Climate Scenario Analysis – What It Is and What It Isn’t
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Broadly, Scenario Analysis is a tool that has been used for over a half-century by corporations worldwide to have strategic conversations about business decisions in the face of uncertain futures. The point of scenario analysis is not to pick one preferred future and hope for it to come to pass, nor is it to find the most probable future and adapt to it. Scenarios are not predictions. Rather, scenarios are vehicles for helping people challenge their mental models of the world and lift blinders that may limit our creativity and resourcefulness. Scenarios help corporations make strategic decisions that will be sound for all plausible futures. They present alternative images of the future; they do not merely extrapolate trends into the future. Corporations are, for example, performing scenario analysis, contemplating how the outcome of the 2020 U.S. Presidential election might affect their tax strategies, or how the duration of the COVID-19 pandemic might affect their workforce productivity. While they might hope for the best (case scenario), smart organizations also plan for the worst (case scenario).
Climate Scenario Analysis - TCFD Approach:
The TCFD was convened by the Financial Stability Board (FSB) in 2015 to develop a set of voluntary, consistent disclosure recommendations for use by companies in providing information to investors, lenders, and insurance underwriters about their climate-related financial risks. The FSB convenes financial authorities and standard-setting bodies to develop and promote the implementation of effective regulatory, supervisory, and other financial sector policies in the interest of financial stability. The recognition by investors that market instability will be likely due to the complexity of climate change – and the potential materiality of the long-term risks it may pose – was, and continues to be, a primary driver of the FSB’s ongoing work coordinating the TCFD.
The recommendations are grouped into Governance, Strategy, Risk Management, and Metrics & Targets categories.
Within the Strategy category, TCFD recommends organizations “describe the resilience of the organization’s strategy taking into consideration different climate-related scenarios, including a 2°C or lower scenario.” With the support of TCFD’s recommendations by key stakeholders in the global financial community, Climate Scenario Analysis is emerging as a new version of a trusted tool for organizations testing their resilience in a future possibly impacted by climate change, replacing denial as the reaction to uncertainty, with confidence, built on insight into the possible outcomes of choices within an unpredictable context.
A Climate Scenario Analysis is a process an organization can undertake - often iteratively - to imagine (and plan for) plausible future scenarios involving the large-scale and complex nature of climate change. Once risks (and opportunities) are identified and understood, mitigation efforts are developed and applied to those risks that are material. Figure 1 (below) published by the TCFD lists risks, opportunities and steps a company takes once they are known.
Risks fall into two categories as outlined by the TCFD: (1) transition risks, created by the world’s transition to a low-carbon economy as a result of carbon policy changes, and (2) physical risks created from a changing climate, particularly in the absence of carbon policy measures.
Transition Risks include:
Policy and legal risk, market risk
Companies subject to regulatory developments related to climate change and energy-specific regulations globally. Examples include regulation of greenhouse gas (GHG) emissions, carbon pricing, fuel mix, energy and fuel cost, and energy policy. Related to changes in regulations are changes in the market. This includes the supply and demand for certain commodities, products, and services.
Reputational risk
There is a reputational risk to businesses as climate change moves up the consumer agenda. Businesses that are seen as not doing enough or not actively contributing to climate change mitigation may fall out of favor.
Physical Risks include:
Acute physical risks: Extreme weather, including tropical cyclones (hurricanes and typhoons), flooding, wildfire, drought, and heatwave
Extreme and severe weather could disrupt operations by rendering facilities and surrounding infrastructure inaccessible, increasing costs to repair facilities.
Chronic physical risk: Long-term changes in climate and weather patterns, including changing levels of precipitation, mean temperatures, and sea-level rise
Operational costs may increase as a result of shifts in climate patterns, through increased energy usage and spend. These impacts could also result in drops in productivity or increased operational costs for our suppliers.
Figure 1: TCFD Climate-Related Risks & Opportunities
(Source: Task Force on Climate-related Financial Disclosures, Overview, March 2020, pg. 13-15)
Figure 2: TCFD’s Process for Applying Scenario Analysis to Climate-Related Risks & Opportunities
Figure 2 below provides a helpful schematic for describing the process established by the Financial Stability Board (FSB) Task Force on Climate-Related Financial Disclosure’s (TCFD) outlined in the TCFD Technical Supplement: The Use of Scenario Analysis in Disclosure of Climate-Related Risks and Opportunities, June 2017. Using publicly available resources (e.g. scenarios, tools, datasets) coupled with proprietary data, KERAMIDA completed steps 2, 3 and 4 of a Qualitative Climate Scenario Analysis using this process.
Visualization of Outcomes
In designing a climate scenario analysis, organizations benefit from its technical integration with functional tools (e.g., visualizers, calculators, and mapping tools) that can help organizations comprehend and communicate outcomes.
Constructing a Strategic Conversation
Conversations about a future based on the idea that “things will work out okay tomorrow because tomorrow will basically continue the experience of today” do not cause companies to be more resilient. Instead, conversations that challenge this idea and consider alternative – but plausible – futures result in companies that are prepared for otherwise surprising events. The conclusion of qualitative climate scenario analysis is only the starting point for those strategic conversations.
KERAMIDA’s sustainability professionals can help your organization identify and describe climate-related risks and opportunities, and coordinate mitigation responses. Contact us or call (800) 508-8034 today for immediate assistance.
Contact:
Becky Twohey, Ph.D.
Vice President, ESG Strategy, Planning and Reporting
KERAMIDA Inc.
Contact Becky at btwohey@keramida.com
