Building climate resilience: Toward a practical corporate framework

Multiple authors
2023-10-03
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Floods

The views expressed are those of the authors at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.

Key points

  • Worsening physical climate risks are creating challenges and opportunities for companies in many sectors and regions.
  • Companies can potentially lower costs and increase their long-term value by becoming more resilient to climate change.
  • We propose a practical framework that can help companies apply business resilience concepts to the climate context.

The physical risks of climate change, including heat, drought, hurricanes, floods, and other perils, are rising, with widening social and economic costs that companies, governments, and consumers need to prepare for. Given the significant financial risks that climate change poses to business operations and supply chains, we believe companies have a vested interest in assessing and managing those risks. In our view, companies that build resilience can potentially increase their long-term investment value, decrease costs of capital, and fortify economic lifelines against rising climate perils.

We believe an effective, sustainable approach to managing climate risk entails adapting and building resilience to systemically prepare for increasing climate uncertainty. Adaptation refers to discrete solutions that enable households, companies, or communities to protect themselves from expected and defined physical climate changes. Adaptive solutions are financed and executed according to current projections for expected climate change, including, for example, meters of sea-level rise or the probability of a Category 5 hurricane. Climate resilience encompasses adaptation, but ultimately is broader. Resilience also includes structural transformation measures that enable entire systems to prepare for, manage, and recover from increasingly uncertain climate-related impacts over time, regardless of their eventual timing or severity.

In this paper, we describe the accelerating climate-risk environment, explain what we mean by climate resilience, and present a practical framework to help companies enhance resilience in their own operations and the broader systems in which they operate. Finally, we illustrate the practical application of this framework through case studies for an industry at the forefront of climate resilience: electric utilities.

The worsening climate-risk landscape 

Given projections of worsening physical climate risks, the need for greater climate resilience measures is clear. Average global temperature rise has accelerated over the past few decades, with no sign of slowing, and the frequency and intensity of extreme weather has increased, wreaking economic havoc. A few of countless recent examples follow:

  • In 2022, floods in Pakistan, caused by heavy monsoon rains that followed a brutal heat wave, killed nearly 1,400 people, displaced at least 33 million, caused tens of billions of dollars in damages, and threatened to severely disrupt the agricultural planting season.
  • Since 2017, the US has experienced an average of 17.8 climate events per year, each causing at least US$1 billion in damage.
  • In the EU, total economic losses from weather- and climate-related events from 1980 – 2020 were between €450 and €520 billion.
  • In 2020, flooding in Asia affected 50 million people and resulted in more than 5,000 fatalities. Estimated losses were US$238 billion in China, US$87 billion in India, and US$83 billion in Japan.4

As temperatures continue to climb, research also shows that we are edging closer and closer to “tipping points” in the Earth’s system — points beyond which small incremental changes could trigger large-scale, potentially cascading — and unstoppable — changes across our atmosphere, carbon cycles, and terrestrial, marine, and freshwater ecosystems.5 The Amazon rainforest and Arctic permafrost, for example, are massive carbon sinks, trapping hundreds of billions of tons of CO2 in soil, vegetation, and ice.6 Once a certain percentage of those areas is lost, the amount of gas released could shoot the world past the temperature targets set by the Intergovernmental Panel on Climate Change (IPCC), with existential threats to human health and well-being. 

Beyond these tipping points, scientific uncertainty jumps as well, as climate models cannot project or quantify the outcomes. Against this backdrop of increasing instability and uncertainty, the need for climate resilience becomes clear. It is not enough to mitigate or adapt to known or expected climate risks. The world will need to become more resilient to unexpected (and potentially inevitable) changes in the natural world — or risk facing economic losses on an unprecedented scale. And while the effects of biodiversity loss are beyond the scope of this paper, the connections between climate change and ecosystem viability are clear, as are the enormous potential value-chain risks to many economic sectors. Preparing for uncertainty is now part of the financial equation.

Enhancing climate resilience 

The IPCC defines climate adaptation as “the process of adjustment to actual or expected climate and its effects, in order to moderate harm or exploit beneficial opportunities.”7 The panel further distinguishes climate resilience as “the ability of a system and its component parts to anticipate, absorb, accommodate, or recover from the effects of a potentially hazardous event in a timely and efficient manner, including through the preservation, restoration, or improvement of its essential basic structures and functions.”8 This distinction is important, because as climate change worsens, uncertainty increases. In other words, adaptive measures based on current climate projections may not be enough to protect life and property. Proactive resiliency is key.

The concept of resilience emerged from ecology, engineering, and child psychology in the 1970s. It has since carried over to other fields, including international development, health care, agriculture, community planning, and disaster management. Traditionally, resilience refers to the capacity for operational continuity during an event, and recovery soon afterward. More contemporary definitions include the ability to manage change, whether gradual or abrupt; predictable or surprising. In that vein, we see climate resilience as the capacity of a system to not only minimize and recover from climate shocks, but also to learn from those shocks and transform itself in preparation for future risks.

Toward a climate-resilience framework

We modeled the resilience approach outlined in this paper on one developed by the World Business Council for Sustainable Development (WBCSD) in two white papers, “Building long-term business resilience” in 2020 and “Business climate resilience: Thriving through transformation” in 2019. The WBCSD explores how companies can establish resilience attributes, which it defines as diversity of operations, modularity, cohesion, and adaptability. While not an exhaustive list of resilience principles, we believe these concepts form a good base for discussing how companies can enhance and operationalize climate resilience.

Diversity of operations
Operational diversity — sometimes referred to as redundancy — provides a system with flexibility, including the ability to respond in multiple ways to systemic changes and shocks.9 By diversifying and creating redundancy in operations, entities may find pathways to innovative problem solving and eliminate single points of failure. Economic specialization or highly concentrated supply chains can erode operational diversification and increase risk. Companies seeking to diversify their operations can potentially do so by:

  • Establishing operations or warehouses in multiple locations
  • Maintaining a regionally diverse supply chain
  • Building redundancy into operations to be prepared in the event of climate-related stoppages
  • Diversifying revenue sources, either by geography or business activity

Modularity
Modularity is “the degree to which a system’s components can be separated and recombined.”10 Modularity requires a system to be both open and connected, with parts of a whole that can operate autonomously; ramping up production in one area, for instance, when operations in another area must be temporarily suspended. Companies can integrate modularity by: 

  • Analyzing interdependencies across the value chain and minimizing weak points that could disrupt or halt operations
  • Increasing transparency, collaboration, and interconnectedness of information among business units and value chains
  • Adopting disaster-preparedness plans to ensure seamless operations during and after a climate event

Cohesion
Cohesion refers to the extent to which a company is “likely to be founded on social cohesion and trust, to be inclusive, have strong leadership, and own a shared vision.11” Cohesion aims to deliver value for stakeholders, including consumers, employees, shareholders, local governments, and regulators. By strengthening these relationships, a company may be better able to mitigate resistance to changes intended to increase long-term value (such as the need to pass price increases on to consumers) and/or facilitate collective action in response to climate-related risks (such as the need to modernize power grids or transportation networks). Businesses can enhance cohesion by:

  • Communicating with state and local leaders about climate resiliency plans, including associated costs and contingencies
  • Providing management incentives for supporting climate-specific initiatives with external stakeholders to enhance long-term value
  • Creating a shared vision and getting buy-in from employees to reach climate resilience goals
  • Disclosing climate vulnerabilities and establishing credible climate transition plans

Adaptability
An adaptable company learns from past uncertainty and embraces innovation, increasing the potential to be a market leader on climate change. It is agile in establishing new “management and response” structures that encompass both tactical-response scenarios and shifts in strategic planning to manage climate-related risks. Companies can build adaptability by:

  • Broadening the range of climate-risk-management approaches and testing innovative or unproven ideas
  • Improving weather monitoring and gaining a better understanding of weather-event impacts on a company’s business activities
  • Creating governance structures that enable a company to regularly revisit and update climate resilience plans
  • Improving materiality assessments of longer-term climate risks and opportunities

Toward systemic climate resiliency 

Because climate change is a shared risk — not unlike a global pandemic — society will need a broad-based, systemic approach to climate resilience. While some parts of the world, most notably equatorial regions, will experience outsized effects of climate volatility, very few countries or companies are immune. In our interconnected world, businesses operate with global supply chains and governments rely on one another for food, raw materials, technology components, pharmaceutical inputs, consumer goods, and tourism. A climate crisis in one region (for example, a crop-killing heat wave in a wheat-exporting country or drought in a semiconductor manufacturing hub) will have extensive spillover effects across regions and sectors. The world is socially and economically integrated, so building systemic climate resilience is essential.

After Superstorm Sandy in 2012, a few buildings in New York City, notably the headquarters of one prominent Wall Street firm, stood out in the Manhattan skyline as still lit up and operating in the storm’s immediate aftermath. In 2018, a single waterfront home on a segment of Mexico Beach, Florida, withstood Hurricane Michael. As impressive as the resilience of these structures was in these climate events, the surrounding systems failed. Employees in the operational building could not get to work. Homeowners of houses that survived were left without a community or services. Most recently, while some Florida hospitals in the path of 2022’s Hurricane Ian avoided structural damage thanks to past investments in resilience, interruptions to local water and electricity service hampered their ability to operate following the storm. In all cases, the entities had achieved some degree of protection but suffered from a lack of systemic, community-level climate resilience.

Climate resilience case studies: Electric utilities

Electric utilities are, in many ways, the nexus for systemic climate resilience. If power-generation assets, substations, and transmission and distribution infrastructure cannot withstand the negative impacts of extreme weather and climate events, the consumers that rely on them suffer. During power outages or rolling blackouts, homes, businesses, and local governments (including emergency services), may be unable to function normally. Entities may be unable to run air conditioning during a heat wave or power water pumps during wildfires. Utilities — and the grids they operate on — will need to be able to function reliably and continuously during climate events, particularly when electricity loads spike. Innovations in energy storage and power-demand management will be key. In this section, we outline examples of electric utilities’ climate challenges and how the application of a climate-resilience framework could improve outcomes.

Modularity: Lessons from the first climate bankruptcy
In one of the most widely publicized examples of climate-related financial losses, Pacific Gas & Electric (PG&E), a power company based in California, was forced to file for bankruptcy because of its role in local wildfires. In November 2018, with fire conditions high, heavy winds threatened to topple PG&E’s aging power poles and ignite the dry forest floor below. The utility weighed issuing mandatory blackouts, known as public safety power shutoffs (PSPS), for 250,000 people in 19 counties. Fearing reprisals from angry customers, officials kept the power on. The wildfires caused US$30 billion in damages, destroyed entire towns, and killed more than 80 people. The California Department of Fire and Forestry Protection accused the company of failing to properly maintain and safeguard power lines, which exacerbated the fires. A federal judge concurred, and the company filed for bankruptcy in 2019.

In the ensuing years, PG&E and other California power companies improved fire-detection management, began undergrounding power lines, and modularized power shutoff systems. By sectionalizing power circuits, the utilities can issue PSPS for more targeted population segments, causing smaller, shorter service disruptions and keeping more customers safely up and running during a crisis.

Paradise fire

Paradise, California, following wildfires in 2018

Diversity of operations: Texas power grid shutdown
When temperatures plummeted to record lows across much of Texas in February 2021, the state’s power sector shut down. The Electric Reliability Council of Texas (ERCOT) carries 90% of Texas’s electricity load and serves more than 25 million households and businesses. During the extreme cold snap, liquid natural gas froze in non-insulated pipes and wind turbines iced over, ceasing to function. The resulting power outages deprived 4.5 million homes of heat and electricity for nearly a week. The deaths of 57 people across 25 counties are blamed on the crisis, and the state suffered an estimated US$195 billion in infrastructure damage. 

The lack of operational diversity in Texas’s standalone energy grid may also have contributed to its resilience challenges. Most power plants in the state rely on natural gas, supplies of which were reduced by as much as 50% during the storm. Electricity generators were unable to produce enough power (or tap other energy sources), exacerbating the crisis. Amid rising climate volatility, Texas, like many other states, will need to diversify its power sources and harden its electricity generation and transmission infrastructure.

Modularity: Energy storage provides crucial backup power
In July 2022, a major European utility opened a large pumped-storage hydroelectric facility in Portugal. The new plant can store energy equivalent to that consumed by 11 million households during a 24-hour period. The company is also building wind turbine complexes that will be linked to the storage facility, creating a hybrid, modular power plant. Incorporating energy storage into its renewable power sources enables this company to manage supply and demand fluctuations across hydro and wind, depending on the availability of both resources. The result is a more resilient system that can operate regardless of conditions such as drought or heat.

Cohesion: Preparing for second-order risks
Hardening of electric grids is a climate-resilience imperative. Merely adapting a utility’s assets is not enough. Despite spending nearly US$3 billion adapting its operations for climate change, Florida’s largest utility, NextEra’s Florida Power & Light Company, was unable to prevent widespread blackouts during Hurricane Irma in 2017. At peak load, 62% of the state’s customers lost power. A report from the Florida Public Service Commission concluded that the leading cause of outages during the event was “fallen trees or branches that were outside of the utilities’ rights of way and where utilities typically do not have a legal access to perform vegetation management.”12

Ironically, while climate adaptation projects typically involve efforts to protect facilities from weather impacts, including hurricane-force winds, the company had not accounted for the impacts of trees felled by high winds. This example exemplifies the need for cohesion, as a pillar of resilience. Had the utility engaged the stakeholders responsible for vegetation management in their service areas, the grid resilience might have been assured, keeping millions of customers safer and more comfortable during the storm. Notably, efforts over the past several years by Florida’s utilities to upgrade transmission infrastructure and improve or bury distribution lines may have prevented worse damage and power outages in the wake of Hurricane Ian.

Irma branches

Vegetation caused power outages in Florida during Hurricane Irma

Adaptability: Instituting climate governance
To build resilience, many electric utilities have created governance structures aimed at formalizing climate-specific leadership roles and responsibilities, creating policies and risk-management systems, and guiding climate-related decision making. One large US electric utility consortium has charged its board’s corporate governance committee with overseeing annual reviews of the company’s performance associated with extreme weather and resiliency. The company has also instituted a climate policy to formalize its approach to enhancing systemic climate resilience. To engage and empower employees on this mission, the company has partnered with an industry association to pilot climate change training with its infrastructure engineers and to solicit feedback from other workers on how to tailor extreme-weather training to various jobs.

Conclusion 

According to the WBCSD, “Climate risk is something we all face, no matter our geography, sector, or socioeconomic status. It is global in nature and will impact every single one of us in one way or another. Taking the appropriate steps to prepare and adapt will be critical for any business who wants to continue operating past 2050.”13 In addition to working with climate scientists at Woodwell Climate Research Center to study the effects of physical climate risks on financial markets, Wellington’s Climate Research Team frequently contributes to engagements with company boards and management teams. We believe business leaders need greater appreciation of the financial risks posed by climate change to their operations and supply chains. 

In our view, it is in companies’ best long-term financial interests to pursue robust climate resilience and establish credible, science-based transition plans. If more companies embrace the growing momentum to reduce greenhouse gas emissions at a pace and scale that exceeds current trends and pledged reductions, global resilience to climate risks may be attainable. A resilience framework that may offer practical guidance for companies seeking to enhance resilience of their own business model and the broader system in which they operate includes combining the concepts of diversity of operations, modularity, cohesion, and adaptability. 

Building climate resilience will require a holistic, systemic approach. Companies should consider their own operations and how they influence the systems in which they function, including communities, industries, and supply chains. As the WBCSD puts it, “To better prepare for future shocks, businesses must change and extend their view of long-term resilience. Critically, they must accept that a company’s resilience is not limited to what’s inside its four walls, but also encompasses ecosystems, communities, economies, the rule of law, effective governance and governments, and more.”14

1“’Very dire’: Devastated by floods, Pakistan faces looming food crisis,” New York Times, 11 September 2022. | 2US National Oceanic and Atmospheric Administration data. | 3“Economic losses and fatalities from weather- and climate-related events in Europe,” European Environment Agency, February 2022. | 4“Weather and climate extremes in Asia killed thousands, displaced millions and cost billions in 2020,” World Meteorological Organization, 26 October 2021. | 5“Exceeding 1.5°C global warming could trigger multiple climate tipping points,” Science, 377, (2022). | 6Ibid. |7Ibid.| 8“Managing the Risks of Extreme Events and Disasters to Advance Climate Change Adaptation,” Chapter 1: Climate Change: New Dimensions in Disaster Risk, Exposure, Vulnerability, and Resilience,” IPCC, Cambridge University Press, 2012. | 9For the purposes of this paper, we will use companies as a proxy for “systems,” when discussing resilience. | 10“Building long-term business resilience,” WBCSD, September 2020. | 11Ibid.| 12“Review of Florida’s Electric Utility Hurricane Preparedness and Restoration Actions: 2018,” Florida Public Service Commission, July 2018. | 13“Business climate resilience,” WBCSD, September 2019.| 14Ibid.

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