Simply good business sense
With climate change threatening revenue, profitability and growth, it’s time to get serious about investing in resilience, argues Ian Allison, head of climate resilience at Mott MacDonald.
There is a worldwide, exponential upward trend in disruption and losses resulting from extreme weather, affecting ever more people, ever more severely.
On the global scale the ‘beast from the east’ cold snap that hit the UK in February 2018 was minor, but productivity losses cost the economy an estimated £1bn a day.
In 2017, Hurricane Harvey displaced 30,000 people across Texas and the Gulf of Mexico. Losses are estimated at US$160bn. Harvey was only one of 16 ‘billion dollar plus’ hurricanes in 2017, for which economic losses total US$300bn.
In Asia, the 2017 cyclone season was no less severe. Infrastructure density is not as great as in the southern US, so the economic losses weren’t as eye-popping. But the human tragedy was far greater. And let’s be clear: Models and predictions confirm there is much worse to come.
Climate change is making global weather patterns more volatile, with increasingly severe and frequent extreme events, and causing sea level rise. Meanwhile, twin drivers of population growth and social development are adding new infrastructure to the asset base at a staggering rate. Globally, the need for investment in new infrastructure is estimated at US$6trn a year over the coming decades.
If left unchecked, our forecasts estimate that global losses will rise rapidly towards US$1trn per year, not only because of increasingly severe climate impacts, but because there is ever more infrastructure at risk.
Who's paying for it?
If they think about resilience at all, organisations still do so in silos, which is a barrier to achieving full resilience. Because the benefits of investing are disaggregated and, in part, intangible, organisations reasonably ask: ‘What’s the return on my investment?’ Answers lie largely in economic self-interest.
The economies of Asia Pacific and East Asia have been growing strongly – more than 6% in 2017. The Organisation for Economomic Co-operation & Development (OECD) sees no let-up in growth to 2023 and beyond. The Asian Development Bank (ADB) estimates that US$22.5trn worth of infrastructure is needed over the next 15 years in the region to service ‘business as usual’ economic and social development.
But the resiliency of that infrastructure is critically important to the effectiveness of the investment. Here’s why. Infrastructure has to provide both a defined quality of service and value for money.
To do so it depends on:
Society: Society creates demand and pays for services. It provides the workforce on which infrastructure owners and operators, and their suppliers, rely. If society is disrupted, the effects rapidly manifest in lost revenue and reduced workforce availability. Infrastructure may be as reliant for continuity on the competence and integrity within its ‘customer-side’ networks as within its own asset and supplier base.
Money: Business success hinges on the ability to obtain investment, loans and insurance. Losing access to capital makes it impossible to create new assets, enhance existing assets, or carry out essential repair and maintenance, which jeopardises the ability to respond to increasing demand, improve quality, or build resilience against potential disruption. Losing insurance cover makes it impossible to attract capital.
Policy: Infrastructure is created and managed within a policy environment shaped by legislation, regulation, standards and governance. Compliance is key to gaining a ‘license to operate’. But policy can be slow to adapt, and often lags behind social, economic and environmental agendas.
Asset system and supply chain: An asset system consists of the many discrete pieces of physical infrastructure and their component parts that collectively a business depends on. A supply chain is made up of the individual organisations that provide services, equipment and materials. The integrity and competence of these networks are essential to operational continuity, service provision, revenue and capital recirculation. There are layers of complexity and dependency, with each link in both networks having its own sub-systems and sub-chains.
Surviving climate impacts
Each of these four interdependencies is crucial to the performance of infrastructure. Yet, as in any system or process, the strength or resilience of the whole is only as great as the weakest and most vulnerable component.
A business is finely balanced between the service it provides, the policy framework that regulates and governs it, and money – access to investment, finance, funding and insurance. But the organisation’s stability is determined by factors relating to service provision.
Providing any product or service involves the management of uncertainties and risks, offset by revenue and return. Asset system and supply chain integrity are the building blocks enabling a business to effectively reduce uncertainty, mitigate those risks, and deliver that return.
When an asset system is put under stress – for example from rapid population growth and social development – quality of service can suffer, resulting in loss of revenue and reputational damage. Legislation and regulatory compliance is also likely to be compromised.
Equilibrium can be restored by more investment in the asset and systems. But investors and insurers may not extend additional financing or cover. If they do, they may impose harsher terms, or impose terms that make finance unaffordable. Often, the business or infrastructure is left stressed or degraded.
In these circumstances, the impacts resulting from climate change can add catastrophic additional pressure.
Stress is imposed by the long-term chronic effects of climate change: higher average temperatures can affect infrastructure, plants and animals, workers and customers; rising sea-level elevates risk from erosion, coastal flooding, saline intrusion into aquifers, and groundwater flooding.
Severe weather events can apply an intense shock load to already stressed and vulnerable systems, resulting in more extensive damage, service interruption and sometimes total failure.
Bad to worse?
Losses today are occurring in a world that is 1°C warmer than pre-industrial times. Our current emissions pathway takes us to more than 4°C by the end of the century.
Insurer Munich Re has been charting losses over the last 40 years. Its figures, confirmed by the World Economic Forum, show severe weather events as the greatest risk to the global economy today, with losses rising exponentially.
In 2015, in Paris, 196 signatories pledged to curb emissions of greenhouse gases, to limit climate change to 2°C or less, thus curbing the inexorable rise in physical losses. In April 2018 each signatory enacted national policy and regulation to turn their pledge into action.
Yet climate impacts will continue to worsen over coming decades due to the ‘locked-in’ effects of past and present emissions.
The financial industry has started mobilising to protect investments and shareholder returns from climate-related losses. Investors, lenders and insurers are pressuring companies, including the owners and operators of infrastructure, to play their full part in transitioning to a 2°C world. That means reducing carbon emissions to net zero by 2050, and disclosing and managing the physical risks from increasingly extreme weather events. They are threatening to withdraw support from companies that don’t move fast enough.
Extra cost but greater benefit
The $22.5trn infrastructure spend that the ADB estimates is needed over the next 15 years does not include investment in climate resilience. That increases the estimate by US$3.6trn. What will that added 16% buy?
Recent US figures demonstrate a 6:1 return from targeted investment in climate resilience. For Asia, the ADB has assessed the range between 5:1 and 11:1 when physical losses are added to co-benefits. These benefits come from:
Supporting society-wide resilience, which protects labour forces, supply chains and consumer bases, thus enabling business continuity
‘Banking’ avoided losses – ‘full resilience’ eliminates about 80% of the potential total losses that would occur under ‘do nothing’ scenarios
Eliminating uncertainty and unpredictability around when losses would have been incurred – a severe event may not strike for decades, but could equally occur every year or even several times in a year.
Investing in climate resilience doesn’t provide a steady rate of return. But over the long-term, the return is high and this provides the macroeconomic justification.
Getting the money flowing
In the USA, and many other places, there is deep frustration at state level about the approach to resilience. Federal money flows in the aftermath of a major weather event for emergency response and recovery. But funding cannot be mobilised proactively, to build resilience that would reduce losses in the first place.
One of the challenges is scale. Post-disaster clean-up costs may be big, but are localised and therefore bounded, and also shared by insurers.
By contrast, the scope of providing social and economic resilience is varied and vast. It is impractical for governments to cover the cost of protecting against multiple and diverse future events at a national scale. They do have a vital role to play, however.
In aid funded projects, donor money and low interest development bank loans are increasingly used to mobilise private sector capital. This seed investment can initiate projects, when the risks that make private sector investors nervous are greatest. After the risk profile has been reduced, or returns demonstrated, private capital may become much more forthcoming. Private investors not only bring capital but often provide commercial and operational expertise that are needed to optimise project performance for longer term returns.
While governments don’t have the capital to wholly fund resilience, they do have access to capital at lower rates of interest, and are generally well positioned to carry initial risk. With refinancing and reinvestment, the government capital can be repaid and recycled into the next resilience project, perpetuating investment.
Why should the private sector play its part?
To anyone who runs a business, there is a simple question: what could you lose? At anything close to a consolidated 6:1 return, investment in resilience is just good sense.
And without resilient communities, who will buy goods or services?
Yet, the crunch question remains: how to generate the cash?
To protect the infrastructure that is so critical to growth from the impacts of climate change, assets, systems and supply chains have to be secure. That resilience will inevitably be factored into pricing of goods and services – in the end, the consumer pays. It is not a popular principle, but it is easier to sell where GDP is strong.
The resilience dividend extends beyond simply avoiding losses. Resilient businesses, services, cities, and nations are more attractive to investment and people. It initiates a virtuous cycle, whereby better fiscal terms promote inward investment that supports economic growth and development, which enables enhanced resilience…
Seriously joined-up thinking is required to achieve this. Businesses, city authorities and national governments must assess the vulnerabilities and interdependencies in their supply chains and asset systems. And they must work with their neighbours to understand their shared vulnerabilities, even if those vulnerabilities fall outside their conventional risk management strategies.
That is the challenge and opportunity that climate change presents – to examine the complex system of systems that characterise our world today. We need to spot the weak links now – weaknesses that, when triggered, could cause a cascade of effects, harm and losses hitherto unimagined.
Building resilience to climate change calls for collaboration and co-operation on a grand scale. It will involve determination, openness, changes in thinking and behaviour, and mature conversations.
There is no real option as to whether this happens or not. The only choice, as we move towards the middle of the century, is this: to suffer loss after loss at that hands of climate change, with the ultimate prospect of business failure, or to survive and prosper.
It is a tough situation, but an easy decision.