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An uncertain climate for business: from risk to resilience

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​According to Andrew Auty, an expert in liability advice from Re: Liability (Oxford) Ltd, the classical approach to risk management cannot cope with the uncertainties of predicting variations in the weather that we face as a consequence of climate change. Instead, a resilience-management model may be the better way forward, if as yet an unfamiliar one.


Public life is generally goal-centred; knowing what to do today means knowing what we’re doing tomorrow. And, of course, the actions we take are bound up with the state of the world we inhabit. If there are large doubts about the future state of the world, then it becomes very difficult to make decisions in the here and now.

In the face of such uncertainty, how do we know what we decide to do is right? Climate change is a particularly complex problem of uncertainty, cutting across – or uniting – economic, environmental and political divides. Andrew Auty, director of Re: Liability (Oxford), explains that when it comes to the boardroom, one of the effects of uncertainty is that “action is often deferred until a convincing narrative can be adopted or factual certainty obtained.

“For example, the science behind climate change (questions like ‘is it happening, how quickly, what impacts?’) may be uncertain; but what can be certain is a country’s political determination to switch away from fossil fuels to renewables. This narrative can take the form of pledging greater investment in renewables and providing business with a more certain financial environment to make decisions.”

Climate change in a nutshell
Fundamentally, climate change is about rising temperatures driven by the effects of increased quantities of greenhouse gases (carbon dioxide being the major culprit) released into the atmosphere. Sources for these greenhouse gases are at the heart of modern, global, industrial production, with an intensive use of fossil fuels. It doesn’t matter where the gases originate from: when it comes to climate change the atmosphere has no borders; every local emission is already global.

Andrew Auty explains that “there is no doubt that sea surface temperature (SST) and global average surface temperature (GAST) are on an upward trajectory”. He explains that “higher temperatures in the lower atmosphere and in the sea surface mean that more energy is stored there”. This increase in energy has to go somewhere and various mechanisms to redistribute energy will respond, whether greater water vapour and rain, or higher winds. The responses of the weather systems can be qualitatively predicted.

Of course the earth’s weather systems are extremely complex and interconnected through complicated feedback mechanisms. Those responsible for modelling changes to the weather struggle to share predictions and even when “several modellers more or less agree with each other, it is not the same as saying they are right”, he continues.

For the moment there are general predictions that sea levels will continue to rise with increasing sea temperatures and that some places will have more rain. More specific predictions at a local, national or even regional level are incredibly difficult.

But we should not forget that we also see – if we know what to look for – the future in the present. “Any signs of climate-related impact happening right now would be essential knowledge for decision-makers.

If effects are already apparent, just imagine how much bigger they will be in 2070,” explains Andrew. Gathering evidence on climate change to bolster our predictions and models requires a detective-like attention to detail and politicians’ grasp of the interconnectedness of events.

Climate change today
One of the predictions of climate change is that storms are expected to be more frequent and more intense. Andrew notes that we can already see the impact of such events. “In Europe, the biggest single flood-event losses since 1900 have been monetised in terms of a percentage of 2010 GDP of European countries. It is unusual for such an event to exceed 0.8% of GDP. Events of around 0.5% happen once every 100 years. This is not usually enough to tip an economy into recession, but it is a significant event.”

We have to beware of simple readings when it comes to the frequency and economic impact of events like storms. Greater economic losses due to storms can be simply a reflection of the greater economic development of the country or region in the form of infrastructure, etc. Andrew explains that there is a certain amount of special pleading to highlight the impacts of climate change and its certainty, whether in the form of “flood defence workers, remediation services, and insurance products”.

Predicting the future from the present is a special art. For him,  uncertainty remains, no matter what the various modellers are saying. He thinks it will be another 30 years before we can say what is happening with more certainty. The problem then of course is that it may be too late. “If the predictions are right, it would be good to have done something about it before then. If wrong, then let’s hope they didn’t waste taxpayers money.”

This still leaves us in the present, full of uncertainty and the need for business and political leaders to make decisions about where to invest, what to build or where to expand.

Options
When a government is looking to introduce new laws it usually assesses three options: do nothing, do the minimum or go the whole way. Though the science about greenhouse gases is pretty certain, its influence on our complex weather systems is not.

The models that have been created to map the future or the data produced to show our current state compared to past times (whether in terms of temperature, floods, economic destruction due to weather events), also have questions hanging over them. Some in government or in business would plum for the ‘do nothing’ option (or even go further by undoing previous advances); others will try to introduce some kind of cap on emissions; others will go for a quick and wholesale shift away from fossil fuels and put society onto a different economic system.

While the world waits for politicians to decide on what to do, in the face of public pressure or not, the business community must take decisions now. For Andrew the best approach to these questions of risk management is to “shift from the classical risk focus to a more enabling and immediately useful, resilience focus”. A process is resilient if, despite changes, it continues to meet its objectives.

The classical risk-focused approach
According to Andrew, “once causal uncertainty has been reduced to an acceptable level, the classical risk- management routine is: identify, evaluate, control and monitor. Causal uncertainty is transformed into managing the uncertainty in the four familiar risk management activities.”

Many scientists are convinced that climate change is happening, and for them the question moves on from causation to ‘how does this affect the weather and sea level?’ So the focus then moves to identify the scale of weather events: ‘how high will the sea rise? Will storms or droughts be worse and where it is likely to happen?’ Once these phenomena are identified, we can then evaluate whether we can nationally, regionally and locally cope with that new level of storm, flood, drought, etc. Answering this question of evaluation leads us onto what control measures we need to put in place.

There is, though, a slight problem, explains Andrew: “This framework is only really logical if the causation question has been answered in a way that leads to useful answers.

Timescale
“Projections about the effects of climate change are fairly consistent in their expectation of very slow change in probabilities, with very low curvature [i.e, it is changing slowly] and with very wide error margins.

“Obviously perspective of timescale varies considerably. For those with easily re-locatable businesses a major change in weather risk would need to be on, say, a two-year timescale if it is to test the resilience of the business. For those with a 30-year business cycle, e.g. a new refinery, change over a 15-year timeframe could be very problematic. For risk managers it usually helps if the predicted uncertainties are smaller than the predicted change. It seems that the classical approach currently fails at the ‘identify’ level of the risk management routine process.”

Andrew goes on to assert that “the risk-focused approach to climate change is not meeting the basic aim of risk management, which is to proportionately increase the chances of meeting your business objectives”.

The resilience-based approach
A resilience-based approach is more unfamiliar, asking for a richer set of data and information from past events upon which to base decisions. It is desired to get a sense of how much stress a business can take. It provides a holistic look at a business, rather than focusing on particular impacts from particular causes.

In an example of whether to build more flood defences or move location, the risk manager will “know how high his defences are and he knows how much it would cost to upgrade them. He knows how valuable the protected assets are and how much return on those assets he needs to make and over how many years.”

The risk-manager’s question to the resilience modeller will be “how long will it be before a two-day flood event exceeds the known maximum to date by 40cm? What is the probability that this will be less than 10 years from now? Probabilities must be stated to within a 5% margin of error.”

If the probability that the flood event will be less than 10 years into the future is greater than, for example, 20%, then the pre-defined options are: start to abandon the protected site or reduce the value of the assets. An estimate of around 20% ± 5% margin of error would be informative and allow for the business to take certain actions. If the margin of error was 20% or more (i.e. the estimate was 20% ± 20%), then there is still too much uncertainty to justify dramatic changes like abandoning the protected site. Unfortunately, the margin for error in climate modelling is at around the same scale as the size of the predicated change, often larger.

The operation of any business can be measured by how resilient it is, and of course how resilient a business is depends on what it is resilient to. When it comes to the impact of climate change, the kind of timescales involved in the business – for example, capital projects extending years into the future – would be a relevant measure of resilience to climate change impacts; where a business with short-term projects would be less affected in this instance.

More specifically, higher indoor temperatures can cause computer server failures, and in turn this is most relevant for those businesses where there are greater transaction volumes or greater use of electronic data.

Other impacts could be transport interruptions that cause a loss of sales and productivity, and again, how much a business depends on transport is a measure of its resilience.

Evaluation and responses
As Andrew explains “the key to managing the risk is to identify the appropriate measure of resilience and quantify how much change there would need to be before resilience is challenged. Then, if not currently resilient, what can proportionately be done about it?”

He goes on to explain that “the chosen measure of resilience has the great advantage that it applies to all the ways in which the business can be affected, not just those related to weather. As well as flood, stock could be lost to fire, theft and being substandard, for example.”

Options for managing resilience risk
Andrew thinks that the current response is “by-and-large acceptance of climate change: do nothing. Retention, e.g. setting aside a reserve supply of a key component, would tie up capital, but this would be reversible. The most flexible response is risk transfer through contractual relationships or insurance. Flexibility is a reasonable response to uncertain risks.”

Modelling the future
There are good signs that this approach to risk will be more widely adopted. Andrew says: “Government agencies are beginning to assist with the resilience-focused approach to risk management. For example, water supply resilience has recently been mapped at a European level. The European Environmental Agency report 12/2012, Climate change, impacts and vulnerability in Europe, analyses water availability, flood, heat wave, wind storm, etc. on the basis of regional resilience.

“Where the business chain includes a water-dependent product, then resilience of the chain will be weaker in areas that have been designated as severe in terms of annual water stress.”

The problem for the standard risk-based approach to climate change is that uncertainties around weather events are still too large to meet the needs of decision makers. For Andrew, “adopting a resilience-based approach means that managers armed with business-relevant measures of resilience can assess whether or not the business is resilient to known weather conditions and, if not, how much to invest.”

In conclusion he hopes that one day climate modelling will become more precise to be useful but until then he recommends a resilience-risk management as “an attractive option with immediate benefits to business”.

Some appropriate measures of resilience

  • Length of time that an asset must remain viable/operable. This would be several years for high capital projects, depending on the rate of repayment. Plus or minus one year would normally be precise enough. For a free toy that you provide with a meal, 20 minutes from exchange would usually be enough for operability
  • Number of days of down time that can be coped with. Total business shutdown, single operating unit, etc; each would have a different resilience threshold and precision
  • Number of product units that can be rendered valueless. Gradual loss would have a different resilience threshold than would sudden loss
  • Accuracy of factual communication. An annual accounting error of 0.1% would usually not kill anyone. Misspecifying a building design project could be fatal
  • Delivery delays. Fresh food that misses the boat by one minute is as valueless as missing it by three days. Target date and time would usually have a resilience factor already built in.

 

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