ISSUE NO. 38: LENDERS’ GUIDE TO TCFD CLIMATE CHANGE RISK ASSESSMENT APPLICATION – LESSONS LEARNED AND OUTLOOK
wo years ago, Blackrock[1] and other investors released reports citing that climate risks in assets are underpriced, and just last week the US Security and Exchange Commission[2] launched a Task Force to investigate and enforce against violation of Climate and ESG reporting rules. Leading up to this, the Task Force for Climate-Related Disclosures[3] (TCFD) and subsequently the updated version of the Equator Principles[4] (EP4) have both called for operating companies to perform climate change risk assessment (“CCRA”) to disclose the impact and likely cost to their business under various climate change scenarios. Now that these requirements are being rolled out – how are they actually being applied and what new considerations are they revealing for asset management and investment?
Our experience in applying CCRA for both physical and transition risks, has revealed lessons about the benefits and challenges that may help guide investors and industries alike in risk and strategy planning and stimulate progress in the application of CCRA for improved investment decisions.
In the table below, we summarize findings and implications from CCRA’s conducted for three assets – in the oil & gas, renewable power and mining industries.
| CROSS BORDER OIL PIPELINE, CANADA, US | RENEWABLE POWER GENERATION DEVELOPMENT, MEXICO | MINE TAILINGS MANAGEMENT DESIGN, SOUTHERN AFRICA [5] | |
|---|---|---|---|
| Physical Risk | |||
| Climate Change Hazards (based on scenario analysis following IPCC’s 4 RCPs )[6] | General scenarios of increased flooding and rain/surface flow intensity or increased drought, temperature rise would elevate risk of wildfire and habitat loss. | Increased rain intensity, extended drought, extended flooding and increased frequency and intensity of hurricanes entering southern Gulf of Mexico. | Climate models compared with IPCC’s 4 RCPs predict shift to significant increase in rainfall from 2070-2100 in the region. |
| Considerations | Pipe scouring and spill to rivers at/near water crossings, erosion of backfilled corridor, wildfire damaging facilities and impeding maintenance/emergency response. | Flooding and storm intensity impact to ethanol and associated co-gen plant. Increased flooding, drought or fire impacts success of sugar cane production needed for feedstock. | Integrity of tailings management site cover/design to prevent environmental and safety impacts of tailings facility failure. |
| Alternatives Analysis | EIS alternatives analysis did not formally consider climate change scenarios. | Pre-EP4 EIA alternatives analysis did not address climate change risk reduction alternatives. | Not performed – this was a regional study of climate change implications for mine waste management design. |
| Risk Reduction | Risk assessment performed for river crossing above indigenous group water supply considered. | Facility integrity design, crop management and fire prevention / emergency management plans. | Design cover systems to withstand increasingly likely, more-concentrated rainfall events with higher cover percolation. |
| Potential Financial Impact | Development costs of Dakota Access doubled to $7.5bn and Keystone XL tripled to $10bn due in large part to environmental opposition rooted primarily on enabling more use of high-carbon fossil fuels[7] | Minimal – additional design resiliency and feedstock option capacity/flexibility needed. | $7bn reparation agreement announced for Brumadinho dam failure impacts that Vale attributes in part to excessive rainfall, impact could swell from ongoing lawsuits. |
| Transition Risk | |||
| Considerations | Risk of shift away from fossil fuels significantly impacts project viability – risk transferred through Government of Alberta guarantee. | Increased demand and premium for bioethanol that meets California (CARB) standards foreseen over long term (demand significantly constrained during pandemic). | Significant cobalt, zinc, nickel production from this region critical feedstock for surge in demand from renewable energy, electric vehicles & batteries. |
| Potential Financial Impact | Up to $10bn development investment supporting $>70bn annual production for Alberta and an estimated 10,000 US temporary construction jobs. | Should create more demand for bioethanol as a fuel until supply/demand is overtaken by electric vehicles. | Ability to ensure resilience of full life cycle operations may be critical to region’s ability to sustainably capture value of demand surge. |
TAKEAWAYS:
- CCRA benefits from increasingly available guidance and tools for defining scenarios, modeling and predicting asset/project-specific impacts, but alternatives analysis will continue to be lacking until CCRA becomes more mainstream to strategic planning and decision-making
- Physical risk assessment reveals risk reduction measures that are generally feasible to implement and can build asset resiliency but may not have been identified without CCRA.
- Transition risks are difficult to assess, requiring deep understanding of potential technological advances, policy responses, and resulting combined impacts to the project/company. (For example, an LNG offtake contract for a new LNG terminal in Louisiana was rejected because of methane emissions concerns of Permian production – how does one assess that risk?)
- Lender expectations for CCRA are evolving and lender specific – but we expect this to become more standardized and rigorous over time.
IMPROVING APPLICATION AND VALUE OF CCRA
Based on our experience and analysis, here are some pathways to improve the application of CCRA going forward:
- Guidance on performing alternatives analysis based on CCRA will help companies build more climate-resilient projects and asset portfolios.
- TCFD and EP4 require reporting that organizations have a process for CCRA but not what results indicate for asset and project investment decisions. Building a database on both processes and anonymous results will help drive industry knowledge on how to better apply and plan for outcomes of CCRA.
- Lenders can assist by moving more aggressively toward common, rigorous and well-defined expectations for CCRA in cooperation with TCFD and other organizations.
We’re interested in hearing from you about your experience with applying CCRA to enhance the value of your investments. Contact us at info@acornintllc.com.
Acorn International delivers the expertise, solutions and assurance that global businesses need to thrive in high-risk environments amidst community opposition, environmental liabilities and shareholder activism.
[1] See https://www.blackrock.com/corporate/sustainability/committed-to-sustainability/assessing-climate-risks [2] See https://www.sec.gov/news/press-release/2021-42 [3] See recommendations at https://www.fsb-tcfd.org/recommendations/ [4] See specific CCRA guidance at https://equator-principles.com/wp-content/uploads/2020/09/CCRA_Guidance_Note_Ext_Sept_2020.pdf [5] See 2016 paper by O’Kane Consultants at http://www.okc-sk.com/new/wp-content/uploads/2017/03/Baisley-et-al-2016-Climate-change-and-mine-closure-IMWA-Conference.pdf. Other 2 examples based on Acorn International direct experience. [6] The Intergovernmental Panel on Climate Change (IPCC) produced 4 Representative Concentration Pathway (RCP) scenarios that support scenario analysis for both physical and transition risks. [7] These values are influenced by many factors and should not be considered accurate indicators of climate risk alone.
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