How can better scenario planning today lead to a more sustainable tomorrow?
Climate change is happening faster than we thought. The report of UN’s Intergovernmental Panel on Climate Change indicates increase in extreme weather conditions over the next decade, irrespective of mitigating actions taken. Global warming has already reached 1.1 degrees and will reach 1.5 degrees by 2030 in all known scenarios.
The increasing global temperatures are expected to drive major societal changes beyond human imagination. Soils may become impossible to cultivate and crops may be lost to floods or droughts. In some regions, this is already happening, as brought forward by the latest UN report.
Global warming is also leading to a growing push for industries to reduce emissions as more and more countries introduce border taxes, and costs for greenhouse gas (GHG) emissions. A wave of new regulations and reporting requirements with the aim of reducing carbon footprint is ongoing. EU is in the lead with its aim to become a carbon-neutral continent by 2050, as per the Green Deal.
A growing awareness of the impending risks associated with climate change got Yara, a world-leading crop nutrition company and a provider of agricultural solutions with presence in over 160 countries, to take action before it is too late.
Physical risks from climate change
Executives at Yara were already aware that floods and rising sea levels can increase risks for some of their European assets like Le Havre, France and Ravenna, Italy. Also, heavy rains, drought, wind, heat, fire and other extreme weather conditions can present significant physical risks for Yara’s business. This has potentially big consequences that might lead to loss of value, assets and lives across the production chain.
Transition risk from climate change
Additionally, there are transition risks that results from societal changes, technology and regulations. The EU taxonomy is one such change. The EU taxonomy is a system for qualifying the sustainability of an activity, company or initiative, which requires reporting and new internal processes for data management. The taxonomy is expected to affect the distribution of capital because investors turn capital toward green solutions and sustainable activities. This might impact the opportunity to collect green capital benefits and make “brown” capital more expensive.
The major questions facing Yara amid all this climate-driven uncertainty were:
- What will be the consequences of these physical threats and transition risk for business continuity?
- Are there any opportunities emerging from the changes and risks?
Understanding potential scenarios and preparing for them
The key insight from the study is summarized in the following three scenarios with starting point at what will happen in 2030 and in the longer term toward 2050:
1. Low carbon revolution
This scenario reaches zero emissions and limits global warming to 1.5°C by 2050, thanks to swift and rigorous public policy on climate and innovation.
This results in the lowest physical risk of the scenarios, with a shorter period of uncertainty compared to the other two scenarios. There will be more extreme weather towards 2030, less physical risks compared to the other scenarios and more transition risks in terms of much stricter requirements for everything that has to do with environmental footprint.
“A scenario where one succeeds in reaching the 1.5°C goal will require a more ambitious climate policy in almost all economies, and thus less uncertainty associated with the design of various measures. It will provide increased security for long-term investments in green solutions, and it will provide great opportunities in future-oriented agriculture,” says CFO of Yara, Thor Giæver.
2. Gradual adjustment
In this scenario, the temperature rise will exceed 2°C by 2050; this involves a lot of physical risk, more regional differences and variations in policy implementation. The variations in global action on national commitments adds to the future uncertainty for businesses.
“To put it simply, it will be a mix of everything. There will probably be more regional differences, a lot of physical risk, a lot of different opportunities. But the situation will be quite confusing on the regulatory side, there may be large regional differences in the regulations which we will have to adjust to,” says Giæver.
“In the 2°C scenario, there are several different approaches to regulations, which will provide much more complexity and unpredictability. In contrast, in the 1.5°C scenario, there will have to be a global coordination which won’t be as demanding, having to deal with regulations that now only applies in the EU,” says Hanne Thornam, Nordic Head of Climate Change and Sustainability Services in EY.
3. Climate chaos
This scenario assumes temperatures rise above 2.4°C by 2050 and above 4°C by 2100. This involves a lot of physical risk, especially after 2030. Agriculture will possibly change the most during this scenario.
“This is a gloomy scenario with a lot of physical risk and great uncertainty about what happens in terms of regulations. It will be unpredictable and difficult to know where to invest resources, because it is very unclear how it will be regulated. But there are opportunities as well; agriculture will change drastically under this scenario. In large parts of the southern hemisphere and around the equator, it will be more or less impossible to farm. Developing new ways of farming will probably be necessary to protect crops against weather effects, and there will be a significant change in which crops can be grown where,” says Giæver.
In the 2°C scenario, there are several different approaches to regulations, which will provide much more complexity and unpredictability.
Concrete action: Preparing for the scenarios
Yara will build on the above risk analysis and future scenarios to conduct analyses across all business units. The company will continue to develop its own insights, which will provide better strategy processes, assessments and decisions.
“I think this exercise forces us, and I say this in a positive way, to be even more active in following through on our strategy. This is needed because the world is changing. With this, we are moving from general assumptions to more solid knowledge that enables us to be more concrete in our work as we look ahead,” says Giæver in Yara.
An example is a more detailed risk map of all physical assets such as factories, terminals and warehouses with ratings for whether there is a high, medium, or low medium risk along various risk parameters.
“You cannot say anything about the value of your physical assets without taking into account future scenarios. I think all CFOs must expand the concept of KPIs to include much more than financial parameters,” says Giæver.
Adapting to climate change through real actions and metrics
If the farmers get incentives to produce in a more environmentally friendly manner, it can create great opportunities.
Once the top management has decided to account for the various risk scenarios, they must start doing the mathematics and take it into the financial accounts properly. Yara has already started talking about climate risk in the notes of its financial statements.
Some examples of the concrete measures Yara is working on:
- To produce fertilizer and ammonia without CO2 emissions, Yara has launched several initiatives to produce hydrogen using renewable energy instead of gas.
- Established a separate business unit for clean ammonia to focus on green ammonia, including for shipping. Ammonia can be produced carbon-free by rebuilding existing factories, such as the factory in Porsgrunn.
- Digitally managed fertilization allows farmers to use less fertilizer by optimizing usage, which can increase resource efficiency and reduce pollution. Digitization can also contribute to the farmer gaining more insight and knowledge, which makes it possible to improve production.
- Yara has adopted an approach where it works to help farmers produce more efficiently in a sustainable way. “If the farmers get incentives to produce in a more environmentally friendly manner, it can create great opportunities,” says Giæver.
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