For the energy industry and its investors, the past 18 months have brought fundamental and disruptive changes. Saudi Arabia is charting a path away from oil. Solar power is now cheaper than coal in much of the world. Shell’s CFO is warning that global demand for oil could peak in as little as five years. And in late 2016, the historic Paris Climate Agreement was entered into force, including detailed national commitments to reduce greenhouse gas emissions and a first-ever global commitment to limit climate warming to below two-degrees Celsius.
For all of the above reasons, global investors are pushing energy companies to forsake ‘business as usual’ and plan for the coming low-carbon transition through the use of scenario analysis. This effort gained enormous momentum last year when investors in the U.S. and Europe worked together to call on oil companies through shareholder resolutions to assess and disclose the resilience of their portfolios in a future in which the two-degree target is achieved. These resolutions achieved the broadest mainstream shareholder support ever for U.S. climate risk resolutions, garnering a 49 percent vote at Occidental Petroleum, 41 percent at Chevron and 38 percent at ExxonMobil. Wall Street icons such as Northern Trust, State Street, HSBC, Charles Schwab, TIAA and MFS were among the supporters.
Fast forward to today. At the request of G20 nations through the Financial Stability Board, an industry-led task force led by Michael Bloomberg has created a critical risk management tool for energy companies and companies in any industry where 2-degree scenario planning matters.
The “Task Force on Climate-Related Financial Disclosures (TCFD)” has released specificrecommendations that highlight the “potential impacts of climate-related risks and opportunities on an organization’s businesses, strategies and financial planning under different potential future states (scenarios), including a two-degrees Celsius scenario.”
Although many companies already use scenario planning, questions still remain on how to conduct a two-degree scenario analysis. That’s why the TCFD and Ceres have both developed tools to help companies conduct scenario analysis and meet increasing calls for robust climate risk disclosure.
The TCFD released a Technical Supplement report to help companies better understand the need for disclosure, while Ceres teamed up with global energy expert Amy Myers Jaffe of University of California, Davis, to release a two-degree scenario framework geared specifically for oil and gas companies and investors.
Key requirements for conducting a two-degree scenario analysis include:
- Analyzing the range of potential exposures to a climate-related transition, physical risks and opportunities;
- Evaluating the effect on the company’s strategic and financial position;
- Identifying options for managing the risks and opportunities to adjust strategic and financial plans;
- Disclosing key inputs, assumptions and methodologies to investors.
As investors, analysts and other industry actors bring unprecedented pressure on companies to assess and disclose material climate risks, their efforts are sure to be bolstered by these two tools. Future market conditions may be uncertain, but energy companies now have the tools they need to evaluate risks and opportunities and create strategies for transitioning to a decarbonized world.