Climate risk for companies: How to adapt?

Mitigation and adaptation: two complementary strategies in the fight against climate change.

November was marked by the 26th Conference on Climate Change (COP26) in Glasgow. The four main stated objectives are mitigation, adaptation, mobilization of finance, and collaboration among stakeholders.[1] While the latter two objectives are self-explanatory, the first two may require some clarification. Climate change mitigation involves reducing global greenhouse gas emissions, ideally in accordance with the Paris Agreement, to ensure they do not exceed the 2°C threshold.[2] However, the organizers of the upcoming COP emphasize that “the climate is already changing and will continue to change even if we reduce emissions, with devastating effects.”[3] Therefore, adaptation to these effects is an essential pillar.

Emphasis on the role of businesses in mitigation rather than adaptation.

To date, companies are primarily seen as key players in mitigating climate change. Indeed, businesses implementing actions to reduce their emissions, especially in sectors like energy, transportation, and industry – which account for over 75% of global emissions[4] – can have a significant impact. Regulations generally lean in this direction, requiring companies to measure their emissions and sometimes even set reduction targets.

The role of companies in adapting to climate change is less publicized and regulated, despite the fact that they are equally susceptible to the effects of climate change, which are already being felt.

What climate risks do businesses face?

In 2017, the Financial Stability Board of the G20 established an expert group on climate (Task Force on Climate Disclosure, TCFD) to assess the risks of climate change facing businesses and the economy. The TCFD identified two main types of risks: firstly, physical risks such as hurricanes, floods, and heatwaves. The second category, transition risks, refers to the risks associated with a shift from our current economy to a low-carbon economy. These include regulatory risks, such as the introduction of a carbon tax, and market risks, as consumers increasingly prefer “green” products.

While transition risks weigh more heavily on the highest CO2-emitting companies, physical risks can affect a much wider range of activities. Indeed, these risks will primarily depend on the geographical locations of companies. Some countries, especially developing countries, are already and will be more affected by the effects of climate change. More industrialized countries will not be exempt, with varying levels of risk even within the same state. The floods this summer in Belgium and Germany reminded us that companies located near rivers are already heavily exposed.

Whether service companies or industries, the physical risks associated with climate change will affect all businesses, regardless of sector or contribution to climate change.

The climate risks associated with the value chain

Beyond these immediate effects related to climate disruption, there are also indirect risks that weigh on most businesses through their value chains. The floods in Belgium and Germany not only affected the flooded companies, but also all companies, including those in France, whose supply usually passes through the Rhine. Between July 13 and 23, some gas stations in Haut-Rhin experienced fuel shortages, as the high water level of the river prevented the passage of supply barges. While companies were able to find alternatives, delivery times and costs significantly increased. This is not the first time such a situation has occurred. In recent years, it was rather droughts (!) – whose frequency is increasing with climate change – that had lowered the level of the Rhine, with the same effects on fuel supply.

These phenomena are even more concerning today, as 70% of international trade depends on globalized value chains, and certain suppliers, by industry sector, tend to concentrate in limited geographical areas. The slightest climate disruption on a transit route or in a ultimately extremely localized area can cause considerable disruptions for all downstream businesses in the value chain.

The past few weeks have once again demonstrated the vulnerability of these value chains: while its order book was full, the automaker Renault faced a shortage of electronic components, leading it to close about 50% of its factories in France. While the causes of this shortage are not apparently climate-related, they foreshadow the potential consequences of climate disruption in the years to come.

The CDP (Carbon Disclosure Project) has already estimated the cost of the effects of climate change on value chains at €120 billion for the next five years. €120 billion that will necessarily be passed on to final buyers.

How to adapt ?

The first question for businesses to address is to determine which types of risks (physical and transition) they are exposed to.

Analyzing direct physical risks is the simplest, as it primarily depends on one criterion: geographical location. Adapting to physical risk will therefore involve making infrastructure more resilient to climate risks or establishing operations in geographic areas less exposed to consequences. Having multiple operational centers with different locations can also allow one to take over in case of a problem.

For the physical risks that weigh on the value chain, the analysis is more complex. It involves first knowing the different links in this value chain, their location, as well as the transit routes. Adapting may involve identifying alternative suppliers, diversifying suppliers based on their location, or studying the adaptation strategies of suppliers – when that information is available.

As for transition risks, which primarily affect the highest emitting companies, adaptation will primarily involve reducing their CO2 emissions and/or developing offerings of “green” products and services.

The growing interest of investors in adaptation

While regulations currently focus more on the role of companies in mitigating climate change rather than adaptation, there is a growing interest in assessing climate risks. French investors are, in fact, subject to an obligation in this regard, and as a result, they are actively interested in the risks to which the companies they invest in are exposed and the measures these companies put in place to prevent or adapt to these risks.

Fortunately for companies, reporting frameworks such as the TCFD and climate risk resources like the World Risk Index are starting to become more widespread, allowing them to become familiar with the process before more restrictive regulations are put in place.

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