Introduction: what The Economist has to say about climate change and business
More than a year ago, we started off a series of blog posts on mandatory non-financial disclosures with a post on climate change. At that point, four risk groups of climate change were identified and suggestions were made on how to integrate climate risks in your overall risk management strategy. It is time to revisit and update the story on climate change, as climate science is advancing and impacts are becoming clearer.
As a heuristic (always a good idea, see this post), we gathered that the number of times The Economist, a weekly current events newspaper, wrote an article on ESG-related topics (i.e. risks stemming from environmental, social or governance aspects) would be a proxy for how serious firms should take ESG-risks. Climate change was the topic of the most articles by far in the period from roughly the end of 2015 to the end of 2017. We counted the following number of articles on ESG-topics:
- Climate change: 38 articles.
- Renewable energy: 18 articles.
- ESG-risks: 12 articles.
- Natural resource depletion and pollution: 11 articles.
Here’s how we think these topics fit together:
Please note we don’t claim any scientifically established causal relationships here; just a framework to put different topics loosely together and offer a way to think about interrelations. If you are looking for a scientific take on this, please visit the excellent report A Guide to SDG Interaction: from Science to Implementation from the International Council for Science.
Since climate change as a topic has the highest count in articles, is central to other topics such as the worldwide push for renewables and natural resource depletion (see schematic above), and climate change is advancing rapidly, we felt it was time to update our previous post on climate change risk. The importance of climate change risk is echoed by The Economist:
Ignoring the climate issues altogether looks like the biggest risk of all.
We will therefore revisit the four business risks already identified earlier (i.e. asset and infrastructure risk, yield and price risk, regulatory risk and reputational risk), and will propose a number of new risk groups that we found by reading recent articles by The Economist on ESG-topics.
Climate change and business risk, updated
In the table below, you will find all the business risks stemming from climate change found in The Economist. New risks (compared to our earlier blog post) are shown in bold italics. First, there are two additional business risks added to the risk group ‘external stakeholder actions to curb climate change’. Second, we found an entirely new risk group: ‘funding risk’.
For every business risk identified, we will now briefly describe the risk, give the examples found in The Economist, and offer a way to mitigate the risk.
Regulatory risk. More and more jurisdictions are introducing cap and trade schemes or carbon taxes. This inevitably means that firms have to take into account (future) carbon prices in investment decisions. According to the Carbon Pricing Leadership Coalition (a World Bank funded outfit that puts together business and governments to advance carbon pricing), ‘as of 2017, 42 national and 25 subnational jurisdictions are pricing carbon’. That already accounts for more than 20% of global CO2 emissions. In Canada, the announcement of a national carbon price puts high emitters at immediate risk. The province of Quebec in Canada, for instance, is lobbying to funnel $1 billion to Bombardier, an aircraft-maker, to make up for its payments of carbon taxes under a nationwide introduction of a carbon tax. Even if your own government is not imposing a carbon tax, there is increased risk that other governments start installing an import tax for every ton of CO2 emission in the making of a product. Indian steel makers, for example, will have to take into account a carbon tax when exporting to the EU, even though they do not currently face a carbon tax in India. What to do? More and more firms are using a price for carbon emitted in their long-term investment decisions. Putting a price on carbon in decision-making – and using a realistic price, say in the range of €50-60 per ton – will take into account any future carbon tax or cap and trade system. The Economist lists a number of companies that already use such internal carbon prices: Microsoft, DSM, AkzoNobel, Indian cement manufacturers ACC, Ambuja & Dalmia, French building materials producer Saint-Gobain, and supermarket chains Carrefour and Sainsbury’s.
Reputation risk. The sectors that face reputational risk include an obvious one and a, maybe, not so obvious one. To start with the obvious sector, the fossil fuel industry, it is not only CO2 emissions that are the target of environmentalists, but also methane leaks. That leaves companies like Shell, BP and ENI vulnerable to reputational risk even if they pledge to switch more and more to natural gas (infamous for methane leaks). Already, NGOs such as the Environmental Defence Fund are drawing attention to methane emissions in the production of natural gas that ‘now surpasses cow burps as a source of [methane] emissions’ according to The Economist. A sector that, as of yet, has not attracted the attention of environmental campaigners, is the cement industry. That might be about to change however, as more and more NGOs draw attention to an increasing number of industries now that it becomes clear that humanity is unlikely to keep temperatures less than 2°C warmer than pre-industrial times. Cement, together with steel, makes up a large part of the CO2 footprint for any building. And as firms try to lower their CO2 footprint, buildings, and thus cement, is another link in the chain in trying to reduce emissions. Firms that are exposed to this type of risk (i.e. reputational) are, according to The Economist, especially the major players in the cement industry, e.g. Heidelberg Cement Group and Cemex. Examples for mitigating these risks, as listed by the same newspaper, include setting publicly available targets (and reporting against those targets), carbon capture and storage, and using higher internal carbon prices for long-term investment decisions.
Shareholder pressure. An unlikely pressure group that turns its attention to climate change, are shareholders. Unlike environmental groups, who strive for direct reduction in emissions, shareholders would like to see that companies identify the impact of climate change regulations and policies on business plans. Again, the industry where shareholders are, at the moment, most active is the fossil fuel industry. The Economist refers to Shell, Total, Chevron and Exxon as firms where shareholders are particularly active to push towards pricing in carbon in investment decisions as the preferred mitigation strategy. Total goes further: ‘It plans to set out its ambition to develop an energy mix by 2035 consistent with Paris-style global-warming limits, including a pledge to invest $500m a year in renewables, and a “symbolic objective” to raise their share to 20% of its portfolio, from 3%. In an effort to complement its acquisition of a solar-energy company, it launched an offer to acquire a battery-maker, which will bolster its expertise in electricity storage’. Hidden in this mixture of Total’s plans, are a plethora of mitigation strategies that would please many shareholders pushing for just that: increasing the stake in renewable energy, taking head of broad international movements like the Paris agreements and adjusting strategies accordingly, and setting publicly available targets. Do this, and add to the mix internal carbon prices for investment decisions, and your firm will have a good policy mix to satisfy shareholder demands.
Lawsuit risk. In an article dubbed ‘Lawsuits against climate change’, The Economist points out that the number of lawsuits where the negative effects of carbon emissions are central, are rising. The targets are both governments and big energy firms. Ironically, governments also sue energy firms: San Francisco is taking BP, Chevron, Exxon and Shell to court. All of this is made possible by improved climate science: ‘Scientists are increasingly confident that they know roughly what shares of the greenhouse gases in the atmosphere were emitted by individual countries, and even by the biggest corporate polluters. (..) just 90 belched out 63% of all greenhouse gases between 1751 and 2010.’ In a fascinating report by the Carbon Majors Database, all these companies are listed. Unsurprisingly, the 90 firms are either big energy firms, mining corporations, or cement manufacturers. Even if your firm is not listed, you might want to check if a similar study is done for your own country, and you may find that your company is listed in that ranking. Climate litigation is on the rise. The focus is on big energy firms for now, but cement manufacturers and mining corporations might be next. The sooner you map your firm’s GHG emissions and estimate the risk that an interest group or government targets you in the near future, the better.
Decreased access to capital markets. The last new risk that we identified as compared to our last post on climate related risk for companies, is a funding risk. As climate change becomes more of an issue, investor demand for green bonds is increasing. At the same time, investors are backing away from industries that run greater risk from climate change (these risks are, essentially, all other risks described here). Moody’s, a rating agency, puts energy firms and car makers, for example, in a higher risk category. This can obviously translate in lower stock prices and higher premiums in bond markets. Big investors are adopting climate strategies rapidly. Allianz, for example, is not putting money in firms that derive more than 30% of their energy from coal; and even the biggest asset management firms like BlackRock have set-up dedicated green-bond funds fueled by investor demand. Another recent development is that rating agencies are threatening cities with downgrades if they don’t do more on climate change mitigation (also see asset and infrastructure risk below). Companies might well be next.
Asset and infrastructure risk. As 2017 proved, with hurricanes Harvey and Irma as horrifying examples, climate change increasingly poses a threat for assets and infrastructure. As wet places get wetter and stormy places get stormier, cities around the world are making plans to raise roads and improve drainages. Your business would be well advised to do the same. As an example, you could use impact models (such as the Inter-Sectoral Impact Model Intercomparison Project (ISI-MIP)) to establish which of your business locations are at risk, and implement a mitigation strategy for those locations accordingly. We could not find any specific examples in The Economist of businesses that have already implemented mitigation strategies for asset and infrastructure risk, however. It mainly refers to cities and governments to take action to protect assets and infrastructure. Your firm should follow the example of cities.
Price and yield risk. What we discussed for asset and infrastructure risk, more or less also holds for price and yield risk. Although The Economist acknowledges the risk (‘by 2050, even if temperature rise is successfully limited to 2°C, crop yields could slump by a fifth’), we could not find any mention of individual firms that are already affected by this. Again, this should not be a reason for a wait-and-see attitude. A good starting point is the Agricultural Model Intercomparison and Improvement Project (AgMIP). This major international collaborative is an effort to improve agricultural simulation and to understand climate impacts on the agricultural sector at global and regional scales. AgMIP produce highly useful maps for your businesses to gauge the impact of climate change on yields for crops in your supply chain.
Industry climate change risk profile
Reading through the business risks in the previous section, you will have been able to quickly assess if your firm faces a particular risk or not. By deconstructing climate change risk into seven distinct business risks (i.e. regulatory, reputational, shareholder pressure, lawsuit, funding, asset & infrastructure, and price & yield), you now have a tool to help you decide if the – arguably – abstract concept of climate change is relevant to your organization.
By way of summary, we have added specific industries (mentioned in The Economist articles that we consulted) to the individual business risks identified. This isn’t to say that other industries aren’t impacted by each type of business risk. See the table below:
Coming up with the right strategy mix to mitigate these risks might not be easy. Renewable energy, insurance policies, carbon capture and storage, (higher) internal carbon prices, improving drainages, moving production locations: they could all be visited as possible solutions. Keep in mind that the combination ‘climate change’ and ‘business’ does not feel like a realistic combination. We would argue that this is normal human behavior, since climate change is not a risk that has hurt your business in the past. But we hope to have shown with examples taken directly from The Economist, that your competitors and fellow business organizations are already fully taking on business risks stemming from climate change. A final word of caution from Nicholas Taleb:
People in risk management only consider risky things that have hurt them in the past (given their focus on ‘evidence’), not realizing that, in the past, before these events took place, these occurrences that hurt them severely were completely without precedent, escaping standards.