With scientists warning of climate change and consumers demanding more environmentally-friendly goods and services, companies need to change. We look at the transition risks
The impacts of climate change are becoming ever clearer – global temperatures for June and July last year were the hottest ever, for example, and all the nine hottest Junes recorded have occurred since 2010. The world has been transfixed by the scale of the wildfires that have been burning for months in Australia. People are finding it increasingly hard to ignore climate impacts, from consumers and employees to regulators, investors and governments.
Scientists are clear that, to prevent dangerous climate change, we need to limit average temperature rises to “well below” 2C, and consumers are starting to demand that the companies they buy from are doing their part, while governments and regulators are introducing rules to force them to act. This means that companies, which should already be taking steps to deal with the physical impacts of climate change, also need to prepare for the transition risks, which could have an even bigger impact on their operations, certainly in the short term.
Transition risks are less obvious than physical risks, but the signs of them are all around, and they are starting to become really significant. These risks arise because we know that we need to move from a high-carbon to a low-carbon economy and so policies and commitments are being introduced to encourage this.
“Transition risks can occur when moving towards a less polluting, greener economy,” says the Bank of England. “It’s not that policies stemming from deals like the Paris Climate Agreement are bad for our economy – in fact, the risk of delaying action altogether would be far worse. Rather, it’s about the speed of transition to a greener economy – and how this affects certain sectors and financial stability.”
Tighter regulations have been introduced at every level, from the global Paris Agreement on climate change to EU and national government renewable energy targets, all the way down to cities such as Liverpool and Manchester declaring a Climate Emergency.
The UK recently announced its plan to become a “net zero” economy by 2050, meaning that all parts of the economy will have to either emit no greenhouse gases (GHGs) or those emissions will have to be offset by cutting emissions elsewhere. It joins a growing list of countries including France, Sweden, Spain, Denmark, New Zealand and Costa Rica. Other countries have less stringent rules, but the trend is clear – all of the 197 signatories to the Paris Agreement have some kind of climate change law or policy.
The UK recently announced its plan to become a “net zero” economy by 2050
These rules give legal force to the pressures on companies to cut their emissions. A look at one of the biggest emitting sectors, energy, illustrates how profound the changes can be. Countries in the European Union are phasing out their coal-fired power stations and replacing them with renewable energy and energy storage. Utility companies were hit hard by the change, with two of Europe’s largest, E.ON and RWE, having to split themselves into renewable and fossil fuel units after recording billions of euros of losses.
Oil and gas groups are facing up to the fact that if government policies follow the Paris Agreement, then two thirds of the world’s known fossil fuel reserves must be left in the ground.
Similarly huge adjustments are happening in the transport sector, where carmakers are in the process of making the switch from internal combustion engines to electric vehicles. There is also growing pressure on the shipping and aviation sectors to cut their carbon footprints, as well as less obvious culprits such as food producers – farming uses a lot of fertilizer, which is made from fossil fuels, is responsible for deforestation and cattle are also a huge emitter of GHGs.
All of this regulation leads to the danger that companies failing to react will be left with “stranded” assets – be they aircraft, ships, oil wells or beef cattle – that they can no longer use or sell.
The regulation also implies huge changes to the way we do business, with moves to decarbonise not just the electricity system but also the transport and heating sectors, on the horizon and promising significant upheavals. However, many in the business community and financial markets have not understood the changes that are coming. “Markets don’t seem to be pricing in the dramatic changes that governments are planning,” Harriet Baldwin, UK international development minister told the Economist’s Climate Risk summit in London in July 2019.
But it is not just new laws that companies have to deal with. Investors, concerned about whether the businesses they invest in will continue to offer good returns, are calling on them to act, too. They are starting to have a real impact. Climate Action 100+, a $33 trillion investor group that targets the world’s biggest emitters, has extracted significant change from oil and gas companies, not only getting them to set out their exposure to climate risks, but in some cases commitments to change their strategies as well.
Shell, for example, has set the industry’s first emissions reduction commitment that includes the emissions produced by customers using its products and its chairman Ben van Beurden has come out in support of net zero targets. The company has also started buying companies involved in electric vehicle charging, electricity utilities and renewable energy developers.
Climate Action 100+ has just announced that it has turned its sights on the cement industry, which is one of the biggest sources of GHGs around the world, responsible for seven per cent of all emissions.
Generation Z consumers are becoming increasingly intolerant of companies that fail to take climate change seriously
“The cement sector needs to dramatically reduce the contribution it makes to climate change,” said Stephanie Pfeifer, a member of the Climate Action 100+ global steering committee. “Companies that are not yet sufficiently pursuing new technologies and approaches to maximise emissions reductions from cement production and use risk being left behind or significantly disadvantaged as construction methods change.
Changes such as this are given added urgency by a generational change that is seeing millennial and generation Z consumers becoming increasingly intolerant of companies that fail to take climate change seriously. The global school climate strikes and Extinction Rebellion protests are the most obvious sign of this, but many other people are deeply concerned and want to do something. Companies from Amazon to Barclays Bank to Primark have been threatened with consumer boycotts because of their approach to climate change. The rise of the digital economy has made it easier for shoppers to see who is responsible for how their favourite brands behave and tell their friends about it if they don’t like what they see.
Less visibly, but more seriously, consumers just shift their buying habits – growing numbers of people are reducing the amount of meat and dairy products they eat, and switching to electric vehicles and renewable energy – leaving incumbent businesses that have invested millions on the basis of continuing demand left high and dry unless they can adapt to new climate realities.