What Are Climate Investment Scenarios? | 15Rock

Introduction

Climate change is one of the most pressing issues of our time, and it is essential that investors understand the implications of climate change on their portfolios. Climate scenario modelling is becoming increasingly popular as a tool to assess the potential risks and opportunities associated with climate change. This post will discuss what climate scenarios are, why they are important, and how they can be applied to investment portfolios.

What are Climate Scenarios?

Climate scenarios are forward-looking analyses that explore possible climate futures. They are used to assess the range of climate-related risks and opportunities that may manifest in investment portfolios over time, under different potential climate futures. The metrics used to analyze the results of a climate scenario analysis will depend on the investor’s use case, such as whether the aim is to consider the impact of a low carbon transition or physical climate change on a portfolio.

The Assumptions Made in the Climate Scenario

Climate scenarios make a number of assumptions about how the next few decades may play out, including around technology advancements and costs, and policy choices. It is important to understand that the assumptions underpinning climate scenarios can considerably affect their results. For example, scenarios might differ in the importance they attribute to specific technology solutions that are yet to be proven at scale, such as carbon capture and storage (CCS), and bioenergy with carbon capture and storage (BECCS).

The Climate Scenario Model Type Used

The type of model used in the analysis (its structure and algorithm) can also affect the results of climate scenario outputs. Climate models vary across a number of characteristics, ranging from optimization to simulation models, from myopic to perfect foresight models, and from general to partial equilibrium. For example, perfect foresight models assume perfect information across their time horizons, while recursive-dynamic models adopt a myopic perspective.

The most popular scenarios are the UN IPCC IAM scenarios and the NGFS(Network for greening the financial system).

How Can Investors Use Climate Scenarios?

Climate scenarios can be used by investors to assess the range of climate-related risks and opportunities, and the underlying drivers, that may manifest in investment portfolios over time, under different potential climate futures. The metrics that are most appropriate for stress testing or risk management are Climate Value at Risk (CVaR) metrics, as these allow users to consider outputs across a variety of different scenarios and over different time periods. This information can help investors minimize climate risks and harness climate opportunities in portfolios, understand the range of potential outcomes under different climate pathways, and obtain useful insights that can be used when engaging with investee companies on their need to set or strengthen climate-related targets.

Conclusion

Climate scenario modelling is becoming increasingly popular as a tool to assess the potential risks and opportunities associated with climate change. This essay has discussed what climate scenarios are, why they are important, and how they can be applied to investment portfolios. It has also discussed the assumptions made in the climate scenario and the climate scenario model type used. Finally, it has outlined how investors can use climate scenarios to assess the range of climate-related risks and opportunities that may manifest in investment portfolios over time.

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