Confronting the Energy Transition: Identifying and Addressing Physical Risks for a Sustainable Future

The tangible threat

In the final instalment of our three-part series on the Environmental, Social and Governance (ESG) aspect of transitioning to a low-carbon economy, we turn our attention to physical risks.

In the first article of our series, we explored transition risks, examining the financial and reputational challenges businesses face amid the shift to a low-carbon economy. The second article moved from risks to opportunities, showing how forward-thinking companies can capitalise on new regulations and societal shifts. Now, we focus on physical risks and the immediate and tangible impacts of climate change on business operations.

Physical risk in relation to ESG refers to changes in the physical environment that impact a business's operations. This includes the economic impacts of environmental damage to property, stock and industry supply chains. Such risks pose a substantial threat to the long-term viability of many sectors, significantly impacting how businesses will allocate and invest their financial resources.

As global warming continues to be the largest physical threat to businesses' sustainability, the frequency of extreme weather events will escalate, demanding effective climate risk management. Understanding your carbon footprint and recognising the risks and opportunities are essential. This requires a forward-looking industry analysis that assesses vulnerabilities to both physical and transition-related climate risks.

Types of physical risks

Physical risk can take many forms and affect various aspects of day-to-day business. The most common forms of this risk throughout the year are heatwaves and storms, which usually only cause minor damage to stock and physical property.

More extreme weather events (like flash flooding, bushfires, heatwaves and cyclones) occur, though at a lower frequency. These extreme weather events pose a much more significant risk, often presenting a major financial threat in the way of damages. As climatic conditions get warmer over the coming years, the frequency of both extreme and common physical risk events is likely to increase substantially.

Warmer sea and air temperatures also directly and indirectly impact business operations. Some of these risks are likely faced by most businesses, while others may only impact certain areas.

Rising temperatures drive long-term climate changes, like higher sea levels caused by melting polar ice and expanding seawater. This leads to coastal erosion, more frequent flooding and lost habitats. Temperature increases also disrupt precipitation patterns, causing more severe storms, droughts and heat waves. These changes impact water resources, agriculture, and ecosystems, risking food and water shortages and threatening biodiversity.

Australian industries at risk

The impacts of global warming on Australian industries are likely to be both common and severe. Industries that rely upon these resources and stable climatic conditions will suffer at the hands of global warming. Their resources will be stretched as inputs become costlier and resources become more scarce.

More deadly and severe bushfires will wipe out livestock and crops for Australian farmers of all varieties. Water shortages caused by droughts will affect whole supply chains, depriving farmers and mines of much-needed resources and pushing up the cost of inputs for those further down the line. More frequent cyclones, flash floods and heatwaves will risk damages against all sorts of stock and physical property, coming out of the pockets of businesses and driving up insurance premiums across the board.

Despite the negative impacts on the greater economy, a minority of businesses can benefit from global warming. Industries like repair and emergency services, as well as the wider healthcare sector may see benefits in the form of greater demand and more government funding, though at the expense of others suffering. The greater frequency of extreme weather events will impact virtually every business, underscoring the importance of proactive climate risk management.

Business strategies for resilience

Businesses face future financial risks, so they must have comprehensive and proactive strategies in place to foresee and tackle the issues they will encounter. Integrating physical risk management will allow businesses to minimise future physical damages and supply chain issues. Businesses that fail to prepare face unnecessary and substantial financial risk.

Risk assessment and management

Risk assessment and management of physical risks can often be straightforward with the right approach. It’s most important to understand your exposure to extreme weather and to understand the impact that increased frequency can have on your physical business. This involves tasks like risk identification, risk assessment and adaption planning. An assessment of this kind can help foresee the necessary changes that need to be made to minimise damages.

Financial risk

Minimising financial risk can be significantly harder. This is about foreseeing exposure to risk in the supply chain and assessing how vulnerable your supply chain is to changes in inputs and damage to production capabilities. Such an analysis can have various outcomes regarding diversification strategies and input variation.

ESG innovations

Another key aspect of risk management planning involves integrating modern solutions to build resilience. This approach strengthens businesses resilience, especially in strategic areas like ESG and risk management, by allowing more accurate risk assessments and data-informed decision making. ESG frameworks can improve reporting accuracy and ensure compliance with regulatory requirements.

Australia’s upcoming climate-related financial disclosure regulations emphasise the need for greater transparency and accurate ESG reporting. These stricter mandates address inconsistencies and greenwashing, helping businesses use ESG data effectively to identify performance indicators, transition risks and strategic opportunities.

By integrating data analytics and digital tools, companies can benchmark against industry standards, make informed strategic decisions and stay ahead of regulatory changes. Using technological advancements for research and compliance assists with business resilience and promotes sustainability and a competitive edge.

Who is particularly impacted by physical risk?

Agriculture

Global warming poses severe physical risks to the Australian agriculture sector. Elevated temperatures resulting in drought and heat stress jeopardise crop yields and livestock health, diminishing agricultural productivity and escalating costs.

The frequency of extreme weather events, including storms and floods will also grow, worsening problems like crop damage. Wildfires, already a severe problem in Australia, can further devastate crops, livestock, and infrastructure. Extreme heat also affects human labour capacity, reducing the number of workable hours and total agricultural output.

The agricultural sector in Australia has previously experienced substantial economic loss due to such climate events. These effects, ranging from direct impacts on production to indirect effects on food and input prices, present significant challenges. The Australian agriculture sector must brace for adaptation and mitigation measures to safeguard its future.

In financial terms, agricultural businesses face further risks from possible investor losses, reduced access to capital, and lower market access.

Graincorp is leading the charge in climate resilience and sustainability

As a prominent player in the agribusiness sector, GrainCorp is preemptively taking decisive steps to address the challenges posed by global warming. GrainCorp is improving drainage systems at locations prone to flooding, reducing road damage and minimising dust and sediment issues during repairs to combat the impacts of increased climate variability.

Moreover, they are broadening their ESG supplier risk dashboard to promote greater sustainability in their supply chain. By scrutinising data related to energy, water and waste, GrainCorp is aiming to pinpoint trends and uncover opportunities. In support of these initiatives, they are also revising their Safety, Health, Environment and Quality (SHEQ) management protocols to include clear performance goals focused on resource efficiency to prepare for future heightened prices.

Strategies for success

Make physical changes

Australian farms must adopt comprehensive strategies to withstand the physical impacts of climate change, focusing on resilience and adaptability. Advanced farming techniques like conservation tillage and soil amelioration are essential to maintaining soil moisture in the face of declining rainfall. Additionally, irrigation systems can help optimise water use, ensuring crops receive adequate hydration even during drought conditions.

Adopting sustainable farming practices like precision agriculture and regenerative methods can decrease greenhouse gas emissions and enhance soil health. These practices improve productivity, promote biodiversity and reduce dependence on chemical inputs. Farmers can focus on climate-resilient crops and livestock capable of enduring extreme weather conditions.  

Invest in new technology

Technology can optimise water use and enhance the productivity of crops and pasturelands, even in hotter and drier conditions. Farmers should also look to diversify their operations by incorporating activities like carbon abatement, biodiversity conservation, or renewable energy production alongside their traditional practices. Additionally, reliable climate information and accurate weather forecasting can help make informed decisions.

Developing effective drought insurance products can also offer financial protection. Government-supported research and development initiatives are crucial for fostering innovative technologies and farming practices that promote long-term resilience to climate variability.

Adapt your finances

Financially, enhancing environmental credentials and lowering greenhouse gas emissions can help maintain market access, particularly as Australian policies develop and likely align with EU regulations like the Carbon Border Adjustment Mechanism.

Improving ESG practices can also facilitate access to sustainability-linked loans and draw in equity investments, making your business more appealing to conscientious investors and lenders. This also demonstrates a commitment to sustainability, which can improve your reputation and brand loyalty among consumers.

Mining

The Australian mining sector will grapple with substantial but differing physical risks induced by global warming. The sector has historically endured extreme weather conditions like cyclones, floods, droughts, bushfires and heatwaves, which have consistently disrupted operations and incurred legal and compensation costs.

The increasing frequency of droughts presents a severe threat because of the industry's heavy reliance on water, with past droughts nearly halting operations in various areas. Extreme heatwaves exacerbate risks by causing chronic heat stress among workers, leading to diminished productivity and higher incidences of accidents.

More bushfires also pose a danger by sparking exposed coal seams, resulting in significant losses of time and resources. An increase in rainfall can also cause tailings dams to overflow, devastating operations. As global warming progresses, the need for the sector to adopt adaptive strategies and develop resilient infrastructure grows increasingly prevalent.

Strategies for success

Prepare for disaster

It is critical for the Australian mining sector to adopt comprehensive adaptive strategies to mitigate physical dangers posed by global warming. Mining companies can reevaluate construction standards to improve resilience against a greater number of cyclones and extreme rainfall. Key steps can involve refining flood defence measures, implementing advanced drainage systems, and employing state-of-the-art pumping equipment to manage water levels effectively.

Additionally, diversifying transport routes to avoid disruption ensures that goods can still reach their destinations even if one path is compromised, reducing the risk of delays and maintaining operational flow. Securing long-term insurance policies provides a safety net against unforeseen events, thereby supporting supply chain consistency and safeguarding financial stability by mitigating potential financial losses.

Adopt sustainable solutions

In the event of future water shortages, mining companies can prioritise improving the efficiency of water storage and recycling systems. Developing alternative water sources, like desalination plants, can also help sustainable operations.

In the same way, mines need to put emphasis on improved cooling and ventilation systems, with a focus on energy efficiency. This involves upgrading equipment and implementing solutions to increase the overall effectiveness of these systems. Greater energy efficiency will reduce possible costs as usage rises and contribute to the reduction of the mine's carbon footprint.

Develop adaptive plans

Rising temperatures and frequent bushfires are significant concerns for the mining industry. Comprehensive heat stress prevention plans (like providing cooling stations and scheduling work during cooler parts of the day) and bushfire management strategies (like creating firebreaks and maintaining emergency water supplies), are essential to protect worker health.

Improving emergency response protocols and investing in resilient infrastructure can help the Australian mining sector withstand these threats. This approach protects worker safety and supports mining operations' long-term sustainability and resilience.

Manufacturing

Although the Manufacturing sector in Australia faces physical climate risks, its exposure is lower than that of many other sectors. A majority of its risks come from a combination of supply chain issues and minor damages to physical property. As with many other industries, manufacturing operations are dispersed across the entire country, though certain regions and specific industries may be more prone to more severe challenges.

Just as agriculture and mining are impacted by climate warming, production operations for manufacturers will become more challenging as workers contend with tougher conditions. Moreover, increasingly frequent severe weather events like floods, bushfires, and cyclones can cause significant damage to property and inventory.

Supply chain disruptions pose the greatest risk for manufacturers, as they rely on these affected industries for raw materials. Shortages in inputs, driven by extreme weather, will lead to increased costs and decreased availability of goods, complicating production efforts. Consequently, this situation will likely impact demand and make it harder for producers to sustain reliable revenue streams.

Strategies for success

Invest in physical protection and policy

Creating strategies to counteract these threats is difficult for manufacturers, given that these impacts are largely out of their reach. To overcome physical risks to their own property, manufacturers can invest in disaster infrastructure and develop comprehensive prevention plans and management strategies. This can include investing in more efficient and modern building designs that evenly distribute heat and better withstand harsh weather conditions like storms, extreme temperatures and heavy rainfall.

Disaster-prone businesses must have up-to-date and comprehensive policies addressing employee risks, including heat, bushfires, floods, and other natural disasters. Training programs for employees on emergency protocols and regular drills can further ensure safety and preparedness in the face of potential disasters.

Shore up supply chains

In order to strengthen their supply chains against the challenges posed by global warming, Australian businesses must devise and implement a comprehensive supply chain strategy. Businesses must extend their risk mitigation strategies to consider long-term climate changes, integrating extended climate data into their risk assessments to better plan for future disruptions. Wider analysis must also be undertaken to identify possible avenues for future supply shocks. This can be done either through internal or external means.

Additionally, geographically diversifying operations can mitigate the impact of region-specific climate threats, spreading the risk more evenly. Actively engaging with policymakers to advocate for improved infrastructure and effective climate action is also substantial for system-wide resilience.

Utilise technology

Technology can greatly improve a manufacturer's operational efficiency and adaptability climate change. Data analytics and AI can help manufacturers anticipate needs, optimise resource use and strategically plan production schedules based on weather forecasts.

Incorporating circular economy practices, like recycling and material reuse, reduces waste and reliance on new raw materials, promoting more sustainable operations. Moreover, investing in energy-efficient machinery and renewable energy sources can lower operational costs and carbon emissions. Water recycling systems can also guarantee a consistent water supply during drought conditions.