The Multiple Myths about Climate Risks for Corporates

By Li
Posted May 02 2023

As we delve deeper into the project, many facets of the corporate climate risk discussion emerge. While our project's initial focus is on determining the effectiveness of private versus collective responses actions to climate risks for the three companies we chose, I've come across many interesting thoughts on the broader topic of climate risk along the way. They may be only tangentially related to our research, but I believe they can be a useful reflection on more systemic thinking about climate risk - a topic that everyone is attempting to address but remains hazy in many ways. I may not be able to provide a clear answer to each of these "myths," but I believe it is the debate that forces the subject to evolve.

1. Monetization of climate risks: what is the “right” methodology? 

Putting a monetary value on climate risks is frequently at the center of climate risk discussion - it's a required component by CDP and recommended by TCFD, a research topic academics are attempting to solve, and a "business" that many consulting firms are exploring. We discovered numerous methodologies through our research, all of which are based on numerous assumptions, even for the more straightforward physical risk component. We see NIKE report the cost of physical risk by multiplying a percentage of factory numbers by the extra spending induced by the recent flood in Honduras. We also discovered that S&P and MSCI all sell their proprietary climate risk modeling tools. Even we have attempted to model the change in stock price by making GHG inventory a liability at the cost of a predetermined carbon price. When comparing these methodologies, it's difficult to say which is correct or incorrect. It makes me wonder if the monetization of climate risks is just for reporting and transparency for stakeholders, or if it can actually be integrated into decision making. It appears to me that this is a topic with no single "correct" answer, but if it's not "right" enough (or comparable enough), how can it serve the two goals of better investor knowledge and better internal decision making?

2. Lost in translation: mitigation vs adaptation

The classification of mitigation and adaptation is very clear in the scientific world, but it does cause confusion in the corporate world. In our interview with an academic, she identifies all "decarbonization" activities (such as more renewables) as mitigation and changes in business strategy (such as more sustainable products) as adaptation to customer needs as a result of climate change, whereas our client from the private sector views the latter as a mitigation action to the broader climate change trend. It astounded me that such fundamental concepts as mitigation and adaptation are lost in translation. Of course, neither side is to blame. On the contrary, it's because climate change is intertwined with many more actors (government, customers, etc.) in corporate decision-making, and thus, unlike in science, where the only subject is the climate itself, they have more trends to adapt to, or simply respond to. However, we should not overlook the fact that the gap in common concept still exists.

3. Can companies gain comparative advantage by turning the risk into opportunity? 

Aside from mitigating the negative effects of climate risks, the company has the potential to gain a competitive advantage by becoming a leader in climate-change-aligned transition. For example, given the trend toward more sustainable aviation fuels (SAFs), we believe that airplane manufacturers with more advanced engine designs that are compatible with SAFs will be able to dominate the market in the future. This case is particularly interesting in the airplane industry, where there are only two oligopolies. If our assumption is correct, the two companies will compete in R&D for future engine development as a means of mitigating climate change. However, we see them working together in this area by joining the "First Mover Coalition," where they exchange technical information. Now the question is, if this is considered a "collective climate action," what is the actual motivation, as well as the cost and benefits? Are they truly collaborating as they have claimed to the public? Or do they not believe in the assumption and view the collective action as a purely public relations exercise aimed at convincing policymakers that the airline industry has already made adequate efforts? We wanted to get answers to these questions from our conversation with one of the industry's major players.

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