Why Climate Scenario Analysis Matters

Scenario analysis quantifies financial impact of climate risks and opportunities. It answers:

• If policy tightens (carbon price rises), how does this affect profitability?
• If renewable energy costs decline faster, where is opportunity?
• If physical hazards (bushfire, flood, drought) increase, what’s operational disruption cost?
• Under different futures, what’s our competitive position?

Scenario analysis builds strategic resilience by identifying risks early and opportunities for first-mover advantage.

AASB S2 Scenario Analysis Requirements

Required Scenarios

AASB S2 requires at least three scenarios:

• 1.5°C scenario: Policies implemented to limit warming to 1.5°C above pre-industrial; aggressive climate action; high policy costs, rapid transition
• 2°C scenario: Policies implemented to limit warming to 2°C; moderate climate action; medium policy costs
• No-policy or current-policy scenario: Baseline; assumes current policies continue without tightening

AASB S2 recommends including physical climate scenarios (e.g., 2.7°C warming under no-policy scenario) to show physical impacts if policy doesn’t tighten.

Scenario Pathways

NGFS (Network for Greening the Financial System, central banks) provides standardised scenarios:

• Net Zero 2050: Policies target net zero by 2050; 1.5°C pathway; rapid transition, high policy costs 2020–2030
• Delayed Transition: Policy delayed until 2030; then rapid; greater physical damage and stranded assets
• Disorderly Transition: Rapid, uncoordinated policy tightening; high asset price volatility; financial instability
• Fragmented World: No coordinated policy; regional divergence; high physical and policy risk

Use NGFS scenarios for consistency with investor expectations and regulatory alignment.

Conducting Climate Scenario Analysis

Step 1: Define Scope and Key Variables

What aspects of business are climate-sensitive? For most: energy costs/supply, carbon pricing (Safeguard Mechanism), customer demand shifts, supply chain disruption, physical hazards. For each, identify key variables:

• Energy prices (electricity, gas, hydrogen)
• Carbon price (Safeguard Mechanism baseline tightening)
• Technology costs (renewable energy, batteries, electric vehicles)
• Physical hazards (temperature, precipitation, extreme events)
• Customer/investor demand (ESG expectations, carbon pricing)

Step 2: Determine Scenario Parameters

For each scenario, define parameter values. Example (1.5°C NGFS Net Zero 2050):

• Electricity price: increase 2% annually (renewables cost decline offset by carbon pricing)
• Carbon price: increase from AUD $20/tonne (2025) to AUD $100/tonne (2050)
• Renewable energy costs: decline 40% by 2030, 60% by 2050
• EV adoption: 40% fleet by 2030, 80% by 2050
• Physical hazards: 1.5°C warming = lower physical risk

Source assumptions from climate science (IPCC, CSIRO), economic models (IEA, World Bank), and expert judgment.

Step 3: Financial Modelling

Build financial models for each scenario: revenue projections (market share shifts, product mix), cost projections (energy, carbon price, capex for transition), profitability, valuation. Compare across scenarios to identify: climate-dependent business risks, opportunities, strategic inflection points.

Step 4: Sensitivity Analysis

Test how changes in key assumptions affect outcomes. Example: if carbon price rises faster than assumed, what’s impact on profitability? If renewable energy costs don’t decline, where’s our cost risk? Sensitivity analysis quantifies uncertainty and identifies priorities for monitoring.

Step 5: Strategic Implications

What does scenario analysis imply for strategy? Are we resilient across scenarios or dependent on one outcome? Do we need to pivot business model, diversify, or accelerate transition? Use findings to update strategy.

Physical Climate Scenarios

Beyond policy scenarios, model physical climate impacts. For Australian organisations, key physical hazards:

• Heat stress: More frequent, intense heat; impacts agriculture, energy demand, worker productivity
• Bushfire: Longer fire seasons; larger fires; operational disruption, asset damage
• Flooding and drought: More intense; impacts water supply, agriculture, infrastructure
• Sea-level rise and storm surge: Coastal assets at risk

Quantify potential losses: facility downtime cost, supply chain disruption, asset damage. Model: how many events per year under 1.5°C vs. 2°C vs. no-policy scenario. Build resilience: facility hardening, supply chain diversification, insurance.

Frequently Asked Questions