How to master the art of climate scenario analysis for business planning

Climate scenario analysis is used to help organisations develop a more comprehensive and robust climate-ready business strategy. In this article, we’ll explore the what, why, who and how of climate scenario analysis (CSA) and provide insights into available scenarios, selection factors to consider and, most importantly, what the scenario outcomes mean and how to use them for strategy development. 

What is climate scenario analysis? 

Climate scenario analysis is an important tool used for exploring, assessing, and preparing for climate-related issues. It entails examining how future changes in our climate could impact your business operations, finances, markets, and supply chains in order to mitigate the impacts and build resilience. 

Scenario analysis is not new. It’s been used by organisations as part of strategic business planning for decades and is about preparing for the long term. What is new(er) is the use of scenario analysis specifically for climate-related risks and opportunities. This means looking at plausible future climate scenarios and assessing how these situations may impact your organisation, how resilient it would be and what you can do to enhance resilience by mitigating  risks and taking advantage of any opportunities.

Climate-related issues can be split into two main types: physical and transition. 

• Physical risks and opportunities focus on the environmental impacts from climate change such as extreme weather events. For example, a physical risk could be the inability to operate machinery in extreme heat. Whereas an opportunity could be developing innovative solutions to protect coastal cities from sea-level rise and flooding
   
• Transition risks and opportunities look at the technological, political, legal, market and economic changes required to reach a low carbon economy. A transition risk could be reputational damage from not taking climate action whereas an opportunity could be improved market positioning through the development of sustainable products and services

Recognising and addressing both risks and opportunities is crucial for businesses navigating the complexities of a changing climate. The magnitude of these risks and opportunities can be assessed through either qualitative means, involving the recognition of directional trends, and understanding broader implications, or quantitatively, by assigning numerical values to the size of the impact. 

Organisations must determine the scenarios that will best help them to strategically plan and build resilience, these can be drawn from a number of publicly available scenarios, sector specific scenarios, scenarios specific to a particular organisation or a combined approach.

A key benefit of CSA is the ability to overcome the barriers caused by the uncertainties of climate change, because its likelihood and severity can be easily influenced by multiple factors, such as the urgency/magnitude of global climate action, changes in population growth and other socio-economic and geo-political factors. The aim is to stress test your organisation under these scenarios and to understand what the impacts might be so that some level of preparation can be made. It’s all about ‘what if?’.

Why should businesses conduct climate scenario analysis?

Business resilience

CSA serves as a crucial tool in informing strategy and business planning, allowing organisations to manage risks, optimise opportunities, and evaluate the potential impact on their operations. 

Regulatory readiness

The increasing emphasis on climate-related disclosures, both voluntary and mandatory, underscores the importance of scenario analysis and the evaluation of risks and opportunities under short-, medium- and long-term timelines. The objective is to both inform and strengthen the business strategy internally and to provide important decision-making information for investors externally.

The Task Force for Climate-related Financial Disclosures (TCFD) does not require companies to report quantitatively on climate risks and opportunities, but it is encouraged. However, many companies that will fall under the scope of the EU Corporate Sustainability Reporting Directive (CSRD) and UK Climate-related Financial Disclosures (CFD) regulations, will be required to quantify the financial impacts for material risks and opportunities.

Enhancing reputation 

Embracing CSA demonstrates a proactive approach to climate strategy, and signals a commitment to addressing the longer-term challenges of a changing climate.

Who should be in your climate scenario analysis team?

A successful climate scenario analysis with a meaningful output hinges on effective governance that establishes a framework for organising the analysis, identifies key stakeholders, and determines the optimal means of executing it.

First, assemble a core team involving finance and risk management. Scenario analysis thrives on diverse perspectives so ensure you bring in representation across departments and functions. Include perspectives from operations, strategy, technology, procurement, as well as sustainability. Leadership teams also play a vital role in shaping and guiding the scenario analysis because of the forward-thinking role they play in business planning and strategy. An external consultant with relevant field expertise is a highly valuable addition to the team bringing experience from working with other organisations, specialist viewpoints, analysis, and an outside perspective. 

How do you conduct climate scenario analysis? 

CSA is an iterative process and will develop year on year. Before you start, it is best practice to complete a financial materiality assessment of climate-related risks and opportunities. This identifies which risks and opportunities are, or may be, financially significant to the business and provides the hotspots to focus on.

There are multiple ways to conduct scenario analysis, but they generally follow the below process. Setting a clear and transparent process at the beginning of your CSA will lay strong foundations for achieving your aims. This could include governance documents and procedures, templates, and will support the communication of CSA results later down the line.

What scenarios should businesses consider? 

There are generally three different routes for scenario selection:

1. Selecting publicly available and established scenarios
2. Creating tailored scenarios
3. Using sector specific analysis

The latter is normally a combination of the former two, resulting from a pooling of business experts within a sector to provide sector specific insights, based on reputable and publicly available scenarios.

To ensure the analysis is practical and relevant, organisations should tailor their selected scenarios to their unique business context, considering factors like industry, geography, and risk profile.  Transparency is key: disclosing the rationale behind scenario choices builds stakeholder confidence in climate resiliency planning.

There is no one-size-fits-all solution, and, for it to remain useful, you must regularly update your analysis. As the climate forecast and your business evolves, scenario analysis necessarily becomes an ongoing process, in order to not only navigate climate-related uncertainties but also to fortify your strategies against potential vulnerabilities.

What should you consider when selecting scenarios? 

Use a range of scenarios

Relying on a single scenario creates potential blind spots as it cannot capture the full spectrum of potential future climate impacts. At a minimum, the TCFD recommends considering a minimum of two scenarios to overcome climate uncertainty: 

• A scenario aligned with the Paris Agreement goals of limiting global warming to well below 2°C, preferably to 1.5°C. A widely used 1.5°C scenario is the Shared Socioeconomic Pathways (SSP) scenario SSP1-1.9, which aims to limit global warming to below 1.9°C by 2100
  
  
• A scenario reflecting the continuation of current trends ie a business as usual scenario.  This scenario anticipates a rise in global temperatures above 2°C and could even reach 3-4°C or higher by the end of the century. This scenario often aligns with the Representative Concentration Pathway (RCP) scenario RCP8.5, which represents the highest greenhouse gas emissions trajectory among the RCPs

Many organisations also use a middle ground scenario between these two.

Most scenarios do not cover both physical and transition risks well. Therefore, you may want to consider using separate scenarios to assess physical and transition risks or supplement your scenarios with data from other sources.

Align with internationally recognised scenarios

Consider using the established scenarios developed by bodies such as the Intergovernmental Panel on Climate Change (IPCC), the International Energy Agency (IEA) and the Network for Greening the Financial System (NGFS).  The scenarios should be realistic and credible, based on the best available scientific, economic, and social data and projections. Many organisations choose to align with publicly available internationally recognised scenarios as this approach fosters credibility and comparability, which is particularly important for investors who rely on such information for their portfolio assessments across companies.

Factor in the specific context of your organisation 

Tailor the chosen scenarios to your industry, geography, and risk profile to ensure the analysis is both practical and relevant. This may involve adjusting assumptions about future climate impacts, the pace of technological change, regulatory developments, or other relevant factors. They should allow for sensitivity analysis to explore how changes in key assumptions or drivers could impact the outcomes and insights of the analysis.

Disclose the rationale behind your scenario selection 

Explain why specific scenarios were chosen and how they inform your analysis and strategic decisions. Transparency gives stakeholders confidence in the process and rigor undertaken.

Update regularly

Scenario analysis is an ongoing process and climate scenarios are continually improved. Therefore, regular updates to the analysis and the assumptions that have been made are crucial as the climate landscape continues to evolve and more is understood.

What do climate scenario outcomes mean, and how can they inform your business strategy?  

Climate scenarios are not predictions of the future, they consist of a range of plausible characteristics of different futures that may occur. This is why conducting scenario analysis using a range of scenarios is extremely important, because we don’t know what the future will hold, particularly in 20, 30, or 50 years from now.

Many organisations find it helpful to set ‘triggers’ within their business strategy to ensure they are ready to act when the time comes. For example, a business which is reliant on rare earth metals may wish to consider a shadow price where the purchasing of these materials becomes impractical, and they should look for alternatives. This may be in 10 years from now, so having this integrated and acknowledged in their strategy helps to ensure this resilience is carried through business changes such as new leadership.

CSA should not be seen as a compliance tool for TCFD requirements but as a strategic asset to integrate into risk management processes to support navigating the complexities for climate change. Our experience with clients has found that CSA, when done well, helps empower organisations to better understand and prepare for a range of future conditions, ensuring sustainability and resilience in times of uncertainty and transition. By embracing sector-specific considerations, integrating advanced methodologies, and addressing regulatory requirements, climate scenario analysis can become a competitive advantage for business planning, helping companies to convert climate risks into opportunities for innovation and growth. 

How can I get support with climate scenario analysis?

Ricardo’s team of ESG and climate risk experts can support you through the whole process of climate risk analysis from conducting an initial materiality assessments through selecting the most effective scenarios to gathering data and exploring how the scenario outcomes can enhance your business strategy. We are also able to support with all aspects of ESG reporting including CSRD, CFD, TCFD and more.

• Download our checklist checklist of factors to consider when selecting scenarios to use in your analysis with practical examples of scenarios used across different sectors, risks and opportunities.
• Get in touch to start a conversation about how we can help your organisation build resilience into your strategy
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