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Interview — Tim Nelson: Climate change risks is Governance 101

Governance professionals shouldn’t get hung up on climate change as a political or social issue. Instead, they should view it as a scientific issue that manifests as risk and treat it like any other risk they deal with.

That’s the advice from Tim Nelson, associate professor at Griffith University.

He says the risk management of climate change is not about taking a view of whether the science is right or wrong. It’s about considering how the risks may emerge and how you can best manage them.

According to Nelson, climate change and climate policy manifest in two types of risks.

The first is mitigation risk — the risk that the world will change as a result of governments imposing limits on emissions of greenhouse gasses. Australia is a signatory of the Paris Agreement which aims to curb climate change by keeping the global temperature rise this century well below 2 degrees Celsius above pre-industrial levels.

‘Mitigation risk could also manifest through consumers or investors making decisions to allocate capital to organisations, or consume certain types of products and services, that have different emissions profiles,’ says Nelson.

‘It’s the risk that things will effectively change the way in which any particular investment or operation looks relative to the counterfactual.’

The second risk — adaptation risk — refers to how the climate is physically changing and is a risk faced by individual businesses or participants in any real market process.

‘For example, if you were operating a shopping centre, mitigation risk could involve thinking about how the energy supply system could change as a consequence of government policy, what the impacts would be and your ability to source the lowest cost energy for your shopping centre after the change,’ says Nelson.

‘On the adaptation side, it is about thinking through whether your particular asset exists in an area that is susceptible to increased flooding or other climate change related hazards.’

Everyone is interconnected in some way through supply chains, consumers or as buyers of your services.’

When considering these risks, Nelson says you should remember that your organisation doesn’t operate in a vacuum. ‘Everyone is interconnected in some way through supply chains, consumers or as buyers of your services.’

He adds: ‘Whenever you are talking about risk, you are talking about both risk and opportunity. You are talking about the residual risk after treatment as well as the inherent risk. You are also talking about consequences and probability.’

When it comes to disclosing risks, Nelson says: ‘Probably the best framework to consider is the Task Force on Climate-related Financial Disclosures (TFCD) and how that fits alongside other disclosures. These could include the ASX Corporate Governance Council’s Corporate Governance Principles and Recommendations ‘ if not, why not’ environmental, social and corporate governance (ESG) risk provisions or just general good disclosures of risks and opportunities.

‘The TFCD framework requires you to talk about how you have assessed the risks and how you think about them in a governance sense in terms of what roles the board or the executive should play. It also requires you to document how you calculate your organisation’s inherent emissions. For example, Scope 1 might be the burning a particular type of coal or gas to generate heat. Scope 2 may be embedded emissions associated with your electricity supply.’

Nelson says once you start measuring your emissions, you can begin thinking through what your actual risks and opportunities are relative to your competitors and other participants in your industry.

‘The TFCD framework also requires you to considering using scenario analysis. But one of the biggest misconceptions about climate change is that it is easy to come to a landing on what its impact will be. The impacts will be very different for different businesses and different industries. So, the scenario analysis really requires you to demonstrate you have assessed the risks across a wide range of potential futures and where relevant, you have treatments for those risks and are disclosing what they look like.’

In addition to examining what the mitigation risks mean for your particular organisation, Nelson says it is important to consider how Australia as a sovereign entity will be affected.

That’s no easy task.

‘It is inherently difficult to forecast very long-term parameters set by governments,’ he says. ‘That involves subjectivity, not objectivity because people’s interpretations on how international negotiations on climate change in the future will go can vary widely.’

Nelson says tackling climate change risks is basically governance 101. ‘Get the right advice. Make sure you incorporate it into your strategic risk framework. Ensure you have the right decision-making matrices whereby strategy and Tier 1 risks are being considered by the board. Do your scenario analysis and communicate with your stakeholders in an effective manner.

‘The old adage that sunlight is the best disinfectant really comes to the fore here. Ultimately investors and other stakeholders are after a transparent view on how well any organisation is placed to address these risks in the future.

‘The most important thing to remember when reporting is that the report is a by-product of the effective governance and management of the risk inside the organisation. The report should not be the be all and end all. It should be an output of that effective risk management and governance framework.’

Meanwhile, Nelson says Australia has among the highest penetration of renewables of any market in the world.

‘If you look at the South Australian market, it has around 1,500 megawatts of wind currently installed and operating. That’s in a market where the peak demand is only 3,000 megawatts. If you look at the total energy that’s being supplied into South Australia, roughly half of it is now coming from renewables, both large scale wind but also distributed solar photovoltaic (PV). In the last quarter alone, Australia installed around 500 megawatts of small-scale solar PV distributed energy resources — basically, those are the types of things you see on people’s rooftops.’

Nelson adds that there is around 8,000 megawatts of new renewables currently coming into the system in Australia through projects that are either under construction or at financial close.

‘South Australia is certainly where a lot more activity has taken place historically, but we are seeing huge amounts of investments in renewable capacity from Victoria right up to Queensland as a consequence of Australia having some supportive state and commonwealth policies and also because Australia has very good solar and wind resources when you compare those internationally.’

Nelson says the cost of renewable energy has come down quite significantly over the past decade. But there are still issues to be addressed around the integration of large amounts of renewable energy into the grid.

‘Those issues present themselves in ways that require engineering solutions as well as market solutions,’ he says. ‘Entities like the Australian Energy Market Operator, which operates the market, and the Australian Energy Market Commission, which effectively sets the rules for the market, are just getting on with the job of making integration happen  in a manner that minimises costs to consumers.’

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