By Lydia Messling
A group of the world’s largest companies have valued the substantive risks presented to their businesses as a result of climate change as costing almost US $1 trillion, with many of the risks likely to occur in the next five years. However, firms identified climate-related opportunities worth around $2.1 trillion. The disparity between financial risks and opportunities is likely due to businesses failing to accounting for the full spectrum of climate risk. Indeed, the report by CDP found that a lot more work needs to be done to quantify and measure risk, and that it is likely that climate change will have a much bigger impact than currently estimated.
For the report, CDP gathered data from 6937 countries across the globe, including a sample based on the 500 biggest global companies. 215 of these companies reported estimations of the potential financial impact their climate risks. They reported that US$ 970 billion is at risk, with over half of the risks being likely, very likely, or virtually certain to occur within five years. While this figure is not insubstantial, it is likely that firms in most sectors are considerably underestimating the impacts of climate change to their operations.
As shown in Figure 1, a large proportion of the climate risk reporting comes from the financial services sector, with other highly-vulnerable sectors such as retail, fossil fuels, manufacturing, power and, food, beverage and agriculture reporting very low financial risk impact from climate change. Only two sectors, infrastructure and transportation services, reported that the financial risks of climate change will outweigh the financial opportunities.
FIf this reporting is to be believed, then top businesses expect climate change to be a financial boon. Far more, likely is that they are significantly underestimating their climate risk exposure. So where is the missing climate risk? Digging deeper into the CDP analysis provides some answers.
Missing the full spectrum of climate risks
Companies are not yet able to sufficiently understand and identify physical climate risks. The report found that of the companies reporting to CDP, 53% of them identified climate-related risks that have the potential to have a substantive financial or strategic impact on business. However, almost two-thirds of risks identified were as a result of transition to a low-carbon economy, as opposed to physical risks presented by climate change. The increased prices of GHG emissions was a main focus for many companies’ analyses. This report focussed on the assessment of risks that were deemed to be substantive, but there are many more risks that present themselves to companies.
Additionally, most companies only identified potential physical and transition risks that would impact their direct operations, and not assess impacts to their supply chains and customers. This is concerning as, due to the complexity of supply chains today, disruption in one part of the world can greatly affect operations elsewhere. The report strongly recommends that investors and companies broaden their climate risk assessment practices to include these other areas.
The legal risks of climate change were another significant blind spot for firms. Of the companies that identified transition risks, only 25% of them focussed on potential policy and legal risks related to climate change, and many did not identify climate-related market, reputation, or technology risks as being substantive.
Strong cost incentive to act
Despite the narrow appreciation of climate risks, firms reported that taking action to build resilience made financial sense. Many of the companies who disclosed financial implication figures alongside the cost to manage these impacts showed that the potential implications of the risks greatly outweighed the costs that it would take to manage them.
Whilst there may be serious concerns about unaccounted risk, companies also identified climate-related opportunities, mainly driven by the demand for low emissions products and services as well as shifting consumer preferences. In almost all industries, the costs to realise these opportunities is reported to be significantly smaller than the total value of the opportunity – meaning that it would only cost US$312 billion to facilitate US$2.1 trillion in potential opportunities. These too could be realised in the next five years.
A mixed picture
Across the sectors, financial services reported most risks and opportunities. This may be expected as it is the biggest sector in the G500, and considerable work has been done on climate risk disclosure in recent years. However, the report states that the sector is likely to be missing a significant number of transition risks, despite being good at identifying physical risks for their clients.
The power sector also differs in that its costs to manage risks and realise opportunities are higher than the risks’ implications. Sector assets are long-lived and require a lot of investment, so the costs are proportionately higher for making them more resilient, retiring assets or investing in new ones. The power sector has also seen the biggest low-carbon transition change to date. Companies that were late in integrating these risks into their strategies are now facing much higher risks. An important lesson for other sectors to learn from.
Finally, the fact that fossil fuel companies report that there are more opportunities than risks from the low-carbon transition, raises questions about the nature of their reporting. Does this suggest that they are preparing for a large-scale shift towards low-carbon energy production? It would appear that climate-related risk disclosure still has some way to go to fully account for the risks that present themselves to businesses, but there is potential for these risks to be managed and for new opportunities to be realised.
Read the CDP report here.