anticipated. The characteristics of climate change as a risk problem put companies at a significant risk management disadvantage, even as those risks grow.
An obvious question for business observers is just how sure scientists are about climate change and the existence of physical climate risks. There is no question that consensus exists among the scientific community that anthropogenic climate change poses serious risks, notwithstanding a range of continuing uncertainties regarding the magnitude, pace, and impacts of climate change. In interpreting the continuing scientific debates over these aspects of climate change, we have to remember that there's virtually nothing that scientists agree upon universally. This should not be interpreted as somehow undermining scientific certainty about climate change; there's almost nothing that scientists consider 'certain' in the way the term is commonly used.
From a business risk standpoint, it is useful to characterize a range of climate change scenarios against which potential business risks can be compared and evaluated. Five scenarios are profiled below, representing a large part of the potential distribution of climate change and climate policy outcomes:
• Scenario 1: Issue collapse. The prospects of climate change, and the pressure for policy action on climate change, could come to an end.
• Scenario 2: Stay the policy course. This scenario can be thought of as reflecting a continuation of current policies, and comparable to an explicit or implicit carbon price of US$5-30/ton of CO2 equivalent.
• Scenario 3: Policy induced atmospheric stabilization of CO2. This scenario is based on emergence of the political will to pursue the aggressive emissions reductions and technology development initiatives that would be necessary to stabilize GHG concentrations in the atmosphere.
• Scenario 4: Policy induced return to 350 ppm CO2. This scenario carries Scenario 3 further by suggesting an actual reversal in the accumulation of GHGs in the atmosphere, and would only be motivated by a revolution in public and political climate risk perceptions.
• Scenario 5: Technology induced transition to a low carbon economy. This scenario is premised on big changes in the rate of development and or deployment of low-carbon technologies leading to a stabilization or reduction in atmospheric GHG concentrations, even in the absence of material carbon pricing.
Companies evaluating climate risks may wish to assign relative probabilities to the five scenarios introduced above as part of their risk management strategies. Such strategies have to accommodate potentially rapid future transitions from one scenario to another. Could the 'stay the policy course' scenario suddenly switch to the 'policy-induced atmospheric stabilization' scenario, or the 'return to 350 ppm' scenario in response to climate change itself? Are there circumstances in which the 'technology-induced transition to a low-carbon economy' scenario becomes more or less probable?
The business community has no prudent choice but to consider climate change as an integral part of corporate planning. For some companies, climate change and climate policy outcomes will create business opportunities. For the others, climate risk management strategies can already reduce companies' exposure and vulnerability to both climate change and climate policy. Climate risk positioning strategies can make companies 'response-ready' for climate risks that will evolve, or which cannot be materially or cost-effectively mitigated today. Companies with effective positioning strategies will be able to move more quickly than competitors when uncertainties around key variables are narrowed and thus enhance their competitive advantage.
The potential for business risk and business opportunity based on climate change and climate change policy is greater now than in the past, and will continue to grow as the gap between climate science and climate policy continues to expand. It is important that corporate risk management strategies keep up.
CHAPTER 2
Introduction
SCIENTISTS HAVE CALLED for a near-term reduction in global emissions of carbon dioxide (CO2) of more than 70% to stabilize the concentration of CO2 in the atmosphere. Meanwhile global CO2 emissions, as well as emissions of the other so-called greenhouse gases (GHGs), continue to increase. While a political consensus exists for the view that exceeding 2°C of global temperature change would constitute 'dangerous anthropogenic interference with the climate system' (the avoidance of which global governments are committed to through the United Nations Framework Convention on Climate Change), that amount of warming is already almost inevitable. More importantly, there is no global action plan in place to prevent much more dramatic temperature rises in coming decades.
Even as climate science has solidified, companies have been hearing for years that they don't need to know much about climate change science, they just need to recognize that 'the climate policy train is leaving the station, and you want to be on it'. This 'policy paradigm' of climate risk assumes that policy and regulation are the primary contributors to corporate climate risk, rather than climate change itself, and encourages policy-oriented risk responses. Correspondingly, the primary focus of corporate risk management activities has been to be at the policy table (rather than 'on the menu'), to measure and commit to reducing corporate carbon footprints, to anticipate the timing and magnitude of a future price on carbon, and to use carbon offsets to voluntarily reduce corporate or product-based emissions. Hundreds of corporate footprint reduction commitments and a slew of 'carbon-neutral' products and services have sprung up as a result.
Some 25 years after initial calls for broad-based GHG emissions reductions, agreement on climate change policy to accomplish these reductions has proven an almost impossible nut to crack through domestic legislation or international negotiations. It's not for a want of trying; numerous policies intended to help reduce GHG emissions, and reduce or adapt to climate change are in place or being developed around the world. The problem is that these measures are unlikely to do more than scratch the surface of what scientists have said is necessary in order to materially reduce climate risk.
With the failure of national climate change legislation in the US, and the anticipated failure of international efforts to extend a meaningful version of the Kyoto Protocol, many companies are asking themselves: Climate risk? What climate risk? Companies should question, however, whether the 'policy paradigm' that underlies this conclusion, and that has guided corporate thinking for more than a decade, is actually the right risk management paradigm.
For example, does the growing disconnect between societal climate change risk and climate change policy have risk implications for business? How material to business is climate change itself, including all of the associated supply chain and brand risks? Is it reasonable to assume that if climate change makes itself increasingly felt it will become politically harder and harder to ignore, and that the risk of sudden and draconian policy risk will escalate? A gradual glide path to lower GHG emissions and toward a higher price on GHG emissions – long an objective of corporate efforts to influence climate policy – could be rendered moot if the public and policy-makers conclude that we have run out of time for gradual measures.
CHAPTER 3
The Elements of Climate Risk
THE BURNING OF FOSSIL FUELS was identified as a potential cause of future climate change more than 100 years ago. At that time, however, no one foresaw the exponential rise in fossil fuel consumption that has accompanied global industrialization, or that the composition of the Earth's atmosphere would change at a rate the planet has never before experienced.
Why do scientists conclude that the climate is changing in response to human activities, and that such change poses risks? Risk is not about being able to predict the future with certainty; rather, risk is about understanding how exposed and/or vulnerable a system is to change:
RISK = EXPOSURE x VULNERABILITY
Perceptions of climate risk are therefore based both on 'knowns' and 'unknowns' regarding our exposure and vulnerability to climate change outcomes.
Climate change: What do we know for sure?
• We know that Earth supports life because trace levels of greenhouse gases (GHGs) (measured in parts per million), naturally warm the atmosphere by approximately 15°C through the so-called 'greenhouse effect'. Without the natural greenhouse effect, Earth could not support life.
• We know that global temperatures have varied substantially over tens of millions of years of Earth history. But as illustrated in Figure 1, we also know that the last 10,000 years, during which human societies have evolved, have been remarkably climatically stable, with the global average temperature staying within a band of about 1°C.
• We know that human activities, primarily the combustion of fossil fuels, are releasing large volumes of CO2 to the atmosphere, where it accumulates and contributes to radiative forcing beyond that associated with the natural greenhouse effect.
• We know that GHG concentrations in the atmosphere are rising substantially. Concentrations of CO2 have grown from 278 ppm (parts per million) at the onset of the Industrial Revolution to almost 400 ppm today; indeed, concentrations of all six major GHGs have increased significantly.
• We know that the last time global temperatures were 2°C and 3°C higher than 1900 levels, global sea levels were 4–6 meters and 20–30 meters higher than they are today, respectively.
• We know that conventional fossil fuels, if fully exploited, would increase atmospheric concentrations of CO2 to more than 1000 ppm. Unconventional fossil fuels (e.g. oil shale and shale gas) have the potential to release even more CO2 than conventional fossil fuels, as could (in CO2-equivalent terms) the release of methane from melting permafrost or the release of huge quantities of methane stored as clathrates on the ocean floor.
• We know that we're already seeing changes in local and global biological and other systems that are consistent with expectations of a higher-CO2 and a warmer world, including reductions in the pH (acidification) of the world's oceans.
Climate change: What don't we know for sure?
• We don't know how quickly GHGs will accumulate in the atmosphere. It depends on many variables including population growth, economic activity, energy prices, and public policies. Thus, we don't know whether CO2 concentrations will rise to 450, 550, 650, or even higher ppm levels during this century.
• We don't know whether the oceans and other biological systems will continue to absorb, as they have been, approximately 50% of the CO2 annually emitted to the atmosphere by human activities, or whether a slow-down in ocean absorption will accelerate the growth in atmospheric concentrations.
• We don't know how sensitive the atmosphere is to changing levels of GHGs, e.g. through impacts on global cloud cover. Most global climate forecasts are based on assuming that a doubling of CO2 concentrations will translate into approximately 3°C of average global temperature rise. Scientists' estimates of climate sensitivity, however, range as high as 6°C.
• We don't know exactly how or when large-scale climate feedbacks (e.g. melting permafrost, Amazon forest dieback, or rapid melting of the Greenland ice pack) might be 'tripped'.
• We don't know exactly how anthropogenic climate change is already manifesting itself, as compared to witnessing natural climatic variability.
• We don't know for sure why certain climate change impacts seem to be occurring more rapidly than forecast even just a few years ago (e.g. the rate of Arctic ice melt).
These lists of what we do and don't know for sure reflect just a small slice of the available thinking around climate change. What is notable from even this short list is the range of potentially risky outcomes associated with these uncertainties:
• What if GHG concentrations in the atmosphere start growing more rapidly?
• What if the sensitivity of the atmosphere to changing GHG concentrations is higher than assumed in the global models being used in political decision-making?
• What if suspicions prove true that climate change is already stressing global food production, leading to declines in reserves and significant price increases?
• What if climate 'tipping points' lead to step changes in observed climate change?
Rather than generating a policy debate over how much climate change risk is acceptable, however, the prevailing public debate has been characterized by arguments over exactly what is happening today, whether it is definitely attributable to climate change or might reflect natural variability, and exactly what will happen in the future as a result of anthropogenic climate change. This political discourse runs contrary to the whole notion of risk assessment and management under conditions of uncertainty.
(Continues...)
Excerpted from The Changing Profile of Corporate Climate Change Risk by Mark C. Trexler, Laura H. Kosloff. Copyright © 2012 Mark C. Trexler and Laura H. Kosloff. Excerpted by permission of Do Sustainability.
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