The uncertainties regarding the future state of the earth’s climate are vast. With the potential for many different climatic conditions, preparing businesses and the economy for the future poses a great challenge. To tackle this, increasing attention is being given to scenario analysis.
Scenario analysis can provide organisations with a robust and flexible approach in the face of such uncertainty and will help bring to light the various risks and opportunities associated with wide-ranging potential future climate conditions. Scenario analysis cannot predict the future with certainty. However, it can hypothesise likely future conditions dependent on varying future levels of GHG emissions and climatic warming.
THE STEPS OF SCENARIO ANALYSIS
The first, and possibly most challenging step, is to choose your climate scenarios. For example you might choose a 2 degrees warming scenario (in line with the commitments of the Paris Agreement) and perhaps a worst-case scenario such as the predicted levels of climatic warming under a global business as usual (BaU) model.
Once you have selected an appropriate set of scenarios to focus on, analysis will need to be carried out on each. This allows organisations to foresee the potential climate-related risks and opportunities their organisation could be exposed to depending on varying climatic conditions.
There are two distinct analysis types and it is advisable for organisations to consider both when looking at each scenario:
Physical Analysis: to identify the potential and magnitude of physical risk to organisations occurring under different projections. This could be the increased likelihood of acute events like severe weather or flooding, or more chronic shifts in climate that might impact sea-level rise. If organisations have sight of how these risks will affect their organisations, they can work on.
The Intergovernmental Panel on Climate Change (IPCC) uses a physical analysis approach. It identifies that in order to avoid catastrophic physical outcomes of climate change, temperatures increase must be limited to 2oC. To achieve this, carbon dioxide emissions need to be limited to a maximum of 450 ppm by 2100.
Transition Analysis: anticipates the various different legislative updates, market changes, technology developments, and the risks and opportunities to an organisation and its reputation during the transition to a low carbon future. It takes into account different potential policy pathways and their associated impacts on an organisation.
The International Energy Agency (IEA) uses a transition analysis in formulating its reports on World Energy. Its baseline scenario takes into account all current national commitments regarding emissions reductions, and projects future changes based on these.
The final steps will then be to prioritise risks and opportunities for your particular business and formulate a strategy. From undertaking this approach, organisations will then be better equipped to then take action to mitigate the worst outcomes and capitalise from the best.
WHY IS IT IMPORTANT?
Scenario Analysis is a critical part of understanding the implications of climate-related risks and opportunities, which can then be used to direct successful business strategies. Specifically, it:
- Allows organisations to quantify the impact of climate-related risks and opportunities on their business model under future climate projections and determine where they need to focus capital and efforts.
- Gives organisations the opportunity to mitigate future impacts and to develop a strategy to futureproof their business.
- Provides more security or foresight on company ratings. So far 106 companies have had the credit ratings changed due to climate-related factors.
- Gives organisations a competitive edge as investors, customers and other stakeholders start to see climate-related impacts and preparedness as increasingly important. In addition to this, organisations can capitalise on any opportunities identified.
INCREASING USE IN SCHEMES
There is an increasing push by various organisations to encourage the use of climate scenario analysis. The key players include the Task Force on Climate Related Financial Disclosures (TCFD), who include scenario analysis as part of their recommended disclosures. The TCFD aims to increase comparability and the transparency of climate-related financial reports.
Another player is the Science Based Target Initiative (SBTi), which encourages organisations to set targets that have been determined using a scenario which limits warming to below 2oC. This year CDP will also incorporate a number of questions related to scenario analysis in its questionnaires.
Consequently, scenario analysis is now increasingly talked about. It is becoming widely accepted as the required form of analysis to enable businesses to keep up with current developments in climate-related disclosures; to set, and more likely meet, the targets required for the commitments of the Paris Agreement; and ultimately to future-proof their organisations.
If you would like more information on scenario analysis or would like to find out how we can support your organisation carrying out such as analysis, please do contact us.