Climate change brings a host of other risks for businesses

This article is brought to you thanks to the collaboration of The European Sting with the World Economic Forum. Author: John Scott, Head of Sustainability Risk, Zurich Insurance Group

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It may be somewhat surprising at first glance that environmental factors do not feature among the top 10 risks named in the World Economic Forum’s 2019 Regional Risks for Doing Business Report. On deeper analysis, however, we can see that environmental risks – especially risks related to climate change – are certainly important to business leaders, not only in terms of physical threats in specific regions and countries, but also in the form of economic hazards related to climate change transition.

The report is in stark contrast with the WEF Global Risks Report, where environmental risks earn the highest ratings globally. In part, this is related to the nature of the respondents to the surveys that underpin the two reports. The World Economic Forum’s Global Risks Perceptions Survey, on which the Global Risks Report is based, is driven by the Forum’s global multi-stakeholder network, which has a broader demographic, and includes more young respondents who may naturally be more concerned about long-term risks. The Regional Risks for Doing Business Report, on the other hand, reflects the opinions of current business leaders, who are burdened with solving many short- and long-term risks.

“Extreme weather events”, “failure of climate change adaptation” and “natural catastrophes” were ranked in the top 10 risks for business leaders in East Asia and the Pacific and North America in the Regional Risks Report. This reflects the vulnerabilities of countries in these regions due to water stress, prolonged periods of drought and the increasing risk of devastating wildfires, or the more obvious physical effects of global warming such as tropical storms and flooding.

In East Asia and the Pacific, environmental risks are the leading concerns for doing business, with “natural catastrophes” and “extreme weather events” ranking first and fifth respectively. On a country basis, “natural catastrophes” were ranked first in Japan and New Zealand, while in Indonesia and the Philippines they ranked third. These results are hardly surprising, given that the broader Asia Pacific region witnessed 50% of the world’s natural disasters in 2018. These catastrophes claimed over 80% of the total global deaths through natural disasters, affected over 50 million people, and cost the region a total of $56.8 billion.

Asia Pacific not only suffers the most in terms of loss of life, but its large and highly vulnerable population make the region especially susceptible to economic losses when an extreme weather event hits. Industrialization and unplanned urbanization have led to environmental degradation, which weakens the region’s natural defences against disasters. If left unchecked, the growing frequency of climate events runs the risk of eroding East Asia and the Pacific’s economic competitiveness.

In other regions, too, business leaders are nervous about the physical risks of climate change. In the Middle East and Africa, water crises rated 7th among the top 10 risks – hardly surprising for such an arid region. Desertification of the Sahel region and in the Horn of Africa are indications of how climate change is impacting life there, along with the devastation caused by Cyclone Idai in March 2019, for which costs were estimated at over $2 billion dollars. Accordingly, in the Sub-Saharan Africa region of the report, “extreme weather events” and “natural catastrophes” topped the list in Mauritius and Mozambique.

Environmental risk continues to represent a blind spot for Africa that could hinder the economic and social progress of that region. This was highlighted in last year’s report on Climate Change and the Cost of Capital in Developing Countries by the Imperial College Centre for Climate Finance and Investment, which looked at how climate risks are incorporated into the returns of developing market sovereign bonds.

One interesting aspect of the report was the strong link shown between economic risks, such as “energy price shock”, and climate change transition risks. As countries transition to a low-carbon economy in pursuit of the Paris Agreement goals, fossil-fuel producing nations are vulnerable to price drops driven by a reduction in demand. The tension between vulnerability to the physical effects of climate change and to transition risks is felt most strongly in Canada.

The report reveals that, in Canada, business executives rated “extreme weather events” and “failure of climate-change adaptation” highly, while in the US these two risks also broke into the top 10 this year. Altered weather patterns were a factor in North America in 2018, with the “polar vortex” creating extreme low temperatures and one of the snowiest Januaries on record for the Great Lakes region, while the North American coasts experienced unusually moderate weather. Canada, specifically, is warming twice as fast as the rest of the world, with damaging impacts on physical infrastructure, coastal and northern communities, human health, ecosystems and fisheries. At the same time, however, the Canadian economy is heavily dependent on fossil fuel production in the form of crude oil, uranium and natural gas. Any global shift to renewables could strike its competitiveness hard.

This paradox is not only a Canadian problem, but also seen in other regions and countries. While certain environmental risks, such as extreme weather events and natural catastrophes, appear among the top concerns for some Latin American countries, their absence from the top regional risks to business is noticeable. Other environmental risks, such as biodiversity loss, did not appear in the top five risks for any individual economy in the region. Given the public spat between President Bolsonaro of Brazil and President Macron of France this summer, this was surprising, to say the least. Deforestation activity in the Amazon has become a matter of growing concern, both regionally and internationally. If left unattended, this could become a leading risk for many businesses around the world, as destruction of the rainforest will exacerbate threats in the form of climate change, food insecurity, health risks, trade risks, supply chain breakdown and reputational risks for business.

The paradox is also alive and well in Australia, with its coal-dominated exports, where “energy price shock” was the most highly rated business risk, compared to a region-wide ranking that placed it eighth. Australia is the only net energy exporter in the Asia Pacific region, and energy prices in Australia have remained volatile as a result of the country opening its domestic natural gas markets to international trade, along with network distribution issues and the closure of some coal-based energy sources. It’s an irony not lost on many that the carbon-intensive economy of Australia contributes to the global warming that is impacting the country in the form of drought, bush fires and damage to the Great Barrier Reef – a jewel in the crown of Australia’s tourism industry.

In South Asia, executives ranked “water crises” as the number one risk for doing business (up from fifth place last year), but also placed “energy price shock” fifth overall. It was rated the leading risk in Pakistan and Bangladesh. Water crises, meanwhile, ranked as the topmost risk in India, while it was second in Pakistan and fourth in Sri Lanka. South Asia is home to around a quarter of the global population, but has less than 5% of the world’s renewable water resources, making it one of the most water-scarce regions of the world. Additionally, its water infrastructure is underinvested by global standards, making it difficult to manage the floods and droughts that afflict the region, and which are expected to increase with climate change.

Yet, at the same time, there is rising demand for energy in South Asia as populations and economies grow. The region is a net importer of crude oil and is building coal-fired power stations, even while trying to electrify rural communities using renewable energy. The fossil-fuel sector is highly subsidized, which only exacerbates the repercussions of market price fluctuations. The leaders of South Asian nations need to get to grips with decarbonizing energy and other economically important carbon-intensive sectors as quickly as possible to mitigate greenhouse gas (GHG) emissions, help slow global warming and reduce the physical impacts of climate change on their nations.

A very clear message from the Regional Risks of Doing Business Report is that the world economy is in an incredibly fragile position. The extraordinary period of ultra-loose monetary policy since the 2008 financial crisis did not solve the problem of indebtedness, but just managed it. The symptoms of this fragile economy have become clearer this year, with lower growth and higher debt increasing the likelihood of “fiscal crises”, the most highly rated risk in the report, rising from sixth in the adjusted 2018 results. The global public finance crisis is closely related to four of the other top 10 risks about which chief executive officers are also the most worried. These include “unemployment or underemployment”, “energy price shock”, “failure of national governance” and “profound social instability”.

“Energy price shock” is the risk that is most clearly linked to transition risk, one that deeply concerns the private sector – although it is present in the responses for different reasons. In the fossil-fuel producing nations, it’s a key risk. In the Middle East and North Africa, this risk ranked first and “fiscal crises” second. Oil and gas remain primary sources of public revenue in this region, so a sharp fall in energy prices could require governments to make delicate spending adjustments, and more so when energy prices are heavily subsidized.

But it’s not only the traditional oil-based producing economies that are affected. The top moving business risk in Europe compared with 2018 is “energy price shock”, which rose eight places to become the fourth major risk, taking first place in Serbia and appearing in the top five in another 12 countries, including France and Spain. Meanwhile, the transitional costs from the region’s number-one energy source, coal, to greener energies threatens to add further burdens on energy prices. As does the ability to deliver a “just” transition, in which jobs in carbon-intensive industries are changed without bringing destitution to thousands.