Climate change is emerging as one of the most significant risks facing the Australian economy. Increasingly, shareholders, younger employees and investment managers are asking companies about their policies around climate change. Prudent, long-term planning is essential to mitigate its adverse impacts and exploit the opportunities presented by the new environment.
The former Federal government introduced new legislation that came into effect in mid 2008; new Renewable Energy legislation was passed in the Senate recently and it is likely that an Australian Government will place a price on carbon soon.
These changes all impose new compliance obligations on Directors.
Unfortunately, scientists have predicted that Australia will be heavily impacted by climate change. Australia will face more severe droughts, bushfires and storms.
Risks resulting from changes in the climate should be treated in the same manner as any other risk addressed by the Board Risk Committee. The nature of the risk has more dimensions than other traditional risks and it has the potential to cause considerable disruption to the operations of some industries.
Companies may suffer reputational risk if it transpires that Directors did not act prudently to mitigate the impacts of the new risks.
Industries most exposed are the large emitters, companies that have substantial operations located near the sea and those that have long supply chains. Industries dependent on primary production will need to be particularly mindful of the changes to the supply of water, arable land and impact on growing cycles.
The Stern Review in 2006 concluded that for Governments – the cost of inaction far outweighed the cost of early action. The same principle could be applied to individual organisations.
Climate change is emerging as one of the most significant risks facing the economy. Increasingly, shareholders and investment managers are interested in how Boards are addressing the risks presented by climate change. Prudent, long-term planning is essential to mitigate the adverse impacts and exploit the opportunities presented by climate change risks.
Traditionally, credit, operational and market risk have been the responsibility of the Risk and Audit Committees of large companies. However, surveys suggest that risks emanating from natural hazards and climate change are now receiving more attention from Boards and Board Risk Committees.
This article identifies the various categories of risks that can be ascribed to climate change and suggests that climate change should be treated in the same manner as any other business risk. We do not debate the science, since prudence demands that the issue, as an established area of regulatory and customer focus, be addressed by the leaders of companies. The potential risks should be assessed and if they impact the company or its stakeholders, appropriate and considered action should be taken.
Some companies have been proactive in addressing climate change at the Board level. For example, BHP Billiton has a Board Risk & Audit Committee and a separate Sustainability Committee. Caltex Australia has an Occupational Health Safety & Environmental Risk Committee. Westpac has a Board level Corporate Responsibility and Sustainability Committee.
However, most companies in Australia have only just begun to address the potential impacts of climate change. Many of these have not yet addressed it at Board level. In some cases, interest from individual Directors has not yet translated into formalised responses.
This article considers the risks from climate change and their relevance to Directors – whether they sit on a sustainability committee or on a more traditional risk committee.
In the last few years, climate change has become a headline issue for governments, the community and certain industries. But its impacts will be felt by almost every sector of the economy. The Intergovernmental Panel on Climate Change (IPCC) periodically publishes a series of comprehensive reports on climate change. The latest studies suggest that the climate system is changing more rapidly than predicted. Australia, in particular, faces the impacts of severe droughts, heatwaves and floods around the country.1
Companies must assess and understand the risks arising from these extreme events. But companies must also consider gradual, incremental changes to our climate that may impact business models and supply chains. A key federal government agency, the Australian Greenhouse Office (AGO) has produced a climate change risk management guide for business that concludes that climate change risk can and must be treated as any other source of risk.2
The AGO believes that it is incumbent upon directors to consider, based on their professional knowledge, which activities and assets of their organisation are sensitive to climate change impact. They can then determine whether climate change is a significant source of risk with reference to criteria used to judge other sources of risk.3 Detailed climate change scenarios provided by the Federal Department of Climate Change make it even simpler for organisations to undertake initial climate change risk assessments.4
Although some may argue that acting too early presents risks, the authors of this article suggest that companies have more to gain from action. In 2006, Lord Stern wrote a report on the economics of climate change. Its main conclusion is that the benefits of strong, early action on climate change considerably outweigh the costs. It proposes that one percent of global gross domestic product (GDP) per annum is required to be invested in order to avoid the worst effects of climate change, and that failure to do so could risk global GDP being up to twenty percent lower than it otherwise might be.5
Large investors are increasingly focusing on the performance of companies in the face of climate change risks. Organisations such as the Carbon Disclosure Project and the Dow Jones Sustainability Index have collected data from companies for a number of years.6 These reports include recommendations to investment managers regarding the preparedness of companies to effectively deal with operational, regulatory and reputational risks resulting from a change in the climate. There are a number of other organisations (INCR, IGCC) that represent very large investment portfolios.7 Due to the size of portfolios they represent, these groups have considerable influence on the investor community. Directors can expect increased scrutiny in the coming years from investment managers regarding their companies’ responses to climate change and preparedness for climate change impacts.
An emerging view from the investment community also links companies’ climate change responses to operational effectiveness.8 Investors are increasingly using sustainability reporting and climate responses as a barometer to measure how effective management is addressing emerging risks and opportunities. Absence of Boards’ accountability and awareness is a clear indication to investors that the company has not fully understood or addressed the issues. This ultimately translates into lower valuations relative to more engaged competitors.
There are approximately 1,000 companies in Australia that generate substantial carbon dioxide emissions or are large consumers of energy. These companies are subject to the Federal Government’s greenhouse gas accounting system called National Greenhouse and Energy Reporting Act 2007 (NGER). The government will use the data submitted by companies to establish baseline and future measurements of greenhouse gas emissions. This data will determine liabilities (i.e. the requirement to acquit permits) under a future emissions trading scheme. The CEO of a company is subject to civil and even criminal penalties if found to be in breach of the Act by not collecting or correctly reporting emissions data. Civil proceedings may also be taken against the company.
Electricity retailers and large buyers of electricity in Australia are now subject to new legislation (the Mandatory Renewable Energy Target) that mandates the amount of renewable energy that is generated in Australia. These companies are required to increase their purchases of renewable electricity until 20% of Australia’s total electricity generation is from renewable sources such as wind power, solar power etc. Non-compliance penalties are substantial.
Businesses are at risk from the physical impacts of climate change, including the increased intensity and frequency of severe weather events such as prolonged droughts, floods, storms and sea level rise. The Zurich Australia and National Insurance Brokers Association Climate Risk Survey states that 82% of brokers have dealt with extreme weather events. More than 75% say their views on climate change have been affected by this year’s weather events and a similar number believe Australia is experiencing a change of climate. Insurance statistics demonstrate that both the number and extent of extreme weather events are increasing.9
Severe hot weather has led to extended disruption to power supplies in the Eastern States due to bushfire damage of power lines, interstate power connections being shutdown due to high temperatures and a lack of water causing coal fired power plants to reduce output. During hot spells, excessive use of domestic air-conditioners exacerbates the problem and results in power distributors load-shedding during peak consumption.
According to the CIA’s National Intelligence Council, as many as 800 million more people will face water or cropland scarcity in the next 15 years. Competition for water resources has already occurred in SE Queensland and is now endemic in the broader Murray Darling basin. The purchasing of water rights in the Murray darling Basin will result in higher prices and reduced availability of water for farmers. Most state Governments have decided to construct desalination plants because of the uncertain future water supply – resulting in higher water prices. In many jurisdictions, companies have not yet felt the full impact of these changes. Yet it is inevitable that water availability and cost will increasingly impact the operations of large businesses in Australia.
Companies dependent on long supply lines that use sea or rail transport may find themselves unable to source raw materials or ship finished goods due to disruptions caused by climate change. Companies operating offshore oil drilling platforms have suffered extensive repair costs due the severe cyclones occurring in the Gulf of Mexico over the last 5 years. A very substantial percentage of the US refining and petrochemical industry is located on low-lying land in Texas and Louisiana. This land could be subject to inundation with rising sea levels.
Climate risk preparedness will be a key driver in a company’s ability to compete. Many companies in Australia and overseas are investing heavily to benefit from new opportunities and to improve their reputation in the eyes of their customers and shareholders. The car industry in Australia is substantially changing its product line in order to be better positioned for a carbon-constrained economy. China is planning to close its borders to the importation of renewable energy products in order to build its own industry and be better positioned to export in the future.
Human Resource surveys have found that younger prospective employees are very cognisant of a company’s reputation regarding climate change and sustainability. If the job applicants have choice, they will often choose in favour of the company with the better reputation.
In the US, utilities have already been sued for contributing to climate change and impacting the welfare of the public. The Environment Protection Agency in the US has recently been cleared to treat carbon dioxide as a pollutant – substantially increasing the remit of their compliance enforcement role. In a similar situation in NSW, the first ever legal action against a coal-fired power plant was initiated by the Environmental Defenders Office in July, 2009. The claim states that the plant will break NSW pollution laws.
There are many opportunities available to those that take prompt measures in the face of a changing climate. But the longer that action on climate change is postponed, the greater the resulting risks. The current global financial crisis has shown that the danger of ignoring risk can be disastrous. It is possible for companies to become climate resilient while still being sceptical of the science. The uncertainty associated with climate change increases the risks and should be “a driver for analysis, rather than a reason for inaction”.10
The world is moving on regulation to mitigate and adapt to climate change. Yet PricewaterhouseCoopers has found that just 24% of large Australian businesses have formally assessed climate change risk.11
The introduction of the Carbon Pollution Reduction Scheme means that companies must develop an effective strategy to prosper in a low carbon economy. Climate change presents challenges that companies will have to confront through integrated planning and management. Directors can ensure their companies minimise the risks and exploit the opportunities by exhibiting risk management leadership. They will be rewarded for being proactive.
Forward thinking companies tend to treat risk management as a tool to add value to a company’s operations. Addressing climate change should be treated similarly. In fact, many companies have developed new products and services that have been made possible from new situations arising from climate change.
Boards need to provide guidelines to the Risk Committee and ensure that the CEO shares the same risk appetite and planning horizon as the Directors. However, Boards cannot act in isolation of the risk infrastructure of their companies. Risk managers therefore need to understand and communicate climate change risk issues to their Boards. This means focusing on the issues that concern Boards and presenting information in a way that is both meaningful and useful to the directors’ decision-making process.
Risks and opportunities resulting from climate change should be incorporated into the strategic planning process of companies to ensure compliance costs are minimised and opportunities maximised. Risk managers have a vital role to play in informing this strategic planning process. Incorporating the issues into the enterprise wide risk management system is crucial to ensuring all aspects are addressed. There are a number of new software tools available on the market and these could be used to more effectively manage risk across the enterprise.
- Will Steffen (2009) ‘Climate Change 2009 – Faster Change and More Serious Risks’, Department of Climate Change, available: http://www.climatechange.gov.au/science/publications/faster-change-more-risks.html
- Australian Greenhouse Office (2006) ‘Climate Change Impacts & Risk Management – A Guide for Business and Government’, available: http://www.climatechange.gov.au/impacts/publications/pubs/risk-management.pdf
- Australian Greenhouse Office (2006)
- See http://www.climatechange.gov.au/science/index.html
- GCC (2008) ‘Carbon Disclosure Project Report 2008 – Australia & New Zealand’, available: https://www.cdproject.net/CDPResults/65_329_151_CDP%20Australia%20and%20New%20Zealand%20Report%202008.pdf
- Ceres (2006) ‘Managing the Risks and Opportunities of Climate Change: A Practical Toolkit for Corporate Leaders’, available: http://www.pewclimate.org/docUploads/Ceres_corportate_toolkit_012006_010507_130824.pdf
- Marsh (2006) ‘Climate Change: Business Risks and Solutions’, available: http://global.marsh.com/risk/climate/climate/documents/climateChange200604.pdf
- Zurich leads the industry with inaugural Zurich-NIBA Climate Risk Broker Survey: http://www.zurich.com.au/zportal/cs/ContentServer?pagename=Brokers/Page/ThreeColumn&cid=1248047296018
- Acclimatise (2009) ‘Building Business Resilience to Inevitable Climate Change’, Carbon Disclosure Project Report 2008, available: https://www.cdproject.net/CDPResults/65_329_211_Acclimatise_CDP6_FTSE_350_Building_Business_Resilience_HR%20(2).pdf
- PricewaterhouseCoopers (2009) ‘Carbon ready… or not – A Survey of Australian business leaders’ preparedness for the carbon-constrained economy and the Carbon Pollution Reduction Scheme’, available: http://www.pwc.com/extweb/onlineforms.nsf/docid/948793be74e01df0ca2575d1001727b5 Climate Change Risk as a Competitive Edge