How does all of this translate into risks and opportunities for firms? I want to start out by talking about climate risks. Now, some of these may be obvious to you and some of them may not be obvious. But there are different types of risk arising out of climate change; physical risk, transition risk, litigation risk, and reputation risk. Physical risk can either be long-term and gradual or short-term also known as stochastic. Some of the long-term or gradual risks associated with climate change, those that are physical include; sea-level rise, increasing temperatures, both on land and in the oceans, ocean acidification, which occurs when the oceans absorb carbon dioxide and a chemical reaction turns it into carbonic acid. In addition, physical risks include geographic shifts in agricultural productivity. The idea that while wine grapes may be plentiful now in France or California, we might need to think more about the Northern neighbors going forward to grow those grapes. In addition, a long-term and gradual risk could include drought and water scarcity. On the short-term side, we know from research that climate change is leading to increasingly intense storms, as well as heatwaves and droughts, coastal flooding, and storm surge from those storms, and wildfires. Transition risk is related to physical risk but is a slightly different form of risk. This is the risk that comes as a result of the transition to a net zero economy. As we transition, that transition can either be smooth or it could drop off a cliff. The more we do now, the less likely it is that the transition risk is going to be the off a cliff kind. When we think about transition risk, this includes things like new laws or regulations that require a disclosure or changes in business activity to address climate change. Transition risk also include stranded assets, which I'm going to explain in just a few moments. Transition risk can include shifts in consumer demand or commodity supply. Certain commodities may be more difficult to obtain and consumer demands may shift as we transition, for example, from internal combustion engines to electric vehicles, or from natural gas stoves and boilers to those that are electric. Transition risk also includes the cost of the transition, which again, if it is smooth, those costs will be lower than if we are in the off a cliff scenario, as well as the speed of the transition. The third type of risk that firms face is litigation risk. This could include litigation to allocate the costs of adapting to climate change, for example, recent litigation filed by municipalities against major fossil fuel firms seeking money to pursue climate adaptation and resilience strategies like building seawalls to hunker down from the increasingly intense storms. This can also include litigation over lack of adequate climate disclosures or what is known as greenwashing, the idea that a firm is over-inflating the environmental attributes of a product, service, or the firm itself that are not backed up by the evidence. A final form of litigation risk comes in bankruptcy. Many people will refer to the bankruptcy of electric power provider PG&E in California as the first-ever climate bankruptcy because PG&E filed for bankruptcy after major wildfires to place that were caused by its power lines sparking and leading to the fires. This created massive liability for the company and its assets were insufficient to cover those losses. A final type of risk is reputation risk. This can come as a result of consumer boycotts and can lead to lost sales for poor performance when it comes to climate change. I want to take a moment to help you link these different types of risks together. How is it that physical risk from climate change can lead to these other forms of risk to the economy? We know, for example, from research that severe weather events and disasters are becoming more frequent. These include; hurricanes and cyclones, like the one in the image that I'm showing you, the resulting coastal storm surges, severe precipitation leading to flooding, as well as the gradual effects of sea level rise. These physical risks can lead to significant uninsured and insured losses for homeowners and business firms. How is it that physical risk can translate into a financial stability risk? Imagine that we begin with a physical risk like an extreme weather event or gradual change in the climate, this can lead to disrupted business, people can't get to the office. The supply chain breaks down because ships can't enter the port. Capital must be scrapped, buildings and plants need to be reconstructed or replaced, commodity prices can increase, and people may end up migrating. Those are all effects on the real economy. Secondarily, these can have effects on the economy and the financial system. These can lead to lower residential property values in areas that are subject to repeated flooding or sea level rise similar with lower commercial property values. If your house is worth less, you are less wealthy as a household. There may be more litigation over whether insurance covers these losses, who's going to pay for the damage? This can lead to financial stability risks for the financial system as a whole. One important aspect of climate risk is the concept of stranded assets. There are three types of stranded assets distinguished by the method of stranding. There's economic stranding of an asset. This is the idea that the cost or price of an asset changes and leads the asset to be worth less than expected or worthless. This could be as a result of losses or changes in consumer demand or for other reasons. The second type of stranding is physical stranding. This is the idea that weather events like flood or drought or other extreme or gradual events render an asset worth less or worthless. Finally, there's regulatory stranding. This is the idea that a change in policy, for example, the introduction of a carbon tax or a ban on certain types of energy production or a ban on internal combustion engines, for example, renders an asset worthless or worth less. Assets that can be stranded would include things like oil reserves. Imagine an oil field on the books of a major fossil fuel producer that has economic value now, but if there's a change in policy, that means that the company can no longer drill in that oil field and sell that oil or it is less profitable to do so. That is an asset that can be stranded. It's not just fossil fuels and reserves which are the most obvious cases of stranded assets, but there're also knock on effects or downstream effects that can lead to additional forms of stranded assets. These could include things like distribution infrastructure, production and processing within the value chain, or imagine a house or a mortgage that is literally under water. Just to give you a sense of the scale of the problem, in 2020, the consulting firm, BCG concluded that between 1 and $4 trillion in assets in the oil and gas sector are likely to become stranded by 2030. Other estimates suggest that even higher proportions of hydrocarbon assets will be stranded or must be stranded and left in the ground in order to meet either a 1.5 degree or even a two degree Celsius target. As you can see here from Standard and Pours, the largest fossil fuel financers from 2016 - 2020 are the major banks listed on the left. You can see the negative numbers in the third column representing the year-over-year change in the proportion of fossil fuel projects that they are providing financing to. This is suggesting that these major lenders are declining to provide more financing for fossil fuel firm projects. Another important aspect of transition risk that's worth focusing on are shifts in consumer demand. What if you don't work for a major fossil fuel producer but you just work for an ordinary small business? Consumer demand may affect you. These data demonstrate that consumers are increasingly focusing on climate and other ESG or environment social and governance factors as important to their purchasing decisions. You can see that it may be less important to the boomers of the Gen Xers among us, but the Millennials and Gen Z care more and more. This is consistent with data that demonstrate that more than 50 percent of consumers interviewed have said that they would spend more on environmentally friendly products. These numbers are higher for some groups. After all that bad news about the risks, I think it's also important to focus on climate opportunities. Business firms need to be taking an active approach to consider the ways in which they can pivot and adjust to take advantage of opportunities to promote a transition to a net zero economy in ways that will be consistent with consumer demand, their employee interest, and other stakeholder pressures. For example, all firms need to be thinking about ways to increase their efficient use of resources. How can we as a firm be more efficient in how we use energy, water, and how we manage our waste? Is it possible for us to engage in some technological innovation? Can we promote more efficient heating and cooling systems or energy generation? Are there ways to think about using water more efficiently? There's also opportunity in the energy innovation space including in the development of low emission alternative energy sources like wind, solar, geothermal, hydropower, and CCS which stands for carbon capture and storage, as well as improving storage capacity, for example, of batteries. Other climate opportunities include the possibility of developing new products and services that have a reduced carbon footprint, as well as in reducing emissions in the supply chain through greater efficiency. Financial organizations are actively thinking about opportunities to create new markets or provide access to new markets through things like green bonds or the marketing of carbon offsets, as well as engaging in public-private partnerships to promote infrastructure investments and new networks. Then finally, a topic that is incredibly important that perhaps gets a little bit less attention than the idea of reducing climate emissions is, how can we think actively about promoting climate resilience? To recap what we've been talking about so far, I want to offer two important takeaways. The first is that organizations and researchers including the IEA and the Intergovernmental Panel on Climate Change have set forth scenarios that would allow the global community to keep global warming at or below our target of 1.5 degrees Celsius. This involves getting to a net zero economy by 2050. This transition to a net zero economy by 2050 poses not only risks for business firms, but also many opportunities in the transition. We need to be mindful of the fact that physical risk is connected to financial, transition, and reputation risk in material ways. These ways are likely to differ by industry. Opportunities include everything from developing new products and services, to thinking about how to use energy more efficiently, to thinking about how to finance this whole transition.
