Climate Risk

Written for publication in May 2006.

Climate change will be the dominant issue of the 21st Century. There is now consensus within the scientific community that not only is the problem caused by human activities but that it is more serious and more urgent than was first thought. Climate change has already begun but we may not yet have crossed the irreversible thresholds into the realm in which it is dangerous to our security and prosperity.

A changing climate is uniquely a problem that affects every single person on the planet. Far too many of the world’s six and half billion people lead lives disfigured by sickness, ignorance and poverty, but there are also many of us who lead lives of healthy, educated affluence; armed conflict renders life desperate for many millions of people, but there are also millions who lead lives of peaceful fulfilment. A changing climate exposes individuals, communities and societies to new and unfamiliar patterns of risk.

It also presents new risks and opportunities to the business community. The prospects of every single business on earth, from the smallest and most local to the gigantic and most global, will be impacted as the climate changes. Few businesses have yet given much thought to how they will be affected. Even fewer are well equipped with the skills and internal processes to devise strategies to manage the risks or take advantage of the opportunities.

Corporate responses to date, such as they are, have mostly taken the form of measuring their emissions and setting, often rather soft, targets for their reduction. This is a useful expression of good intentions, but it will not do as a sensible response to the emerging pattern of climate risk. These risks will affect costs, markets and shareholder value and will have two dimensions; those arising from the changing climate itself and those arising from the policy response to climate change.

The direct risks arising from climate change – rising sea level, more extreme weather events, alterations to rainfall patterns – will affect operational costs for many businesses as they adapt sites and processes to mitigate them. The insurance industry, the sector that has thought more deeply and for longer than any other about climate change, recognises that climate risks have the potential to make insurance costs too high for many businesses to bear. This not only increases costs and risks for affected businesses, it also shrinks the insurance market.

A changing climate will also affect the structure of many other markets. Consumer preferences will change as consequences of climate change become more evident. There will be growing pressure for more climate compatible goods ands services and parallel declines in demand for those that are perceived to be contributing to the problem. As coral reefs bleach and glaciers melt the businesses dependent on their existence will also disappear.

As costs and markets change in response to the changing climate it will become more difficult to assess the value of businesses whose future cash flow becomes less predictable. This will be particularly important for those businesses with long investment horizons. These are just some of the possible consequences of the direct impacts of a changing climate. They will be compounded by the responses governments make to prevent or adapt to a changing climate.

Responses so far by government to this challenge can best be described as tentative. Even the Kyoto Protocol, for all the controversy it has generated, will make only a small and very slow reduction in the threat. As the science becomes more certain and the effects of a warming climate become more apparent governments will act more aggressively. The longer they take to do so, the more abrupt, and costly, the policy measures they will deploy.

For a great many companies this combination of direct and policy risk will have a material impact on the value of their business. Yet there is no agreed methodology for assessing these risks. Indeed, there are not even the comprehensive risk registers or agreed definitions of key terms which would be essential to developing such a methodology. Without such a methodology, it is not possible either for companies to make credible statements about their climate risk or for investors to make confident comparisons of how those risks are being managed.

About tomburke

Tom Burke is the Chairman of E3G, Third Generation Environmentalism, and an Environmental Policy Adviser (part time) to Rio Tinto plc. He is a Visiting Professor at both Imperial and University Colleges, London. He is a member of the External Review Committee of Shell and the Sustainable Sourcing Advisory Board of Unilever and a Trustee of the Black-E Community Arts Project, Liverpool.
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