Infrastructure plays a crucial role in the global economy and is instrumental to efficient production, transport and trade that all spur economic growth.1 To fund this growth, projects must be financially attractive after accounting for risks to gain private sector interest.
This global investment firm has a large portion of its portfolio focused on infrastructure, including renewable energy projects and communications networks. The CEO of the firm strongly believes that climate risk is investment risk, given the increasing frequency and severity of climate-related events that are negatively impacting assets around the world. He wanted to put in place a standard approach for all teams across the firm to assess physical risks from climate hazards − such as flooding, storm surges and wind damage from hurricanes − as part of the regular due diligence process for infrastructure investments. Having more clarity on potential exposures would help the firm zero in on attractive undertakings and suitable investment timeframes.
This global investment firm does not have a separate sustainability function since the CEO strongly believes that climate risk is investment risk and should be understood by all. To develop a standard approach for assessing potential physical hazards, he wanted to find a reputable firm that could help his teams:
- Identify a range of physical risks in different locations across the world.
- Evaluate how these risks could increase operational costs of an infrastructure project or result in damages that would require expenditures for repair.
- Express the risks as a financial impact for different types of projects and locations
- Use a ‘self-serve’ capability to run the analysis on their own as needed.
The value of infrastructure projects can be significantly impacted by a wide range of chronic climate hazards, underscoring the importance of looking at climate risk as an investment risk.
The CEO had heard that The Climate Service (“TCS”) had a cutting-edge solution in this area and made contact to learn more about its capabilities. TCS explained that the company had recently been acquired by S&P Global and was now part of its Sustainable1 division, further enhancing the TCS offering. Sustainable1 brings together S&P Global’s extensive environmental, social and governance (ESG) resources to provide clients with a 360-degree view to help achieve their sustainability goals.
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TCS described its Climanomics® platform that measures physical risks in financial terms under different climate-warming scenarios. Clients can use the platform directly to evaluate a wide range of infrastructure projects, such as pipelines, oil terminals, water networks, airport terminals, communication networks and wind and solar farms.
The assessment would start with team members inputting four details for a project: (1) the specific asset type (e.g., pipeline) (2) the location, (3) the value of each associated asset, and (4) ownership.2
This last factor is important since it is the project owner who will bear the costs associated with climate hazards. These costs could impair the project’s ability to generate cash flows and extend the timeline for paying down any associated debt financing, resulting in material risk for the investment firm.
With this information, the Climanomics platform would then project the impact of major hazards, including extreme temperatures, drought, coastal flooding, fluvial flooding, water stress, tropical cyclones and wildfires. This would be done in conjunction with a sophisticated analysis of the unique vulnerabilities to each asset from each hazard. For example, tropical cyclones would impact communication networks differently than pipelines.
To quantify the financial risk, it is important to determine how a hazard will affect a project in a way that is financially material. For example, how will an increase in temperature impact cooling costs or damage from a flood impact clean-up and repair costs? This will depend on the type of project and the vulnerabilities of its associated assets.
All hazards and assessments of vulnerabilities are considered for each asset in a project to model the average annual loss, which calculates the cost of damage and/ or lost revenue over time as a percentage of the project’s value. At some point, this loss could become material to the financial viability of a project. The total average annual loss is the sum of the financial impacts of all hazards. This can be disaggregated by type of hazard and, within each hazard, by type of loss. The loss data are provided for each decade out to 2100 and for four greenhouse gas (GHG) concentration scenarios.
In summary, TCS explained how these capabilities would provide the investment team with:
A rigorous screening of physical risks
TCS starts by utilizing publicly available raw climate data from sources such as NASA, the Intergovernmental Panel on Climate Change (IPCC), the National Oceanic and Atmospheric Administration (NOAA), the World Wildlife Fund HydroBASINS and much more. The data may include information on temperature and precipitation, which expert TCS scientists use to build and refine their own climate models. For example, while precipitation is important for flooding, so is topography, land use and basin area, variables that are included in TCS’s hazard models.
TCS has a growing library of proprietary impact functions that model the vulnerability of individual assets to climate-related hazards based on a wide range of factors specific to each project type.
A price on climate change
The TCS Climanomics platform quantifies physical risks in financial terms (average annual loss) that are aligned with the recommendations of the Task Force on Climate-related Financial Disclosures (TCFD).
TCS incorporates four climate scenarios based on the IPCC’s Representative Concentration Pathways (RCPs). The pathways describe different climate futures, all of which are considered possible depending on the volume of greenhouse gases emitted in the years to come.
Visualizations of insights
The Climanomics platform delivers simple charts, graphs, narrative and data for export that provide insights into the location, severity and timing of climate-related risks.
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The CEO and team members were impressed with the TCS solution and the firm decided to subscribe to the Climanomics platform. In particular, they thought they would benefit from having:
- An ability to assess a wide range of physical risks on different projects and the potential financial impacts to provide an additional lens on the attractiveness of investment opportunities.
- Outcomes across scenarios and timelines to better understand reasonable investment dollars and investment horizons.
- A hands-on capability that can be used directly by team members across the firm.
- Ongoing training and support to use the platform efficiently and stay up to date on enhancements.
- Access to renowned leaders in the climate arena, with offerings powered by a transparent methodology and rigorous science.
- A platform that is now part of S&P Global Sustainable1, an organization with extensive global data on ESG issues, the transition strategies of heavy fossil fuel-emitting sectors, private markets, infrastructure development and much more.
Team members have come to embrace the platform, as it is easy to use and the results are straightforward. All members has been trained, and the platform is used as part of the due diligence process on every investment.
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1 "Infrastructure Investment", OECD, as of May 2022 on, www.oecd.org/g20/topics/infrastructure/.
2 Large assets can be broken into smaller ones to provide a more nuanced view of risk. For example, a pipeline may be hundreds of miles long and include fuel stations. The pipeline could be structured as multiple assets in order to analyze the fueling stations separately. Everything would then be combined to look at the overall risk.