Non-profit CDP (fka the Carbon Disclosure Project) has released its analysis of the responses to its climate change questionnaire for 2018 from two groups of companies—a large group of almost 7,000 respondents and, analyzed separately, a group of 366 respondents that were among the world’s 500 largest companies (by market cap). The analysis focused on the risks and opportunities presented by climate change and, for the first time, the analysis considered companies’ expectations regarding the potential financial impact of climate risk. In the aggregate, the amount reported was eye-popping, if not exactly surprising, and, given that many companies did not respond at all, is undoubtedly an underestimate. Notably, however, the aggregate amount companies attributed to potential climate-related opportunities was even “bigger than the risks.” The significance of the potential financial implications, together with the imminence of these risks, suggest that companies may need to think hard about climate risks and the associated financial implications in crafting their public disclosures.

According to the report, more than half of the companies in the large sample submitting questionnaires identified climate-related risks that could have a significant impact. However, the report noted that most companies had too narrow a focus, looking only at risks that could directly affect their operations, but often not taking into account their customers and supply chains, which, in many parts of the world, had already experienced significant disruption from climate change. Companies identified twice as many “transition risks” as “physical risks.” Transition risks identified were primarily related to policy and legal issues rather than market, reputation or technology risks. Over 2,700 companies (39%) reported at least one transition risk. The four transition risks most commonly reported were:

  • “Policy and legal: Increased pricing of GHG [greenhouse gas] emissions (nearly half the companies—1123 companies);
  • Policy and legal: Mandates on and regulation of existing products and services (792 companies);
  • Policy and legal: Enhanced emissions-reporting obligations (645); and
  • Market: Changing customer behavior (627).”

The most commonly identified physical risks were:

  • “The increased severity of extreme weather risks;
  • Changes to precipitation and weather patterns; and
  • Rising mean temperatures.”

For the larger group of respondents, the analysis showed that the two most commonly identified contributors to financial impact related to climate risk were “increased operating costs (e.g. higher compliance costs, increased insurance premiums), largely linked to GHG emissions pricing” (1739 companies), and “reduced revenue from decreased production capacity due to the physical impacts of climate change,” such as transport difficulties or supply chain interruptions (1359 companies). Increased operating cost such as inadequate water supply for hydroelectric plants or to cool nuclear and fossil fuel plants was identified as a contributor by 773 companies, reduced revenue from decreased demand for goods/services was identified by 656 companies and reduced demand for goods and/or services due to a shift in consumer preferences was identified by 584 companies.

Of the large sample of companies reporting, 51% identified potential opportunities that could have a substantial or strategic impact on their businesses. Over 35% indicated that they were not aware of opportunities, and about 10% identified opportunities but were unable to bring them to fruition. According to the report, most of the new opportunities identified were linked to new products and services “affecting both the customer and direct operational parts of the supply chain. Resource efficiencies and alternative energy sources are the next most frequently identified money savers. Those operating in the apparel; food, beverage & agriculture; manufacturing, services and transportation services sectors all report fewer substantive opportunities than the average, while those in the financial services, fossil fuels and power industries report much higher rates, at nearly 80% of companies.”

In general, companies in the group of 500 largest companies identified “higher rates of risks and opportunities than others, reporting: 1) higher rates of board oversight of climate-related issues; 2) increasing stakeholder scrutiny on climate-related issues; and 3) higher rates of potential reputational risks.” Among the group of 500, 300 companies (out of 366 respondents) identified substantive risks (82%). The top three transition risks identified were the same as reported by the larger group, but the fourth most commonly reported risk for the group of 500 was the reputational risk of “increased stakeholder concern or negative stakeholder feedback.” Respondents identified concerns regarding extreme events, such as droughts, floods, cyclones and hurricanes that had in the past and could in the future damage manufacturing, R&D and distribution facilities of companies and of key suppliers, as well as incremental changes that had the potential to gradually erode performance. Extreme events could halt operations, endanger lives of employees, disrupt supplies, increase costs, delay deliveries and reduce sales. Respondents also described reputational risks that could affect stock prices if major investors, particularly those that consider socially responsible investment as core to their investment strategy, perceive an absence of alignment of company business activities and global efforts to combat climate change. Others described reputational risk arising out of increased scrutiny and campaigns mounted by NGOs and other groups against actions by financial institutions in financing industries that contribute to climate change through their operations and products. Consumer behavior could also change as consumers resist engaging with companies that were perceived as contributors to, or not proactive in attempting to combat, climate change.

The questionnaire for 2018 included for the first time questions regarding the potential financial impact of the risks and opportunities identified, and CDP focused its analysis here on the group of 500 largest companies. Of that group, 215 companies (representing almost $17 trillion in market cap) responded to this question regarding at least a portion of the risks identified, estimating, in the aggregate, almost a trillion dollars at risk from climate-related factors. In terms of likelihood of occurrence, about half of these risks were reported as “likely, very likely or virtually certain,” while most of the remaining risks were reported as “about as likely as not.” The majority of these risks (about $747 billion) were expected to materialize in the short- to medium-term (around five years or less).

The report cites these factors as the four biggest drivers of potential financial impact related to climate risk for the group of 500:

  • “Increased operating costs (due to higher compliance costs, increased insurance premiums etc.) at ~US$179 billion;
  • The write-off of assets or their early retirements because of potential damage to them / being in high-risk locations at ~US$170 billion;
  • Reduced demand for goods and / services due to a shift in consumer preferences totalling US$102 billion; and
  • Changes in policy leading to write-offs, asset impairment and early retirement of existing assets totalling ~US$73 billion.”

The vast majority of the financial impact was identified by companies in the financial services industry (the biggest sector in the group of 500), with most identified risks related to their clients rather than to their direct operations.

Among the group of 500, 326 companies identified the availability of climate-related opportunities. With regard to the financial implications of those opportunities, 225 companies responded, estimating, in the aggregate, over $2.1 trillion for disclosed climate-related opportunities. The disclosed potential financial impact figures were primarily related to products and services, accounting for over $1.7 trillion (80%), with the financial services industry accounting for $964 billion of that amount.

The report identified these as the four biggest drivers of potential financial impact related to climate opportunities:

  • “Increased revenue through demand for low emissions products and services—US$970 billion;
  • Better competitive position to reflect shifting consumer preferences—US$487 billion;
  • Increased revenue through new solutions to adaptation needs—US$236 billion;
  • Increased capital availability (as more investors favour low-emissions producers)—US$198 billion.”

The vast majority of the potential financial opportunities were categorized as “likely, very likely or virtually certain.” Of these opportunities, companies reported that $471 billion could be recognizable now, but $1.34 trillion (62%) was expected to materialize in the short- to medium-term. Over $1.2 trillion of these opportunities were identified by companies in the financial services industry, followed by manufacturing ($338 billion), services ($149 billion), fossil fuels ($141 billion) and food, beverage and agriculture ($106 billion).