How can Asian companies address climate change in a post-pandemic world? This is more important than anywhere else in the world, with the majority of impact of climate change falling on Asia. Sustainability has become the imperative of our time and risen to be a number one priority for society and businesses. In this episode, we discuss the nature and extent of physical climate risk over the next three decades. For more conversations on Future of Asia, subscribe to our podcast here.
Oliver Tonby: You are listening to the Future of Asia Podcast by McKinsey and Company. I am Oliver Tonby, your host and Chairman of McKinsey Asia. In this series, we feature leaders from across the region to discuss the forces, the opportunities, and the challenges that are shaping the future of Asia.
Yuito Yamada: Hello and welcome to another episode of Future of Asia Podcast. My name is Yuito Yamada. I am a partner from the McKinsey Sustainability Practice based in Tokyo. The following episode is adapted from our recent interactive webinar session on Climate risk and response in Asia in a post-pandemic world. I am joined by four distinct panelists: Oliver Tonby, Senior Partner, Chairman of McKinsey in Asia, Dickon Pinner, Senior Partner and Head of the Global Sustainability Practice, Jonathan Woetzel, Senior Partner and Director of the McKinsey Global Institute, and Mekala Krishnan, Senior Fellow of McKinsey Global Institute. Now I’d like to turn it over to Oliver Tonby who would open the briefing. Oliver, handing it to you.
Oliver Tonby: First of all, welcome everyone. I’m absolutely delighted to have several hundred people join this webinar. The background that we are here is that over the last several years, sustainability and climate change has really risen to be a number one priority. Number one priority for society, for customers, for our employees in all companies across all sectors, for CEOs and for investors. This is really a number one priority. We really saw this happen for example in Davos earlier this year where it was the number one discussion topic.
I think this comes after we’ve now seen for years, we see videos and reports from India, from Delhi last year, just too hot to work for significant periods of the summer. We see capital cities being flooded. We hear about Jakarta or Indonesia moving the capital city because it’s going to be submerged. We hear about worries regarding the sustainability of fisheries, of our agriculture, lower yields, and highly variable yields. We are seeing evidence that this is really something that we need to do something about now and I think now everybody needs this.
This now becomes sustainability is the imperative of our time. What we have done in McKinsey is also now launched this as one of the important chapters in what we call the Future of Asia. We are looking at what is the future of Asia across many different dimensions. Sustainability is one of those key topics because Asia–Pacific is going to be affected even more than most by climate change. What we want to do today is give a little bit of a background. Talk about how Asia–Pacific is being affected. We also want to draw are there any learnings that we have from the ongoing COVID-19 crisis, and I think there are some.
We have seen the effect of when business, when government, when society works together, we can really move the needle. Can we take some of those learnings and apply that to sustainability as well? Then finally we’re going to start talking about what is the path forward? Personally, I think there are many reasons to be optimistic that there are solutions coming. But the amount of effort that needs to be put behind them need to be of a different dimension than we’ve had in the past.
So those are some of the topics that we’re going to be discussing today. I hope we have a good and engaged webinar. Please keep the questions coming to our esteemed panelists Dickon and Jonathan. With that, thank you very much and I hand over to Jonathan.
Yuito Yamada: Thank you, Oliver. And before going into Jonathan, we’ll have two chapters today. One discussing about the Importance of Climate Change, which indeed Jonathan and Mekala would be. Second chapter, Lessons from the Current Pandemic for Climate Change as Oliver was introducing. We’d like to make our session interactive as much as possible, so let me start off with a simple poll. We’d like all of you to push the button appearing on the right side of the screen and answer the question “When will physical climate risk response be critical for your organization?” Let’s start the poll.
And while we wait for a few seconds here, Jonathan, what are some of the reactions that you’ve been seeing from this report globally?
Jonathan Woetzel: Thank you, Yuito. First of all, we launched this report in January and before COVID-19 became a global pandemic. I could say that launch was a top of the agenda moment for a broad range of finance and public sector and corporate decision makers. Of course in the last five months what we have to bear in mind is that events have overtaken us to some extent in the sense that other priorities came to the floor. But what we’re seeing now is people coming back to this issue of risk in a broader sense, saying “We have just had a very big demonstration of risk.” Climate risk on top of that makes this world that much more challenging.
And I think that’s the feedback we’re getting is that, “Well we can’t lose track of where we are today but we have to take into account how climate adds to that and what we should do to address all the risks that we face.” I think we’ll touch on that in the course of this seminar. I think an audience response is saying we’re glad that we have data now in the sense as I think Dickon might say later that the good news is that we know the bad news, but now we will have to do something about it.
Yuito Yamada: Very good. Thank you. Thank you, Jonathan. The poll results are coming out and 66 percent of the people are saying, “Right now. Already.” So that’s also encouraging to see. Over to you, Jonathan and Mekala.
Jonathan Woetzel: All right. Thank you, Yuito. We’ll start with an overview and then Mekala will take us to some of the more Asia-specific implications. But at a global level, of course our work was to essentially first of all take the science. So to be very clear, McKinsey is not a climate modelling institution. The work to develop the understanding of climate hazards was done by our research partners and drawing out a broad range of publicly available sources. But we should call out Woods Hole Research Center for their excellent work in developing global insights on the hazards that are the consequence of climate change.
And those hazards of course include everything from heat and drought to extreme precipitation and hurricanes and so forth. So building on those hazards, we then looked at how exposed are we and what is the vulnerability? That’s the framework in the sense that physical climate risk is the product of the hazard times the exposure times the vulnerability. And because we have to measure this in some context, we said, “Impact our vulnerability on what?”
We looked at five systems. We looked at our communities and how hazards affect their livability and workability. We looked at our food systems, how things will grow and agricultural prospects and productivity. We looked at physical assets, infrastructure, and finally natural capital. For each of these five systems, what we are trying to understand is what is again the level of risk, the hazard times the exposure times the vulnerability? And what we found as is summarized is that clearly by 2050, that risk will increase. Part of that risk is driven by the increases in the hazard.
A very significant part is driven by exposure. But the real kicker is vulnerability as we pass thresholds where our systems are no longer able to cope with that. Every system has a stress level it can take, whether it’s a building or a bridge or a corn field. And once one passes the temperature or the wind speed or the level of precipitation, you have a flood and a catastrophic failure. So that’s the kind of analysis we did and here are the results: That as we look at livability and workability, in the range is 700 million to 1.2 billion people who will live in areas by 2050 that have a 14 percent annual probability of having a lethal heatwave.
A lethal heatwave is defined as a [34 degrees] wet-bulb temperature, which is a combination of heat and humidity. There will be four times the increased risk of a greater than 15 percent global grain yield decline in a given year versus today. I should note there will also be a three time increased risk of a greater than 15 percent global grain yield oversupply. So we will see so much more volatility in our agricultural systems. Big implications for infrastructure there. We will see four times the capital stock versus today that could be damaged from riverine flooding by 2050 reflecting the impact of extreme precipitation, as one way of measuring the risk to physical assets.
And finally, 45 percent of the earth’s land area will experience a biome shift between now and 2050 compared to 1900. That reflects that today we’ve already seen 25 percent biome shift. By 2050, we will see a 45 percent biome shift. That means a dramatic acceleration at the rate in which we’re changing the living environment for our flora and fauna. So those are some of the big global impacts that we see. We highlight how we then went to try to turn those into real world impacts. And for each of these systems, whether it’s livability or food systems, we looked at specific cases and we will illustrate those cases.
Will India get too hot to work? What will the Mediterranean be without the Mediterranean climate? Can coastal cities turn the tide on rising flooding risk? So for each of these cases, again, we look at the hazard, for example flooding. We look at the exposure, the size of city, where the city is. We look at the vulnerability, how bad could it get? What would a one in hundred year storm do to the city? One last point, the philosophy behind this work is to measure the full inherent risk of climate change. It is not to, first of all, give a point of view on what trajectory we are on.
It is to say in the full inherent risk of climate change where it fully materializes, this is what you are exposed to. And as a result, as you can see, there’s a note here that we are basing this on RCP 8.5 and that is a measure of full inherent risk. It is not intended to say this is a projection of our climate change trajectory, but it is to say what is the impact of experiencing that full inherent risk? So I’m just going to highlight one of those cases and then I will turn it over to Mekala. This is the India example, and again, it’s based on RCP 8.5.
On the top row, you can see first of all what is going to happen in terms of working hours lost. On the bottom you see the probability of experiencing an annual lethal heatwave. And as you can see on the left hand side, there’s some amount of working hours, which are lost but there isn’t that much lethal heatwave experienced. But by the time you get to the right, of course it’s a different story. In India alone, we think that 2.5 percent to 4.5 percent of GDP would be at risk by meaning that it is exposed to that lethal heatwave, as this is outdoor work. It’s in agriculture or it’s in construction on days where it is too hot to work.
So that is the GDP which is at risk and needs to be taken into account in any kind of economic development strategy. As far as the communities go as you can see out of the 1.2 billion that we said, up to half of that maybe 500 million, would be in India, people who could live in regions of the 14 percent annual likelihood of a lethal heatwave. So I would say this is a highly technical analysis but it builds on science. It’s built on what we know about natural systems and how they work. And it drives the realization that we have a very significant amount of both GDP but importantly lives at stake here. So with that, passing it to you, Mekala, for further insight.
Mekala Krishnan: Great. Thanks, Jonathan. So Jonathan provided an overview of what we have done globally and also started to give some examples of case studies we looked at. But we wanted to now dive a little bit deeper into some of our findings, specifically for Asia–Pacific. So if you remember, Jonathan talked a little bit about some of the hazards that we interrogated, hazards being things like a rise in temperature or lethal heatwaves, extreme precipitation, et cetera.
So on the very top, you see on temperature that already we’ve seen increases in temperature relative to preindustrial climates. That’s the first column that you see there. But then fast forward to 2030 and then out to 2050, we could see about a 2 to 4 degree Celsius increase on average in many different parts of Asia and that includes parts of Northwest in India, Pakistan, parts of China as well as Australia. What that means is that we could see that 2 to 4 degree Celsius increase on average, but on extreme days in specific parts of these regions, we could even actually see temperatures that exceed that.
And now, as those temperatures start to rise, that triggers a range of other climate effects including for example lethal heatwaves. So Jonathan’s talked a little bit about the lethal heatwaves and also we did globally as well as in India. As we look at those lethal heatwave numbers for the Asia–Pacific region, we find again a significant portion of parts of Asia–Pacific exposed, so that’s about 480 [million] to 730 million people could live in a few South Asian countries that experience such lethal heatwaves with ever-increasing probability up to 2050.
We give two other examples, one for extreme precipitation and one for hurricanes. So what we see again is with those rising temperatures we also see increased conditions of rain. Events that used to be one in 50 years, this is a common language that used to describe the frequency of an event, so an event that used to occur with a one in 50 chance. A 2 percent chance of occurring in the ’50s to ’80s now is occurring with more and more frequent probability. If you fast forward to 2050, we could see that event happening now with a four times higher likelihood than we saw in the past.
And that could expose parts of Japan, parts of central China, parts of India, parts of Indonesia. And we see a similar trend when we look at hurricanes where the probability of an extreme hurricane, a hurricane that used to have a 1 percent chance of occurring now occurs with 3X that likelihood. And that exposes entire regions on the Eastern part of Asia all the way from Japan down to China. And if you think about the point Jonathan was making that this is about the evolution of hazards, but when you think about the risk from that hazard, that risk manifests as a result of exposure to the hazard as well as vulnerability to the hazard.
And many of the geographies that we’re highlighting that are going to see increased hazards are the very geographies where we have high level of exposure. We have factories in these regions, we have people that live in these regions, and these are also regions where we’re continuing to build, continuing to grow. As we think about managing this risk, remember this is an inherent risk assessment absent mitigation and absent adaptation, that starts to point to what we can do toward managing this risk. we wanted to share one other example for everyone to see.
And this is looking at flooding in Ho Chi Minh. Now, Ho Chi Minh in Vietnam is a city that already experiences significant flooding today. But what our analysis found is that with climate change under this RCP 8.5 scenario, more and more parts of the city could be exposed to flooding, and you see that on the map here where the areas in orange indicate. Fast forward to 2050 what parts of the city will be exposed to flooding. So not only is an increased area of the city exposed to flooding, but when it’s exposed to flooding we also see increased depth of flooding.
Between now and 2050 we find about a one and a half to two times increase both in flooded area in the city as well as in flood depth. And remember Jonathan talked about this idea of thresholds. When we translate that [into] economic damages, we find the increase in economic damages could be much more than one and a half to two times. Today, when we look at infrastructure damage in a typical hundred year event in Ho Chi Minh, those numbers are about $300 million. But fast forward to 2050, that could rise to $0.5 billion to $1 billion of infrastructure that could be damaged.
And infrastructure is something that then becomes the backbone of the rest of the economy, so you could see knock-on effects on things like GDP and economic activity as a result of that infrastructure getting damaged. And again there, we find this increased nonlinearity to while flooding damage might increase 1.5 to two times, we find that the knock-on effects from damaged infrastructure could rise from about $400 million today to anywhere between $1.5 billion to $8.5 billion by 2050. So this idea of nonlinearity and thresholds, vulnerability to hazards is very important to think about when we think about finding ways to manage this risk.
It raises two imperatives for stakeholders to consider. On the one hand, it’s thinking about the adaptation agenda. If you look on the chart on the left, what this is showing is different temperature trajectories that we could be on. We could choose to be on 1.5C path, a 2C path, and then a “no further action” path. But what you see if you look at this chart is that between now and 2030, there’s some amount of temperature increase that’s essentially guaranteed regardless of which path we’re on.
We are guaranteed some increase in warming, and with that increase in warming, we’re guaranteed some increase in risk. So at a minimum, our stakeholders need to start to understand what is their exposure to this risk and how might they think about adapting to manage this risk. Then on the right chart we show what that means in terms of a carbon budget. So each of these different temperature trajectories are associated with different levels of CO2. And what we find here as well is that over the next 10 years our actions will influence the path that we’re on.
So the next step here becomes decisive not only to manage the risk that’s baked into the system, the risk that we need to adapt to, but also to decarbonize to reduce further buildup of risk. So with that frame in mind, what should companies and investors think about doing? So we’ve laid out four fairly simple steps, or intuitive steps I should say, to think about as we look to manage this risk.
The first of course begins with accessing your exposure to these forms of risk, to these hazards, and analyzing the impact to your business. A lot of times when we’ve spoken to people about this research, the question that has come back to us is, “Are you scared? Are you concerned? Are you trying to be alarmists?”
And that is by no means our intention. Our goal in doing this form of analysis, this inherent risk assessment, was to say, “Let’s quantify the magnitude of the challenge that we need to solve so we understand what we need to put in place to manage these forms of risk.” And that’s what companies need to do. They need to start thinking about what is the risk to their core production, what is their risk to their distribution and sourcing, what is their risk upstream downstream, what is the risk that their customers may see. So if you think end to end on a corporate value chain, there’s a whole range of reasons that companies could experience risk and the first step is starting to assess and understand what that exposure is.
The second is to then think about what are opportunities that may arise from this risk, and those are opportunities both in the adaptation agenda as well as the decarbonization and mitigation agenda. We’ve seen a lot of companies by the way do both A and B. Both start to do risk assessments on their footprint and also think about what are the opportunities this creates for them. That leads you to step B. So really thinking about as you look at this entire set of risk, the entire set of opportunities, what do you look to prioritize now, what do you look to prioritize in the future, and how do you systematically incorporate these risk assessments into your processes.
For a company, that might mean impact on everything from where they choose to locate their production, where they think about locating their supplier bases, how they think about capital allocation, where they expect market growth to be. So there are a whole slew of decisions that companies make that now all need to be made with a climate lens with understanding climate risk. Much in the ways that something like supply chain risk or cybersecurity risk has become embedded into how companies work, we believe that climate risk also needs to be a part of that assessment, be a part of corporate decision making.
What that leads us to is this point B. Really building capabilities to manage, to understand, to quantify these forms of risk, building both the mindset of risk and resilience, a lot of which we are learning the hard way right now through our pandemic experience. But then also thinking about what are the tools, metrics, capabilities that you need on the backend to help you do these risk assessments and make these prioritization decisions that I’ve described.
Oliver Tonby: Asia’s standing in the world has changed and it’s clear that where the focus once was on how quickly the region would rise, the reality is now all about how Asia will lead. Keep listening to the Future of Asia Podcast.
Yuito Yamada: Thank you, Mekala and Jonathan for your presentation. Just a reminder to everyone, if you have any questions you can go into Q&A at the right side. But now, I’d like to ask the audience again another poll. “How well has your organization assessed exposure to physical climate risk?” If everyone can answer on the screen on the right side. While we wait maybe Mekala, what are you especially worried about maybe personally when it comes to physical climate risk here in Asia–Pacific?
Mekala Krishnan: Yeah. Good question. So I would say that for me, a lot of the climate risk discussion so far has focused on the acute events, so things like flooding, storms, hurricanes. And those of course are ... Large magnitude events can have very significant impacts on lives and livelihoods, economic activity. But I think what I worry about most maybe because it often gets less attention is the chronic effects. In particular, the chronic heat effects. So we’ve talked about some of the impacts on India for example from rising heat and humidity that could impact people’s ability to work outdoors. Many of these countries that experience such effects by the way are the ones that rely significantly on outdoor work.
A very significant portion of GDP and incomes and employment depends on outdoor work. So I think us collectively understanding the impacts of some of these chronic effects I think is very important going forward. I would also say while I am worried, I am also cautiously optimistic. So going back to my alarmist point, I think the good news is certainly that “we know what the bad news is” per Jonathan’s quote of Dickon earlier. But I think also that we have the tools now to start to do these forms of risk assessment. This does require new tools in the form of understanding geospatial analysis, understanding how asset footprints might influence your exposure to risk.
So it is a new model, but I think we’re starting to now have the tools to be able to do these types of assessments. We’re starting to build a mindset of risk and resilience. So I feel cautiously optimistic about that.
Yuito Yamada: Well, very good, thank you Mekala. And we have the poll results saying, “Not at all, 12 percent; Somewhat, qualitative assessment. 54 percent being the majority; and Done rigorous assessment, being 12 percent.” So we’ll come back to this capability point a little later as well. Thank you, Jonathan and Mekala.
We’d like to move on to the next chapter: chapter two, Lessons from the Current Pandemic for Climate Change. We’d like to start off with a poll here as well. “How have the relative importance of physical climate risk response shifted, considering the current COVID-19 circumstance?”
But while we wait, Dickon, as the Global Sustainability Practice Leader here in McKinsey, what are some of the conversations, reactions you’re seeing from clients during COVID? Financial institutions, oil and gas, aviation. What do you hear?
Dickon Pinner: That’s a great question. I wait with interest to see the results of this because I think there’s a geographic labor to the answer to some of these questions. But we were quite surprised actually with some of the most impacted sectors taking very much a through cycle view. So you mentioned two. Oil and gas, aviation [have] been hit hard by this crisis. And yet many of the conversations we’re having is the realization that climate change, particularly carbon intensity of the operations in business is going to remain and increasingly become a topic of kind of great relevance to consumers, regulators, and investors.
So one, we’ve a through cycle view and then investors I think are increasingly picking up on this framing that Mekala and Jonathan mentioned of risk. And the realization that an exogenous physical risk from a pandemic has some similarities to an exogenous physical risk that climate change poses. And factoring that risk equation into investments and the book of business is becoming increasingly important. And I’d say thirdly, at a country level, there’s probably an initial response of we can’t afford to do this, and I think there’s a bit of a realization of perhaps we can’t afford not to do this.
And in fact, some of the actions here could be accelerants out of the current crisis and create long term resiliency. So it varies by geography, but those are some of the reactions.
Yuito Yamada: Thank you, Dickon. An interesting poll result has come up as well being “28 percent being Decreased, Neutral being 23 percent, and Increased being 24 percent” so very close and this as you said might differ quite a lot by different geographies. But Dickon, over to you for chapter two.
Dickon Pinner: Of course. So one of the questions we’ve been asked is, “Is there anything to learn from the current situation as it pertains to climate change and physical climate change?” And many of the factors here that Jonathan talked about early on that are characteristics of physical risk of climate change we see as having some similarities to COVID-19. I’ll just pick out a couple of them. The first one is the systemic nature of it, and I think Mekala alluded to the knock-on impacts. And it is very clear that the knock-on impact of people getting sick in one geography and the impact on the global economy as we’re all experiencing and that domino effect has a very systemic nature.
The second one is actually the physical nonlinear thresholds. So we see it in the demographics. We also see these thresholds in hospitals in terms of how many people can you take and what does it take to flatten the curve. That is a function of a physical threshold of a physical system. Similarly we see the regressive nature. I’m sitting here in California where I think in the U.S. something like 39 million people have been made unemployed in the last nine weeks or so. This is a stunning rate and it is the most vulnerable who are most exposed. So it is highly regressive.
So we are underprepared for a problem that is quite visible. it’s also really important to understand some very significant differences. The time scale. Clearly we saw COVID-19 kick in, in days, weeks, months. Climate risk is a years, decades, even centuries phenomenon. The manifestation is also interesting. It is discreet and clear where it came from in terms of root cause, whereas climate tends to be a cumulative impact on the basis of all the historic emissions. Similarly, we see with COVID it is massively correlated. Spatially correlated, temporally correlated all around the world. Where I think we will see less of that on physical climate risk, which is highly spatially dependent and will happen at different places at different times, even though the overall kind of growing macro situation is the same.
Then lastly, the human response. It’s actually easier to respond when you see something that is so clear and directly attributable. Humans are less conditioned to respond to something that accumulates over time than something that you can’t see and the attribution is less clear. So there’s some very important similarities and differences. And you have to be very careful here not to overplay your hand, but there are areas, as Jonathan said, what climate change or physical climate risk is really. It is a risk multiplier. And when the risk in the system is already high and you put climate change on top of it, you end up with a multiplication of that risk. So while I would not put attribution to the current situation, I think looking forward it is not a stretch to say that infectious diseases could spread more and become more prominent as temperature and humidity rise around the world. Then in terms of displacement, either of animals coming in touch with animals that haven’t happened and we know that it is often the jumping from species to species that cause some of these pandemics. And similarly if humans get displaced, it both puts them at risk and creates fertile ground for the dissemination of pandemics. But it’s a risk multiplier, not to say that there’s direct attribution here.
So if we just look at one or two of those in a bit more detail, this is looking more at the Mediterranean, and if you look at West Nile Virus, which doesn’t have that much of a foothold in Europe today and you look at what happens with the spread of this pink area, and these are the cases reported in 2014 on the left, and you wind that clock forward to 2025 or even 2050, and you see these are the areas that have greater than the 50 percent probability of the presence of West Nile [Virus]. You see that beginning to encroach significantly into the Mediterranean, into Eastern Europe, et cetera, in a way that hasn’t been seen.
And we’re beginning to see these discussions coming out with our pharmaceutical clients, et cetera, wondering, “I’ve been investing in cancer drugs but maybe I should be thinking out heat maybe. Maybe I should be thinking about disease vectors, et cetera. Similarly, if you look at Dengue Fever and you look at the change of prevalence, and this just shows what the change of areas at risk would be over the next 30 years. And again, anything that has a red spot is an area where you have increased probability and anywhere you have a blue spot is decreased probability. Can you see the Gulf of Mexico in the U.S., parts of central and Southern America and South Africa having significant more hot spots?
And that’s a function of, as many disease vectors are, temperature, precipitation, and humidity conditions changing. And this gets back to the other attribute we talked about which is nonstationarity. And when things are changing, it means the boundaries or the thresholds of places, which events occur changes too and it exposes potential vulnerability for areas that are not used to these types of things. We could ask ourselves, “Well what has been the impact of COVID, say, on emissions?” And we’ve obviously all noticed a massive impact on our lives. The way we live our lives, our working lives. You see, at least in Europe and the U.S. very few planes in the sky, very few cars on the road.
So surely, emissions would go to zero. No, they’ve only come down we think by about 5.5 percent in 2020. The actual reduction net is very, very small. Now admittedly, we want them to come down by 2 percent, 3 percent a year if you wanted to get to that kind of 50 percent reduction by 2030. But the point being is one, the economic cost of this virus is absolutely horrific. And two, actually the impact is not as great as you might think. So clearly, which I think we’re all pleased about, we’re not advocating that pandemics would be a cure to climate change but the cost is horrific, but moreover it doesn’t actually even begin to solve the problems so something else needs to happen.
So we asked ourselves a question, “What would accelerate the climate action?” And we saw on the answers we had about a third, a third, a third and what might be accelerate. And I think there are reasons to be both optimistic and pessimistic. I think on the accelerate front, and Oliver alluded to this earlier, we are seeing obviously massive increase in government action and the role of government in solving some of the climate change challenges is obviously crucial. We’re also seeing historic low interest rates, which could be good for infrastructure. And we’re seeing risk coming up much more prevalently as a measure of consideration.
However on the downside, we are seeing low fuel costs although those may be more temporary. The government action is more national than multinational, which is problematic because you do need cross border agreement so that is not necessarily a good sign. And obviously the economic situation is such that focus will be elsewhere in some governments minds, obviously to get out of the current situation. And the capital turnover cycle of replacing the old assets to new in a situation where wealth is lower could also be decelerated. So that’s a bit of the balance but we’ve begun to look at this in a bit more detail.
There should be a reframing, which is, a lot of the actions that you can take around climate change to establish greater resilience or decarbonization could actually be accelerants out of the current situation. We just published a paper yesterday, which details some of this work. But if you look at the job creation potential of, say, clean energy investment versus fossil fuel investments, the number of jobs per million dollars is 2X or 3X for some of the renewable type investments. Similarly in construction, the public transportation if you index it per million dollars compared to, say, new roads and bridges is about 30 percent higher.
And similarly you can go and look at things like farming, which are a little bit more labor-intensive, et cetera. So the ability to put people back to work and to create GDP could in some cases be very attractive for a bunch of these measures. And we’ve done a fairly expensive analysis. These are some of the questions going through governments and companies minds. If you look at the economic impact across the top and the decarbonization, what is the number of jobs, and we did this for Europe, per million euros invested? What are the gross value of multipliers? What skill level do I need? What is the speed of impact? Very important.
And similarly then you can look at decarbonization and say, “What are my impacts, both CO2, remote speed, et cetera?” And you see this just lists about 15 levels for transport from electrifying bus fleets to deploying EV charge points, commissioning high speed connections, et cetera. You can go through and you can begin to rack and stack this. And we’re finding government by government and state by state, there’s quite a serious analysis going on and looking at this. I think when you rack and stack a bunch of these even relative to non-climate related opportunities, a number of these things will float to the top because there are serious infrastructure investments, serious O&M investments, which could put quite a lot of people back to work.
There’s a framework where if you look on one hand and you think through what is the socioeconomic impact, the GDP multiplier, the ability to reduce inequality, the speed of impact on the hand, and the climate impact on the other hand, whether that’s funds removed or adaptation resilience created, or the speed of impact. And you begin to see, and obviously it will vary by geography, but you can start seeing how certain levers jump to the top. So a lot of the O&M opportunity, Operations and Maintenance, can put a lot of people back to work very quickly. Similarly, infrastructure has a lot of opportunity to create jobs and wealth but that takes a little bit longer than things like O&M. But we’re beginning to do this type of analysis for different regions of the world and I think it’s pretty quite interesting.
So I think it raises the questions now that we’ve walked through what are some of the lessons that COVID poses for climate change, what are the risks we talked about in the beginning, and then how does that pertain to the current situation? So I think before we go to questions, just think what does it mean? What does it mean for companies in Asia? So a couple of thoughts. One, from an investor point of view, I think there’s going to be a lot of need for new capital formation. So in many cases, governments can provide the demand signal, as the European Green stimulus just came out yesterday. I think lots of states, for example where I live, California, New York, et cetera are looking at this.
But they don’t necessarily have the money and they will be looking to the private sector to form that money and think about deploying it in interesting mechanisms. So how do you securitize your infrastructure? How do you create public–private partnerships? How do you do blended financing to go after things like EV charging points or solar deployment or retrofitting of buildings, et cetera? And I think what’s required to do that both in the private sector is to help government shape those plans and think through what those mechanisms are to deploy that money. This could be a major theme for the next 12, 18, 24 months where the government is a much more significant actor than it was.
Then I think it tees up from a delivery point of view. We’ll also have to think through new delivery models. So for example, even though retrofitting of buildings looks very interesting, I think the whole social distancing thing raises challenges. So should there be more modular construction techniques, how much stuff can be done offsite before it is deployed, et cetera? So that’s just going into a little bit of detail to sort of summarize by saying, yes, I think there’s a lot to learn. I think this is a wake-up call in terms of risk and vulnerability. And actually if we learn the lessons and take that risk mindset and think through what is required as Mekala showed, from an adaptation resilience and a decarbonization point of view to deal with physical climate risk.
There are actually a lot of things that can be done here that would both accelerate out of the current situation and create that longer term economic and environmental resilience. So with that, Yuito, I’ll hand it back to you.
Yuito Yamada: Thank you very much, Dickon, for your presentation. I would like to go for the final poll asking the audience once again, “When will physical climate risk response be critical for your organization?” as we asked in the beginning as well. But Dickon, finally, while we wait there was also a question that was coming up as well. What are the specific capabilities, that Mekala was mentioning as well, that are required for companies to get prepared on physical climate risk?
Dickon Pinner: So I think a few things. One, I wouldn’t be surprised if every major company within the next three to five years had a climate scientist on board. So the need for decent climate science, the ability to look forward on the basis on how things are changing, versus being purely reliant on the past empirical evidence is going to be very important. Secondly, I think strengthening this risk muscle is huge. And I think that the companies that we see who are most advanced on thinking through physical risk and transition risk are beginning to think through how do I embed it into the governance in every decision I make? What organization do I need? And the answer is probably not to have a stand-alone sustainability function.
It’s a little bit like cyberrisk was 10 years ago, where now every cyberthreat is sort of integrated into all of the decisions you make. Climate risk will have to be integrated into capital allocation, into budgeting, into supply chain management, et cetera. So I think there’s a huge governance and organization piece including all the way up to the board in how you structure for this, and a host of new kind of climate analytics capabilities that will be required.
Yuito Yamada: Thank you very much, Dickon. And we see actually the numbers going slightly up as well in terms of “Right now. Already.” So I feel that the audience is feeling this as well. But now we’d like to, and there are some questions coming up already, open up discussion from the participants as well. Again, to ask a question please go to the Q&A tab, lower right side of your screen. Type your question and then click send. There are a few coming around. And let me start off with one here. Jonathan, there’s a question on Asia. What are you seeing specifically in the companies in Asia–Pacific, banks, infrastructure companies, when you’re talking about the climate risk analysis?
Jonathan Woetzel: Well, first of all, a company in a business portfolio it’s important to get a handle on that risk. So that’s, as Dickon was saying, an across-the-board issue. So part of it is about getting the data and some companies are already there. In fact, if you look at companies that operate in extreme environments where they already have exposure to natural hazards, they’re very familiar, and so there’s actually quite a bit of expertise in some areas. But in others, potentially also in areas that are essential and critical like utilities, there needs to be more investment made.
From the finance side, what we see is a similar sort of awareness that now this hasn’t perhaps been factored into equity values and market values, and it will be important to build that capability as a function of risk. But also as an opportunity, in a sense that what we’re looking at here is ensuring there’s a full set of information for investors so they can in turn improve the quality of their decisions. And from a financial institution perspective, that then translates into a benefit. So the question we could have from banks and investors in Asia is, “Who can do this for me? Who can provide this set of information that allows me to instruct a climate optimized portfolio?”
Then finally, the third reaction we get is from companies that do see this as simply saying, “Some aspects of physical climate risk are locked in,” and we see that momentum. So we do need to address it and that creates a set of investment challenges and opportunities. You have plenty of folks who are taking this as a mandate to invest in technologies for adaptation and for mitigation. And I think that actually is, again, in spurring investments, not freezing them in place.
Yuito Yamada: Very good. No, thank you. There’s a number of questions coming in and thank you very much. Dickon, maybe and Mekala, two questions I’ll ask you at the same time. One, what are some of the key questions boards need to be asking to the top management on whether the company is becoming ready for the climate risks? How do boards become more comfortable on these analyses? Is there any questions that we’d like to pause? Then number two, there’s also a question, Jonathan or Dickon, Mekala, around insurance. Because all these natural kind of risks are getting higher, how could an insurer kind of plan? What are the implications for the insurance sector? Please, two questions at the same time.
Dickon Pinner: Okay. Maybe I’ll start with the insurance and then maybe Mekala you’ll want to comment on boards. Insurance is a very interesting one, an area we’re spending a lot of time in. There is a lot of confusion I think about who holds the risk here. I mean, insurance really transfers and in best cases it helps mitigate the risk by changing behavior. But it rarely holds that much risk because typically policies are one year policies, and so when you have a mortgage, your 30-year mortgage is actually subject to you having insurance. So if you don’t get insurance a year after, you are actually maybe in default.
So insurance is tricky and some of the actors that we think are going to be most interesting in the insurance space is the insurance brokers who don’t actually hold the risk but can actually put the pieces together. And I think there are some regulatory challenges in the insurance market. In some areas where there have been disasters you see that there’s been a moratorium on dropping insurance or changing insurance to reflect forward looking risk, which I think means that in some places insurers—when that moratorium ends—will just leave.
So I think this is really worth looking at because at the end of the day, they’re a kind of middle man and the two people who are really left holding the risk are the consumer and potentially the sovereign. And to some extent I think there’s also worth looking at sovereign risk and trying to educate the risk that’s coming their way so that they can sensibly and thoughtfully think through what risk to put back onto the private sector to drive the rights of the behaviors. But it’s a complex problem.
Mekala Krishnan: Yeah. Maybe just to add on the insurer side. I think maybe insurers also have a crucial role to play in terms of building some of the analytical capabilities to quantify this risk in some ways. If you think about national catastrophe modelling, that what insurers do. That’s been their job but now it’s about how you integrate a forward looking view of climate into many of these models and we’re seeing a lot of insurers really investing in trying to build such capabilities. Then I think the other angle we’re seeing around insurance is the role of insurers advising on risk management.
So what are the types of advisory services they can put in place to help insurees, whether that’s companies or homeowners, think about practices to adapt to risk, whether that’s elevating homes or building other forms of physical hardening, et cetera.
Dickon Pinner: One other thing on the insurance side just made me think is the investment side. So there’s the underwriting side but then there’s actually quite a lot of exposure on the investment side. Then there’s the reputation and a regulatory piece. But I think one of the things that could be considered are things like parametric pricing, which is where your privacy and sort of set of outcomes overall whether or not ... So you pay out if it rains 26 inches but not 25, even if the property didn’t flood and that’s beginning to be a manifestation of client risk. But I think that some of those fundamental product redesign may be required. Sorry, Mekala.
Mekala Krishnan: No, that’s good, Dickon. On the board side, and Jonathan, Dickon please add on as well, I think a little bit this goes back to what Dickon was saying and I was saying relates to companies embedding climate risk into their operations. Rather than it being a separate function that is owned by a sustainability head, really putting in place practices that integrate it into every aspect of a company’s business. And certainly there needs to be analytics and tools that underpin that, but it needs to be a part of purchasing and supply chain decisions. It needs to be a part of capital allocation, capital planning decisions. It needs to be a part of financial modelling.
So it’s really talking about an end-to-end integration of these risk capabilities. The board providing oversight to that I think is an enormous role and responsibility. I think the other piece we’re seeing a lot of momentum on, on the part of companies, is around disclosures. So one of the big things that happened in the last two years was momentum around the task force on financial disclosures, TCFD, which many companies have now started to adopt. So as a tool to create transparency on a company’s practices and for companies themselves to communicate to their shareholders, their consumers, on the practices they’re taking that’s been gaining a lot of momentum. And boards playing a role in ensuring those disclosures meet their standards, meet their needs, I think will be important.
Yuito Yamada: We have a final question and maybe 30 seconds each from Jonathan and Dickon. Do you see an upside for Asian countries or companies from this climate-related outcome, especially in the COVID? In the solar ages, you saw some of the Asian companies rising for market opportunities. Do you see any opportunities in this Green stimulus for Asian countries? Jonathan and Dickon maybe 30 seconds each.
Jonathan Woetzel: Yeah. The opportunity is essentially about well the science tells us what’s going to happen. It’s up to us what we want to do about it. And companies and decision makers that respond more effectively will have an upside. So cities that are better cities because they’re flood-proofed and they’ve managed their exposure to heat and agricultural productivity is sustained will obviously do a lot better. Having foresight and being proactive will be critical and that extends to of course the industry as well. As far as the specifics on the stimulus and how that plays out, I think of course in any economic investment there are going to be winners and losers. And what we’ll have to look for is the competitiveness of a company or for that matter the government in support and making these investments will ultimately determine whether that is a value creating investment or not.
Dickon Pinner: Yeah. Maybe the one thing I’d add I think capital formation is huge. Take Europe right now, there’s a big stimulus. That will be a signal but there is not necessarily the money behind it. So capital formation and then I think the need for, as I said, infrastructure for the next 10 years that can be securitized. I think there’s a lot of opportunity there, both for decarbonization, but also for long-term resilience and adaptation is, I think, a big opportunity for Asian manufacturer and services companies.
Yuito Yamada: Very good. Thank you for hitting the time. Thank you again, Dickon, Mekala, and Jonathan. On behalf of the McKinsey Sustainability Practice and McKinsey Global Institute, I’d like to say a huge thank you to all the participants joining today.
Oliver Tonby: You have been listening to the Future of Asia Podcast by McKinsey and Company. To learn more about McKinsey, our people, our latest thinking, visit us at mckinsey.com/futureofasia. Or find us on LinkedIn, Twitter, and Facebook.
