Ed. note: This is part 2 of a contribution from Mark Trexler, one of our Advisory Board members, is possibly the most meaningful piece on climate risk I have seen. It is practical, concise and gets to the very foundation of why corporate climate management policies are flawed in multiple ways, leaving unrealistic expectations and hidden risks. Part 1 is available here.
In this continuation of the article, explore more commonly held assumptions that are informing corporate and investor climate policies and responses, and why they might they be worth revisiting.
Assumption 4: Business planning and decision-making should focus on the same 2o C and 1.5o C scenarios that are the topic of most international policy discussions.
Auditing the Assumption: Companies should arguably focus on climate matters they’re most likely to encounter in the real world, rather than goals and targets that may or may not come to pass. By many accounts, for example, the world is currently on track for between 3o and 4o C of average global temperature change, not 2o C or less. In addition, human activities are “forcing” climate change at a rate at least an order of magnitude beyond what led to past cycles of climate change. Decision-makers would be prudent to question how exactly to forecast the pace and path of human-induced climate change. It might be, for example, that prevailing climate forecasts turn out to have been premised on an under-estimate of the “sensitivity” of the climate to human forcing.
Assumption 5: Market mechanisms such as carbon offsets will always be available to significantly moderate the cost of business compliance with climate policy.
Auditing the Assumption: Market mechanisms have been a key component of proposed climate change policies domestically and internationally for three decades, so the source of this assumption is easy to understand. But it effectively assumes that governments will never seriously tackle climate change; is that a bet companies want to go all in on today? If governments seriously pursue 2o C or 1.5o C targets the supply of carbon offsets would shrink dramatically. That’s because offsets by definition come from sectors that are not under an emissions cap, or subject to public policies and regulations. As countries get more serious about achieving climate targets and expand regulation, the supply of potential offsets will decline.
Assumption 6: Systemic climate risks are largely outside the ability of companies to influence or manage.
Auditing the Assumption: Systemic climate risks are arguably the “bull in the china shop” of business climate risk, and include drought-driven global food price spikes, political instability, and even future global pandemics.
While companies cannot effectively hedge against systemic risks on their own, the COVID-19 pandemic should make us question what companies might be able to do collectively. While many companies had pandemic response plans in place prior to COVID-19, those plans were overwhelmed by the failure of governments. Given that the cost of effectively preparing for the pandemic might have been as low as $2-3 per capita globally, perhaps the global business community should have banded together to ensure that the world’s governments prioritized the problem and allocated the necessary funds. Enormous business losses might have been avoided. Arguably, climate change systemic risks pose a similar challenge and opportunity for collective action.
Assumption 7: Disclosing climate risk, e.g. through the TCFD scenario planning process, will provide investors and others with objective information needed to help decarbonize the economy.
Auditing the Assumption: It is clearly a good practice for companies to better understand their climate risks and risk management options. What is less clear is whether disclosing climate risk information necessarily serves the interests of the companies themselves, or even of the investors as the intended consumers of that information.
- First, strategic planning and scenario planning is often a proprietary exercise given its competitive implications. Scenario planning specifically for public release could easily turn into a “check off the box” exercise that serves no one’s interests particularly well.
- Second, the assessment of climate risk is far from an objective or standardized exercise. The longer-term the risk assessment, the more comprehensive its coverage of 1st, 2nd, and 3rd order effects of climate change and climate policies, and the more risk-averse its framing, the more material the perception of climate risks is likely to be. By implication the reverse is also true. The first major climate risk assessment in the U.S., carried out by a major coal utility, concluded that climate policy did not pose a material risk to the company. How could that be? Well, it assumed slow and limited climate policy and an infinite supply of carbon offsets at $4/ton. In that context the “no materiality” conclusion is easy to understand, even if it might seem silly today. But even now, climate risk variables can be interpreted in various plausible ways to arrive at very different climate risk conclusions. To make risk disclosures comparable, all companies might need to use the same underlying scenario, but that poses complications of its own.
Wrapping Up
I’ve barely scratched the surface of the ways in which the known unknowns and unknown unknowns of climate change and climate change decision-making could play out in creating business risks and opportunities. In such a complex and rapidly-evolving arena, and whether assessing, disclosing, or managing climate risks, revisiting or even intentionally challenging some of the key assumptions company decision-makers might be bringing to the table will serve the company and its stakeholders well.
