Environmental, Social and Corporate Governance (ESG) factors have been around for over a decade, but whereas they were once considered “nice to have” principles or an ethical stamp of approval to show that you were a good, moral company, times have changed. This is something that the renewables sector continues to leverage as a strategic opportunity. ESG has now become a financial and strategic imperative, with many ESG factors demanding Board level attention. It may feel like a lifetime ago, but it was only last year that climate change dominated discussions at the 2020 World Economic Forum in Davos, at the beginning of what was supposed to be the “Year of Climate”1. While COVID-19 has swept Board agendas and headlines clean, the issue hasn’t gone away. Investors are demanding climate disclosure; central banks are continuing to work together to ‘green the financial system’ and expectations of employees and customers are rapidly shifting, as ESG truly enters the mainstream and accelerates with calls for a “Great Reset”2. While the industry has a head start as a key enabler for climate mitigation, all players will demand a level playing field. So if your CEO or CFO hasn’t been asked yet about your company performance through an ESG lens, then rest assured: it’s coming, and coming soon.
Warren Buffett is often quoted as saying “a reputation takes 20 years to earn and five minutes to ruin”. But ESG is more than enhancing reputation and trust. By having a more rounded approach to ESG, the availability of finance could be enhanced. Clustering deployment with other infrastructure investments – such as charging stations for electric vehicles or green hydrogen production to feed into hard to abate industries such as steel and aviation – can make returns more attractive while providing community benefits in terms of pollution reduction and quality jobs. Good ESG performance is also often reflected in equity value outperforming the market.3 4
For pureplay renewables companies, climate change and energy security have been key drivers for the gains in renewable power generation. For those companies with a mixed portfolio of energy generation assets, transitioning out of high carbon will need finance, with strict conditions on adherence to carbon budgets in alignment with the science of minimising global warming.
The renewables sector will play a key role in meeting the need for diversified sources of future-proofed energy production - indeed, it has the potential to create jobs and infrastructure projects at a scale not seen since President Franklin D. Roosevelt’s New Deal5 - but it will be needed in every country. And yet the sector will face the same questions from investors and financial institutions if they can’t meet the same reporting requirements and robust management of their stakeholder impacts.
Transforming sources of energy needs to be done via a just transition – this means supporting targets set out in the United Nations’ Sustainable Development Goals and considering ESG impacts. In particular, this will be critical as the technologies underpinning batteries, wind, solar and other renewables rely on the extraction of “earth metals” – which may result in other environmental impacts and involve high-carbon energy in the short term, as the deployment of low carbon technology scales. While renewables have already carved out a market based on these principles, they will need to capitalise on communicating the intangible value that their proposition brings, despite the relatively new status in comparison to long-running industry players. These range from ensuring energy security to health benefits around the improvement in air and water quality from reduced pollution, and the creation of a brand-new industry of jobs. Scottish and Southern Energy (SSE) has recently included these wider factors into 20 principles underpinning its just transition plan6.
Add to this the idea that COVID-19 may accelerate the broader appetite towards ESG, as financial markets look to build resilience to systemic risks, and there is an even stronger case for enhancing your ESG response. It is becoming increasingly apparent that ESG performance is going to be an important driver for energy industry stakeholders – lenders, insurers, shareholders, regulators – and even consumers. Indeed, it’s likely that the money will increasingly follow those companies, with the highest proven ESG credentials, as recognition of the systemic nature of issues beyond climate change mitigation (such as resilience to acute and chronic physical events) and a plan to manage them increasingly become key indicators of appropriate risk management.
So there has never been a better time to ensure that your company performance can be articulated through an ESG lens. Much like the warning signs of the 2008 financial crisis, it is time to pay attention to the ripples before they turn into waves, and to enhance organisational resilience to steer through the rapids of change - before you hit a rock.
The good news is that risk managers can be proactive in addressing ESG and the renewables industry is well placed to meet that challenge; furthermore, many industries are finding that the insurance sector is uniquely placed to help them, given its experience of being on the front-line of managing the impacts of a changing climate over many decades.
As we navigate the challenges of a COVID-19 infected world, it will be critical to maintain momentum and interest in this area; the effects of oil prices dipping into negative figures and disruption to global cargo markets are placing a sustainable recovery high on the agenda and triggering new infrastructure projects in an effort to bolster GDP. With green strings being attached to national bailout schemes7, and green debt issuance over-subscribed8, this is the ideal time for the renewables sector to demonstrate its value over other industries and take advantage of the opportunity to accelerate the transition.
The sector’s expertise and services will be in demand to commission, operate and decommission renewable infrastructure for other companies. In Texas, a new $1.6 billion solar farm is set to provide 1,310MW of energy in the largest solar project in the United States9. Currently under construction, the Samson Solar Energy Center is designed to support the sustainability objectives of five major consumer brands and supply power to three Texas municipalities. These types of partnerships – between utilities, corporations and local governments – demonstrate the leadership opportunity for renewable energy companies to share their knowledge with the value chain and establish new business models10. They will also provide a foundation of knowledge, and the sector should look to share this through partnerships with other sectors – this could be working groups, or by taking non-executive director roles on Boards.
Demonstrating ESG performance will help reduce cost of capital, enhance partnerships within industries and municipalities and increase the ability to win lucrative corporate contracts. In the next 10 years, renewables deployment will accelerate and branch out from power production and storage into supporting new transport infrastructure, as well as industrial production and use of hydrogen. Risk managers will need to understand, quantify and manage the risks from expansion into new partnerships with these technologies and the associated business models, and to be ready to support these strategic developments. There’s never been a better time for risk managers to bring together a system-wide perspective, play a critical role in guiding the Board’s strategy and pivot from risk to opportunity.
In July, Blackrock announced that they had identified 244 companies that were making insufficient progress on climate risk. 53 had voting action taken against them on climate issues, and 191 were warned they would risk voting action against management in 2021 if they do not make significant progress.
Source: Blackrock13
Since the industrial revolution, and particularly over the last 50 years, the world has experienced significant economic growth, powered by ever increasing use of natural resources, driven by a substantial increase in global energy demand. This increase in human activity is known as ‘The Great Acceleration’ and has resulted in many benefits, lifting millions out of poverty and creating our modern world; however, it has also had some unintended consequences, including unprecedented changes in our climate.
Indeed, events that would have seemed unimaginable only a few years ago, such as PG&E becoming the first recognised corporate casualty of climate risks in the energy sector11, or the Chairman and CEO of Black Rock discussing climate risk and referring to a fundamental reshaping of finance12, are now becoming the norm and receiving Board level attention. It should also serve as a reminder to consider complex climate exposures in transmission networks, which could include fire, flood or wind to name a few potential perils that could cause severe disruption.
For the first time in the history of the World Economic Forum’s Global Risk Report 2020, environmental threats dominate issues on senior leaders’ agendas. While the industry is very much part of the story, it is useful to more fully understand why there has been such a significant shift in the ESG zeitgeist, current views of the science, the frameworks being used and the actions that central banks, regulators and investors are taking.
These factors will have a big impact on your role as a renewable energy risk manager, and there has never been a better time to get up to speed with the ESG landscape and help your Board develop a strategic response that meets all the questions you will be asked.
As shown above, 2020 represents a fundamental fork in the climate change road. The actions we take now, and in the coming years, may well determine the future of the world’s climate system. Views on how extreme weather events will change in a warmer world vary, depending on the type of event and its individual characteristics. This is where modelling future climate scenarios using state of the art scientific knowledge can play a key role in your strategic planning and risk
management processes. While a 2°C increase in temperature may not seem important, it’s worth bearing in mind that for the last 10,000 years, it’s the relative climate stability of +/- 1°C that has, at least in part, been the foundation of our collective progress today: a climatically stable nursery for civilizations to grow. Beyond 2°C, or even 1.5°C according to a recent IPCC (Intergovernmental Panel on Climate Change) report14, we are going in to uncharted territory with increasing risk of climate tipping points.
There has been a significant and rapid increase in concentrations of atmospheric carbon dioxide (CO2), especially since the 1970s, reaching levels unprecedented for at least 800,000 years, during which time we’ve been through many ice ages and warm periods (inter-glacials, such as our pre-industrial climate). In fact, palaeoclimatological evidence shows that the last time CO2 concentration was this high was at least 3 million years ago. Temperatures were two or three degrees higher than pre-industrial climate and seas were 15-25 metres higher.
CO2 is a greenhouse gas that acts like a thermal blanket around the Earth, and it’s getting thicker every year. In response, our planet is warming, sea levels are rising and weather patterns are changing. The rapid increase in CO2 takes time to exert these impacts on the planet, and so the emissions produced already will continue to affect our climate for centuries to come. If we continue along a similar pathway – continuing to increase carbon emissions – global temperatures could rise over 4°C by the end of the century, and this has been quoted by some as being an uninsurable world15.
As the worlds of ESG, climate science and finance have come together in recent years, a new language of climate-related financial risk and disclosure has developed.
One framework you may be increasingly aware of is the “physical, transition, and liability” financial risks from climate change, which Margaret-Ann Splawn referenced in the previous article. This framework was first set out in a report by the Bank of England in 201517, published alongside a seminal speech on ‘Breaking the Tragedy of Horizon’ by the then Governor of the Bank of England, and Chair of the Financial Stability Board, Mark Carney18.
These three channels of climate risk are highly relevant to the renewable energy sector and are already having a meaningful financial impact across natural resource sectors.
Physical risks are the direct risks arising from damage, loss of business or supply chain disruption due to increasing intensity of extremes of weather and climate. For the renewables sector, with numerous sub-sectors each having different physical location requirements, sites are often located in remote and climate-vulnerable areas. Extreme weather events and climate variability have the potential to damage fixed assets and disrupt supply chains. For example, in Mexico the construction of one major solar plant was delayed for several months due to Hurricane Odile19, and yet climate risks were not acknowledged.
Assessment of physical risk can help renewable energy companies understand their operational risks and respond to extreme events. Key locations may not be impacted by water stress or flooding right now, but that could change and soon. This is where the use of Intergovernmental Panel on Climate Change (IPCC) scenarios is incredibly useful because they give an evidence-based frame to consider possible futures for asset management and new capital expenditure.
Insurance industry catastrophe modelling techniques can be applied to assess risks to infrastructure or incorporate IPCC-projected climate scenarios to investigate extreme events and changes to resource demand, as well as identifying which assets are most exposed to physical risks.
Transition risks are the financial impacts of moving towards a low or zero-carbon economy, such as re-pricing of carbon intensive assets. For the renewables sector, transition risks may arise from changes in government policy, for example through the alteration or elimination of revenue support schemes, or the risk of technology substitution in the next few years. As an emerging sector with numerous competing sub-sectors, leaps in technology are both welcomed and a disincentive to large-scale investments. As ‘subsidy free’ renewable energy developments become more common, there is uncertainty around future policy support and commercial development20.
2020 has seen an acceleration in global commitments to action to reduce emissions dramatically. In February 2020, 49% of anual global GDP was committed to net zero targets ($39trillion)21. In June this had grown to 53% and $46trillion. Since then Japan, South Korea and China have all set net zero targets as well. Amongst many initiatives, we have The Race To Zero initiative and Climate Action 100+ calling for businesses to set net zero targets, importantly underpinned by large cuts in emissions in this decade.
The transition to a low carbon economy is also the greatest opportunity for the industry; understanding these changes will be essential, as risk managers consider how to make investments in the most sustainable way, whether this is by improving the efficiency of existing infrastructure, investing in new technology or committing expenditure to new projects. Investors have a growing concern over the viability of high carbon business models in an increasingly carbon-constrained world; this is where the industry can communicate awareness of these challenges and provide disclosures that clearly set out the benefits of their proposition as more viable assets. For instance, some renewable energy companies are producing TCFD (Taskforce for Climate-related Financial Disclosures) reporting and showcasing their negative direct emissions impacts22.
Creating an effective climate risk mitigation plan is not impossible, and renewable energy companies have the potential to play a leading role in conversations with the whole value chain, for example by leading discussions around evaluating and improving ESG impacts from their suppliers. While lithium supplies look relatively robust for the future (although its own issues can be found in our Mining Risk Review, published in September 202023), cobalt demand is sourced in large part (64%) from the Democratic Republic of Congo, a region at the heart of concerns around military conflict and human rights24. No industry is immune from its supply chain, and reputation risks around being a responsible business will go hand in hand with the ESG trend. This is where trusted partnerships to enhance research and development will become business essential.
Liability risks include those that arise from parties who have suffered loss or harm due to climate change and seek to recover damages from those who they view as responsible. These risks could arise from a failure to adapt, mitigate or disclose the financial risks from climate change. As highlighted by Margaret-Ann, there are over 1,800 climate laws and policies which are increasingly viewed as a tool to influence policy outcomes and corporate behaviour25. While the renewables sector looks to shift towards climate progressive solutions, each subsector can hold their own risks and complexities.
Within Wind, Offshore and Onshore, environmental damage can range from construction and operation to liabilities from property damages and bodily injuries26; as yet, the decommissioning risks for early and subsumed technologies have not been tested27. While liability risks can be passed to insurance firms - if policies allow - and the market capacity is there, damage to reputation and subsequent uninsurable claims could be significant. With increasing interest for climate-related disclosure reporting from investors, the renewable sectors can be proactive and demonstrate a lower comparative risk and diversification point. As regulatory and legal frameworks adapt, litigation risk may benefit from much greater attention.
In many ways, these risks are not new per se; they translate into existing categories of financial risk such as credit, market, business, operation and legal risks that risk managers have been managing effectively for many years. For example, physical risks, such as storms or droughts, can lead to operational risks in the form of risks to key infrastructure, such as ice on turbine blades or lack of rain to clean solar panels reducing operational efficiency, or even causing damage if it falls as hail28.
But as new sources of financial risk, they do present new challenges, not least a more extensive modelling of the natural world and developing a much more granular understanding of the transition to a ‘net zero’ future (see Figure 1 earlier in this article for more details). That’s one of the reasons why Willis Towers Watson is now working in multiple sectors and geographies across the world to help clients manage and respond to ESG and climate risks.
Over the last year or two, there has been an equally important development which is only just beginning to filter into financial markets, and in turn, into the natural resources sector and through renewable energy markets.
Many of the world’s central banks and supervisors, through the Network for Greening the Financial System (NGFS)29, have upgraded their view on the financial risks from climate change. As highlighted in Figure 2 on the next page, the risks from climate change are now increasingly seen as having ‘distinct characteristics’ which means these risks need to be ‘considered and managed differently’. Key areas where questions are now being asked include:
The conversation continues to move from understanding to action. The UK’s Prudential Regulation Authority recently issued a letter to the CEOs of its regulated firms – banks and insurers – requesting that they fully embed approaches to managing the financial risks from climate change by the end of 202132. Furthermore, the Network for Greening the Financial System (NGFS) recently published a set of reference climate scenarios which support the economic case for an early and orderly low carbon transition33.
This step change in action by central banks is being matched by the private sector, with many companies already signed up to voluntary climate risk disclosure initiatives such as the Task Force on Climate-related Financial Disclosures (TCFD).
The number of organizations expressing support for the TCFD has grown more than 85% in the 15 months to October 2020, reaching over 1,500 organizations globally, including over 1,340 companies with a market capitalization of $12.6 trillion and financial institutions responsible for assets of $150 trillion34. And there’s already clear signs from multiple jurisdictions that TCFD could soon become mandatory, at least for listed companies and large asset owners35.
Some of the world’s largest investors and banks are now going further, not only disclosing risk but also committing to align their investment or loan portfolios to the ‘well below 2⁰C’ goal of the Paris Agreement on climate change36. In 2018, the Global Sustainable Investment Alliance (GSIA) estimated that ESG investments, i.e. sustainable investing, represented in excess of $30 trillion globally, with industry research suggesting that this would double in the next three years.37 The next GSIA review is due out in Q1 2021 and will be one to watch for shifts, alongside the ongoing work of the Coalition for Climate Resilient Investment (CCRI) which is chaired by Willis Towers Watson CEO John Haley. The CCRI represents the commitment of the global private financial industry, in partnership with key private and public institutions, to foster the more efficient integration of physical climate risks (PCRs) in investment decision-making39.
As the landscape continues to shift, the demands on firms in the wider economy to respond to ESG measures will only increase. And sectors such as renewable energy, that represent the future of energy and a net zero future, are likely to thrive in the face of the oncoming storm.
Climate Quantified brings together our deep weather and climate analytical experience from the (re)insurance and investment markets, our extensive academic, research and institutional investor relationships, and our multi-discipline expertise and capabilities in a fully integrated, strategic offering. Furthermore, it embodies a proactive approach to helping shape the global community’s response to climate risks. For example: through our $50 million investment in the award-winning Willis Research Network40 to support open climate and natural hazard research, insights from our Thinking Ahead Institute41 to influence change in the investment world, and our founding role, with the World Economic Forum, in the CCRI42.
We find the starting point for many clients is modelling the impact of the current physical risks from a changing climate, such as storms, floods and other extreme weather events, on an operational site-by-site basis. We’ve helped a number of clients along this journey - for example, supporting a large bank to understand its climate risk exposure on a large rail infrastructure project. This engagement focused on physical risks to assets and anticipated downtime following damage as part of creating a common asset resilience language.
Increasingly our clients are also asking them to help them identify, quantify and provide input into managing transition risks and opportunities as the 2020s start as a decade where transition accelerates, possibly exponentially across Energy, Transport, Agriculture, Manufacturing and Finance systems. This involves producing climate transition scenarios of changes in policies (e.g. carbon prices, net zero targets), technology innovation and disruption (e.g. rapid decrease in solar, wind and battery pricing), market changes (e.g. movement of finance and customer sentiment to transition and green only finance) and increasing successes in liability from lawsuits.
Modelling the likely amounts of damage or financial losses linked to future climate projections, i.e. 2030, 2050, 2100, and under different climate scenarios, can help to make the impacts of possible future climate change more tangible. Knowledge fosters understanding, and then action. This might include modelling flooding risks to electric substations43 to estimate potential business interruption, or the impacts of extreme weather on the construction and ongoing maintenance of different types of turbines44 and solar panels45 – issues that can move from operational concerns to strategic imperatives.
Through this type of climate risk assessment, your company will also be much better prepared to respond to increasing expectations of consumers, lenders and investors around climate disclosures, and to guide future planning, risk management and strategy.
Risk managers are uniquely placed to ensure their companies are prepared to meet the increasing expectations of disclosure by investors and regulators, embed climate risk into existing frameworks and ensure Boards are taking a strategic approach.
Transitioning to low-carbon energy technology and considering sustainability in a holistic way represents a tangible opportunity for market differentiation and talent acquisition, and the renewable energy sector can take advantage of uncertainty to bring in longstanding workers whose knowledge can support the long-term management and processing of assets. There are roles for everyone, and risk managers have a unique opportunity to facilitate them in key areas, including:
Having a solid understanding within the business will not only prepare you for the changes that are already happening, but also those that are coming down the pipeline. By engaging with Climate QuantifiedTM, risk managers can benefit from a structured, data driven and strategic approach that delivers deeper insights into ESG issues. And by being pro-active, risk managers can be far better prepared to meet the demands of their regulators, investors and Boards.
While there may be challenges ahead, the mainstreaming of ESG presents a strategic opportunity for risk professionals, particularly in the renewable energy sector. As Boards grapple with the ESG onslaught, risk managers can play a lead role, providing not only risk quantification and analysis but also insight to inform strategy in a rapidly evolving ESG landscape.
Tony Rooke is Director of Climate Transition Risk in the Climate and Resilience Hub at Willis Towers Watson in London. Tony.Rooke@willistowerswatson.com
Geoffrey Saville is Weather and Climate Risks Hub Leader for the Willis Research Network at Willis Towers Watson in London. Geoffrey.Saville@willistowerswatson.com
Lucy Stanbrough is Emerging Risks Hub Leader for the Willis Research Network at Willis Towers Watson in London. Lucy.Stanbrough@willistowerswatson.com
1 https://www.euractiv.com/section/climate-environment/news/davos-wrap-up-forum-runs-out-of-steam-as-climate-becomes-king/ 2 https://www.weforum.org/great-reset/ 3 https://www.morningstar.co.uk/uk/news/203214/do-sustainable-funds-beat-their-rivals.aspx 4 Capturing the climate factor, XDC 2020 https://uploads-ssl.webflow.com/5ddbd8f4d31f0fb0ad6f12fd/5f99aecef133db41b07e5934_Whitepaper_right_FINAL.pdf 5 https://www.whitehouse.gov/about-the-white-house/presidents/franklin-d-roosevelt/ 6 https://www.sse.com/media/km5ff0fx/sse-just-transition-strategy-final.pdf Nov, 2020 7 https://www.carbonbrief.org/coronavirus-tracking-how-the-worlds-green-recovery-plans-aim-to-cut-emissions 8 “Majority of ESG funds outperform wider market over 10 years” FT, Siobhan Riding JUNE 13 2020 https://www.ft.com/content/733ee6ff-446e-4f8b-86b2-19ef42da3824 9 https://electrek.co/2020/11/20/texas-largest-solar-project-us-samson/ 10 https://invenergy.com/news/invenergy-powers-daily-life-with-largest-solar-project-in-the-u-s 11 https://www.wsj.com/articles/pg-e-wildfires-and-the-first-climate-change-bankruptcy-11547820006 12 https://www.blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
13 https://www.blackrock.com/corporate/literature/publication/our-commitment-to-sustainability-exec-summary-en.pdf 14 https://www.ipcc.ch/sr15/ 15 https://www-axa-com.cdn.axa-contento-118412.eu/www-axa-com%2Ff5520897-b5a6-40f3-90bd-d5b1bf7f271b_climatesummit_ceospeech_va.pdf 16 https://climateactiontracker.org/global/temperatures/ 17 https://www.bankofengland.co.uk/climate-change 18 https://www.bankofengland.co.uk/speech/2015/breaking-the-tragedy-of-the-horizon-climate-change-and-financial-stability 19 https://energytransition.org/2017/06/unknown-climate-risks-for-renewable-energy-projects/ 20 https://eciu.net/news-and-events/press-releases/2020/almost-half-of-global-gdp-under-actual-or-intended-net-zero-emissions-targets 25 https://climate-laws.org/ 26 https://www.lloyds.com/~/media/files/news-and-insight/risk-insight/2020/renewables-media-items/renenergy_risksandtechnologies.pdf 27 https://www.wired.com/story/solar-panels-are-starting-to-die-leaving-behind-toxic-trash/
28 https://insuranceinsider.com/articles/129660/texas-solar-farm-faces-likely-70mn-80mn-hail-loss 29 66 central banks and supervisors and 13 observers https://www.ngfs.net/en/communique-de-presse/ngfs-publishes-first-set-climate-scenarios-forward-looking-climate-risks-assessment-alongside-user 30 https://www.bankofengland.co.uk/prudential-regulation/publication/2019/enhancing-banks-and-insurers-approaches-to-managing-the-financial-risks-from-climate-change-ss 31 https://www.bankofengland.co.uk/-/media/boe/files/speech/2020/the-road-to-glasgow-speech-by-mark-carney.pdf?la=en&hash=DCA8689207770DCBBB179CBADBE3296F7982FDF5 32 https://www.bankofengland.co.uk/prudential-regulation/letter/2020/managing-the-financial-risks-from-climate-change 33 https://www.ngfs.net/en/communique-de-presse/ngfs-publishes-first-set-climate-scenarios-forward-looking-climate-risks-assessment-alongside-user 34 https://assets.bbhub.io/company/sites/60/2020/09/2020-TCFD_Status-Report.pdf 35 For example, see the Green Finance Strategy https://greenfinanceplatform.org/national-documents/green-finance-strategy-transforming-finance-greener-future
36 See, for example, https://www.unepfi.org/net-zero-alliance/ and https://www.unepfi.org/banking/bankingprinciples/ 37 https://www.greenbiz.com/article/global-sustainable-investing-assets-surged-30-trillion-2018 38 https://www.banque-france.fr/sites/default/files/media/2019/04/17/ngfs_first_comprehensive_report_-_17042019_0.pdf 39 https://www.willistowerswatson.com/en-GB/News/2020/10/california-joins-the-coalition-for-climate-resilient-investment-to-advance-the-inclusion-of-climate 40 https://www.willistowerswatson.com/en-GB/Insights/research-programs-and-collaborations/willis-research-network 41 https://www.thinkingaheadinstitute.org/ 42 https://www.willistowerswatson.com/en-GB/Insights/trending-topics/climate-risk-and-resilience 43 http://www.resccue.eu/sites/default/files/sustainability-12-01527-v3.pdf 44 https://www.vwrm.rw.fau.de/files/2016/05/Wind_Insurance_2016-02-18_WP.pdf 45 https://webstore.iea.org/download/direct/2999
