Navigating risk, climate change and the green transition
The green transition encompasses a shift away from the dominance of fossil fuels towards a sustainable and carbon neutral economy and financial system. Its priorities are a reduction in the emission of greenhouse gases, the preservation and restoration of natural ecosystems, increasing the use of renewable energy sources and the realisation of a circular economy. The green transition informs key climate policy such as the Paris Agreement, the European Union Green Deal and the African Union Climate Change and Resilient Development Strategy and Action Plan. Significant global action and cooperation towards this transition is necessary to get back on track for limiting global warming to the 1.5 degrees Celsius mark. However, global warming – and the process of moving away from a fossil-based economy – are not a simple nor riskless. Understanding the risks associated with climate change and the green transition is integral to minimising and navigating potential hurdles and turning them into opportunities.
There are two risk categoriesassociated with climate change and the green transition. Physical risks relate to the physical impact that rising temperatures will have on the natural environment and human societies. Rising sea levelswreak havoc on habitats, the erosion of coastlines and more intense and frequent natural disasters such as hurricanes and cyclones. Changes in rainfall patterns lead to both devastating floods and droughts. These consequences of climate change also impacthumanity: an increase in natural disasters leads to loss of life, damage to infrastructure and negatively affects productivity and economic outputs.However, these impacts will not be felt equally. As the Imperial College London’s Grantham Institute puts it: “people living in poverty are the least able to adapt to warming, and small changes in their income due to climate change-related events can result in overwhelming losses to welfare and livelihoods.” Efforts to mitigate the physical risks of climate change are already underway: the United States and China have invested heavily in renewable energy, with the latter being the world’s largest investor in renewables. Japan and the United Kingdom have built sea walls to protect their coastlines. The Great Green Wall aims to grow a verdant shield stretching 8,000 km across the Sahara.
On the other side of the coin is the risks associated with climate action. Transition risks are defined as “the potential costs to society of evolving to a low carbon economy to mitigate climate change.” The green transition’s focus on both moving away from a carbon-based financial system and embracing a circular economy incurs a certain level of uncertainty. Transition risk drivers include changes in public policy, market shifts and customer trends, technological advancements and new legislation and regulation. Though these risks are not always permanent, these may cause significant financial losses and increased costs for communities, institutions, businesses and countries. An example of such a risk is the development and increased popularity of electric vehicles. The sale of electric vehicles tripled between 2020 and 2022, and BloombergNEF forecasts that e-vehicles will be cheaper to produce than fuel vehicles by 2027. Whilst e-vehicles are a part of the transition away from fossil fuels, a sharp decline in the production and sale of fuel vehicles will affect big car makers, workers and economies.
When it comes to market risk, a report by the Bank For International Settlements explains the impact: “Physical and transition risks can alter or reveal new information about future economic conditions or the value of real or financial assets, resulting in downward price shocks and an increase in market volatility in traded assets.” Asset stranding is another risk. When assets lose value because they are no longer competitive or viable in a low-carbon economy, the investments that went into those assets – for example, an oil drilling platform or a coal mine – also lose their value. This will not only affect shareholders and company owners, but also the many workers and communities that rely on these assets for employment and economic benefit.
This is not to say that the transition risks are not worth the reward. Ultimately these risks are temporary, and they are a necessary risk to take to ensure a sustainable planet. However, it is important to acknowledge these risks – both physical and transition – to minimise any negative impacts and losses, especially for those living in poverty and harsh economic and social conditions.