What every manager should know about (1/5): Climate Change

before-the-flood

As your organization is getting ready for the implementation of EU guideline 2014/95/EU on the disclosure of non-financial information, I hand you a series of blog posts on non-financial topics that business managers might be less familiar with. My aim for this series of posts is twofold. First, to give you insight into concepts that are integral to non-financial frameworks on reporting, such as the Global Reporting Initiative (GRI) framework. Second, to show why and how you should integrate these specific non-financial disclosures into your overall risk management strategy.

The first blog in this series will discuss what climate change is and what climate change has to do with managing business risk. If you are in need of a broader perspective on climate change I recommend Leonardo DiCaprio’s clear and informative film Before the Flood.

Defining Climate Change

Climate Change, according to the Concise Oxford English Dictionary is:

The change in global climate patterns apparent from the mid to late 20th century onwards, attributed largely to the increased levels of atmospheric carbon dioxide produced by the use of fossil fuels.

In his insightful book Climate Change, A Very Short Introduction, Mark Maslin writes:

Over the last 150 years, significant changes in climate have been recorded, which are markedly different from the last at least 2,000 years. These changes include a 0.85°C increase in average global temperatures, sea-level rise of over 20 cm, significant shifts in the seasonality and intensities of precipitation, changing weather patterns, and the significant retreat of Arctic sea ice and nearly all continental glaciers. (…) The IPCC [Intergovernmental Panel on Climate Change] 2013 report states that the evidence for climate change is unequivocal and there is very high confidence that this warming is due to human emissions of GHGs [i.e. greenhouse gases, such as CO2].

To be able to visualize why it’s so hard to combat climate change caused by CO2, consider this illuminating analogy from Climate Shock, by Gernot Wagner and Martin Weitzman:

Think of the atmosphere as a giant bathtub. There’s a faucet – emissions from human activity – and a drain – the planet’s ability to absorb that pollution. For most of human’s civilization and hundreds of thousands of years before, the inflow and the outflow were in relative balance. Then humans started burning coal and turned on the faucet far beyond what the drain could handle. (…) Inflow and outflow need to be in balance, and that won’t happen (…) unless the inflow goes down by a lot.

Recently, we have learned (see a recent Guardian article) that the amount of CO2 in the atmosphere reached 400 parts per million (ppm); that’s 40% higher than pre-industrial levels (280 ppm). In Climate Shock we read why this is a serious problem:

Last time concentrations of carbon dioxide were as high as they are today, at 400 parts per million (ppm), the geological clock read “Pliocene”. That was over three million years ago, when natural variations, not cars and factories, were responsible for the extra carbon in the air. Global average temperatures were around 1-2.5°C (…) warmer than today, sea levels were up to 20 meters (…) higher, and camels lived in Canada.

The conclusion that we must draw from this is not that climate change is new. Rather, for the first time in the earth’s history, climate change is manmade and happens at a rate which would make it impossible for us to re-actively adapt our infrastructure accordingly. Think for example of shifting entire agricultural regions, or moving complete cities from their present-day ocean front locations.

For an illustrated (and witty) example of how extraordinary the current spike in average temperature really is, see A Timeline of Earth’s Average Temperature. Below, only the very last brief time period – with a sharp increase in average temperature – is shown; the full infographic shows much slower changing average temperatures in the last 20,000 years.

temperature

Skepticism towards climate change is like denying smoking causes cancer

Perhaps most of the general public would not see climate change as an urgent problem, as Wagner and Weitzman point out in Climate Shock.  Although the science behind climate change is solid and has been accepted by the scientific community on the weight of evidence of the research, there seems to be an amazing amount of skepticism around the subject in non-science circles. In trying to explain this phenomenon, Maslin writes:

…the media’s ethical commitment to balanced reporting may unwittingly provide unwarranted attention to critical views, even if they are marginal and outside the realm of what is normally considered ‘good’ science. (…) Add to this the greater ease of communication, from conventional media, such as newspapers, radio, and television, to more informal blogs, tweets, etc. Normal private debate among scientists and experts can easily be shifted into the public arena and anyone, what ever their level of expertise, can voice an opinion and feel it is as valid as that of experts who have dedicated their whole lives to studying areas of science. Overall, this contributes to a public impression that the science of climate change is ‘contested’, despite what many would argue is an overwhelmingly scientific case that climate change is occurring and human activity is a main driver of this change.’

Or, maybe skepticism has to do with cognitive dissonance (i.e. a state of inconsistent thought, beliefs, or attitudes), write Wagner and Weitzman:

Whenever science points to the very real potential of these types of catastrophic outcomes, cognitive dissonance kicks in. Facts might be facts, the reasoning goes, but throwing too many of them at you at once will all but guarantee that you will dismiss them out of hand. It just feels like it can’t be true.

Leonardo DiCaprio in Before the Flood echoes this:

We keep being inundated with catastrophic news about the environment every single day, and the problem seems to get worse and worse. Try to have a conversation with anyone about climate change, and people just tune out.

The key point here is that the efforts to understand climate change are a scientific effort. Maslin rightfully states that ‘science is no belief system’. As Armand Marie Leroi points out in his book, this has been true ever since Aristotle invented science:

‘A scientist is someone who seeks, by systematic investigation, to understand experienced reality.’

Being skeptical towards climate change is therefore the same is being skeptical towards the process of scientific discovery itself. It is, Maslin states, to ‘deny that smoking causes cancer, or that HIV causes AIDS’.

Climate Change and business risk management

Integral risk management for your organization should include climate change risks. As the authors of Climate Shock put it: ‘First and foremost, climate change is a risk management problem’.  A risk analysis of climate change would lead to defining business risks that stem from both the direct consequences of climate change (like more severe weather events), and risks that stem from external stakeholders’ actions to curb climate change that, in turn, have an effect on the company’s operations or profitability (e.g. tighter regulations for GHG emissions). Without making any claims of exhaustiveness, as a minimum, your organization’s risk assessment should include the following risks in a risk assessment:

risk-matrix

Asset and infrastructure risk. We already see an increase in extreme weather events that could hurt a firm’s assets and supply chains. In Climate Change, A Very Short Introduction, numerous relevant examples are given:

[I]n recent years massive storms and subsequent floods have hit China, Italy, England, Korea, Bangladesh, Venezuela, and Mozambique. In England in 2000, 2007, and 2013/13, floods and storms classified as ‘once-in-200-years events’ have occurred within 13 years and frequently within a single year. Moreover, in Britain the winter of 2013/14 was the wettest six months since records began in the 18th century, while August 2008 was the wettest on record.

Organizations could use climate forecasting models to show which assets and infrastructure are more at risk because of climate change. A next step would be to develop scenarios that would lessen the impacts on your assets and supply chains (e.g. moving operations to areas less affected by extreme weather events).

Yield and price risk. When climate change starts to affect crop yields, it will also affect purchasing prices. The IPCC (Intergovernmental Panel on Climate Change) brings together key climate research conducted all over the world and provides a consensus of this research. The IPCC, 2014 report found:

Based on many studies covering a wide range of regions and crops, negative impacts of climate change on crop yields have been more common than positive impacts. [S]everal periods of rapid food and cereal price increases following climate extremes in key producing regions indicate a sensitivity of current markets to climate extremes (…).

Your organization should know which commodities are most at risk from the impacts of climate change. This should be a starting point for developing scenarios to mitigate yield and price risks.

Government regulations. Now that the Paris Agreement has come into force, we can see governments stepping up their work to implement policies that will make sure global average temperatures well below 2°C. Barack Obama in The Economist:

[S]ustainable economic growth requires addressing climate change. Over the past five years, the notion of a trade-off between increasing growth and reducing emissions has been put to rest. America has cut energy-sector emissions by 6%, even as our economy has grown by 11%. Progress in America also helped catalyse the historic Paris climate agreement, which presents the best opportunity to save the planet for future generations.

Any policy changes that try to curb climate change will impact business-as-usual. As a mitigation strategy, organizations should try to understand possible policy options and work out the effects on operations and profitability.

Reputation risk. Awareness of climate change in general is on the rise. Whenever the public is of the opinion that the firm’s activities are harmful (this obviously extends beyond climate change), there’s a probability that profitability is at risk. For example, the big palm oil trader IOI was accused of illegal logging recently  ̶  contributing directly to climate change because of loss of rain forest that stores CO2  ̶  , experienced extreme negative publicity (see this article in the Financial Times), and saw share prices and revenues tumbling. As a first step in creating mitigation scenarios, firms should make an effort in understanding external stakeholder’s views and wishes towards the firm’s climate change actions. As the IOI example shows, reputation risk does not only revolve around emissions but also around having supply chains that contribute towards climate change by deforestation (e.g. beef, soy, palm oil, and wood fiber). Your organization should therefore not only know which operations are most at risk from the impacts of climate change (direct risks), but should also know which commodities contribute the most towards climate change (reputation and regulatory risk).

As I already argued in my blog post The Business Case for Non-Financial Reporting, disclosing non-financial information can lead to insights on how to update your business strategy or improve stakeholder relations. Reporting on climate change gives you the opportunity to update your risk management framework. By breaking climate risks down into direct and external stakeholder risks, and putting in place mitigation scenarios, your organization will be well prepared for an age where climate change is at the top of the agenda.

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