Are businesses prepared for skyrocketing energy costs to combat extreme heat? Can Midwestern farmers handle average crop losses of up to 73 percent in the coming decades? Should businesses invest in oceanfront property that is virtually guaranteed to flood? Because of climate change, these are just a sample of the crucial questions that the U.S. will face before the end of the century, according to âRisky Business: The Economic Risks of Climate Change in the United States,â a report co-chaired by business experts Michael R. Bloomberg, Henry Paulson, and Tom Steyer. The report aims to quantify and publicize the economic risks posed by the impacts of a changing climate. While climate change is an often a polarizing and politicized topic, there is little controversy that the phenomenon presents a great deal of risk to everyone, from individuals to institutions.
How do we begin to address the problems posed by climate change? Risk analysis is already used by businesses and decision makers to address uncertain situations. Organizations routinely evaluate potential threats and challenges such as bad investments, poor sales, cost escalation, cyber-hacking, labor disputes, schedule delays, worker injuries, market stagnation, supply chain risk, and theft. The âRisky Businessâ report adds climate change to the risks for which all decision makers should take into account. Robert E. Rubin, co-chair of the Council on Foreign Relations and member of the reportâs risk committee, says, âIn my view, companies should disclose both their potential exposure to climate risk and the potential costs they may someday be required to absorb to address carbon emissions.â
The âRisky Businessâ project uses risk analysis, Monte Carlo simulation (MCS), and models to illustrate exactly how different regions are likely to be affected by climate change. The projectâs simulation also takes into account efforts to mitigate climate change, showing a changed distribution of probabilities if those efforts are made in the coming years. Given the vast multitude of permutations and combinations of weather events, it would be very difficult to analyze risk meaningfully using an averaged or deterministic approach. MCS overcomes this challenge by allowing thousands of possible combinations of extreme weather events to be analyzed.
MCS can illustrate the potential costs if no adaptation takes place or the costs if adaptation is employed. âThe Risky Businessâ report demonstrates that ignoring climate change risks will lead to disaster while taking steps now will have a big impact.
Dealing with Climate Change Risk: The Narrabeen Lagoon Case Study
Many forward-thinking business and communities have already applied MCS to climate change risk analysis. For example, a professional technical and management support company used MCS software and optimization techniques to evaluate the risk and costs of climate change-related flooding of the Narrabeen Lagoon near Sydney, Australia.
The organization asked by the Australian Federal Government to conduct an economic analysis of climate change impacts infrastructure. When the Narrabeen Lagoonâs entrance is blocked, it can fill like a bathtub, flooding the surrounding land and houses. The community can tackle this problem in various ways such as a lagoon entrance opening, levee construction, flood awareness, and planning controls. Because climate change is expected to increase flooding in the Narrabeen catchment over the coming century, decision makers needed a clearer understanding of the different possible adaptation measures.
The objective of the study was to use an economic cost-benefit analysis to identify both what measures government should invest in to prevent the impacts from flood events and when they should invest.
Modelers estimated the social benefits of adaptation to climate change in terms of willingness to pay rather than just costs avoided. Using MCS, they generated more realistic probabilities of overall costs and benefits and modeled the expected future values of variables such as rainfall.
Planning for Resilient Water and Sewage Systems
In a separate example, a planning, design, and management service company that develops infrastructure and buildings worldwide used MCS to produce a Service Risk Framework (SRF) and to determine the level of flood resilience required by the water and sewerage sectors in the UK which had experienced severe flooding due to new patterns of heavy rainfall in the country.
This detailed analysis assessed the resilience to flooding of critical assets such as water treatment works and pumping stations which, if damaged, resulted in major disruptions to water supplies. Then the SRF was implemented to identify how the consequences of similar events in the future could potentially be mitigated. Following a high-level risk-based exercise to screen and prioritize key assets, a detailed analysis of risk for selected sites using MCS was undertaken to understand the magnitude of uncertainty of the overall analysis. The model also incorporated the costs of repairing flood damage versus preventing it. With MCS, the company was able to view the possible costs of adaptation versus business as usual, learning that certain risk-mitigating steps would improve the net present value over the long-term.
UK Environmental Agencyâs Flood Defense Projects
Previous to this work, the company also estimated and analyzed flood risk for the UK governmentâs Environmental Agency, using MCS to conduct ongoing risk quantification on project budgets, enabling strategic decisions on funding across a whole portfolio of Flood Defense Projects. Risk management is embedded within the core principles of the environment agency, which means that all suppliers to the agency must adhere to a proactive level of risk management. MCS was utilized in the risk quantitative stage to set risk budgets at the start of each phase of an environment agency project commission. Starting with the âsunny day estimateâ of the project risk, MCS helped to identify, assess, and quantify every potential threat that could affect (i.e. increase) this base figure. This allowed for the monitoring of progress against original budget incentive thresholds.
Cambridge Employs MCS for the Stern Review on the Economics of Climate Change
MCS was also used heavily in the Stern Review on the Economics of Climate Change. Released in October 2006, this report for the British government discusses the effect of climate change and global warming on the world economy. The Judge Institute of Management at the University of Cambridge conducted valuable MCS modeling work to the Stern Review, with the goal of providing an accurate view of the impacts of climate change balanced against the costs of various options available to tackle global warming.
By using inputs of climate sensitivity, as well as the length of time it could take the earth to respond to increased greenhouse gases, the Judge Institute researchers calculated specific details on how best to cut back on CO2 emissions (e.g., should reductions of 60 or 80 percent be undertaken by 2050?) and how much it would cost to enact these measures in different parts of the world. Options included using alternative energy sources such as wind turbines and nuclear power stations, reducing oil-fuelled traffic and transport, and halting the destruction of rainforests. As with the impacts, the exact costs of any of these activities are still not certain. However, the use of optimization techniques with MCS quantified uncertainty and, by drawing together the impact, cost implication and potential for success of each option, enabled recommendations on which cutbacks would be most effective.
No Longer a Problem without a Solution
As these examples demonstrate, many organizations are already addressing climate change risks using powerful decision analysis tools. As stated in the âRisky Businessâ report, even modest global emission reductions can avoid up to 80 percent of projected economic costs resulting from increased heat-related mortality and energy demand. While many companies would like to keep a business-as-usual approach, the report makes an undeniable case: we cannot afford to ignore the momentous climate risks that threaten our near- and long-term future. Responding to climate change is no longer a problem without a solution. It is not a question of respond or not respond but how to respond. An effective response to climate change is possible. The complex set of climate change data can be processed through a cost benefit analysis using MCS, producing a set of economic indicators to inform a more meaningful decision-making process on how and when to respond.
Forward-thinking companies demonstrate the kind of careful risk analysis and planning that our whole economy must implement to survive and thrive during the uncertain decades ahead.
Randy Heffernan is a vice president at Palisade Corporation, a provider of risk analysis and decision support software. Heffernan helped the company expand to Europe and Asia Pacific and holds a Bachelor of Science degree in business management and marketing and an MBA from Cornell University.
