Carbon and climate change risks have moved well passed the threshold of being intangible or remote. This is especially true in the Energy & Resources (E&R) sector. Boards and executives need to be giving carbon and climate change risks due and frequent attention at the highest strategic level to enable both compliance and organisational success.

There are three carbon and climate change matters that E&R sector boards and executives should be acting on:

1. Climate change is a material and accelerating financial risk (& opportunity)

Climate change has evolved from an 'ethical', 'non-financial' issue to one that presents material financial risks (and opportunities) for the E&R sector. Expectation of governments, investors and stakeholders on standards of corporate governance and strategy are continuing to rise and change quickly.

By November 2020, 110 jurisdictions representing over half of the global economy had committed to achieve ‘net zero' greenhouse gas emissions before 2050, consistent with Paris Agreement targets. An increasing proportion of mainstream institutional investors expect investee companies to apply the governance, strategy, risk metrics and disclosure framework set out in the 2017 Recommendations of the G20 Financial Stability Board's Bloomberg Taskforce on Climate-related Financial Disclosures (TCFD). Mainstream investors are driving an uplift in expectations. These include the world's largest asset manager BlackRock and the Climate Action 100+, a group of institutional investors with membership of more than US$45 trillion funds under management. The group is committed to engaging with investee companies on climate-related financial risk and disclosure. It is clear that climate-related risks are material, foreseeable and actionable now.

As a sector with a significant value chain emissions footprint – from extraction to processing and, particularly for fossil fuels such as coal, oil and gas, downstream combustion - E&R companies are coming under increased pressure to demonstrate their strategic pathway to navigating the transition to a net zero global economy. In addition to longer-term net zero aspirations, investors are demanding short and medium-term targets that set out a credible roadmap towards that goal, and evidence of meaningful progress.

Questions for E&R boards and executives to consider:

• How does the executive team and the board remain across developments in this dynamic area that may impact on our financial performance, position and prospects? Are we receiving regular briefings, including from independent experts?
• Has the business conducted stress-testing and scenario planning of business strategies against a plausible range of climate futures – including one representing a disorderly transition to a Paris Agreement-aligned economy?
• How do we ensure that our strategy is credible and defensible, and that all internal policies and operational frameworks are consistent and aligned with a climate risk managed strategy?
• Have jurisdictions in which we do business adopted or advanced emissions reduction targets, or adjacent policies such as carbon border tariffs?

2. Past experience is not representative of future risk

Both the physical and economic transition risks associated with climate change are characterised by radical uncertainty. Such uncertainty can often paralyse strategic decision making, with companies inclined to 'kick the can down the road' until the direction of travel becomes clearer. However, the one certainty about climate change is that the physical and market landscape of the future will look very different to that of the past. Tools to assist corporate risk management in the face of uncertainty, such as stress-testing and scenario analysis, have emerged as critical inputs for diligent governance and strategic planning. Accordingly, a 'business as usual' approach, or one in which historical experience is applied as a proxy for future market conditions, can leave companies unprepared for sharp market pivots in the transition to a low carbon economy, and expose their directors and officers to claims for breach of duty. These risks are particularly acute in sectors such as E&R where projects are often characterised by high-fixed costs, multi-decadal asset lives and back-ended positive cash-flows. 

The necessity to apply a forward-looking lens has been reinforced by regulators and credit ratings agencies. In Australia, ASIC has updated its Regulatory Guidance on Operating & Financial Reviews (RG 247) and Retail Prospectuses (RG228) to include discussion on forward-looking climate risks and to incorporate the types of climate change risk disclosures recommended under the TCFD. The Australian Accounting Standards Board and Auditing and Assurance Standards Board issued joint guidance stating that climate change-related assumptions have the potential to be a material accounting estimation variable, with potential implications for E&R asset and liability valuations from mine or facility useful lives, to reserve valuations and capital maintenance provisions. Globally, credit rating agencies have added major capability in climate risk data resources and analytics to apply to their risk assessment practices, and are asking more granular questions of both sovereign and corporate issuers on their inherent exposure and strategic resilience in the transition to a low-carbon economy.

Debt markets have themselves begun to adjust their understanding of climate change in the credit risk/return calculus, overtly pricing in sustainability performance and penalising inaction. This holds even under the shorter terms associated with commercial lending time horizons, as lenders increasingly recognise the potential for near-term market shifts in the transition to a low carbon economy. Green bonds and other 'use of proceeds' facilities such as green loans are increasingly issued within the price curve of their 'vanilla' counterparts. And there has been rapid uptake of a newer form of green-labelled finance, 'sustainability-linked loans', where lenders offer margin adjustment triggers linked to the borrower's progress against agreed sustainability targets.

Questions for E&R boards and executives to consider:

• What are the climate-related 'red flags' that may impact on the reliability, accuracy or completeness of our information?
• Where might we be need to challenge a historically unquestionable assumption?
• Do we understand the range of climate-related financial risks to a project or acquisition, on a forward-looking basis? Have we considered potential impacts – from acute- and gradual-onset physical risks to our operations and distribution chains, to domestic and international policy directions, technological developments and shifts in stakeholder preferences - across our value chain?
• What is our forward-looking central case and plausible future scenarios?
• How do we expect the market to develop out to longer term horizons relevant to project life cycles? 
• How do we expect the different variables and assumptions to change over time?
• Have we considered the impact of material climate-related variables on our balance sheet accounting estimates, including on asset useful lives, fair valuation, impairments and provisions for bad and doubtful debts?
• What are the sign-posts we should monitor to trigger strategic decision-points in the face of radical uncertainty?
• How does our approach to climate change position us to lower our cost of capital?

3. Maximise value through a strategic, rather than compliance-based, approach

The trajectory of change in expectations the E&R sector faces in corporate governance of climate change has been extraordinary in the five years since the Paris Agreement was signed. And the bar set by regulators, shareholders and other market stakeholders only continues to rise.

As the transition of the global economy to a low-carbon trajectory accelerates, the imposition of emissions reduction targets, changing capital regulatory prices and carbon border targets will have significant flow on effects for the E&R sector. Litigation against companies, their directors and officers for climate-related risk management failures is no longer novel or uncommon.

A reactive, compliance-focused approach can no longer be seen as commercially – or legally – prudent. Companies in the E&R sector need to incorporate climate risk assessment into the very heart of their strategy in order to efficiently capture climate-related opportunities, and to minimise associated risks.

Questions for E&R boards and executives to consider:

• Is our approach to legislative baselines and investor demands reactive or forward looking? 
• Are internal processes, due diligence frameworks and disclosures forward-looking?
• What is our strategy to continue to thrive in the transition to a net zero economy?
• How do we ensure that our climate risk strategy is applied and integrated across all our functions – from due diligence frameworks, to procurement and contracting?

Contact us to assist you to navigate this dynamic governance, strategy and finance landscape. We can assist you with your climate risk assessment and keep you up to date with domestic and international regulatory and capital market developments.