Understanding the Use of Energy-Climate Scenarios in 5 Points: An Analysis of the Shift Project Report for AFEP

Monday, November 18, The Shift Project published the report "Energy and Climate Scenarios: Assessment and Guidelines"  In response to a request from the AFEP (French Association of Private Companies), which wanted to better understand the various challenges associated with the use of these scenarios, Carbone 4 has thoroughly analyzed the issue and summarizes the key points for you.

1. Climate change is driving a systemic transformation

Climate change poses two major risks to our systems: physical risks and transition risks.

Physical Risks are linked to climate change itself and to our ability to adapt. Climate change manifests itself in particular through an increased frequency and intensity of extreme weather events, such as floods, heat waves, and droughts, which can disrupt supply chains or even damage a company’s assets or infrastructure. In October 2018, low-water levels were so severe that river traffic on the Rhine—Europe’s primary waterway—had to be suspended. This significantly impacted German industry, as a portion of its supply chain relies on the river. For example, the chemical giant BASF had to halt production at one of its plants, resulting in a loss estimated by the company at 250 M€. In February 2019, Pacific Gas & Electricity Company (PG&E), the California equivalent of EDF, which supplies 16 million households, filed for bankruptcy after being held liable for about 100 wildfires, with total damages estimated at some $30 billion—a sum the company does not have.

Transition Risks are the risks associated with combating climate change and with a trajectory of sharp and rapid reductions in greenhouse gas emissions. Ultimately, this involves bringing the economy’s “playing field” within the physical limits of our planet that are sustainable for human life (of which a stable climate system is a part), which would profoundly transform all current economic activities. The automotive industry, for example, is currently subject to stringent requirements regarding emissions reductions. The European Union has, in fact, imposed very ambitious CO2 exhaust emission targets on automakers: by 2021, they must achieve an average of 95gCO2/km (bearing in mind that today, the European average stands at 120 g CO₂/km), and then, over the course of ten years (between 2021 and 2030), they will have to maintain a reduction rate of -4% per year, whereas the reduction rate observed between 2005 and 2016 was -3% per year.

Transition Opportunities are also associated with this type of risk, such as the development of low-emission solutions or so-called “low-carbon” products. This is the case with electric vehicles when they are deployed in regions where electricity is low-carbon, as well as with hydrogen, for example, which is also a low-carbon energy carrier when produced by electrolysis in such regions.

2. As the economy transitions toward a low-carbon future, a new approach is needed for corporate strategic planning

The two categories of risks mentioned above have systemic impacts on economic activities. They clearly emphasize that strategic thinking within a company’s senior management can no longer rely solely on extrapolating past trends to anticipate economic developments when making major decisions. In the dynamic and evolving context of climate change and the effort to reduce GHG emissions, “the implementation of regular forward-looking analysis based on multiple energy-climate scenarios, describing possible processes for mitigating and adapting to climate change” (Recommendation No. 2 of the report) is recommended for understanding the risks and opportunities associated with the company's operations.

What Is Scenario Analysis??

It involves comparing the company’s current activities with a range of coherent and plausible future scenarios. The idea is to analyze how these activities would be impacted—both positively and negatively—using a “what-if” approach. This powerful analytical tool goes far beyond simply creating a risk matrix; yet it is now commonly used at the highest levels to strategically assess the consequences of climate change. In practical terms, this analysis first requires “identifying, among the factors that shape a company’s operations and markets, those that could be significantly affected by climate change and the low-carbon transition” (Recommendation No. 1).

3. The construction of narratives is the first building block of this approach

Narratives—or, in other words, stories that provide a qualitative description of the world created by the scenario from various perspectives (economic, technical, energy, social, environmental, social organization, lifestyles, etc.)—are essential for fully understanding the scenario’s coherence and direction. This makes it possible to identify “the evolution of the company’s business environment in light of energy and climate challenges.” (Recommendation No. 3) and then guide decision-makers along these various possible paths of transition.

4. Using quantitative scenarios is a second essential step in the decision-making process

Building narratives is essential for engaging deeply in the thought process. However, making strategic decisions that are fundamental to the company also requires a quantitative approach. The quantitative scenario-based analysis approach must therefore be based primarily on the “physical determinants that shape the company’s activities and markets” and analyze how they evolve in order to anticipate future risks and opportunities. (Recommendation No. 4 of the report. Indeed, this is essential given that the transition to a low-carbon society (constrained by a given carbon budget) is seen as driving systemic transformations, and that the traditional economic approach does not incorporate the elements needed to account for these disruptions.

5. Address the need for alternative scenarios based on innovative modeling approaches

The scenarios proposed by the International Energy Agency are based on economic and technical assumptions that are at times highly optimistic and therefore open to question. This is the case with the following assumptions: constant economic growth, a significant improvement in the energy efficiency of economic activity, and a massive deployment of carbon capture and geological storage capacity. Furthermore, the economic assumptions are exogenous, meaning they take into account neither the underlying physical reality (which could call them into question) nor the negative externalities of economic activity on its future capacity for growth. Other scenarios are therefore needed to provide companies with a diverse and contrasting set of strategic considerations through scenario analysis. These scenarios must be based on innovative modeling approaches and more reasonable assumptions, thereby allowing for the consideration of feedback loops between our economy and the planet’s physical limits. To address this need, the report recommends “engaging in dialogue with producers of public energy-climate scenarios to stimulate the development of diversified scenarios better suited to businesses, and to encourage and participate in the creation of business consortia whose mission would be to develop scenarios tailored to their needs ” (Recommendation No. 5).

The Strategy Division Team