Understanding the risks of climate change through scenario analysis
Assessing and acknowledging the risks and opportunities of climate change has been on the agenda of forward thinking companies for some time. However, we believe that there is a more robust approach to impact assessment that considers possible risks and opportunities and acts as a lens through which to view future business operations – climate scenario analysis.
In our 2017 report into the Sustainability Reporting Performance of Europe’s largest companies, we have sought out companies that understand what the risk of climate change means for their operations and highlighted them as best practice leaders. To maintain a leadership position, we recommend that businesses align with the recommendations produced by the Task Force on Climate Related Financial Disclosures (TCFD), an international initiative aimed at improving and standardising company reporting on climate change. The TCFD recommends scenario analysis as a tool to assess possible business outcomes that may occur as a result of climate change.
Climate change scenario analysis allows:
- Businesses analysis that is flexible or robust for a range of futures.
- Understanding of the strategic implications of climate related risks and opportunities.
- Information suitable for stakeholders about how the company will adapt.
What is climate scenario analysis?
Climate scenarios evaluate a range of possible outcomes by considering a variety of alternative possible futures using pre-determined assumptions such as climate projections. The scenarios are not a full description of the future. Instead they challenge conventions about the future, as they are constructed for exploring alternative situations and assumptions. They can include both positive and negative outcomes.
Climate scenarios can therefore be used to assess the probability of reaching or overshooting targets as well as quantifying the likelihood of risks and opportunities for the business. Plans can then be developed to ensure that the business is ready for the transition to a low carbon future.
Why is it important?
Climate scenario analysis is key to understanding the implications of climate-related risks and opportunities, which can then be used to guide successful corporate strategies. It also provides useful information on how the company will perform under different future states for investors, lenders, insurance providers and any other stakeholders.
Globally there is a drive to encourage companies to undertake climate scenario analysis. Beyond the TCFD, the key players in encouraging widespread adoption of scenario analysis are the Science Based Target Initiative encouraging organisations to set targets that have been determined using the 2 degrees climate scenario, and CDP, that will in 2018 incorporate a number of questions in their requests for disclosure related to this type of analysis.
Publicly available scenarios
There are broadly two types of scenario analysis that can be undertaken. In simple terms, physical scenario analysis uses predictions on how the planet will respond to a range of climate change outcomes and transitional analysis incorporates predictions of how changes in policy and technology will occur in response to meeting climate goals.
- Physical – using the results of global climate models that forecast the Earth’s response to changes in the concentrations of GHGs in the atmosphere to understand the impact on business operations.
- Transitional – scenarios present assumptions about the climate policies and deployment of low carbon technology to limit GHG emissions. They draw conclusions by modelling how policy and energy supply related technology will interact with economic activity, energy consumption and GDP as well as other factors.
It is advised that organisations consider both physical and transitional scenarios when undertaking climate scenario analysis to ensure a complete assessment of possible futures.
Scenario analysis provides an invaluable lens through which to assess company’s targets, strategy and governance of sustainability issues and take a view on whether they are fit for purpose. The results allow companies to determine which activities they need to focus on (for example renewable energy production or co-innovation with suppliers). The outcomes of these projects can be communicated to investors and other stakeholders.