Climate futures: assessing risks and scenario analysis

Authored by Michaela Aspell

Climate risk assessment and climate scenario analysis are essential tools for organisations seeking to understand their exposure and resilience to climate change risks. These assessments—along with the evaluation of greenhouse gas (GHG) emissions—also form the foundation for climate-related disclosures required by organisations subject to Australia’s mandatory sustainability reporting regime and the Australian Accounting Standards Board Climate-related Disclosures (AASB S2) standard.

Climate change implications on organisations

The average global temperature has risen by more than 1.2°C above pre-industrial levels which is driving significant changes in the climate, including extreme weather events such as flooding and extreme heat days, as well as longer-term changes like rising average temperatures and sea level rise. In response, the push to reduce emissions and the shift towards a lower-carbon economy are resulting in changes in the business operating environment in Australia from shifts in technology, regulation, market preferences and reputational challenges.  

Failure to address these physical and socioeconomic changes can pose significant financial and non-financial risks for organisations.  Proactively understanding the extent of these risks and effectively assessing, monitoring, and measuring them is crucial for increasing resilience to climate change as well as capitalising on potential climate-related opportunities.

Using climate scenarios to explore risks and resilience

Scenario analysis has been used as a strategic business tool for over 50 years, particularly in the financial and energy sectors, and is now being used to help organisations assess how different climate futures (different levels of global warming) might impact their operations, assets and markets. By looking at different potential but plausible futures with different degrees of climate mitigation and climate adaptation, organisations can determine risks and opportunities under different scenarios and inform stakeholders about the resilience of the organisation.

A climate scenario analysis starts with the selection of scenarios and pathways that will be used for the assessment – under the mandatory Australian sustainability reporting regime this includes scenarios with lower warming (1.5°C) and higher warming (at least 2.5°C). The next step is to select the source(s) of information for the scenarios, and then interpret that information for the business.  

The process of undertaking climate scenario analysis usually starts as a qualitative exercise for organisations. These qualitative narratives can concentrate on areas that are likely to have a material impact on the organisation (i.e., sea level rise for coastal assets, energy grid decarbonisation projections for high consumers of electricity etc.). Owl Advisory has received client feedback that the climate narratives are a useful tool for engaging internal stakeholders in having a conversation about the impacts of climate change and can often help to focus efforts to make quantitative impact assessments.  

Assessing climate risks and opportunities

The assessment of climate risks involves evaluating an organisation’s exposure and vulnerability to climate-related hazards and transition drivers.  

• Climate risks and opportunities should be assessed across multiple time horizons to account for the different time scales at which climate impacts may materialise. These timeframes should be aligned with business decision-making and asset lifetimes while also acknowledging that climate impacts are projected to escalate over the century.

• Risks that are less controllable by the organisation often have greater consequences; for example, clients frequently identify more significant risks within their supply chains rather than in their physical assets. In this case, building resilience is key (i.e., adding additional ‘critical’ suppliers).

• Organisations should concentrate on how climate change may specifically affect them, rather than simply listing the hazards they are exposed to, making a distinction between a general increase in flooding (a hazard) and the increased potential for flood damage to a percentage of their assets.

• Don’t forget opportunities – these might arise from actions to reduce GHG emissions or mitigate risks (i.e., reduced electricity costs from installing solar panels) or from new markets, technologies or geographies from climate change (i.e., changing crop suitability). 

How to get started?

Begin by understanding how climate change has historically affected your organisation, before moving to identify key potential areas of exposure to climate hazards and transition drivers. Setting up working groups to involve key stakeholders as well as clear internal frameworks will support both the assessment of climate-related risks and opportunities and integration of these into overall risk management.

Reach out to Owl Advisory by KWM General Manager Himashi Cameron or Director (and KWM Partner) Tim Bednall to discuss how we can support your organisation with climate-related reporting.

This publication is a joint publication from King & Wood Mallesons, and KWM Compliance Pty Ltd (ACN 672 547 027) trading as Owl Advisory by KWM.   KWM Compliance Pty Ltd is a company wholly owned by the King & Wood Mallesons Australian partnership.  KWM Compliance Pty Ltd provides non-legal compliance and governance risk advisory services for businesses.  KWM Compliance Pty Ltd is not an incorporated legal practice and does not provide legal services. Laws concerning the provision of legal services do not apply to KWM Compliance Pty Ltd.