In 2021, the world’s leading authority on climate change, the United Nations’ IPCC, reviewed hundreds of climate change scenarios and classified 1202 of them.
Climate change scenarios are all the rage, not least because regulators are beginning to give indications of requiring them in future modelling. Two examples are the Bank of England’s 2021 Climate Biennial Exploratory Scenario and the ECB’s 2022 Climate Risk Stress Test.
Other dynamics include corporate Environment, Social and Governance (‘ESG’) requirements and campaigns by investors and NGOs.
Climate is critical, but most organisations are also faced with other vital issues. Which of these also need scenarios? How many sets of scenarios can an organisation handle? How do they interact? How do all of these relate to traditional High/Mid/Low forecasts?
Regulatory bodies sometimes provide a simplifying process. For example, the Bank of England pointed financial organisations towards NGFS scenarios for climate change in 2021.
However, if given a free choice, where should an organisation start?
Fortunately, some good guidance can be found, particularly the Scenario Analysis Guide for Banks (December 2022) by the UK’s Climate Financial Risk Forum (‘CFRF’), which has relevance well beyond the financial sector. CFRF is a joint initiative by the Bank of England’s Prudential Regulatory Authority and the Financial Conduct Authority.
In addition to advising on an overall approach to scenarios, the CFRF gives recommendations for off-the-shelf climate scenarios. Its top three sets are:
- IEA: International Energy Agency (a global multilateral organisation)
- NGFS: Network for Greening the Financial System (a global financial network)
- IPCC: Intergovernmental Panel on Climate Change (a global multilateral organisation)
The IEA analyses only the energy sector, which accounts for around 70% of world total emissions, and assumes that non-energy sector emissions change in line with energy sector emissions.
NGFS scenarios do not incorporate the consequences of the war in Ukraine and the subsequent energy crisis.
IPCC scenarios are complicated and difficult to use.
On the basis of the above, including the predominance of the energy sector in the future of climate change outcomes, IEA scenarios are currently the most useful as a default.