Business can’t ignore climate change risks

The Intergovernmental Panel on Climate Change (IPCC) have released of the latest installment of their report. Its conclusions show companies and investors can no longer ignore the risks of climate change in their reporting and decision making.

The IPCC report

The IPCC released the latest instalment of its Fifth Assessment Report, Climate Change 2014: Impacts, Adaption and Vulnerability, on 31 March 2014, reporting on the likely impacts of climate change in coming years as well as those already being felt around the world.

The report concludes that the impacts of climate change are already being felt, including shrinking glaciers, shifts in the geographic ranges of many terrestrial, freshwater and marine species, negative impacts on crop yields and increased heat-related deaths.

The picture painted for the future is alarming. Submergence, coastal flooding and erosion of low-lying areas and coastal systems; all aspects of food security will potentially be affected; heat stress, extreme precipitation, flooding, landslides, air pollution, drought and water scarcity pose risks in urban areas; major rural impacts are expected in the near-term and beyond through impacts on water availability and supply, food security and agricultural incomes.

This is serious stuff. Climate change is projected to increase human displacement and violent conflict in coming years, slow down economic growth and exacerbate poverty (not to mention the stress on wildlife and habitats, and the increased risk of extinctions – some of which are already being attributed to climate change).

This eagerly awaited report is the second of four parts of the IPCC’s Fifth Report (the Fourth Report was published in 2007). The first part, Climate Change 2013: The Physical Science Basis, published in September 2013, advised that warming of the climate system is “unequivocal“, with each of the last three decades recorded as successively warmer at the Earth’s surface than any preceding decade since 1850, and that it is “extremely likely” – by which the IPCC means “95 – 100%” likely – that more than half of the observed increase in global average surface temperature from 1951 to 2010 has been caused by people-led increases in greenhouse gas concentrations and other human-related causes.

The next part of the report, “Mitigation of Climate Change”, is due to be released on Sunday 13 April in Berlin and a final Synthesis Report is due in October 2014.

Business and financial implications

The report shows it is desperately urgent to reach a global agreement for dramatic reductions in carbon emissions, and sharpens the spotlight on the Conference of the Parties to the UNFCCC in Paris in December 2015. An agreement to achieve a “low-carbon” scenario sufficient to restrict global temperatures increases to 2⁰C above pre-industrial levels is now essential.

However, the report also raises the question of what impact this increasingly confident climate science has on the existing legal obligations of fossil fuel companies, those who fund them, invest in them and insure them, and those whose business is most likely to be affected by climate change.

Chapter 10 of the latest IPCC report identifies the key economic sectors and services that are likely to be affected by climate change. Amongst these are the energy industry, the water services sector, the health sector, transport, agriculture and fisheries and tourism (particularly ski, beach and nature resorts). A fundamental impact on the insurance industry is also predicted.

In the UK, companies are (since October last year) required to produce an anual strategic report in which the directors must report on the “principal risks and uncertainties facing the company” and on “environmental matters”. The UK Companies Act 2006 also requires directors, when making decisions, to promote the success of the company having regard in particular to the likely consequences of any decision “in the long term” and “the impact of the company’s operations on the community and the environment”.

Given the widespread risks anticipated in the latest IPCC report, these obligations must now include a duty to consider and report on climate relate risks. These include:

  • Physical risks to the company’s property, products, employees and supply chain from, for example, drought, floods, coastal submergence and extreme weather events
  • Impact on natural resources used by the company, such as fresh water supplies.
  • Technological risk i.e. the risk that rapid technological development might render fossil fuels less commercially viable than other energy sources
  • The risk of regulatory change, for example the introduction of global carbon capping or carbon budgets which may prevent companies from being able to burn the full extent of the fossil fuel reserves they currently own or are spending money to acquire. The Carbon Tracker Initiative’s argument that there is a very substantial amount of ‘unburnable’ carbon and therefore a ‘carbon bubble’ sitting on the asset sheets of many companies around the world is a compelling one. It is estimated that no more than about two-thirds of coal, oil and gas companies’ fossil fuel reserves can be burned without causing dangerous global warming of 2˚C or more.
  • The risk of litigation. There have been a series of cases in the US in which communities have attempted to establish liability for the effects of climate change on energy companies. In Kivalina v Exxon Mobil & Ors, the island of Kivalina sought damages to compensate it for the cost of having to relocate the town as a result of increased coastal erosion caused by the loss of Arctic sea ice around the island. The US courts found that there could be no claim under federal law because the federal law in relation to climate change had been displaced by the US Clean Air Act. However, the court left open the possibility of a claim under state law (as opposed to federal law) and it is expected that the case is now likely to re-start under state law. It seems likely that similar cases will soon be attempted in other jurisdictions. Given that the standard of proof under English law (and many other jurisdictions) is the “balance of probabilities” i.e. a degree of likelihood of greater than 50%, the increasingly confident language in the IPCC reports provides an increasingly solid basis upon which claims for compensation might be based. Further, a recent “Carbon Majors” report produced by Richard Heede and published in the journal Climate Change in November 2013 attributes 63% of cumulative worldwide emissions of industrial CO₂ and methane between 1751 and 2010 to just 90 entities, providing prime targets for claims.

A recent report by sustainable investment advocates Ceres indicates that the climate related disclosures of many companies listed on the US equities markets are deficient. The same is likely to be the case in the new strategic reports of UK companies, which are likely to come under increasing scrutiny.

The shareholders of Exxon Mobile recently brought a shareholder resolution demanding better disclosure of climate risk by the company. As a result, on the same day that the IPCC released its report, Exxon Mobile published two documents entitled “Energy and Carbon – Managing the Risks” and “Energy and Climate”. Exxon’s answer to the Carbon Tracker argument in those documents is surprising. They “are confident that none of our hydrocarbon reserves are now or will become “stranded“. “Projects are evaluated under a wide range of possible economic conditions and commodity prices that are reasonably likely to occur… In assessing the economic viability of reserves, we do not believe a scenario consistent with reducing GHG emissions by 80 percent by 2050, as suggested by the “low carbon scenario”, lies within the “reasonably likely to occur” range of planning assumptions, since we consider the scenario highly unlikely.”

Exxon are therefore operating on basis that it is “highly unlikely” that the world will reach agreement on carbon reductions that would put us on track for a “low carbon” scenario. Instead, Exxon take the view that a scenario similar to “RCP 4.5” is likely. That scenario is associated with an average global temperature increase of 3⁰C above pre-industrial levels and a mean sea level rise of 52cm by 2100, with further temperature and sea level increases thereafter.

The increased risks associated with fossil fuel assets have led to a number of divestment campaigns gathering pace around the world. These encourage investors (including pension funds and universities) to divest their fossil fuel assets, both on ethical and financial grounds. These campaigns raise their own interesting legal questions as to what the legal duties of investment managers require them to do when faced with information in the nature of that in the IPCC report.

What should be clear is that “business as usual” is simply no longer an option. Companies and investors (and their insurers) can no longer ignore the risks of climate change in their disclosures, reporting and decision making. The risks reported by the IPCC in this report permeate widely through industry. It is high time that climate change took centre stage in corporate minds.

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