CLIMATE RISK FOR COMPANIES: HOW TO ADAPT?
Mitigation and adaptation: two complementary strategies in the fight against climate change.
November was marked by the 26th Conference on Climate Change (COP26) in Glasgow. The four main objectives displayed are mitigation, adaptation, mobilization of finance, and collaboration between stakeholders.[1] While the last two objectives are self-evident, the first two may require clarification. Climate change mitigation (or “mitigation”) involves reducing global greenhouse gas emissions, and ideally, according to the Paris Agreement, reducing them so as not to exceed the 2°C threshold.[2] However, the organizers of the previous COP remind us that “the climate is already changing and it will continue to change even if we reduce emissions, with devastating effects.”[3] Adaptation to these effects is therefore an essential pillar.
Focus on the role of businesses in mitigation rather than adaptation.
To date, businesses are primarily seen as key players in mitigating climate change. In fact, businesses implementing actions to reduce their emissions, particularly sectors such as energy, transport and industry – which account for over 75% of global emissions[4] – can have a significant impact. Regulations typically go in this direction, requiring businesses to measure their emissions and sometimes even set reduction targets.
The role of businesses in adapting to climate change remains less publicized and less regulated, even though they are just as susceptible to the effects of climate change, which are already being felt.
What climate risks do businesses face?
In 2017, the G20 Financial Stability Board decided to set up a Climate Expert Group (Task Force on Climate Disclosure, TCFD) to measure the risks of climate change on companies and the economy. The TCFD identified two main types of risks,[5] first physical risks such as cyclones, floods or heat waves. The second category, transition risks, refer to the risks associated with a transition from our current economy to a low–carbon economy. These are for example regulatory risks, through the introduction of a carbon tax, or market risks, with consumers favoring “green“ products.
While transition risks weigh more heavily on the most CO2–emitting companies, physical risks can affect a much wider range of activities. In fact, these will mainly depend on the geographical locations of the companies. Some countries, especially developing countries, are already and will be more affected by the effects of climate change. The more industrialized countries will not be exempt, with levels of risk that can vary within a single state. The floods this summer in Belgium and Germany reminded us that companies located near rivers are already largely exposed.[6]
Service companies or industries, physical climate risks will affect all companies, regardless of sector or contribution to climate change.
Climate risks in the value chain
Beyond these immediate effects related to climate disruption, there are also indirect risks that weigh on most companies, through their value chain. The floods in Belgium and Germany not only affected the flooded companies, but also all companies, especially French ones, whose supply usually passes through the Rhine. Between July 13 and 23, some petrol stations in the Haut–Rhin observed fuel shortages, the high level of the river preventing the passage of supply barges.[7] If companies have indeed been able to find alternatives, delivery times and costs have significantly increased. And this is not the first time this has happened. But in recent years, it was rather droughts (!) – whose frequency increases with climate change – that had lowered the level of the Rhine, with the same effects on the fuel supply.
These phenomena are more worrying than ever since today 70% of international trade depends on globalized value chains,[8] and some suppliers, by sector, tend to concentrate on limited geographical areas.[9] The slightest climate disruption on a transit route or in a finally extremely localized area can cause considerable disruption to all companies downstream of the value chain.
The last few weeks have again witnessed the vulnerability of these value chains: while its order book was full, car manufacturer Renault had to face a shortage of electronic components that led it to close around 50% of its factories in France.[10] If the causes of this shortage are not climate-related a priori, they give an idea of the potential consequences of climate disruption in the years to come.
The CDP (Carbon Disclosure Project) has already estimated the cost of the effects of climate change on value chains for the next five years at 120 billion euros. 120 billion euros that will necessarily be passed on to the final buyers.
How to adapt?
The first question for companies is to know what types of risks (physical and transition) they are exposed to.
The analysis of direct physical risks is the simplest, since it depends mainly on one criterion: geographical location. Adapting to physical risk will therefore consist of making its infrastructure more resilient to climate risk or locating in less exposed geographical areas. Having several operating centers with different locations can also allow one to take over from another in case of a problem.
For physical risks that weigh on the value chain, the analysis is more complex. It consists first of all of knowing the different links of this value chain, their location, as well as the transit routes. Adapting can consist in identifying alternative suppliers, diversifying suppliers according to their location, or studying the adaptation strategies of its suppliers – when the information is available.
As for transition risks, which mainly affect the most emitting companies, adaptation will mainly involve reducing their CO2 emissions and/or developing “green” product and service offerings.
The growing interest of investors in adaptation
Although for the moment, regulations focus more on the role of companies in mitigating climate change rather than adapting to it, there is a growing interest in measuring climate risks. French investors are also subject to an obligation on the subject, and as a result, are actively interested in the risks to which the companies in which they invest are exposed, and the measures they are taking to avoid or adapt to these risks.
Fortunately for companies, reporting frameworks such as the TCFD and resources on climate risks such as the World Risk Index are beginning to become generalized, allowing them to become familiar with the exercise before more restrictive regulations come into force.
[2] Paris Agreement, Article 2
[5] Recommendations of the Task Force on Climate-related Financial Disclosure
[7] Haut-Rhin: pourquoi certaines stations-service ont subi des pénuries d’essence mi-juillet
[8] Des puces électroniques au plastique: les raisons d’une pénurie mondiale
[9] Quelle stratégie de résilience dans la mondialisation ?
[10] Renault shuts down factories in France
