Factoring climate risk into infrastructure investment

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Picture of a massive wave by Petra Bensted | Flickr Picture of a massive wave by Petra Bensted |Flickr

Extreme weather events swept the globe in 2017 and 2018—from drought in India and record rains in Japan to hurricanes in the United States and typhoons in the Philippines. These events are yet more proof of what the human and economic costs of a changing climate will be.

Businesses have taken note, which is good news for CDP where we aim to make environmental reporting and risk management a business norm. Our newest report covers just shy of seven thousand companies that reported data to CDP in 2018, including a sample based on the 500 biggest global companies by market cap.  

With growing regulations to limit carbon pollution and rapid shifts towards low carbon technologies, it’s perhaps unsurprising that 53 percent of companies responding reported climate risks that could have significant financial or strategic impacts.

We’re pleased to report that investors are increasingly waking up to these risks too and in 2018, for the first time, CDP asked companies to provide potential financial impact figures to identified substantive climate-related risks. This is an important gap in environmental disclosure, and a key consideration for internal and external stakeholders when it comes to decision investment decision making. 

So, what lessons can we learn from this for infrastructure investment? 

We need to better understand the potential physical risks of climate change

Most companies reporting through CDP are identifying risks, with nearly two thousand reporting both physical and transitional risks. While a positive trend in general, we saw almost double the number of transitional risks reported than physical risks—showing the physical side of climate change is still underestimated.

The latest science shows that such risks will only increase in the coming years and companies need to be ready—for both immediate and long-term threats to their business.

Take for example Pacific Gas and Electric Company. California’s largest utility was at the center of the first “climate change bankruptcy” case this year after it was overwhelmed by rapid climatic changes that led to devastating wildfires in 2017 and 2018.

In 2018, the company reported some $2.5 billion in potential physical risks related to forest fires. This was a significant underestimation, considering they later estimated $30 billion in liabilities when filing for bankruptcy in January 2019.

By underestimating or underreporting potential risks, companies are not only leaving existing infrastructure vulnerable but are missing a crucial piece of the puzzle for future investments and facing costly retrospective measures. 

Transition planning has too narrow a focus

When it comes to transition risks, we’re also seeing gaps in  awareness and acceptance of climate-related threats. Some 39 percent of companies (2,737) in our survey report at least one potential transition risk.

Yet, these risks tend to be focused on policy and legal changes—such as increased pricing of greenhouse gas emissions, and increased regulation—and fail to examine the potential market, reputation, and technology risks facing companies.

Given today’s dynamic market changes, this represents too narrow a focus.

Here, the canary in the coal mine is the power sector. This sector faces the biggest changes as a result of the low-carbon transition, and at the same time is planning across significantly longer timescales than many other sectors. An energy infrastructure project built today will still be around 40–60 years into the future.

Companies who fail to integrate risks early could end up locking-in quickly outdated infrastructure for decades to come and facing a hefty price tag to retrofit projects, retire assets, and build resilience.

Take the German utility company RWE, for example. While the company closely monitored regulatory risks such as increasing carbon prices through the EU Emission Trading System, it was market forces—particularly lower prices for renewable energy driven by Germany’s green energy boom—that reportedly wiped billions off the company’s share price. The same is true for others,

By no means is the power sector alone facing such issues. Others should make no mistake: it will take years to restructure a company in line with the new low-carbon economy.

By now we know for certain that the winners will be those who build long-term environmental risk planning into their investment decisions.

To read the full CDP Climate Change report click here.

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Nicolette Bartlett

Global Director of Climate Change at CDP.

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