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CERAWeek: Companies must consider physical, transition risks in shift to low-carbon world

10 March 2021 Bernadette Lee

As the world scales up its decarbonization efforts, every company needs to take into consideration physical and transition risks emanating from the shifts to a low-carbon economy, Massachusetts Institute of Technology's Sergey Paltsev told the CERAWeek by IHS Markit conference last week.

Climate risk has been amplified by a host of physical and transition risks, including those related to the COVID-19 pandemic and a more isolated world, said Paltsev, director, Energy-at-Scale Center; senior research scientist, Energy Initiative; and deputy director, Joint Program on the Science and Policy of Global Change at MIT.

"Those risks are going to affect our everyday lives. It's not only physical risks, but also risks related to damage from the climate itself such as fire, floods, droughts, sea level rises, extreme temperatures, and others. […] the scaling up of low-carbon energy is going to bring transition risks, which [result] from shifts in technological, social, and economic landscapes during the transition to a low-carbon economy," he said.

Some of the dynamics that will pose transition risks include who will be US president after Joe Biden's term ends in less than four years; whether a carbon tax will be imposed in the US; whether the world economy will be fragmented by the pandemic; and whether companies are pressured into doing business in environmentally friendly ways.

As most countries are moving toward net zero by the middle of this century, a shift which Paltsev described as "aggressive," every company is expected to face immense challenges, and every business decision will affect them in different ways and on different levels, he said.

MIT uses tools and scenario analysis to help companies understand various risks by presenting them with the big picture, which comprises different scenarios that are policy- and industry-relevant, said Paltsev. "We try to help them understand different scenarios: what are the risks related to a particular pathway, how different regions are going to affect them in different ways, and what the implications are for international trade. We try to help companies understand these issues and ensure that they have a robust strategy to deal with this new world where the rate of carbonization has accelerated quite substantially from what we had before," he said.

Companies reorienting themselves

Many companies are now in the core of their thinking about the impending tragedy should they make no effort in scaling up to decarbonization and moving to net-zero emissions, Paltsev said. Some companies have gone as far as changing their name, including Statoil, which removed the world "oil" from its name, replacing it with "Equinor." Total recently came up with a proposal to change its name to TotalEnergies.

"All of these companies are thinking about how they are going to reorient themselves. So, all of them are in the same position. If your business is in hydrocarbons, you are thinking of how to reorient your company. Some of these companies have been in existence for hundreds of years and they want to continue to be in business for hundreds of years. They are thinking about how to transition their way [forward], how this is going to happen in the future. We feel that some of these big companies need to be onboard to make this transition successful," he said.

Shell has begun to undertake steps to help it achieve net zero from its operations and those of its supplies (known as Scope 1 and Scope 2 emissions reductions).

Some of the key considerations include switching to electrification, hydrogen, and biofuels, according to Paltsev. "As a result, we need to understand better how we can electrify the society, how we clean up the grid, [while] making sure we are providing stable energy and electricity. But recent experiences showed that some companies were not prepared to take up those risks, or they haven't calculated those risks correctly," he said.

Government policies, support vital

Paltsev also pointed out the importance of government policies and support. A clear framework on how fast companies should go on their net-zero path will ensure a successful transition, he added.

Citing the financial hardship faced by electric vehicle producers worldwide during the onset of the COVID-19 pandemic as an example, Paltsev said the period demonstrated how governments' policies or inaction can have an impact on the dynamics of their net-zero initiatives.

When the COVID-19 pandemic hit, the first six months of 2020 saw a 15% decrease in the global sales of electric vehicles. The European Union and China responded by providing stimulus money and support measures, respectively, to their electric vehicle industries, reflecting their willingness to support changes to low-carbon energy strategies caused by such unforeseeable circumstances. "This again shows that when we … get out of the pandemic in a certain trajectory, we need to make sure that that trajectory is low-carbon. And we need to make sure that we are supporting that transition and yet advocating before the governments to make that transition," he said.


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