“The numbers are stunning,” the FT’s Gillian Tett said in Aspen, Colorado, recently. “I would challenge anyone who sees them to walk away and just say, ‘whatever.’”
Gillian was reacting to a presentation I shared onstage for a panel called “Climate Breaking Points: Business Strategies to Mitigate Economic and Social Risks” at the Aspen Ideas Festival, where my firm is once again serving as Knowledge Partner. We were joined by Prudential Retirement President and CEO Phil Waldeck and Cameron Hepburn, Professor of Environmental Economics, and Director of the Smith School of Enterprise and the Environment, University of Oxford.
My presentation made the case for two climate-related actions: decarbonization and climate resiliency. Talking with Phil, Cameron, and Gillian—as well as hearing from several festival attendees—gave me fresh perspective on what may be the most critical challenge facing businesses around the world today.
As I look back on the session, I wanted to share some of my reflections. (You can read Gillian’s reflections on the panel here.)
Understanding the full business impact of climate change
Business leaders must realize that their decisions over the next decade are absolutely critical to reversing climate change. Gillian jokingly suggested that it could be accountants who ultimately move the world on this issue, not scientists or politicians. Kidding aside, she could be right. Business leaders will need access to the best available data, forecasting techniques, and risk analytics to make informed decisions—ones that weigh sustainability goals against business objectives.
But right now, as Cameron put it, the reality is that “there’s not enough of information getting into the right decision makers’ hands.” Many people I speak to about this topic are preoccupied with the cost of enacting all these climate-related business changes. I always point out that businesses are already facing huge financial losses due to climate risks, and these losses will only get bigger as the frequency and severity of extreme weather events increase.
For example, McKinsey’s assessment of the financial records of ten large power utilities in seven states where hurricanes are common shows that over a 20-year period a typical utility saw $1.4 billion in storm-damage costs and lost significant revenues due to storm outages. But it’s not only utilities that are affected by power outages: homes, small businesses, schools, hospitals, and public safety institutions are all impacted.
Power outages are just one costly consequence of severe weather. In the US, average home prices in areas prone to flooding, hurricanes, and wildfires have fallen by the wayside in comparison with those in lower-risk areas. In fact, homes in exposed areas are worth less today, on average, than they were a decade ago. There are voices arguing that the full amount of risk still isn’t priced in.
“Effectively, for investors, this is debt that we’re exposed to,” said Phil. “And the volume of that exposure can have an impact on the will of people to act. There’s a word for this: it’s called leverage.”
What companies are already doing—and is it enough?
To address climate change, there are two types of actions stakeholders need to take: (1) decisive decarbonization to avoid long-term consequences and (2) immediate risk mitigation to act on near-term consequences that are already “locked in” and unavoidable.
In Aspen, I focused on unavoidable next-decade consequences. In our utilities research, we found that taking extra resiliency measures is cost effective. We estimate it would take $700 million to $1 billion for a typical Southeastern US utility to prepare for impacts related to climate change. That is less than current 20-year storm costs of $1.4 billion and much less than the projected future storm costs of $1.7 billion. Our conclusion is that it pays to prepare for extreme weather.
We also know that every dollar invested proactively in building resilient infrastructure saves $6 in future repair costs, according to the Institute for Building Sciences. Asset owners should answer fundamental questions about localized risks and be prepared to modify existing codes to meet their specific needs.
What companies need more of is three things: a comprehensive risk identification, based on the latest climate modeling data and proper understanding of vulnerabilities; a quantification of expected first- and second-order impacts on their businesses; and a set of resiliency measures and a holistic risk management strategy, to defuse or reduce the expected impact of those risks.
Do we have the capital required to deal with climate risk?
We’ll need a major scale up in capital markets and capital productivity to address climate change. I made the point on Thursday that capital markets are not allocating capital efficiently, and that too much money is going into new and existing high-risk assets. In other words, we are still rewarding risky behavior.
At the same time, most companies are holding too little for resiliency and relying on the government for backstop. The truth is this: Not nearly enough capital is going into risk reduction or innovation.
Phil argued that this is in part due to the different time horizons stakeholders stakeholders face on this issue. “Our society hasn’t typically been very good at intergenerational issues,” he said. “Politicians have a time horizon that is an election cycle. For investors it’s even shorter. To what extent will people observe this and take action?”
My final point at the Aspen Ideas Festival is that economic disparities must be addressed in concert with any climate-related efforts. One audience member asked a question about developing economies, and what the outlook for progress on these issues might be there.
To be sure, developing markets need dramatically more energy services and, at the same time, have fewer resources to deal with the changing climate. While Canada, for example, may have the resources it needs to adapt and absorb climate change impacts, the story in India, whose economy relies heavily on the ability of people to work outdoors, will be different.
An extraordinary moment
Our view at McKinsey is that we can add value to this conversation by converting the climate change science to numbers with real business impact. Those numbers, as Gillian put it, are indeed stunning, and although energy outlooks do show increased investment in renewables, these numbers are otherwise not yet priced into the market.
“You have boards and companies all around the world, for example, that should understand that they have deep supply chain risks,” Cameron pointed out. “They might not think they are exposed. But the reality is that there are a lot of people exposed who don’t know they’re exposed.”
Nevertheless, people are moving. There are people and organizations, like mine, who are injecting transparency into the debate and helping organizational leaders in both the public and private sectors see that this absolutely is a critical financial and business issue right now. It’s an extraordinary moment—and one me and my colleagues are all eager to seize.