Climate Risks

Climate risks refer to the potential adverse impacts on society, the economy, and the environment resulting from climate change and its associated effects. These risks are associated with the changing climate patterns, extreme weather events, and the long-term consequences of global warming. Climate risks can manifest in various ways and affect different aspects of human life, ecosystems, and economic activities. There are two categories of climate risks: 

  • Transition Risks: Risks related to the transition to a lower-carbon economy. 
  • Physical Risks: Risks related to the physical impacts of climate change. 

Transition Risks 

Transition risks are those associated with the pace and extent to which an organization manages and adapts to the internal and external pace of change to reduce greenhouse gas emissions and transition to renewable energy. Transitioning requires policy and legal, technology, and market changes to address mitigation and adaptation requirements related to climate change (see Table 1). Depending on the nature, speed, and focus of these changes, transition risks may pose varying levels of financial and reputational risk to organizations (see Table 2). Alternatively, if an organization is a low-carbon emitter and in the renewable energy or climate transition market, it could experience market, technological, and reputational opportunities. 

Table 1. Climate-Related Transition Risk Categories1 
Transition Risk Categories 
Policy and Legal  Policy actions around climate change continue to evolve. Their objectives generally fall into two categories—policy actions that attempt to constrain actions that contribute to the adverse effects of climate change or policy actions that seek to promote adaptation to climate change. The risk associated with and financial impact of policy changes depends on the nature and timing of the policy change. As the value of loss and damage arising from climate change grows, litigation risk is also likely to increase. Reasons for such litigation include the failure of organizations to mitigate the impacts of climate change, failure to adapt to climate change, and the insufficiency of disclosure around material financial risks. 
Technology  Technological improvements or innovations that support the transition to a lower-carbon, energy-efficient economic system can have a significant impact on organizations. To the extent that new technology displaces old systems and disrupts some parts of the existing economic system, winners and losers will emerge from this “creative destruction” process. The timing of technology development and deployment, however, is a key uncertainty in assessing technology risk. 
Market  While the ways in which markets could be affected by climate change are varied and complex, one of the major ways is through shifts in supply and demand for certain commodities, products, and services as climate-related risks and opportunities are increasingly considered. 
Reputation  Climate change has been identified as a potential source of reputational risk tied to changing customer or community perceptions of an organization’s contribution to or detraction from the transition to a lower-carbon economy. 
Table 2. Examples of Climate-Related Transition Risks and Financial Impacts2 
Climate-related Transition Risks  Potential Financial Impacts 
Policy and Legal 
Increased pricing of GHG emissions Enhanced emissions reporting obligations Mandates on and regulation of existing products and services Exposure to litigation  Increased operating costs (e.g., higher compliance costs, increased insurance premiums) Write-offs, asset impairment, and early retirement of existing assets due to policy changes Increased costs and/or reduced demand for products and services resulting from fines or judgements 
Technology 
Substitution of existing products and services with lower emission options Unsuccessful investment in new technologies Costs to transition to lower emissions technology  Write-offs and early retirement of existing assets Reduced demand for products and services Research and development expenditures in new and alternative technologies Capital investments in technology development Costs to adopt/deploy new practices and processes 
Market 
Changing customer behavior Uncertainty in market signals Increased cost of raw materials  Reduced demand for goods and services due to shift in consumer preferences Increased production costs due to changing input prices (e.g., energy, water) and output requirements (e.g., waste treatment) Abrupt and unexpected shifts in energy costs Change in revenue mix and sources, resulting in decreased revenues Re-pricing of assets (e.g., fossil fuel reserves, land valuations, securities valuations) 
Reputation 
Shifts in consumer preferences Stigmatization of sector Increased stakeholder concern or negative stakeholder feedback  Reduced revenue from decreased demand for goods/services Reduced revenue from decreased production capacity (e.g., delayed planning approvals, supply chain interruptions) Reduced revenue from negative impacts on workforce management and planning (e.g., employee attraction and retention) Reduction in capital availability 

Physical Risks 

Physical risks are those associated with the impacts of climate change. These risks can be event-driven (acute) or associated with longer-term shifts in climate patterns (chronic), as described in Table 3. 

Table 3. Climate-Related Physical Risk Categories3 
Physical Risk Categories 
Acute  Acute physical risks refer to those that are event-driven, including increased severity of extreme weather events, such as cyclones, hurricanes, heat or cold waves, or floods. 
Chronic  Chronic physical risks refer to longer-term shifts in climate patterns (e.g., sustained higher temperatures, sea level rise, changing precipitation patterns) that may cause sea level rise or chronic heat waves. 

Physical risks may have financial implications for organizations, such as direct damage to assets and indirect impacts from supply chain disruption. Organizations’ financial performance may also be affected by changes in water availability, sourcing, and quality; food security; and extreme temperature changes affecting organizations’ premises, operations, supply chain, transport needs, and employee safety. Table 4 presents examples of climate-related physical risks and financial impacts. 

Table 4. Examples of Climate-Related Physical Risks and Financial Impacts4 
Climate-related Physical Risks  Potential Financial Impacts 
Acute Increased severity of extreme weather events such as cyclones and floods Chronic Changes in precipitation patterns and extreme variability in weather patterns Rising mean temperatures Rising sea levels  Reduced revenue from decreased production capacity (e.g., transport difficulties, supply chain interruptions) Reduced revenue and higher costs from negative impacts on workforce (e.g., health, safety, absenteeism) Write-offs and early retirement of existing assets (e.g., damage to property and assets in “high-risk” locations) Increased operating costs (e.g., inadequate water supply for hydroelectric plants or to cool nuclear and fossil fuel plants) Increased capital costs (e.g., damage to facilities) Reduced revenues from lower sales/output Increased insurance premiums and potential for reduced availability of insurance on assets in “high-risk” locations