Climate scenario planning will be essential to address the enormous challenge that climate change presents for enterprise risk management (ERM). The science alone is complex, but add highly uncertain economic, regulatory, financial, and political future contexts, and risk managers are confronted with uncertainty across multiple dimensions. The good news, as this blog will explain, is that there are methods available to manage this complexity.
A recent article in Foreign Affairs magazine reminds us that while our models of the future tend to assume optimized decision-making along the way, the transition to renewable energy is likely to be far from optimized, and far from smooth. Geopolitical upheavals brought about by the transition to clean energy might even stall the transition altogether. As the authors say, “these are arguments to encourage policymakers to look beyond the challenges of climate change itself and to appreciate the risks and dangers that will result from the jagged transition to clean energy.”
This “jagged transition” is just one of the reasons climate change is such a “wicked problem” as co-author and climate policy expert Dr. Mark Trexler observed in an earlier piece. The whole process of trying to assess future outcomes is inescapably messy. On the one hand, climate change is a dependent variable – affected by sensitivity to anthropogenic emissions, positive feedback loops, and assumptions regarding the magnitude of future greenhouse gas (GHG) emissions. At the same time, it is an independent variable, affecting financial stability, supply chains and logistics, human health, and more. Thus, ERM-relevant impacts can come in many forms:
- Direct physical impacts of climate change itself
- The second- and third-order impacts of climate change on business operations
- Climate policies and measures, whether state, national, or international in scope, undertaken in response to the threats posed by climate change
- Changes in consumer attitudes and behavior, and structural market changes associated with an accelerating low carbon transition.
Lives and behavior are affected by climate, but also by the expectation (or not) of climate change, as well as by the policies designed to address climate change, and the expectations (or not) of the nature and magnitude of such policies in the future as climate change worsens. The operating environment for most organizations will be affected by all of these things, as well as by the speed with which they occur.
COVID has provided a vivid illustration of cross impacts. It is a pandemic that has left many dead, pushed huge numbers into hospitals, and given rise to the development of revolutionary vaccines. It has at the same time disrupted supply chains, accelerated virtual work, emptied commercial real estate, stimulated a flight to the suburbs, and seemingly caused large numbers of people to re-evaluate their lives and careers. The pandemic is simultaneously an example of the kind of “wildcard” event that future climate change makes more likely, as well as the kind of event that can elbow rational responses to climate change off the political stage.
What’s already clear is that, despite global commitments dating back decades to prevent “dangerous” climate change, we are between very likely and certain to miss the 1.5⁰C and 2⁰C average global temperature change targets in place to implement those commitments. A large part of the problem is what (former Bank of England Governor) Mark Carney calls the “tragedy of the horizon” – the idea that any catastrophic effects of climate change will be felt well beyond the lifespans of most decision-makers, or at least far enough into the future that we can assume a future technological fix. Short-term sacrifices for long-term gains are a tough sell. As such, even as mitigation efforts ramp up in response to worsening climate change, adaptation too will become the order of the day. What will that look like, where could we encounter “adaptation limits,” and how should organizations prepare?
More immediately, reporting on climate change risks will soon become compulsory for all major enterprises. Regulators such as the SEC and the Bank of England are increasingly expecting companies to be transparent in the assumptions underlying their climate risk reporting. Furthermore, they are requiring more expansive and holistic analyses, to shed light on the fullest range of factors influencing – and affected by – physical risks, liability risks and transition risks.
Presently there are few sufficiently sophisticated tools and processes available to perform these analyses in ways that are likely to satisify increasingly hands-on regulators. What’s needed is the robust strategic foresight that lies at the heart of FSG’s climate scenario planning approach.
How climate scenario planning can help
FSG has integrated climate change into strategic foresight scenarios for a wide range of clients over the last 20 years. Instead of deploying a scenario set, ONE of which addresses climate impacts, or a set of scenarios – ALL of which address climate impacts in various degrees but freeze assumptions about other variables – we utilize a range of scenarios that all encompass climate change AND its interrelationship with the other key scenario variables.
There is value in creating such scenarios, and in using them. Scenarios can be tailored for specific client operating environments, or ready-made for more widespread general adoption. Deliberation over scenario characteristics and their inter-relationships usefully exposes assumptions and strategic priorities. Additionally, climate change can be treated in a variety of ways – actual/perceived, short-term/long-term, regional/global – allowing for a truly wide range of uncertainties to be played out. Finally, scenarios can be dynamically adapted over time as climate change itself, and our responses to climate change, play out.
Used properly, such a climate scenario planning exercise provides a powerful platform to socialize climate consciousness across the organization in an expansive and rigorous manner – to the satisfaction of regulators, directors, and all other stakeholders.
Dr. Mark Trexler is founder of The Climatographers. He has more than 30 years of regulatory and energy policy experience, advising clients around the world on climate change risk and risk management. He is widely published on business risk management topics surrounding climate change, including in the design and deployment of carbon markets. Mark has served as a lead author for the Intergovernmental Panel on Climate Change and holds advanced degrees from the University of California at Berkeley.