Predicting Future Climate Risk for Better Supply Chain Management

The impacts of climate change are changing the natural world as we know it. Businesses and governments are coming under increasing pressure from consumers to prioritize sustainable development and minimize climate risk.

To understand why so many people want action, you need only look at the pessimistic climate models from the Intergovernmental Panel on Climate Change (IPCC) and the United Nations in recent years. They’re very clear that we must change our way of life fast before an expected point of no return in 2050.

Climate risk also introduces uncertainty into company business models. However, much of this risk can be offset by investing now in the technology of the future. Proactively managing climate risk presents competitive opportunities and ESG benefits that will help to future-proof your business, supply chain, and profitability.

In this article, we consider:

• Strategies businesses and organizations can use to manage climate risk and reduce climate impact
• The top business concerns about climate change today
• A selection of the industries most likely to be affected
• How to position your business to respond to the risks and opportunities of going for net-zero.

Strategies to Manage Climate Risk and Reduce Climate Impact

Decision-makers should manage climate change risk with scenario planning, stress testing, and by internally prioritizing climate change.

Scenario Planning

Scenario planning involves forecasting what physical climate risk vectors your business may be exposed to.

In a scenario planning exercise, you predict what events may occur in the future and how you respond to them. By understanding how climate change might affect your supply chain, you have a chance to plan against disruptions.

Here are four ways you might use scenario planning in your business:

• Look for new opportunities: An example might be a farmer changing crops to take advantage of changes in precipitation. Or a food manufacturer may wish to consider moving to a new production location if the local water table is diminishing. 
• Plan for the unexpected: With global warming comes changes to weather patterns. Think ahead about how your business would be affected by natural disasters and other unexpected situations. Identify the risks and create contingency plans of action.
• Build in greater operational and financial resilience: An online retailer might want to derisk against supply chain disruptions by working with partners in parts of the world less exposed to climate-related risks. Or an insurance company could plan multi-year adjustments to its actuarial formulas to reflect growing climate risks. ‍
• Get stakeholders involved: For example, a university could consult with its students and staff to improve campus sustainability and lower its greenhouse gas emissions. 

Stress Testing

Stress testing helps decision-makers understand how resilient they are to risks like climate-related government policy changes and exposure to regular extreme weather events.

The purpose of stress testing is to identify potential vulnerabilities your organization faces and subsequent areas for improvement. You can develop contingency plans for different climate hazards and improve overall business preparedness and resilience. You also have the opportunity to communicate with stakeholders on climate risk management issues.

The three steps in stress testing are:

1. Scenario development: If a company operates a facility in a vulnerable area, this may put its physical capital at risk of being affected by intensifying climate hazards like floods, droughts, unpredictable variability in weather patterns, and heat waves. The point of this exercise may be to decide when further support for the facility becomes unviable.
2. Impact assessment: The impacts of physical climate risk are increased costs, supply chain disruption, reduced productivity, and workers at greater risk of poor health. In light of such events, the company may come under regulatory scrutiny or shareholder/stakeholder pressure to improve sustainability, reduce pollution, and support the workforce.
3. Resilience evaluation: This involves a business examining how well it would respond to climate-change-related events with regard to its general operational resilience and continuity. It would examine what investment was needed to mitigate against disruption, reduce environmental impacts, and protect its workers. Investment in greener production and distribution is also part of good ESG and demonstrates to stakeholders and clients the company’s credentials as a good corporate citizen.

Prioritizing Climate Change in Decision-Making

Traditionally, externalities like climate change weren’t factors in company decision-making. An externality is a cost or benefit that is a side effect of your business’s activities. For example, pollution caused by a factory is an externality because it impacts the health and well-being of the people who live around it but costs the factory nothing.

Sustainable businesses that prioritize decarbonization and other climate goals do consider themselves responsible for externalities. They seek to reflect the cost of externalities on their balance sheets and in their decision-making.

One leading example of a company prioritizing climate change in decision-making is Microsoft. They have committed to becoming carbon negative by 2030 and, by 2050, to have offset all carbon it has been responsible for going back to its founding in 1975.

Here are examples of how Microsoft is doing this:

• Internal carbon tax fee: Company divisions are charged carbon fees for the emissions they generate to encourage departments to reduce their environmental impact and seek out lower-carbon technologies.
• Greenhouse gas targets: The company has set targets to reduce greenhouse gas emissions across its operations and in its supply chain in accordance with the Paris Agreement.
• Lobbying activities: Microsoft was one of the first members of the Climate Leadership Council, which actively lobbies politicians to introduce a revenue-neutral carbon tax.
• Grant-giving programs: The company is allowing its tech to be used by organizations to reduce their carbon footprint. Their AI for Earth program offers grants and resources to environmental groups.

Top business concerns relating to climate risk

Business leaders and politicians understand the effects of climate change and the need to move to a low-carbon economy. However, this will not be an easy change to achieve, and there will be many challenges in getting there.

The key concerns are:

• Climate change impacts: Rising sea levels, unpredictable weather events, and extreme heat and precipitation patterns lead to population displacement, supply chain disruptions, and infrastructural damage.
• Lost labor and sunk costs: Transitioning to a low-carbon economy, although necessary, will have major impacts on land use patterns, transportation infrastructure, and energy systems. Although there will be new job opportunities created by green energy, many may lose their livelihoods. Likewise, carbon-intensive assets may have to be retired earlier, denying the opportunity of a full return on investment. Other assets may have to be abandoned because of changes in local ecosystems.
• Social risks: Food insecurity and a rise in inequality and poverty will affect developing nations disproportionately. This may happen at the same time when continued investment in a developing nation becomes more difficult to justify commercially as trading conditions become harder because of climate change.

The rewards for policymakers and businesses in getting to a sustainable future and climate resilience are significant. The challenge will be building resilience and fairness into that future.

The Industries Most Affected by Climate Change

All sectors will be affected but those at greater risk of changing climate patterns include:

• Agriculture: Changing precipitation patterns, rising temperatures, extreme weather, and other threats are already being felt in livestock and arable agriculture. This is causing food shortages and price increases and threatens food security in many countries.
• Insurance: More floods, hurricanes, and wildfires increase financial risks for insurers and push up premiums for clients. Some areas may eventually present such a risk that insurers will not provide cover to businesses exacerbating economic impacts further.
• Energy: Demand for fossil fuels is declining, and this has already led to major job losses and economic depressions in areas reliant on its production. Although green energy opportunities do exist, shifting too quickly away from fossil fuels may lead to power shortages.
• Tourism: There have been many reports over the last decade of no snow in traditional ski resorts during peak seasons. In hotter climates, heat waves present risks to tourists and workers. Areas dependent on tourism may suffer disproportionately.
• Construction: Extreme temperatures that construction materials were not designed to withstand may cause many buildings to become unsafe. They may also lead to increased demand for HVAC systems, which in turn increases the demand for electricity. Construction projects may be more prone to disruption due to extreme weather events. 
• Real estate: A small sea level rise will put much of the world’s population at risk of having to move further inland. Developers wishing to build near the coast may face additional expenses in building flood defenses. It will become harder for developers to borrow from financial institutions. Also, as we’ve seen in California and Australia, there is a significant risk to property from forest fires.

5 Ways to Proactively Respond to the Challenges of Climate Change 

Managing climate change means identifying, evaluating, and mitigating the effect of rising temperatures on your human, physical, and natural capital. The same is true for the companies in your supply chain.

Five ways to achieve this are to:

1. Involve your stakeholders: Building in the opinions of customers, investors, and regulators will increase general support for your climate change actions from the outset. This will be important if some of your proposed changes will temporarily affect profitability in the coming years. This approach offers reputational benefits and allows you to more easily respond to future regulatory changes.
2. Consider infrastructure location: If you or your suppliers’ assets are at physical risk from climate change, this may greatly impact the smooth operation of your business. When carrying out your enhanced due diligence on a supplier and in ongoing risk assessments, you could examine both past weather patterns and future predictions to see how vulnerable their current locations are.
3. Add resilience to your supply chain: Diversify partners or introduce redundancy so that, in the event of a disruption in one place, the shortfall can be picked up by another. Aim for supply chain diversity.
4. Aim for eco-friendly products and services: Develop or adapt your products and services to that they have a lower carbon footprint. This will reduce your environmental impacts and provide a level of protection against potential climate change regulations. Consider working with suppliers who share this approach for added protection.
5. Reduce your carbon footprint: Look for ways to reduce environmental impacts by sourcing power from renewable energy suppliers. There will also be opportunities to make production processes and the locations you operate from in general more energy efficient too.