Recently shareholders have started to ask direct questions about climate change and how companies are addressing climate and associated risks at AGMs. The Australian Institute of Company Directors (AICD) has made a valuable contribution to helping Board members by publishing Climate change and good corporate governance which assists directors in their understanding of the complexity of climate change risks and establishes the building blocks for good governance. Importantly this work includes a summary of the science of climate change and demonstrates that climate risks are increasingly proven and thus requiring of due consideration by boards.
The AICD guide follows the increasingly broadly accepted climate risk categorisation of:
- Physical risks: risks to your company from the effects of climate change such as temperature changes, rising sea levels, changed rainfall patterns etc.
- Transition risks: risks to which your company is exposed as a result of different parties focused on mitigating or avoiding climate change; these include policy responses, technology shifts, market mechanisms and changes in public sentiment.
While the breadth of this topic is not trivial, there are five themes which you should consider when you define the magnitude of climate risks to which your company is exposed.
1. What is the impact of a carbon price on the value of your assets and investments?
Globally climate policy is changing, while there is limited indication that Australian companies will be exposed to a direct price on carbon in the near term, this is not necessarily the case for international assets, nor is this guaranteed in the long term. Do you understand what impact a price on carbon will have on your assets? What are the major emitting sites? Are they likely to be impacted directly, or only through supply chain costs? Will any of your products attract a carbon price under a trading scheme?
Additional consideration needs to be paid to the information used to assess the magnitude of these impacts. It is easiest to use global datasets as a starting point. However, these datasets are readily available because they are highly aggregated, and can be quite old. If you have assets which may be at risk you should investigate quantifying this risk using best available information, and not just the cheapest information you can find.
2. What would be the impact of a carbon price on the cost of inputs?
A price on carbon has the potential to increase the cost of inputs, not only the obvious ones like electricity, but other emissions intensive materials like metals and building materials, even some chemicals. What impact would a carbon price have on operating costs, and ultimately EBIBT? How do current procurement processes address potential future carbon prices? What allowance is there for your suppliers to pass increasing costs on to you?
3. How exposed are you to energy price increases?
The energy markets are increasingly unstable at the moment. Securing long term energy prices is becoming less likely which leaves companies open to significant prices increases in the short term. In recent years energy (electricity and gas) price increases have significantly outstripped CPI. If budgets are being built using CPI increases on energy costs then these could be significantly under-budgeted.
This risk escalates with increasing exposure to energy costs. Do you know what percentage of your operating costs relates to energy consumption? Do you know how long this is locked in for? Have you considered using more sophisticated approaches to energy procurement which enable you to hedge future energy price risks?
Note that this does not relate to carbon prices at all, only to the increased cost of energy.
4. Have you considered the physical risks that a changing climate represents to your assets?
The first impact that typically comes to mind when people think of climate change is sea level rises. But the impacts of climate change are more wide spread than this. Increased risk of flooding, fires, droughts and storms to name but a few is real. The cost of these to operations, as well as through increased insurance costs should not be overlooked. What does your climate change mitigation and adaptation strategy include? Have you considered the impacts of climate change on inputs and raw materials such as fresh products?
5. Have you costed potential losses from power supply disruption?
Recently power disruption from weather events has been increasing. Be this the South Australian black outs related to the super storm, loss of electricity to large parts of Brisbane during the Brisbane floods, or localised blackouts during extreme heat. Do you understand the impacts of power supply disruption on your business? Have you mitigated these risks adequately through installing backup supply or through your energy contracts?
Increasingly board members need to understand the climate risks to which their companies are exposed. These can be surprising both in their source, and their potential impact. I hope that these five themes help you to better interpret the potential risks climate change and energy considerations pose your business.