Physical risk analysis

Navigating uncertainty: drawing value from credible physical risk analysis

Pressure is mounting for business to take action in the physical risk space

Smashing previous global climate records, 2023 was unprecedented: it was the warmest year on record, and had the warmest oceans and lowest Antarctic sea ice extent for most of the year.

Australia experienced multiple major flood events, as well as dry spells, frequent heatwave conditions and bushfires[1]. This year is tracking to be hotter still[2]. Dr Jaci Brown, CSIRO's Climate Intelligence Director was recently quoted as saying “[it] is a useful glimpse of our not-too-distant future. In a few decades this won’t look like a hot year, it will be a normal year or possibly even a cool year. We need to be asking ourselves – how do we prepare for that?[3]”

Some of Energetics’ clients have already experienced significant impacts stemming from climate-related events, while others are becoming aware of the (in some cases) existential threats they face to operations and/or the performance of investments, as the climate continues to shift. Along with this critical need to adapt, upcoming mandatory disclosure requirements under the Australian Sustainability Reporting Standards (ASRS) provides another driving force to identify and manage climate risks. However, as companies accelerate action and disclosure efforts, sometimes earlier than planned, they are increasingly exposed to the risks of greenwashing (providing misleading information or setting unrealistic targets), greenhushing (not disclosing adequate levels of information) or maladaptation (either under- or over-adapting).

In this article we discuss the common physical risk compliance pitfalls and outline a robust approach to risk assessments that begins with taking a strategic approach to resilience building, backed by credible and transparent data sources.

Without strategy, pressure leads to pitfalls

Without access to the right expertise, businesses rushing to adapt or comply may run into the following pitfalls when assessing physical climate risks:

1. Assuming that interpreting climate data is easy. Doing so effectively and within its limitations requires specific expertise. A partner that is willing to be transparent and help build your internal capacity will ensure your business can speak confidently about its risk exposure and vulnerability.
2. Leaning on easy solutions such as so-called ‘black box’ models[4]. These are proprietary models that do not provide transparency over the approach or assumptions, meaning they are not suitable for auditing and leave businesses in the dark around potential impacts and adaptation actions specific to a business. Make sure the experts teach you how to interpret and leverage the tools and deliverables they provide.
3. Deciding that uncertainties in future climate projections are a reason not to commit. Physical risk is an inevitability; impacts are locked in for the next decade or two, even in the best-case scenario.
4. Assuming only the business itself will be assessing its risks and potential impacts. Physical risk analysis is based on publicly available climate data. Claims can and will increasingly be tested by stakeholders as awareness and skillsets continue to grow. The only way to control the narrative is to disclose credibly and transparently.

The significant investment required to fulfil all anticipated ASRS disclosure requirements calls for a strategic and meaningful approach to this work, to draw value from the process beyond mere compliance. This includes:

• Considering how to integrate climate resilient decarbonisation strategies and nature considerations in a transition plan to achieve targets in a sustainable way
• Integrating climate risk in due diligence such as investment assessments
• Upskilling Boards in climate risk and adaptation to embed this complex and systemic risk into decision making to future-proof businesses.

All of these aspects should be underpinned by decision-useful, challenging, credible and ultimately auditable risk assessments and scenario analyses.

Energetics’ approach revolves around building a strong foundation at the risk assessment stage to shape the selection and customisation of decision-useful climate scenarios and deep dives into the most material matters.

Favour transparent, tailored approaches backed by credible data

Physical climate change risk is determined by the intersection of climate-related hazard (the climatic driver of a risk), exposure and vulnerability[5]. Hazard and exposure are determined by the location of the assets, i.e. their exposure to local climate features, topography and surrounding infrastructure. Energetics leverages our suite of climate data tools, including our Australian hazard exposure tool to:

• Access credible and transparent sources of climate data to support risk assessments, scenario analysis and disclosure
• Quickly determine a business’ exposure to key climate hazards
• Identify regions and assets at highest risk to support prioritisation of adaptation actions.

The third aspect of risk, vulnerability, encompasses the asset’s susceptibility to sustaining impacts and its capacity to cope. This is unique to a particular asset type, its design or characteristics, its criticality within a business’ specific operations and its importance within the broader risk landscape. These are much harder to capture in a one size fits all approach, which fuels our concerns about ‘black box’ approaches. For example, a portfolio that includes agricultural assets needs to be assessed not just for risks to fixed assets, but especially for risks to biological assets (e.g. specific crops and/or livestock) that will suffer under changing climate conditions, ultimately impacting agricultural productivity. Likewise, in practice, impacts from a tailings dam failure to a mining company are much broader than the cost of repair of the asset itself, with financial impacts from penalties, legal fees, remediation, as well as significant reputational impacts.

For this reason, we overlay tailored analysis onto outputs from our hazard exposure tools, to consider business-specific vulnerability and adaptative capacity to understand the potential range of outcomes, draw out detailed implications for the business and define priority actions. We then guide our clients to consider the lifespan of an asset, its criticality to operations and potential broader impacts (for example to the environment or the community) linked to failure to translate climate data into a robust resilience strategy.

Establishing robust approaches and strong data foundations will build confidence for investors and regulators assessing your claims

Managing and disclosing your business’ physical climate risks begins with taking a thorough and strategic approach to these complex risk assessments. Done well, the insights gained should inform your business’ strategies and provide the insights to build resilience against growing climate impacts.