What is climate risk, and how can companies manage it?

As the consequences of climate change are increasingly evident, climate risk management has emerged as a critical component of long-term business viability. According to the 2023 IPCC Climate Report, developing countries will require up to $127 billion annually by 2030 to adapt to accelerating climate effects, but funding remains woefully inadequate.

For businesses, the stakes are even higher: climate disruption to global supply chains could lead to a staggering $25 trillion in net economic losses by 2060 if global temperatures rise by up to 7 degrees Celsius.

Developing effective strategies to address climate risks is a regulatory necessity and a competitive advantage. This article explores climate risk, provides examples of its potential impacts, and outlines methods for companies to assess and mitigate these risks for long-term resilience. 

What is climate risk?

Climate risk refers to the potential financial and operational disruption a company may face due to climate change. These risks can be broadly divided into two categories: physical risks and transition risks. 

• Physical risks arise from direct climate impacts, such as extreme weather events (e.g., hurricanes, floods, droughts) that can damage infrastructure, disrupt supply chains, and affect business continuity.
• Transition risks stem from the global shift toward a low-carbon economy, which includes changes in regulations, market dynamics, and technological advancements that may challenge current business models. 

Understanding these risks is essential for companies to ensure long-term business resilience. Physical hazards, such as floods, may cause immediate operational disruptions, while transition risks, such as regulations around carbon pricing, may lead to increased costs over time.

For instance, a manufacturing company operating in a flood-prone region may be particularly vulnerable to physical risks. In contrast, a consumer goods company might need to adapt to changing market preferences for sustainable products.

Examples of climate risks for businesses

Climate risks impact industries differently, depending on their operations, locations, and sector-specific vulnerabilities. 

Here are some examples of physical and transition risks:

Physical risks:

• Acute risks like hurricanes, floods, and wildfires can cause sudden damage to infrastructure. For instance, a large industrial equipment manufacturer may face operational shutdowns due to hurricanes impacting its coastal facilities. 
• Chronic risks, such as rising sea levels and temperature changes, present long-term threats. In agriculture, prolonged droughts and altered precipitation patterns have reduced crop yields, disrupted supply chains, and increased costs.

Transition risks:

• Policy and legal risks, such as carbon pricing and emissions regulations, increase operational expenses. For example, a significant energy company may invest heavily in renewable energy to comply with new policies. 
• Technology risks arise as businesses must transition to low-carbon technologies, such as tech firms re-evaluating data centre cooling systems to handle rising temperatures. 
• Market risks involve shifting consumer preferences towards sustainable products, impacting demand for traditional goods and services. 
• Reputational risks emerge when businesses face negative stakeholder perceptions due to perceived environmental negligence, potentially affecting customer loyalty and investment.

These examples underscore the importance of identifying and understanding how climate risks can uniquely affect each business sector.

Key steps in climate risk assessment

 We have identified four main steps to assess climate risk: 

1. Identifying climate-related risks: Involves evaluating physical and transition risks, such as extreme weather events and regulatory changes.
2. Assessing business impact: Companies must determine how identified risks could affect their financial performance, operations, and supply chains.
3. Conducting scenario analysis: Businesses should evaluate different climate futures using qualitative and quantitative methods to understand potential disruptions under varying climate conditions.
4. Integrating findings into strategy: The results of climate risk assessments should inform business strategy, ensuring that climate risk considerations are embedded in decision-making processes.

For example, a fictional renewable energy company identifies its production facility in Florida as vulnerable to extreme weather like hurricanes. After assessing the potential business impact and running a scenario analysis, the company recognises the risk of major financial losses due to operational disruptions. In response, they integrate their findings into the company’s strategy by diversifying production to safer regions and investing in more resilient infrastructure. This proactive approach can ensure business continuity while addressing long-term climate risks.

By following these steps, companies can comprehensively understand how climate change might impact their operations and develop strategies to mitigate potential risks.

Tools and technologies for climate risk assessment

Technological advancements have made climate risk assessments more precise and actionable. Companies can leverage several tools and platforms to understand better and manage their climate risks:

• Climate models: These models provide projections of future climate conditions under various emission scenarios, helping businesses anticipate and plan for potential impacts on their operations.
• Risk assessment software: Many companies now use software solutions that integrate climate data with operational and financial metrics, allowing for detailed risk evaluations. Plan A offers a solution in this space, empowering businesses to assess their climate risks and take decisive action toward sustainability through robust carbon management and ESG tools.
• Data analytics platforms: Advanced data analytics platforms, such as Tableau, may be used to track climate trends, identify vulnerabilities, and optimise responses to emerging risks.

Such tools provide companies with valuable insights into their exposure to climate risks, enabling them to make informed decisions and enhance resilience.

The link between carbon management and climate risk

Effective carbon management reduces a company’s exposure to climate risks. By adopting robust carbon reduction strategies, businesses can minimise regulatory and operational risks while aligning with global sustainability goals.

Carbon management strategies

Popular carbon management strategies include improving energy efficiency, adopting renewable energy sources, and compensating emissions that cannot be further reduced. Prioritising direct emission reductions is crucial, with offsetting as a supplementary measure. 

Companies that have successfully implemented these strategies demonstrate the benefits of carbon management. For example, National Grid, a primary energy provider, developed a comprehensive emissions inventory to understand and manage its climate risks better. These efforts have resulted in significant reductions in National Grid's carbon emissions, such as a 68% reduction from 1990 levels, to reach net-zero by 2050. Key strategies include improving energy efficiency, electrifying their vehicle fleet, and integrating carbon considerations into construction and procurement decisions.

Best practices for climate risk mitigation

Mitigating climate risk involves embedding risk considerations into a company’s overall business strategy and proactively reducing exposure. 

Integrating climate risk into business strategy

Companies can adopt several best practices to manage and mitigate climate risks:

1. Conduct regular climate risk assessments: Identifying potential risks allows companies to stay ahead of emerging challenges.
2. Set science-based targets: Aligning emission reduction goals with scientific benchmarks ensures companies contribute meaningfully to global climate efforts.
3. Invest in climate-resilient infrastructure: Companies can enhance their resilience by upgrading facilities and adopting technologies that withstand climate impacts.‍
4. Engage stakeholders: Collaborating with suppliers, customers, and investors on climate initiatives fosters a culture of sustainability and collective action.

What is the cost of not mitigating climate risks?

Failing to address climate risks can have severe financial, operational, and reputational consequences. 

Financial implications

Companies that neglect climate risk management face higher operational costs due to infrastructure damage, supply chain disruptions, and rising insurance premiums. Asset impairments from extreme weather can significantly reduce profitability, while failure to meet regulatory requirements may result in penalties or loss of investor confidence.

For example, a global retail giant experienced significant revenue losses when extreme weather events impacted critical facilities. Additionally, companies in the energy sector that are slow to transition to renewable energy face escalating costs from carbon pricing regulations, eroding profitability. 

Reputational and regulatory risks

Companies not addressing climate risks may suffer reputational damage as stakeholders, including customers and investors, increasingly demand transparency and climate action. Failure to respond can lead to negative perceptions, lost market share, and reduced brand loyalty.

Another risk is regulatory penalties. Governments are implementing stricter climate regulations, and companies may face fines for non-compliance. Investor expectations are also growing, as many now integrate climate considerations into their investment decisions, adding further pressure for robust climate risk management.

Climate risk management is no longer optional for businesses. As the frequency and severity of climate-related disruptions increase, companies must take proactive steps to understand, assess, and mitigate their exposure to climate risks.

By integrating climate risk considerations into their business strategies and leveraging tools like carbon management software, companies can enhance their resilience, safeguard their financial performance, and build trust with stakeholders.

In the pursuit of sustainability, companies that effectively manage climate risks will reduce their vulnerability to climate impacts and position themselves as leaders in transitioning to a low-carbon economy.

Manage climate risk with Plan A. Schedule a call to discover our solutions.