Firms Underestimating Risks From Carbon-Fuelled Climate Change

Global firms are seriously underestimating the threats to their operations from increasingly changing climates, specifically by failing to identify risks to their extended supply chains, experts say.

Record levels of planet-warming carbon dioxide are fuelling a rise in global temperatures, with last year being the warmest on record. That warning has spurred a significant increase in a range of extreme weather events, including unprecedented hurricanes, floods and droughts.

Experts say value chains today are widely vulnerable to environmental risks such as these, and most vulnerabilities are not revealed until some kind of disaster strikes.

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This leads many companies to underestimate or be unaware of them, says Paul Munday, director of global climate adaptation and a resilience specialist at S&P, who co-authored a recent report on the issue.

A key example of an industry exposed to such risk is the semiconductor sector, the report notes. The chip industry, which supplies critical components to a range of important businesses such as carmakers and electronics, is heavily concentrated in East Asia, and Taiwan and South Korea in particular.

Such a geographic concentration of a company’s suppliers, nodes of transport (such as seaports), critical input materials, or consumer markets could heighten the risk that a weather event creates a material disruption, the report notes.

Such a disruption could, in turn, impact the revenue and costs of all companies that rely on the chip industry for inputs.

“A lot of research on physical climate risks focuses on direct risks to business operations from hurricanes, droughts, floods and wildfires,” he says.

“We know companies are not just dependent on their own operations but on other entities, too. What happens to an auto company when its parts supplier is hit by a hurricane? The company’s own physical risk is compounded.”

Sectors such as agribusiness, consumer goods (food), autos, chemicals and paper products, which rely heavily on more climate-sensitive upstream and nature-based sectors, exhibit the highest value-chain exposures, the report says.

But it adds that “all sectors inherit at least some physical climate risk exposures from their value chains”.

Low water levels in the Rhine or the Panama Canal, for example, can affect the entire economy of particular regions for prolonged periods, and have increasingly done so in recent years.

Hurricane Katrina in 2005 famously had a huge impact on oil and gas infrastructure in the US, says Munday, and one of the sectors most affected by that was the airline industry. It faced sharply higher fuel prices, leading carriers to impose fuel surcharges on passengers, which hit demand for flights.

Few companies identifying risks

As a result of examples such as these and numerous lower-profile events, investors are becoming more concerned about the long-term health of the companies they invest in.

Value-chain risks can affect companies by disrupting business operations, increasing input costs, and by prompting investments in adaptation or resilience investments.

But S&P’s research shows that only a few companies are identifying these risks.

“Many investors don’t have information on value chain risk,” says Bruce Thomson, lead social and sustainable supply chain specialist at S&P. “There is an interest, but there’s a recognised gap in the literature.”

Dr Gabrielle Bourret-Sicotte has the title of chief evangelist and head of customer success at Treefera, a firm that uses technology such as AI, satellites and drones to capture data from nature-based assets such as forestry projects.

“Many people view climate risk as being high-profile and primarily physical events, such as drought, wildfires and deforestation,” she says.

Looking beyond direct risks

Yet the impact of extreme climate events on businesses goes far beyond these direct impacts, as they have a knock-on influence on wider environmental effects.

“For example, severe rainfall can create the conditions for plant disease and degrade arable farmland. We’ve seen examples of this across West Africa, specifically Ivory Coast and Ghana, where swollen shoot disease has directly impacted cocoa farms, leading to a potentially 50% reduction in harvest,” Bourret-Sicotte says.

Heavy rainfall in the region, which is the heart of the global cocoa industry, ultimately led to the price of chocolate almost doubling, she adds.

Investors don’t generally look at the interdependence between a company’s assets and the assets in their supply chains in climate risk assessments, says Peter Hirsch, head of sustainability at climate-focused venture capital firm 2150. “But it’s important to be able to think about that one degree of separation, such as where your logistics facilities are sited and what are their risks.

“Developing first-order climate risk assessments to establish what assets are exposed to risks and what revenue is associated with that is important,” he adds.

“For industries that are particularly exposed to high-vulnerability hazards – for example, agriculture when it comes to heat and drought – companies need to really think about whether they are going to be able to maintain their supply chains.”

Climate change is set to change the way any business reliant on outdoor labour – including massive parts of the economy such as construction and agriculture – operates, he adds. “The amount they can get done in a day will decrease significantly in certain parts of the world.

Building resilience

Managing these risks can feel like an impossible task, given the opacity of many companies’ supply chains. For Bourret-Sicotte, greater transparency is key.

“Businesses need to start with visibility – from the first mile, all the way through the value chain to the consumer. This is achieved by leveraging technologies, such as AI, satellite imagery and robust risk modelling. Businesses use these insights to assess the environmental impact across their entire value chain and build strategies to mitigate against them.”

Business coalitions can also play a key role, says Steven Ripley, director of investor engagement at the Responsible Commodities Facility, an initiative to promote the production and trading of responsible soy in Brazil.

The facility, which is supported by UK retailers Tesco, Sainsbury’s and Waitrose, lends money to soy farmers at reduced rates of interest provided they commit to zero deforestation and zero land conversion for the period of the loan.

“The retail sector is really on the ball with this, but the fast food groups seem to turn a blind eye to it and take the view that someone else will sort it out,” says Ripley. “But companies that are not engaging with transition in the soy sector are the ones that are very likely to end up paying the highest premiums for soy down the road. They won’t have the relationships with progressive producers that are necessary to secure the best offers in the market.”

Some companies believe addressing value chain risks will give them a competitive advantage. “We see this as an opportunity, partly because our supply chain management is very robust,” says Mila Duncheva, business development manager UK and Ireland for Stora Enso, the forestry products group.

On the one hand, the construction industry is likely to use more wood in future, because of its renewable nature and ability to sequester carbon, she says. But on the other hand, the forestry sector faces increased risks such as droughts, wildfires and floods, as well as a higher risk of diseases such as bark beetle.

Being able to identify and put a monetary value on potential climate impacts will not only help to inform where investments in adaptation and resilience should be targeted. It could even lead to innovations that help to further future-proof businesses in an increasingly unpredictable world.

• Reuters, with additional editing and inputs from Vishakha Saxena

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