Climate risk and global unpredictability and volatility / power companies

Power companies operate in a global economy that exposes them to a continuously changing business environment of green transition, which not only concerns the company, but also affects the activities of other entities. Hence, each company is exposed to climate change and to the measures taken as part of wider climate policies, which cumulatively aim to reach global climate neutrality. The impact of climate risk in an increasingly global economy becomes critical to the structure of the core activities of power companies, which face progressing complexity and instability of markets. The fundamental management challenge here is to adapt to the new conditions of operational activities that are shaped by an increasing effort to achieve carbon neutrality. This will require power companies to adjust to the new circumstances present in the business environment, in order to flexibly react in new situations characterized by increasing discontinuity and absolute uncertainty.

The concept of “management” should be defined as the activities of company managers that aim to take informed decisions to execute business plans that use company resources in order to achieve the organization's goals. Hence, the importance of a proper change in operations’ management in power companies, that face climate risk, is imperative for securing an undisturbed, continuous increase of future company profits. These developments should enable a conscious and effective steering of the impact of climate risk on the functioning of power companies. Disregarding climate risk may lead to faulty business decision-making when it comes to contracts, loss of market opportunities, and the failure to hedge against significant deviations of the power companies’ operational activities. The main task of company management is thus to strive to take properly reasoned decisions when the company is at risk in the highly volatile business environment of green transition. Managers cannot accurately predict the future shaped by climate risk, which should be dealt with mostly by changing the operational activity of power companies. It requires the development of new competences supporting the implementation of new elements to operational management.

The concept of “risk” shall be perceived as a potential deviation from the expected values, and is associated with the possibility of not achieving the intended results or a deviation from their predicted value. Hence, it creates both negative consequences and opportunities for extra profits. The same applies to “climate risk” that can generate opportunities for the creation of new profit streams, but also high costs of climate risk actually materializing. Climate risk consists of two elements:

1) Transition risk that influences power companies due to changes in the business and regulatory environments towards a climate neutral economy. Transition risk influences the situation on the power market, making some of pre-existing business models unprofitable. However, it also creates opportunities for efficient risk management that supports the formation of new possibilities for generating profits

2) Physical risk that results from the undesirable influence of unpredictable weather conditions on fixed assets and on the operations of power companies. Physical risk covers following factors:

• extreme weather phenomena – heatwaves, landslides, floods, wildfires, storms;
• long-term gradual shifts of the climate – changes in precipitation, unfavourable weather variability, rising average temperatures;
• indirect effects of climate change.

This creates the necessity to hedge profits of power companies against physical factors such as wind, temperature, flood or drought. Physical risk also causes price movements in the commodity and financial markets.

Climate risk is increasingly important in the world of global unpredictability and volatility caused by climate change and green transition. The manifestation of climate risk, often triggered by global processes or local weather events, may result in many power companies going out of business. However, the occurrence of risk may become an opportunity for power companies that are properly prepared to develop and expand their business. The proper execution of a change of the core activities of power companies should facilitate the use of the opportunities of climate change to their benefit. Such change, can provide a sustainable improvement of economic results under conditions where climate risk actually materializes, and where the global green revolution is characterized by high economic risk. Well prepared power companies will be able to take advantage of these opportunities. Climate risk varies in terms of geographic factors, sectors of the economy, and regulatory and legal conditions. Power companies are exposed to climate risk resulting from: increasing severity and frequency of physical risk factors, changes in government policies, technological developments, and changes in the sentiment of societies seeking to reduce GHG emission. Physical risk factors are not linear and increase uncertainty as to the location, frequency and severity of weather conditions.

Transition risk creates uncertainty concerning future developments of climate policies, power sector regulation, technology innovations, and changes in customer sentiment towards de-carbonization. Green transition exposes power companies to potential disruptions, which can be very abrupt, especially if they are not prepared for them in advance. One of the most important factors of transition risk is technological change related to energy-saving, carbon neutral power production and to climate neutral economy. It requires a withdrawal of business models based on technologies using fossil fuel-based energy sources, which might very well become more expensive in the future as a result of climate protection measures. Climate-friendly technological development complies with the sentiment of the society to move towards climate-friendly production and consumption models. This creates a need for power companies to adapt to new conditions, in order to minimize the negative impact of climate risk and to remain competitive. Power companies are exposed to increasing legal and regulatory changes. Green transition generates transition risk, and should be analyzed from the perspective of the discontinuation of expected development trends, and deviations from planned scenarios. Hence, the management of power companies, when taking any decision concerning changes in their operational activities, should always be aware of the possibility of the occurrence of unexpected results, because transition risk creates uncertainty of the conditions in which power companies will operate. Transition risk should be treated as a very broad concept, without excluding any risk factors, even those that are considered to affect the economic results of power companies indirectly.

The concept of physical risk should define the consequences of incidents in the natural world that may lead to unexpected fluctuations in the results of the functioning of power companies. It can even cause disturbances with respect to the continuity of their operational activities – having a negative impact on power production, the power grid, and causing undesirable price movements. Hence, physical risk shall be perceived very broadly, without excluding any risk factors, even considered to be indirectly influencing power companies. Therefore, physical climate risk should be defined as the consequences of events that may lead to unexpected disturbances in the execution of the plans of power companies, resulting both from the impact of the extreme dynamics of natural factors, and from changes in the global economy related to green transition.