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Julia GroteMar 17, 2022 2:22:18 PM4 min read

Paris first

Climate Risk Management & Corporate Development

Recently, the IPPC released the 2022 climate report and showed (again) that climate risks are severe. Furthermore, the European Commission has adopted a proposal for a Directive on corporate sustainability due diligence. Companies with more than 500 employees need to ensure their business strategy is compatible with the Paris Agreement. In this article we want to show you how climate risk management influences corporate development.

Climate Risks

Climate risks consist of physical climate risks and transition risks.

Physical risk means the risk of destruction of your facilities, interruption of supply chains, interruption of your business due to physical events like floods, wildfires, heat and storms. Those risks are already present as the earth adapts slowly to rising temperatures. Global warming we face today is a result from past emissions. It is an irreversible fact that climate-related hazards do and will affect business.

Transition risk means the risk to lose revenues due to economical and regulatory changes made to fight climate change. Transition risk would be zero, if we weren’t trying to reduce physical risks in the long term. As we do, we make business models irrelevant, impossible or deficient. Fossil fueled mobility becomes deficient as the carbon prices rises, this means that related businesses like fuel pump construction will become irrelevant very soon. Bans, obviously, make it impossible to run a business in general.

Physical risks largely affect the production sector in certain regions while transition risk affects business models globally. Certainly, big corporations are facing both and require to manage them effectively. Risk management isn’t something only a risk department should work on, it needs to be incorporated in the overall strategy and should be a central component of corporate development.

Let’s design a case: The Climatonia Group

The German Company Climatonia is a globally operating seeds producer with the following affiliates. Cropta produces nitrogen fertilizer in Canada which is proven to produce greenhouse gases. Genetico is a research company for CRISPR technology based in India. Agritechno is an agri-machine manufacturer with facilities in Louisiana, U.S. and Toulouse, France. Nowadays, the biggest markets for Climatonia, Cropta and Agritechno are France, China and Brazil.

Currency volatility in Brazil and several defaults on payments have put Climatonia under severe financial pressure. The CEO wants to develop a long-term strategy for the group to avoid future sudden shocks. Besides urgent treasury and sales topics the CEO should consider climate risks to ensure sustainable returns. Which climate risk does the group face?

Physical risks of Climatonia

Due to hurricanes the Louisiana facility of Agritechno faces an incremental physical risk. To measure the risk Agritechno needs to define the criticality (the value of the facility for the production), the probability of hurricanes in the area and the facility’s preparedness, for example the quality of the building, evacuation plans and fall-back options. Assuming the likelihood of hurricanes rises, the management should consider to either invest in preparedness or move the facility to a safer place.

Transition risks of Climatonia

In the end, every group member is affected from transition in multiple ways, but some are more influenced compared to others. Cropta’s business model is the production of nitrogen fertilizer. Nitrogen fertilizer leads to a significant share in greenhouse gas emissions. It is possible that it will be banned at some point to achieve Paris’ climate goals. The mere possibility of a ban and the bad reputation of the fertilizer industry could become a problem for Cropra’s sales division and the treasury department.

Today, Genetico’s CRISPR research doesn’t help Climatonia to enlarge the seeds business in Europe, because genetically modified crops are effectively prohibited in EU countries. CRISPR can make plans more resistant against pests and droughts, thus reduces the need for fertilizer. The EU Commission wants to reduce greenhouse gas in agriculture and plans to propose a legal framework for technologies like CRISPR by mid of 2023. This would affect Genetico and Climatonia positively while reducing demand for Cropta fertilizer.
Furthermore, a rising carbon price will raise shipping costs for Agritechno significantly. Facilities in Toulouse and Louisiana on one hand, and markets in China and Brazil on the other hand shipping costs are fundamental for Agritechno’s profitability. A strategic consequence could be to move the facilities to China and Brazil while establishing service as the main business model in the U.S.

Conclusion

As you can see the most obvious climate risks the group faces already have a huge impact on successful corporate development. Maybe Climatonia should sell Cropta, maybe it should reallocate Agritechno’s facilities. These aren’t easy decisions to make. That’s why it is crucial to address climate risks at top-level management as soon as possible and prioritize Paris first.

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