Scenario analysis should inform risk assessment, strategy development and investment decisions – and feed into internal remuneration and incentives.
However, the research found only 15% of the sample feature climate change in their financial statements, suggesting that organizations lack robust data on the financial impact of scenarios or have not yet fully worked through the implications of these impacts across the business.
In the future, regulators and capital markets will be unlikely to accept that companies have performed an accurate risk or opportunity assessment without carrying out a robust level of scenario analysis.
To satisfy their stakeholders, organizations should be able to articulate the relative size and time frame around physical and transition risks in their geography and industry, ideally constructing worst case, base case and most likely case scenarios.
Understanding the biggest emission-reduction levers up and down the value chain
Understanding climate risks and opportunities goes beyond an organization’s own footprint and can involve more complex data management, analysis and forecasting. For most organizations, the emissions from up and down the value chain (Scope 3) are much higher than those from their own operations (Scope 1 and Scope 2). The biggest levers are likely to come either from downstream manufacturing or transport, or the upstream processing, use or transport of products.
This is not just an issue in emission-intensive industries such as iron ore mining, where significant Scope 3 emissions come from a customer turning the product into steel. The global apparel and footwear sector produces more greenhouse gas emissions than the shipping and aviation sectors combined3 – the vast majority through Scope 3 emissions.
As a result, the most powerful emission-reduction levers are rarely intuitive. A major pharmacy brand discovered that 80% of its emissions were associated with the amount of time consumers used its products in the shower. Often, non-meat food production emissions derive largely from transport. For the Information and Communication Technology (ICT) sector, a major plank of its decarbonization strategy is likely to be encouraging carbon consciousness among end users.
Not surprisingly, stakeholder scrutiny around value chain emissions is growing, especially in carbon-intensive and consumer-facing industries. Science-based target guidance states that “if a company’s Scope 3 emissions account for at least 40% of total Scope 1, 2 and 3 emissions, a Scope 3 target should be set.”4
The challenge is that, when it comes to carbon, most organizations currently have opaque supply chains. It is incumbent on organizations to work with their suppliers and offer incentives to make them part of the decarbonization process. Just as organizations are examining their supply chains for human rights violations, they should be putting equal energy into analyzing and reducing supply chain emissions.
Next steps for climate-related reporting
At a time when political will and global public opinion are focused on profound climate action, climate risks and opportunities should be front and center as organizations plan their future growth strategies.
Some organizations are reluctant to act on climate change due to the many uncertainties around the nature and timing of transition risk, as well as its physical impacts. However, organizations frequently make calls on the likely future of emerging technologies without knowing their exact time horizons.
As the science on climate change has become more detailed than ever – and resoundingly clear – the requirement for immediate action has emerged. Organizations that fail to act as the net-zero transition gathers pace may be exposed to climate-related risks and underprepared for the associated climate-related opportunities.
As organizations consider their next steps toward climate adaptation, organizations should be able to answer the following questions:
- What is the extent of the risks and opportunities my organization is facing as a result of climate change?
- How should my organizational strategy change to respond to the identified risks and opportunities from climate change? And what strategic initiatives will be required?
- What should I do to execute on my decarbonization journey?
- How do I communicate with the market on the extent of my risks and opportunities, the proposed changes to my strategy and the progress on my decarbonization journey?
Summary
Scope 1 and 2 emissions are unlikely to be the only – or even the greatest – source of climate risk factors, especially because they have no bearing on exposure to physical climate risk. Organizations should look up and down their entire value chain to identify vulnerabilities and opportunities for growth, and find – and use – their most powerful climate management levers. This will involve understanding the resilience of business strategies and assets under a range of possible climate scenarios.
