Are businesses still failing to adequately consider financial implications of climate change?

January 21 2020

Climate change is a pressing issue that is infiltrating all aspects of society. There is now an increasing pressure for international firms to address crucial questions about how business leaders can take responsibility for future generations.  

Are businesses taking into account the financial implications of climate change, or is the impact of climate change still largely absent from managements accountability? Unfortunately, it is the latter that seems to be most prevailing.

Across the globe, there is an increasing sense of urgency for firms to realise that those in management bear primary responsibility for developing a long-term strategy for climate change. It has become almost a necessity for business schools to teach future managers about how and why it is so crucial to consider the financial implications climate change will have.

Indeed, sustainability accounting and reporting has been considered and discussed for decades, however, only in recent years has there been a growing need for sustainable business behaviour to be made a priority in financial reporting.  The energy industry should be particularly aware of this, and it is incredibly worrying to see how companies within this sector have failed to forecast and plan for the future implications of climate change. This is remarkable because climate change is extremely likely to have an effect on the future value of the production assets employed by both renewable and non-renewable companies.

Climate change means that renewable energy demand increases at the expense of non-renewable energy demand, and it would appear that this has not sufficiently been taken into consideration on both sides. As a result, companies’ financial plans will change significantly in the coming years, and managers should be prepared to respond to these risks.

However, it has become clear that financial risks and opportunities associated with climate change are still not being adequately assessed, and there is growing pressure for firms to provide disclosures specifying the impact climate change will have on their long-term financial performance.

For non-renewable companies, it is concerning to see that many of their financial reports currently lack information on the consequences that will inevitably arise when less oil is available. With the existential threat of climate change continuing to be a global issue, political and social pressure will inevitably cause drilling operations to be scaled back. De-carbonising the economy and society requires considerable lifestyle changes, and to achieve "climate neutrality" - that is, a state where any CO2 emissions are balanced out by green measures, the demand for oil will consequently decline.

Contrastingly, renewable energy resources are underestimated in the financial sector, and suppliers have some deep flaws they need to confront if they are to be considered seriously as having future investment potential. This is because, among businesses that generate renewable energy, they actually undervalue themselves in their financial reports. These firms focus solely on their current revenue and expenses, and in doing so, they are not looking at the long term. Questions such as how much wind energy or solar power they could produce in the future are not being addressed, and this certainly highlights an inadequacy in their understanding of climate change implications.

An explanation for this lack of financial forecasting among renewable energy firms is because the current financial reporting system does not support renewable energy companies. Companies should be able to provide meaningful insights into their expected increases of their future cash inflows and innovation potential; however, under current frameworks this is not possible for renewable energy companies, meaning the financial implications of climate change are being left unaccounted for. This of course hinders financiers and investors to accurately and meaningfully assess the value of a renewable energy company’s financial potential compared with a non-renewable company.  

It is clear that businesses are still failing to adequately consider the financial implications of climate change, and although non-renewable companies disclose their proven energy reserves, renewable energy companies are still failing to release similar information to financial stakeholders and the public alike, despite the rapid increase in demand for renewable energy resources. This is because the current accounting standards and frameworks do not benefit or allow renewable energy companies to report their value. In addition, the existing system does not support renewable energy companies to provide financial investors with insights into their expected increases as well as their innovation potential.

To overcome this, the development of a more sophisticated model is necessary, as well as continuing to educate those who are in positions of management. Climate change’s effect on business is an important subject for business education, because if the risks are as impending as the experts claim, then there are clear implications for the economy. Practical and managerial skills, as well as climate-related courses should be taught in business schools in order to prepare future leaders with the skills to run organisations that consider not only the short term, but also the long-term financial implications of climate change.

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