Strategic Priorities for ESG Integration in Companies

As companies pursue Environmental, Social, and Governance (ESG) goals, the focus is expected to evolve from reporting data and actions taken to achieving specific performance benchmarks. This transition underscores the need for companies to adopt a strategic approach to ESG, prioritizing a clear understanding of climate strategies within their operations, supply chains, and target markets. Achieving ESG performance targets is not merely a regulatory or ethical obligation but a business imperative. Failure to align with these priorities may jeopardize a company’s or production plant’s market viability. On the other hand, implementing advanced climate and decarbonization strategies can provide significant advantages for companies. Such initiatives enhance competitiveness, strengthen customer relationships, increase market share, and improve value propositions tailored to ESG considerations. These factors collectively enable better pricing and margins, underscoring the critical role of ESG in driving long-term market success.

1. Alignment of ESG Metrics with Business Strategy

Top management must carefully select ESG metrics that are directly relevant to the business and aligned with strategic objectives. Metrics could include carbon emissions, diversity and inclusion, community engagement, ethical sourcing, and governance practices. The selection should reflect both industry-specific requirements and stakeholder expectations, with stakeholder input fostering valuable insights and buy-in.

2. Accountability and Incentives

Strategic ESG goals should be reinforced by a robust accountability framework. This involves integrating ESG performance into compensation and incentive structures for employees at all levels, including top management and the board. Such measures motivate and reward individuals and teams for achieving ESG objectives, ensuring a unified commitment to the company’s sustainability goals.

3. Resource Allocation

Companies must allocate sufficient financial and human resources to achieve defined ESG targets and enhance overall performance. This commitment ensures that ESG initiatives are adequately supported and effectively implemented.

4. Ongoing Review and Adaptation

ESG integration is a dynamic process requiring regular review to adapt to evolving sustainability challenges and market conditions. Continuous evaluation ensures that the company remains responsive and aligned with emerging trends and stakeholder expectations.

By embedding ESG principles into its core strategy, an company can secure a competitive edge, build lasting stakeholder relationships, and drive sustainable growth. Proactive and thoughtful ESG integration is essential for maintaining relevance and achieving success in an increasingly sustainability-driven market.

 

Strategic Risk. Imperatives for ESG Integration in Modern Business

The strategic analyses must prioritize product design, product access, and operational carbon footprint, incorporating them into a comprehensive evaluation of social and environmental consequences. This integration links ESG considerations directly to strategic choices, with the outcomes intended to bolster both ESG and financial performance. The impact of ESG performance extends beyond mere compliance, significantly influencing a company’s competitive positioning within the context of pressing issues such as climate change, water scarcity, pollution, and various social factors, including product safety, regulatory relationships, and community engagements. It is crucial to emphasize that the management of environmental and social factors is an integral component of sustaining a competitive advantage in today’s economy. However, there exists a tangible risk of severed collaborations with suppliers and customers, as evidenced by current trends observed among small and medium-sized enterprises providing services and products to companies obligated to report ESG. Additionally, there is the looming risk of diminished market standing for companies failing to demonstrate robust ESG performance. This underscores the importance of proactive ESG integration into business strategies for both risk mitigation and the preservation of market relevance. The implementation of an ESG-adapted strategy is a continuous improvement process that involves enhancing competencies while considering regulatory aspects, international and local business initiatives, and insights from the experiences of leading companies. A well-defined strategy for building competitiveness should serve as a clear roadmap. The initial step involves determining the current status of each company. Subsequently, an analysis of the integration of ESG implementation into the business strategy, reporting mechanisms, communication practices, and the development of human competencies is crucial. Activities within the developed strategy can be carried out in parallel and gradually deepened, detailed, and expanded. Companies currently face issues such as inadequate capabilities and high costs in ESG practices, which greatly reduce their motivation to implement ESG. Despite this, running a business in an ESG-orientated way has become the binding norm of modern management in the global economy. Companies must include in the strategy at least three drivers of the environmental issues:

• The current environmental impact generated by operations and carbon footprint reduction strategies.
• Value creation by delivery of products and services with a positive environmental impact.
• Products and capabilities supporting a sustainable economy.

Social issues should be integral to the company’s strategy, incorporating proper ways of managing relationships with employees, managers, suppliers, and society at large. Companies are obligated to prioritize the well-being of their employees, collaborate with entities sharing ESG values, and actively contribute to local communities by fostering environmental and social values. Consequently, the strategy should serve as a responsive framework adapted to the dynamics of the environment in which the company operates. To address the strategic risk component posed by the green transformation, it is imperative to conduct thorough and multi-aspect future analyses. This entails preparing for the complexities associated with the evolving landscape by considering numerous possible future scenarios and determining their potential impact on the company’s future performance. This proactive approach positions the company to navigate the challenges and opportunities arising from the green transformation effectively, ensuring that the strategic choices align with the anticipated changes in the business environment. The strategy should

· Lead to increased flexibility in the enterprise’s operations by formulating plans for the decarbonization of operational activities. This involves developing scenarios for flexible adaptation to regulatory changes, market conditions, and variations in access to financing; 

· Ensure not only the enterprise’s resilience to external shocks but also, through enhanced flexibility and efficiency, cultivate the ability to capitalize on emerging opportunities.

· Specify how to shape the value-added chain in a manner that enables the reduction of the company’s risk by proactively addressing long-term challenges arising from the necessity to adapt to ESG requirements.

By integrating these principles, companies position themselves not only to adapt to the challenges of the green transformation but also to thrive in a sustainable economy. This strategic foresight ensures resilience, long-term profitability, and alignment with evolving market and societal expectations.

Integrating ESG: ESG Performance. Why ESG Matters?

 Is Sustainability Really a Cost—or a Missed Opportunity?

Sustainability is often perceived within companies as merely a source of costs and responsibilities, or even as a drain on time and resources. But could it be that this perspective itself is the true waste of time?

ESG performance supports the execution of companies’ targets. Various studies have explored the correlation of the economic results of companies with environmental performance, social performance, and governance performance. Important is to indicate the following:

·   Environmental performance refers to a company’s ability to use natural resources in its processes efficiently.

·  Social performance promotes ethical values and generates trust in its employees, ensuring respect for human rights.

· Governance performance refers to a company’s capacity to efficient corporate management systems and effective processes.

Environmental performance is crucial to efficient operations, reducing the usage of energy, water, and other resources, which reduces costs and improves profitability. Consumer perspective from an ESG point of view is secured by ensuring product safety and responding to society’s preferences. Studies have also shown that positive social impact correlates with higher job satisfaction, which results from a good corporate culture, which can create a good working atmosphere for employees, increasing their sense of identity and belonging, reducing staff, and helping maintain the stability of the company’s daily operation. Hence, scholars have proven that social performance positively influences corporate financial performance. ESG also focuses on management performance that requires incentive schemes focused on sustainable issues, independent and engaged boards, employment diversity, and transparency of risk management. ESG activities have a positive relationship to corporate financial performance. The improvement in the ESG performance of enterprises increases the company’s market value thanks to the positive impact of the company’s financial results. Important for the execution of the article’s purpose is that sustainability performance shall be significant for the long-term success of companies.

Consumers are exhibiting an increasing environmental consciousness and are actively demanding more sustainable products and packaging. Companies are facing significant pressure to minimize their carbon footprint, enhance resource efficiency, and utilize more sustainable materials. Consequently, many companies are investing in sustainable packaging, adopting measures to reduce waste and carbon emissions, and exploring innovative technologies, including biodegradable materials and renewable energy sources. Beyond environmental concerns, consumers are also placing importance on social issues, such as fair labor practices, fair trade, and diversity and inclusion initiatives. In response to these evolving consumer expectations, companies are adapting their strategies to align with ESG requirements. Consumers are now more likely to discontinue support for products or services offered by companies that do not adhere to ESG principles.

Companies are recognizing that strategic alignment in the area of sustainable development is becoming a key competitive factor, influencing consumer preferences and shaping the trajectory of business relationships. In response to evolving conditions, companies have initiated activities to reduce greenhouse gas emissions, distinguishing themselves from others by cultivating a competitive advantage. This advantage is defined as a unique position within the sector relative to competitors, enabling the attainment of above-average profits and surpassing the competition. With the heightened focus on ESG factors, consumers are increasingly favoring brands that emphasize their sustainable attributes. A high level of ESG performance supports achievements in environmental and social issues, making a brand more appealing to environmentally conscious consumers and potentially leading to an increase in market share. This, in turn, can have a positive impact on the company’s financial performance.

Integrating ESG: A Strategic Imperative for Sustainable Business Success

The growing emphasis on sustainability and climate action compels companies to rethink their strategies, ensuring they drive competitive advantage while fostering sustainable operations. Recent amendments to the Accounting Act and related legislation in Poland, implementing Directive 2022/2464, expand corporate sustainability reporting obligations. The Corporate Sustainability Reporting Directive (CSRD) aims to provide investors and stakeholders with reliable, comparable, and actionable sustainability information, shifting capital flows toward companies advancing sustainability or undergoing sustainable transformations.

To thrive in this evolving landscape, businesses must embed ESG (Environmental, Social, and Governance) principles into their strategies, complementing traditional financial metrics with non-financial performance measures. ESG offers a more comprehensive view of corporate performance, addressing societal and environmental impacts alongside economic results. This holistic framework encourages companies to integrate environmental management, social responsibility, and governance as interconnected facets of their operations rather than isolated concerns.

Adapting to ESG imperatives goes beyond compliance; it reshapes strategic decision-making and fosters value creation for all stakeholders. Companies that fail to align with ESG priorities risk losing their social license to operate, access to capital, talent, and customers. Societal expectations for sustainability are rapidly evolving, adopting ESG practices becomes a necessity for maintaining customer trust and ensuring profitability.

Operationalizing ESG within corporate strategy requires adjustments across all facets of the value chain—from upstream procurement to internal production and downstream distribution. Companies must reassess their business models, ensuring alignment with ESG principles throughout the product or service lifecycle. These adjustments can yield significant benefits, such as cost efficiencies, improved product quality, and enhanced customer satisfaction.

For ESG to be effective, businesses must:

1. Develop strategic initiatives that prioritize ESG performance.
2. Align organizational units and employees with ESG-driven goals.
3. Supplement financial KPIs with non-financial measures like customer satisfaction and employee engagement.
4. Integrate ESG priorities into operational improvement programs and performance dashboards.
5. Ensure all measures and KPIs align directly with the company’s overarching strategy.

The shift toward sustainability demands innovative approaches in investments, partnerships, production technologies, and governance. Companies must operationalize their ESG strategies to not only achieve compliance but also secure a sustainable competitive edge. By aligning strategy with ESG principles, businesses can navigate the sustainable revolution while creating long-term value for stakeholders and ensuring profitability in a rapidly transforming global economy.

The energy sector serves as a prime example of how adapting to ESG requirements can drive meaningful change, from reshaping supply chains to enhancing product offerings. As the sustainable transition accelerates, companies must place ESG at the core of their strategic planning and execution to lead responsibly and thrive in the future.

 

Strategic Imperatives for Sustainability in a Transforming Business Environment

Toward Long-Term Value Creation

The rapid and fundamental shifts in today’s business environment, driven by the sustainable transformation, demand a rethinking of corporate strategy. Companies face increasing risks linked to Environmental, Social, and Governance (ESG) factors, which are poised to play a pivotal role in shaping economic outcomes in a globalized economy. To succeed in a climate-neutral economy, organizations must identify and leverage their unique competencies to build competitive advantages. This requires embedding green transformation elements into strategic planning, preparing for organizational, cultural, and financial shifts needed to achieve long-term goals. Incorporating ESG factors into corporate strategy influences several critical areas:

1. Climate Risk Management: Addressing climate-related risks and adapting operational activities to mitigate their impact.
2. Capital Planning and Financing: Allocating resources to sustainable projects and ensuring alignment with ESG priorities.
3. Research and Development: Driving innovation to meet sustainability challenges.
4. Asset Development: Planning for a sustainable and efficient use of resources.
5. Digital Transformation: Leveraging digitization to enhance ESG implementation.
6. Marketing and Stakeholder Engagement: Building trust through transparent communication and collaboration.

Studies consistently demonstrate a positive correlation between ESG practices and economic performance, reinforcing the need for businesses to broaden their competitive focus. Sustainability factors must complement traditional business drivers, necessitating new models and a commitment to long-term success. 

Corporate strategies should reflect the creation of shared value across a broad spectrum of stakeholders, from employees and customers to communities and the natural environment. A strategic ESG approach helps reinvent business models and build competitive advantages through positive social and environmental impacts.To integrate ESG into a company’s strategy, the following components are essential:

1. Environmental Goals: Aligning environmental initiatives with the company's overarching strategic objectives.
2. Social Responsibility: Establishing robust engagement frameworks with stakeholders, ensuring ethical and inclusive practices.
3. Governance Structure: Implementing effective internal controls and fostering accountability across all levels of the organization.
4. Disclosures and Transparency: Communicating ESG performance through clear and accessible reporting. 

By embedding ESG principles into their strategy, companies can achieve responsible business practices, drive sustainability, and create lasting value for stakeholders. Embracing these imperatives positions businesses to thrive in a transforming global economy, securing resilience, profitability, and competitive standing.

The most significant challenge facing power companies

The transformation of core activities of power companies towards an efficient reaction to climate risk should be classified as the most significant challenge facing power companies. Thus, power companies have to work out a long-term approach to re-designing their operational activity securing both, physical assets responsible for the continuity of their operations, and hedging future profits against transition risk. The manifestation of physical risk destroys fixed assets as a result of floods, hurricanes, fires and droughts that limit the production possibilities of hydroelectric plants. Transition risk arises from increasing pressure placed on power companies by investors, industry and societies that require them to take action to mitigate climate change. Hence, climate risk directly affects the directions of capital allocation, the development of products and services, as well as, finally, the shape of the global power sector. The identification of such a high climate risk exposure makes it necessary to take preventive measures, which must be reflected in a fundamental change of the core activities of power companies. Power companies must also find ways to fund new investments, which should limit the impact of extreme weather conditions on the infrastructure, and to comply with new climate neutral regulations. Hence, there is an observable process of changing the profitability of value chains in the power industry, customers defining their new needs, and pre-existing assets starting to lose value as well as their potential to remain profitable in the future. Climate risk requires power companies to change their mindsets, to use new operating models, tools and processes in order to integrate physical risk and transition risk into their decision-making process. The analysis of long-term impact of climate risk on the operations of power companies influences decisions concerning technology and the location of power plants, the selection of suppliers of construction materials, smart grid development and the digitalization of their operational activity. Steps taken in reaction to climate risk will create a fundamental change in the power sector, and lead to the creation of a system based on RES and emission-free production technologies, which will replace pre-existing ones based mainly on fossil fuels. However, one can expect that the change caused by this process will deepen in the coming years, significantly changing the conditions of management activities in power companies. That is why the authors argued that power companies should prepare for a strategic change of their core activities, redefining their operations and the way in which they meet customer needs, towards ensuring the profitability of their future operations. The authors indicted the potential direction of the necessary changes of the operational activities of power companies, which can secure their future market success. This change is also the determinant of future success of particular economies, because the scope of carbon footprint reduction will be a determinant of their competitiveness in the global environment.

Necessary changes of the core activities of power companies

Power companies must re-design their core activities in order to hedge future profits against the severity of climate risk that radically changes profit drivers. A fundamental change of core activities is required in order to create new perspectives for operating in transforming environments, and to survive in new market conditions. This applies to power companies as well that have to meet the expectations of customers and policy makers. Power companies need to develop expertise in reacting to climate risk, in order to identify necessary infrastructure and system upgrades, operational changes and adaptation options. The need to re-design business models in the power sector, shifting them towards green developments, also results from the attitude of financial institutions and investors. They have already identified long-term benefits of investing in accordance with Environmental, Social and Governance (ESG) principles, and require for entities requesting capital to act in a way that respects the environment and climate. Activities that reduce climate risk, change globally the power production structure that becomes greener – RES-based. The future shape of the power sector differs fundamentally from the pre-existing fossil-fuels based industry.

There are various perspectives that need to be considered when designing responses to climate risk – deep and urgent decarbonization of power production, based on the increasing competitiveness of RES, as opposed to fossil-based power plants, is the most visible now. RES have globally become the “target” power sources, but it also creates challenges concerning how to fund necessary investments in the environment (that is, for green finance). It is also essential to ensure the security and flexibility of power supply via, among others, large scale power storage, decentralized power supply, peer-to-peer power trading, and highly flexible power plants. As RES technology matures alongside market innovations, it shifts the operational activity of power companies towards carbon neutrality. Pre-existing business based on fossil fuels starts to disappear and new technology determines the decisions concerning the core activities of power companies.

The challenge here lies in the determination of an optimal technological mix of core activities, with regard not only to power production, but also to power grids, customer connectivity or the digitalization of operational activities. The technological context of defining future core activities influences the long-term sustainability of economic profits in a business environment moving towards hedging against climate risk. Technological developments eliminate pre-existing competitive advantages, making it necessary to implement new, innovative technical and trading solutions. Technology can give an advantage, but when a new solution appears and technological novelties quickly become the standard, power companies must develop too. Changes in the conditions of the power market encourage new no-asset entrants, from outside the power industry, to generate profits based solely on trading. The development of RES and power storage technologies, opened the power market to new companies, supplying photovoltaic installations and power storage batteries. These have created virtual power plants, taking advantages of power sales from thousands spread out installations, during periods of prices increase in intraday (buying and selling power at a power exchange on the same day as its delivery) and balancing markets. RES gathered in such virtual power plants replaces production once limited to traditional power plants. The abovementioned trends force power companies to decommission coal power plants. Incidentally, disinvestment of assets that don’t secure future profitability helps collect funds necessary for the transition of the core activities of power companies[1].

Climate risk forces customers to minimize their carbon footprint and de-carbonize industrial processes in order to fight climate change. It creates a significant challenge for power companies to respond to such needs, which make financial institutions commit to fund only green investments reflecting the process of significant capital reallocation – away from assets characterized by GHG emissions and towards carbon-neutral projects. It is the confirmation of the global trend of integrating finance and environmental protection, as the after-effect of the Paris Agreement and the definition of global climate targets. This issue was confirmed during the COP-26 in Glasgow. Power companies shall respond to the needs of societies and the industry by changing their operational activities towards climate neutrality, which will be an important determinant of future competitiveness. The creation of a low-emission economy becomes a key element of staying competitive when customers leave oil and fossil fuels. Power companies cooperating with other business should create partnerships with their customers, for the de-carbonization of their operational activities, by switching to renewables, bio-fuels and the use of green hydrogen, power storage, demand flexibility and energy efficiency. This will speed up the transition into climate friendly manufacturing technologies. In fact, both industry and society perceive the acceleration of green transition and minimising carbon footprints as an additional impulse to future development and to value creation.

The change in the power production mix generates challenges for the stability of power grids that must become bi-directional. It creates a new approach to power supply management increasingly based on decentralised power production. Power grids need further digitalization and technological advancement. Customers, using digital solutions, can increase efficiency of power usage and reducing energy costs. Hence, power companies shall use technology and available know-how (existing technical expertise, deep knowledge of power networks, capital engineering capabilities) to operate in the new environment. Only a fundamental transformation of operational activities and breakthrough technologies will secure the future success of existing power companies.

[1] Ownership of coal power plant requires large capital expenditure, what is unjustified in the conditions of worsening competitiveness of coal-fired power plants.

New conditions of financing long-term adjustments of core activities in power companies

Responding to climate risk means a change not only for the real economy, but also for widely perceived finance, exposing them both to risks and opportunities. New approach to financing power companies requires a long-term analysis of investments with an environmental impact, and compliance with all criteria of climate-neutral developments. It demands a fundamentally new approach to funding, and expertise going beyond current planning practice, because having the ability to adapt to the challenges of green transition demands investments and capital. A broad variety of green finance products and services has already been developed, which can be divided into investment, banking and insurance products, which can be used by power companies. The important issue here is meeting the conditions set by climate-neutrality targets – this means mostly the execution of initiatives and projects connected with sustainable development, carbon-free products and climate-neutral policies. The new approach to financing power companies, set by financial markets, focuses mostly on green sustainable investments, green technologies and carbon-free operations. It requires the creation of funding solutions for necessary investments in a green portfolio, modernization of power grids, digitalization of operations, and development of smart customer technologies. The necessity to adapt to new market situations requires also the consideration of entering into partnerships with investors (joint ventures, partnerships, green bonds) that can support the development of a new model of investment implementation. Such cooperation networks can be created also with industrial customers (e.g. on site solutions) and suppliers of heat-pumps, photovoltaics, as well as municipalities. Industrial customers can be part of contracts hedging the market risk of RES investments by using Power Purchase Agreements (PPAs). EU funds are available dedicated to the support of green transition, which can be used to develop a green portfolio of production assets, and products supporting sustainable development. Capital can be raised from divestments of unprofitable assets (fossil-based mainly) as well.A sustainable financial system designed this way creates and values financial assets, it enables transactions conducted in a way that builds genuine prosperity, in order to meet the long-term needs that favour sustainable development. Promoting the financing of green transition on a large and economically viable scale, should guarantee that green investments are prioritised over investments that promote non-sustainable growth patterns. For that reason, green finance encourages a long-term analysis of investments with an environmental impact, and includes the assessment of all criteria of sustainable development such as a broad variety of products and financial services that can be divided into investment, banking and insurance products. Hence, green finance includes all the financial instruments that are used for the execution of initiatives and projects connected with sustainable development – all economic products and policies within the framework of green transition. Green finance ensures funding for all sectors and asset classes, which take into account environmental, social and investment decision-making criteria, considering their climate risk, that are executed to promote sustainable development. For instance, banks see climate risk as a factor impacting new loans – they may adjust granting loans, taking into account the environmental impact of the project in their risk assessments and cost of capital. It is essential to establish the criteria for defining assets as “ecological”, or classifying financing as “green” or “sustainable”, since an increasing number of financial institutions strive to support initiatives that are completely free of fossil fuels. Such a set of minimum standards for green finance is essential to ensure the transparency of capital flow towards green and sustainable investments, as well as for the analysis of the ever-changing financial market and climate risk[1]. Climate-friendly investments are prioritized over unsuitable capital spending. Power companies must begin to operate in the green financial markets, in order to raise capital for necessary investments, adjusting their operational activities to green transition worldwide. Green finance promotes long-term investments supporting climate protection targets and responding to climate risk.

[1] An example of such a solution could be the EU taxonomy for sustainable solutions proposal published by the European Commission in November 2020, which sets out conditions that an economic activity has to meet in order to qualify as environmentally sustainable, to make it easier for investors to assess their investment as regards their impact on the climate.

Transition risk - element of climate risk

Climate risk impacts the power sector, especially the transition to a climate neutral economy, which influences negatively the value of power companies’ assets, and radical weather phenomena. Climate risk influences the economic conditions of power companies also through green finance – for example, insurance and re-insurance of companies, banks, pension funds. The severity of extreme conditions, resulting from advancing climate change, has a specific financial dimension for the power sector. In order to limit climate change, OECD countries should eliminate GHG emissions by 2035, and the rest of the world by 2040. The analysis of current RES growth rates also indicates that fossil fuels should be squeezed out of the power system by 2030. Hence, power companies face the challenge of adjusting their core activities to new market conditions that reduce the profitability of the traditional power sector. The maturation of RES technologies, and the related reduction of investment costs, affects the situation on the power market, changing the competitiveness of particular production technologies. Existing patterns of executing the operational activities of power companies become useless. For example, a wind farm, when investment costs are reduced, becomes more competitive than traditional fossil fuels-based power production, and can also obtain additional “green” support. The market price of electricity is the same, and the variable cost of production in a wind farm is assumed to be zero[1]. That is why climate change creates strategic risk for power companies, which must define the future structure of their production assets, and allocate funds for investments in generation assets as well as the power grid. In this way, the climate risk issue finds a new perspective reflected in the decisions of power companies concerning the shape of their core activities. They must consider the profitability of various options for RESs’ development, and low-emission power generation, in a constantly changing environment (the so-called 3P approach - Planet, Profit, People) and the impact it has on the efficiency of the operations of power companies. Therefore, the issue arises of determining the optimal model of the core activities of power companies by 2050. Such time perspective creates the risk of faulty investment decisions. Assets in the power sector are characterized by a very long period of operation (up to 30 years) while changes in available technologies are already under way and the maturity of RES, facilitated by investments in RES, has contributed to the reduction of their costs. This creates a need to design an effective strategy ensuring the maintenance of the profitability of operational activities of power companies in the new conditions of the power sector.

The power sector is notably exposed to the impact of climate change policies that affects the long-term operational activity of power companies, identifying the high risk of stranded assets in their balance sheets. The term “stranded assets” describes assets that face a high risk of having to be discarded earlier than planned. Stranded assets can lead to a reduction of the overall value of power companies, as a result of having to write off the value of assets related to the use of fossil fuels. Another result of such a situation may be identified as a sudden deterioration of financial ratings and an increased cost of debt. Therefore, it can be argued that there is currently a major risk to the business scenarios facing the power sector. It can already be stated that the current trends are not adequate for the period covered by this risk. This means a fundamental change must take place in the conditions for the functioning of power companies that must determine the path to achieve climate neutrality. Each of their investment decisions covers a period of at least a dozen (to several dozen) years of capital involvement. This makes them exposed to high strategic risk, which results from climate risk and revolutionary technological changes, increasing the importance for the power market of RES and power storage. As a result, finance institutions take a negative outlook on funding fossil-based investments and operations. Delaying the adaptation process to the new operating conditions of the power industry generates additional costs, and will be accelerated by technological innovations, reducing the costs of implementing zero-emission technologies.

Climate risk influences also customer expectations towards power companies with respect to: de-carbonization of the economy, reduced usage of products with high carbon footprints, electrification of transportation, and electrification of heating. The power sector must thus have the potential to use renewable energy to power transport, industry and heating, as well as hydrogen production. This means defining new ways of meeting customer needs as a response to climate risk. It increases strategic risk, the manifestation of which is particularly severe for power companies. The changes affecting their operating activities arise outside the power sector and destroy the previous status quo. Younger managers, computer scientists and entrepreneurs strive to transition the power industry into climate-friendly power supplies. Rigid and immobile, old-fashioned, concern-based power companies should shift towards a start-up culture. This approach becomes standard for all power market participants. Market dynamics shall be identified as an opportunity for profitability increases, and reflected in the change of the core activities of power companies. Ignoring climate risk can lead to losses resulting from incorrect long-term business planning. While green transition accelerates, responding and adjusting to fundamental changes in the business environment becomes increasingly important. The exit of companies from coal-based power production makes them more resistant to transition risk. Power companies must consider the development of smart solutions, as an instrument of reacting to such risk, which also support better customer connectivity. The long-term changes of core activities of power companies shall cover: initiatives developing prosumers, green electric mobility, using electricity to meet energy demands, green heating using RES, and an electrification of industrial processes. The next important area is the development of products of demand-side management and demand flexibility, offered to households as well as industry. These developments are the basis for new directions of capital investments. Climate risk management, and the use of new opportunities, becomes an instrument protecting the future success of existing power companies. This situation has direct impact on their strategic decisions concerning asset development (making assets greener), and reflected in their operations. Power companies responded to this challenge, deciding to cut GHG emissions or even to develop carbon-neutral production, supported by investments in power storage, pumped-storage plants, new types of nuclear power plants, and green hydrogen. Some power companies decided even to turn carbon-neutral already by 2025, requiring the same from their suppliers, demanding a carbon footprint minimalization schedule.

[1] The largest greenhouse gas emitters in Europe are the following power companies: RWE, EPH, Uniper, Steag, CEZ, Bulgarian Energy Holding, Endesa, ZE PAK, PGE, Enea.

Relevance of physical risk for long-term changes of operational activities of power companies

Power companies unable to flexibly adjust their operational activities will not survive. In order to survive in the volatile environment of climate risk, it is crucial to be able to adapt to the radically changing business environment and market conditions. This is, however, always connected to the spending of funds. Power companies should ensure constant inflow of funds exceeding the costs of the manifestation of climate risk, and divest current strategic resources that don’t guarantee future profitability. They must also adapt to the new needs of customers following green transition developments, and increase their business complexity in order to secure future profitability. Management facing climate risk should be future-oriented, focusing the attention of top level managers on the main areas and main factors relevant to profit generation, and on the criteria for the assessment of their company's success. Climate risk changes the conditions for success of power companies making it risky to continue to pursue pre-existing business models. Hence, climate risk arising in the globalized green business environment cannot be ignored during the development of strategic changes of core activities of power companies, which have to be aligned to long-term trends of the world economy developing towards climate neutrality. Global climate risk disrupts many current strategies. A correct climate risk analysis becomes crucial for the success of business strategies, because it is the basis for creating variants of the decision to change operational activities to secure the highest possible rate of return on investments in the context of specific risk. It requires a radical change of the operational activities of power companies, in order to implement effective tools facilitating future goals, in a business environment characterized by the randomness and discontinuity of market trends. Climate risk becomes a systematic risk for the global economy, because climate change increases macro-economic and investment risks. Climate risk management becomes therefore an important success factor in the power sector. The severity of climate risk increases due to the growing frequency of extreme temperatures, fires, storms or floods[1]. Researches indicate that more than 65% of extreme weather events since 2011 were the result of human activity. Although one can observe a fundamental increase in severe, although not catastrophic, weather events, which are becoming the norm – the sum of small weather events creates high costs of the manifestation of risk. The most important physical risk factors for power companies are wind, fire and water. Physical risk, as the effect of extreme weather dynamics, may also lead to a reduction of the overall value of power companies, following the destruction of technical infrastructure and damage to real estate in exposed areas. Heatwaves increase the demand for electricity in the summer and, at the same time, they reduce the cooling capacity of power plants and water supplies in hydropower plants. There is also the danger of a reduction of the efficiency of solar power plants, which influences the power market because of changes in the demand-supply balance. Heatwaves can also be the cause of low water levels in rivers used to fuel transportation while higher temperatures reduce the efficiency of power production, due to lower availability of water.

The available production capacity of power plants is reduced and power grids are overloaded, which in turn leads to breakdowns, fires and interruptions in electricity supplies, which additionally leads to losses in the rest of the economy. Fires have not only reduced bio-diversity in many areas, but also bankrupted power companies that had to settle claims following fires related to their operations, which burdened public finances with the costs of extinguishing them. Wind is another physical risk factor. Hurricanes can significantly reduce the production in traditional- as well as wind-power plants. Extreme storms can reduce the supplies and quality of fuel, or damage power infrastructure (power plants, power grid). Floods can damage the transmission and distribution networks as well as power plants. Hence, power companies started to reinforce their infrastructure, treating this type of investment as one of the instruments of climate risk management, constituting the process of selecting and applying methods of mitigating the level of their risk exposure. The instruments of climate risk management should ensure continuity and flexibility of the power companies’ operations in the event of unexpected market events and extreme weather phenomena. Power companies should analyze the costs and impact of different measures on climate risk, and choose the most effective investments based on the relation between investment costs and the reduction of risk specific to existing characteristics of their assets. 

Examples of measures aimed to reduce physical risk include: reinforcement of overhead transmission and distribution lines; installation of flood-proof equipment in power plants and transformer stations; using temperature forecasting systems in rivers; creating cooling systems ensuring the continuity of production in power plants; re-designing wind turbines to handle higher wind speeds and passive airflow beneath mounting structures to reduce solar power temperatures; as well as a generally more robust design of power systems. There can be a necessity to consider a relocation of assets if net climate risk exposure (after risk reaction) is unacceptable. The costs of such activities can range from USD 100 million (strengthening overhead transmission lines) to even USD 1 billion (protecting power plants against flooding). The necessity to finance the investment activities of the power sector means that the risk affecting the functioning of individual power companies becomes also an element of risk of investments and credit portfolios of financial institutions.

[1] The Florida governor announced in 2019 that the state would have to spend $ 2.5 billion over a 4-year period to be protected from climate risk, including rising water levels.