Sustainable spaces: Countering climate risk in capital projects

To manage the risk inherent in long-life-span building projects, infrastructure players have traditionally sought predictable revenue streams. Now, governments, investors, and other industry stakeholders face extreme uncertainty—even as they work to build infrastructure that can meet ambitious net-zero and decarbonization goals for mitigating climate change. In this episode of McKinsey Talks Operations, host Daphne Luchtenberg joins Alex Guy, a partner at the international law firm Ashurst, and Brodie Boland, a McKinsey partner and a leader on climate risk in real estate and infrastructure, to discuss how the sector can become more resilient and sustainable, both economically and environmentally. Their conversation has been edited for clarity.

Daphne Luchtenberg: Your company’s future success demands agile, flexible, and resilient operations. I’m your host, Daphne Luchtenberg, and you’re listening to McKinsey Talks Operations, a podcast where the world’s C-suite leaders and McKinsey experts cut through the noise and uncover how to create a new operational reality.

Climate change is creating new levels of complexity for infrastructure and capital projects such as roads, bridges, buildings, and utilities. Long-term planning has become fraught with uncertainty as leaders seek to invest in projects with long life spans and pursue net-zero targets that are decades away. At the same time, extreme weather is already affecting our built environment in real and immediate ways, from electricity outages to flood-damaged roads. These phenomena affect lives and livelihoods. They alter project economics and cause costly service interruptions. Understanding and mitigating these climate risks will be essential to manage costs and ensure critical continuity. In particular, new projects must be planned, designed, built, and operated to account for climate transitions.

McKinsey’s Global Infrastructure Initiative [GII] convenes senior leaders to exchange ideas and solutions on these critical infrastructure challenges. Today’s segment, in collaboration with GII’s Voices on Infrastructure, features Alex Guy, a partner at the international law firm Ashurst. Alex’s key focus is on transport and infrastructure, and he sits on Ashurst’s global infrastructure industry board. He has over 20 years of experience advising on projects across Asia–Pacific and the UK. We’re also lucky to have Brodie Boland, a partner joining us from McKinsey’s Washington, DC, office. Brodie is a leader in McKinsey’s work on climate risk, particularly in real estate and infrastructure. Today, we’re looking at how climate risk and resilience can be built into capital projects, both early on and throughout the life cycle. Welcome, Alex. Welcome, Brodie.

Brodie Boland: Thank you.

Alex Guy: Thanks very much, Daphne.

Daphne Luchtenberg: Alex, to kick off the conversation here, could you give us an introduction? What’s prompting capital project leaders to prioritize climate resilience and sustainability now?

Alex Guy: Players in the infrastructure market are looking for projects with long-term, steady, sustainable revenues, and those projects have to cover the initial capital expenditure they incur in delivering infrastructure assets. At the outset, they’ve got to pay for their ongoing operating and maintenance costs, and they’ve got to achieve a reasonable return. So you set that desire for long-term stability against the fact that we’re going through a period of extreme uncertainty. And what you get is huge pressure on governments, investors, and market players to prioritize resilience and sustainability.

But it’s not just an issue of climate change and extreme weather events; it’s all against the backdrop of other uncertainties like supply chain issues, sanctions, domestic political risk, hyperinflation, and more. Then on top of that, there’s a lot of capital out there at the moment that’s looking for opportunities that fit within investors’ ESG [environmental, social, and governance] goals. That’s another factor that’s inevitably leading to an increased focus on decarbonization sustainability.

Daphne Luchtenberg: Thanks, Alex. Brodie, are we seeing a similar picture in the conversations that we’re having with clients?

Brodie Boland: Yeah, I think Alex stated it really well. One of the interesting things that has happened over the last couple of years is that we have reached a bit of a critical mass of players and stakeholders in the ecosystem that are really focused on these issues. So if you’re a capital project investor or real-estate owner or investor, you’re now getting questions from your investors, you’re getting questions from your lenders, you’re getting questions from your regulators, you’re getting questions from your shareholders, you’re getting questions from your tenants—if you’ve got them. Just over the past 12 to 18 months or so, that awareness has reached a level where it’s essentially a core part of the consideration of any investment opportunity of any major product development.

Daphne Luchtenberg: And what are stakeholders doing differently to start to think about climate risk embedded into their projects? Alex, how do you work with clients on that?

Alex Guy: What we’re seeing is a much more systematic approach to project design and due diligence than we used to, one that really aims to achieve a better understanding of risks and how to mitigate them. That’s leading to much better-developed mitigation—measures, in general, being built into projects up front to address climate and other risks, which leads to more resilient projects. In fact, at the moment, we’re working on a new standardized due-diligence approach for infrastructure projects that looks to take Ashurst’s existing framework and expand it out to specifically focus on climate-related and other resilience risks in areas like energy costs, carbon reduction initiatives—both voluntary and regulatory—supply chain management, labor issues, domestic and international political risks, technology obsolescence, cybersecurity, and so on.

At the end of last year, we commissioned a survey of our infrastructure clients and industry stakeholders. And as part of that, not surprisingly, governments were seen as having the most significant influence on the sector. A lot of respondents were frustrated at the way those governments were carrying out their roles. In fact, more than three-quarters of the respondents named a lack of coherent government policy as the biggest barrier to a coordinated response to the changes likely to impact the sector. So the challenge is for governments to make a step change in the way they regulate and legislate for the sector, both locally and globally, to create an environment that’s going to encourage more resilient infrastructure to emerge.

Daphne Luchtenberg: Brodie, what would you say is needed, in addition to that, to really move the whole movement forward to ensure that we’re using similar standards and approaching this risk in a common way?

Brodie Boland: One of the big shifts that needs to happen is we need to move from a kind of risk register approach to understanding climate risk and resilience to an approach that truly grounds these risks in the fundamental drivers of asset economics. You see a lot of times that kind of scorecard approach where, for example, an asset of one is good and an asset of five is bad. It’s hard to know what to do with that if you’re an operator or if you’re an investor. How bad is four? How good is two? Shifting from that kind of scorecard approach to one that really connects the risks that are likely to be experienced to fundamental drivers of revenue, to fundamental drivers of cost of operations, to uptime, to reliability for an important stakeholder group in a way that allows decision making—it allows folks to figure out, “OK, is it worth making this resilience investment to the asset? Does that generate the level of value creation that we want and need and that fits our investing theses and so on?”

Alex Guy: I completely agree with that, Brodie—and not just about understanding the risks in relation to the project at the outset, but also about taking a more systematic approach to developing mitigation strategies that are perhaps less simplistic than that kind of scorecard approach that you described, so that projects can actually be adapted at the outset to become more resilient and long lasting.

Daphne Luchtenberg: That’s interesting. Alex, when we think about the life span of these projects, which is often very long, how do you inject flexibility and adaptability into that? How do you think about that in terms of mitigating risks?

Alex Guy: Industry stakeholders across the board are working pretty hard at the moment to develop flexible contractual mechanisms to make projects more resilient. One of the things I think really needs to change is the approach to business case assessment on the government side. All players really need to look at their approach on that. It’s no longer good enough to take the previous model and extrapolate it out. There are a whole load of new categories of risks and opportunities out there.

I also mentioned earlier that I think we need better alignment between value and values. For many players in the market, the only way they’re going to affect change is if it’s profitable for them. There needs to be an evolution in mentality from mitigating against the threats of challenge to a mentality that sees challenge as an opportunity—so that governments and businesses can identify and show where the drivers of sustainable growth are, so that taxpayers and the market see the value in the desired outcomes. Therefore, invest in the means of delivering those outcomes.

Daphne Luchtenberg: Brodie, anything you would add there?

Brodie Boland: I love that point about making sure that the value is clear to the broader set of stakeholders. If we think about just the sheer scale of need for investment in this adaptation infrastructure, and in added resilience to existing infrastructure, that’s going to be required over the coming decades, that’s going to be critical. If we’re not able to show that value to a broader set of stakeholders and link that value to the investment that needs to be made in that adaptation infrastructure or resilience investments and existing infrastructure, it’s going to be tough to find the capital to get this done, right?

Daphne Luchtenberg: Brodie, how do you make sure that the infrastructure is resilient in view of climate risk? But, of course, we also have the decarbonization targets that we need to be working toward. So as we build out the infrastructure going forward to 2050, can you see a way that these two objectives can dovetail together?

Brodie Boland: Yeah, and it’s just so critical to make sure that they do and in a few ways. One is, at the project level, many projects can be designed to achieve both objectives. So you can have resilience measures that also serve a decarbonization objective or decarbonization objectives that serve as resilience measures. One simple example of that is building energy efficiency. Energy efficiency investments for buildings both reduce the energy consumption of the building but also make the building more resilient to extreme heat and cold. And there are countless examples like that throughout the built environment.

Whenever possible at the project level, at the portfolio level, at the regional or the country level, we need to make sure that the decarbonization and resilience objectives are paired.

Daphne Luchtenberg: Got it. And that’s part of the value equation, I imagine, Alex, right?

Alex Guy: Yeah, absolutely. And I do agree with what Brodie said. The more that you can highlight to investors and other players in the market the risks that they’re exposed to from climate change, the more likely they are to link their resilience and decarbonization strategies in that way.

Daphne Luchtenberg: So what’s critical here is how to ensure that you’ve got all the data so that you can make the right decisions and calculations. What are some of the challenges? Brodie, I’ll come to you first on getting the decision makers to have access to the right data.

Brodie Boland: I would work backward. Instead of starting from the data and figuring out what data a government, investor, operator, or whoever it is needs, I would start from the impact and work backward to the data. For example, a few characteristics and things that we often see in terms of challenges with data environments are a lot of the hazard data is not granular enough. So if you’re working backward, you will quickly know that a one-square-mile resolution for flood data is just not sufficient. That’s a huge area of a city that, in most cities, includes places that are on hills and places that are in valleys. Getting a sufficient granularity in terms of both space and time of hazard data [is important]—making sure that all the major risks are covered.

You want to be looking across all of the risks, not just whatever data happens to be most easily available. Another important thing is we often focus on the most acute risks. They’re dramatic, they’re big, they’re points in time. In many cases, it’s the chronic risks that are going to have the most damaging effect on assets. If you think about it from the perspective of a building, you can, in some cases, insure against the major flood that happens every three or four years or every ten years. It’s harder to insure and protect against the water gently lapping in the lobby of your building every day. And so really understanding the chronic risks, in addition to the key risks, is important—then, ultimately, making sure they’re able to translate all of that data back into fundamental impact on the asset. How does it affect operations? How does it affect performance of the asset?

Daphne Luchtenberg: Alex, anything to add there?

Alex Guy: Well, some excellent advice there from Brodie. I don’t think you can just take a questionnaire, or whatever, approach to due diligence, or look at the same things you looked at last time and tick the boxes. You’ve got to look at the outset of what are your criteria, what are you trying to achieve, what are your goals? Then design the data, the collection, the data sources, the methodology, and the reporting to match those outcomes so that you can make decisions consistently on a high-quality basis.

Daphne Luchtenberg: Alex, have you seen any examples of things happening that are making you a little optimistic in this area?

Alex Guy: In general, yes. Looking at my home city, Brisbane, as an example, I’m quite optimistic about some of the infrastructure and initiatives that are taking place as part of the planning for the 2032 Olympic Games here. As part of the bid to host the games, Brisbane committed to be the first-ever climate-positive games. There’s a lot of debate about what climate positive actually means. But that commitment is already having a massive impact on project planning by encouraging a focus on decarbonization. As a city that’s experienced at least three extreme flooding events in the past 11 years, we’re going to have to pay a lot of attention to resilience in the lead-up to the games.

Daphne Luchtenberg: Brodie, how about further afield? Have you seen any great examples that can lead the way?

Brodie Boland: Yeah, Alex and I are both thinking about our hometowns. I was in Calgary recently, where I’m from, which had an enormous flood in 2013. At the time, it was the costliest natural disaster in Canada’s history, with major flooding in the whole downtown area. There’s a green-infrastructure project there; it’s essentially a combination of a park and flood mitigation measures. It creates a transportation corridor for cyclists and pedestrians right beside downtown. There are picnic areas, my kids played in a little pool created by the Bow River catchment, my wife and I went for a trail run in the park in the shadows of the skyscrapers of downtown Calgary, and a friend and I sat and chatted by a beaver pond. It was an excellent example of a project that achieved a very important flood mitigation effort that created biodiversity outcomes, livability, increased property values in downtown, activated an area of downtown, and created a number of social benefits for folks in that area. Those kinds of projects make me really optimistic.

Daphne Luchtenberg: It feels like both of those examples have a common purpose, a common vision at the heart of it, which seems to have been shared across the stakeholders. Would that be a fair assessment?

Brodie Boland: Absolutely. I know in Calgary, there was a significant amount of stakeholder engagement of the average citizen, the business community, the experts and flood managers, the transportation planners, and coming up with a project like that. It’s through that kind of stakeholder collaboration that you can get a project that hits the objectives of all those groups.

Alex Guy: Similarly, with Brisbane and the bid for the Olympic and Paralympic Games—that has required a lot of industry stakeholders and others to collaborate and participate together in developing that proposal, and then also in working out how it’s going to be delivered, and particularly how that commitment to be the first-ever climate-positive games will be delivered.

Daphne Luchtenberg: Alex, what other mindsets and models are important? Once you start with that kind of common vision and common purpose, what other things need to be true to be successful?

Alex Guy: We’re talking about uncertainties here and what to do in the face of uncertainty. There is always uncertainty, and smart investors will always move with the times. The mindset that can increase the odds of success is to see challenges but to look for the opportunities in them as well as see the risks. So from a government perspective, it’s asking where are the opportunities to align value with values to create a regulatory environment that encourages the solutions that they’re trying to achieve? And for businesses, it’s where do the challenges actually present opportunities to design solutions to issues arising from climate change and other resilience factors?

Daphne Luchtenberg: Brodie, anything you would add in terms of other success factors?

Brodie Boland: Dealing with climate change, in many ways, can often be extremely overwhelming. It helps to get a handle on the things that you can’t easily get a handle on. You can access some pretty good information and data about what’s likely to happen to your asset. It is certainly probabilistic data, you can’t treat it as a point prediction, but it can be a foundation for just making some better decisions about the design of the asset. In the broader swirl of things that you aren’t able to control, it sometimes helps to do the math on the things that you can. At least get a sense of what might happen in the future and make sure that the asset, the project, etcetera, is being planned accordingly.

Daphne Luchtenberg: Infrastructure and capital assets can be a real vehicle for advancing decarbonization efforts, improving the livelihoods and the environments of our citizens. So there’s a real opportunity, too, right, Alex?

Alex Guy: Absolutely. As Brodie said earlier, resilience and decarbonization are inextricably linked. There are huge opportunities in the development of new technology—for example, in the transport sector, where I do a lot of my work with the move to zero-emission vehicles. I also think the water sector presents a lot of opportunities. As a result of climate change, water is becoming more and more of a concern, both in terms of not enough or too much of it, like the floods we were talking about earlier. I think water infrastructure has to be an area of major focus and opportunity.

Daphne Luchtenberg: Brodie, when talking to clients, where would you say are some of the areas of opportunity where there is white space to act?

Brodie Boland: Green infrastructure—particularly because it does hit both the decarbonization and the resilience objectives—is going to be a real big part of the solution in many places around the world. Then, there is an opportunity for innovative players who are able to think differently about new contracting models, new financial models, or ways in which benefits of a resilience project can be reinvested in improved resilience or an improved decarbonization.

Then, last, there’s a broader opportunity for connecting all of these together in ways that make our cities more livable, more sustainable, more resilient. Alex and I both talked about projects in earlier examples that we were excited about in cities that do achieve multiple objectives. There’s real opportunity for creative designers, for creative infrastructure, for developers and real-estate developers to reshape our cities in ways that make them better places to live, more prosperous, more sustainable, and resilient.

Daphne Luchtenberg: Thank you. So while it’s an uncertain area, it is heavy with risk. We need to continue to move forward, and it feels like you’re both saying there’s some great opportunity here to really build a much, much better world for all of us.

Brodie Boland: Absolutely.

Alex Guy: That’s for sure.

Daphne Luchtenberg: Fantastic. You’ve been listening to McKinsey Talks Operations with me, Daphne Luchtenberg. If you like what you’ve heard, subscribe to our show on Apple Podcasts, Spotify, or wherever you listen. We’ll be back in a few weeks with a new episode.