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PTLearn the difference between physical and transition climate risks
2024 was the hottest year in history, being the first to exceed the safe limit set by the Paris Agreement of 1.5°C in the increase in the Earth’s average temperature when compared to pre-industrial levels, according to the Copernicus Climate Change Service. The period was marked by extreme events such as floods, which occurred in Rio Grande do Sul, in Brazil, and in the Valencia region, in Spain, and heatwaves around the world, among others. In the Brazilian context, climate disasters have increased by 250% in the last four years compared to the 1990s, according to a study by the Brazilian Alliance for Ocean Culture.
Physical and Transition Climate Risks
In addition to the clear social and environmental losses, extreme weather events have a financial impact on public and private institutions and threaten the existence of territories and businesses in the short, medium, and long term³. Therefore, it is urgent for the private sector to understand the risks associated with climate change and integrate them into corporate management systems. To address this issue, it is essential to understand some initial concepts, such as the difference between physical and transition climate risks, which have different but complementary scales of action.
Physical Climate Risks
The physical risks of climate change stem from changes in the frequency and intensity of climatic events and are divided into acute and chronic. Acute risks are those triggered by extreme weather events, such as heat waves and floods. Chronic risks, on the other hand, are related to long-term consequences, such as the progressive rise in sea levels and the gradual change in precipitation patterns.
For companies, these events can damage buildings, paralyze operations, generate declines in agricultural production, and increase energy and insurance costs, among others. For investors, some impacts are the loss of investment value, demand for debt and capital adjustments, and even the need to divest assets.
Transitional Climate Risks
Transition climate risks are identified from the impacts of the route (or transition) to a low-carbon economy on an organization. Analyzed within a pre-defined time frame, they assume a variety of premises based on regulatory, legal, technological, market, and reputational elements.
In the case of regulatory risks, the analysis to be carried out is on the impact for a given company when adopting government policies to mitigate and adapt to climate change, such as carbon pricing and taxation of greenhouse gas (GHG) emissions. One example is the carbon tax mechanism for products exported to the European Union: the Carbon Border Adjustment Mechanism (CBAM), which will come into force in 2026, but has been in the transition phase since 2023. There are also cases of climate litigation when questions or complaints are carried out by actors (such as civil society organizations or the judiciary) about environmental and climate damage.
The need to incorporate new technologies into production processes also contributes to climate risk, given their potential to affect competitiveness and production costs. Increasing energy efficiency and investing in low GHG emission energy, for example, can give companies a competitive advantage over those that make no effort to modernize their processes. For these companies, the technological risk will be relevant.
In addition, climate change could affect product demand and supply, constituting a market risk. To reduce this, some opportunities include finding new business fronts through collaboration in low-carbon government projects and promoting small entrepreneurs and local communities.
Finally, reputational risks refer to a company’s image in the eyes of society and its stakeholders, given its conduct in dealing with climate change. For example, a company can be publicly blamed for not fulfilling a specific decarbonization commitment, which can negatively affect its reputation.
How Can WayCarbon Help?
At WayCarbon, we have been closely following the movement of large companies in sectors such as retail and energy, which are already aware of the need to integrate climate risk into corporate strategic planning. To this end, corporations are analyzing and managing climate risks and adopting adaptation measures to reduce the impact on assets, operations, value chains, territories, investment portfolios, credits, and guarantees. To support the private sector on this journey, WayCarbon offers specialized advisory knowledge leveraged by technology. Find out more about our solutions.
Want to know more about the strategic value of climate risk management? Download our White Paper.
