Climate change and the transition to the low carbon economy are creating risks and opportunities for businesses. Investors want to understand these risks and opportunities to inform their investment decisions. This need for greater transparency is illustrated by recommendations made by the Task Force on Climate-related Financial Disclosures under the Financial Stability Board, which continues a drive by the investment community for greater transparency:
- Three out of four investors use climate-related risks and opportunities to underpin financial decisions (CDP Climate Change Report 2016, CEE Edition).
- Some of the biggest index providers in the world, including S&P and STOXX, have created low carbon indices to help investors direct their portfolios towards sustainable companies (CDP Climate Change Report 2016, CEE Edition).
- CDP collects climate performance information annually from listed companies. It recently started also asking questions addressing climate-related risks and opportunities.
- European Union (EU) directive 2014/95 requires larger publicly listed companies to report on non-financial information like environmental and social issues starting in reporting year 2017.
Climate-related risks are related to physical risks and transition risks like policy & legal actions, technology shifts, and changing markets. Companies that thrive will communicate how these risks will affect their direct business operations and supply chain. They will also develop strategies to capitalize on opportunities. Consider the different types of risks and the potential financial impacts and benefits for companies:
- Policy & legal: The Paris Agreement provided the international political signal that the global economy needs to transform towards a low carbon economy. It is likely that policy measures will be implemented to accelerate the transition. Carbon pricing will increase production costs that can be passed along the supply chain, leading to higher prices and eventually changing consumer demand. Energy and emissions-intensive industries must consider the potential impacts of carbon pricing on business revenue. Product policies like the EU Energy Label and the US ENERGY STAR require products to achieve a better environmental performance. Such policies help level the playing field for low carbon products, like energy efficient dishwashers and computers, which can be used by companies to differentiate their performance and products.
- Technology: There is growth potential for low carbon technologies like solar cells, insulation, EVs, low carbon materials, plant-based alternatives for animal-based food products, smart digital solutions, and so on. This could mean risk or opportunity for your product portfolio. Companies active in producing such technologies can differentiate themselves by showing investors this growth potential. They can also start searching for solutions or diversify their product portfolio to mitigate risks and capture opportunities. A car company can diversify its product portfolio by including EVs and energy utilities can diversify their energy mix by introducing renewable energy.
- Markets: The changing energy generating mix and shifting demands for raw materials will mean changes to operating costs throughout a company’s value chain. Circular products and business models will be beneficial and digital solutions will gain market share. Consumer demand for certain products may change depending on the physical environment and/or an awareness of the effects of products on climate change.
Physical risks: Extreme weather events can lead to higher capital costs due to supply chain disruption. Changed precipitation and droughts can affect the cultivation of agricultural products and production of food and beverages. Products that enable companies to adapt to climate change effects could experience an increase in demand. The chemical industry, for example, sells products that help consumers to adapt to a changing climate.
Source: Navigant Consulting, Inc.
Each climate-related risk brings opportunity. Whether opportunities can be materialized depends on awareness of risks and opportunities, the type of business, the ability of the organization to change its governance system, and the moment of acting. It is therefore beneficial to start with assessing and monitoring the risks and opportunities of your company and its product portfolio using accurate metrics. This enables you to anticipate changes and inform investors about your company’s growth potential.
Written by Annemarie Kerkhof of Ecofys