Embracing climate disclosure; avoiding the scenarios trapNigel Topping, CEO
Forward-looking businesses and investors recognize that climate change represents both financial risks and opportunities. It’s these risks and opportunities that the Financial Stability Board’s Task Force on Climate-related Financial Disclosures (TCFD) is aiming to help organizations address with its final recommendations report.
In its report, the TCFD recommends organizations disclose their governance around climate risks and opportunities, as well as detailing the actual and potential impacts of those risks and opportunities on their business, strategy and financial planning. Critically, this disclosure should take into account the global efforts to limit the average temperature rise to below 2 degrees Celsius.
The challenge for companies is to make smart decisions in the face of uncertainty around how and when that change will materialize. For example, predicting which technologies will win out, when new policies will take effect, and how these could impact investments, is no easy task.
‘Scenarios planning’ was designed for just such uncertainty and is a well-established method for developing strategic plans that are adaptable and robust in the face of radical change. There are challenges with this approach; as the TCFD notes, the use of scenario analysis for assessing the potential business implications of climate-related risks and opportunities is still relatively recent.
However, perhaps the greatest risk in using scenarios planning is the tendency for one widely used scenario to become normative. This can limit thinking to just one prescribed vision of the future, instead of a range of potential outcomes.
Making unfounded assumptions around a normative scenario can provide little more than a safety blanket, enabling boards to make the same old decisions instead of preparing for the future and making the right investments.
This is dangerous both systemically and for individual organizations. Businesses and investors could prove underprepared to manage risks and maximise opportunities; while a lack of investment could slowdown the global efforts to transition to the low-carbon economy.
Overestimating the CCS rollout
One clear example of scenarios creating distorting assumptions is with carbon capture and storage (CCS).
In the Energy Transitions Commission’s (ETC) report Better Energy, Better Prosperity, the ‘third-party medium carbon sequestration scenario for future fossil fuels use’ assumes that some 7-8 GtCO2 per annum (pa) needs to be captured and sequestered by 2040 to meet the 2 degree objective.
The Intergovernmental Panel on Climate Change agrees that reaching a 2 degree goal requires widespread deployment of CCS. But this level of deployment is at risk of being wildly unachievable.
Scaling up CCS to 7-8 GtCO2pa would require building around 2.2 new plants per week during 2020-2040, according to the ETC. CCS projects currently in operation or under construction puts capacity at roughly 40 MtaCO2, and while there is a strong pipeline for new capacity, the idea that we can hit these targets without drastic action seems to be dangerously optimistic.
The IEA’s report Tracking Clean Energy Progress: 2017 shows that progress in achieving the scale of CCS required for a 2 degree scenario (2DS) on ‘not on track’.
“Average storage must accelerate to reach over 400 MtCO2 (4 GtCO2) annually to be on track to meet the 2DS in 2025,” according to the report. “The total potential annual capture rate of existing projects is over 30 MtCO2, but given its current proven rate of 9.3 MtCO2, storage is falling short of meeting the 2DS.”
As research from Greenpeace notes, the IEA forecasts make “generous assumptions about technological success in CCS.”
This may be a risky assumption as progress to date on the technology has been described by the Financial Times as “woeful”, and today several governments and companies are pulling back from CCS projects, Greenpeace added.
Greenpeace also notes that assumptions among the oil and gas majors, such as Shell and Total, are overly optimistic on a CCS breakthrough; though Statoil has a “healthier degree of scepticism about CCS, based on performance to date”.
“The scale of the challenge must not be underestimated,” the Global CCS Institute said. “The current level of CO2 capture capacity is dwarfed by the amount of CCS deployment required over the next 25 years under the IEA’s 2°C scenario (2DS).”
Key uncertainties such as this must be navigated collectively because the consequences of making unachieveable assumptions, and then investing on those assumptions, could be hugely damaging to the efforts to tackle climate change, as well as returns on investment.
A set of alternative scenarios needs to be used to allow for stress testing the impact of assumptions on technological development and other outcomes. With the example of CCS, both a low and high CCS prediction should be considered for investment decisions. If oil and gas firms are investing based on a high CCS assumption, such as 8 GtCO2pa, then investors have the right to ask what they are doing to research and develop these technologies and what they base their confidence on.
And of course, these risks are not limited to the field of CCS. Other assumptions around the low-carbon transition, such as the rate of transport electrification and demand destruction for fossil fuels, also pose major risks for investors.
As Carbon Tracker points out, the management teams at many fossil fuel companies can be overly focused on demand and price scenarios that assume business as usual. Because of this, there may be a risk assessment ‘gap’ between their view of the future and a view that would result from action on climate change, technology developments and economic assumptions.