Scenario analysis involves exploring risks and opportunities in a range of hypothetical futures. It can enhance strategic thinking and form a key part of climate-related financial disclosures. Granular data is available on transition pathways, climate impacts and macro-financial indicators to support this analysis. The NGFS is working with key stakeholders to set out a more standardised set of scenarios and variables for disclosure.
Climate scenarios have a number of useful applications
Navigating the models and data
The NGFS Climate Scenarios bring together a global, harmonised set of transition pathways, physical climate change impacts and economic indicators. The strength of the NGFS suite of models is in their global coverage and integrated assessment of risks. Where possible, multiple models have been used for each scenario and warming level to indicate some of the uncertainty.
The transition pathways provide a view of how the energy system and land-use would shift in response to different levels of climate policy and technology trends. Three Integrated Assessment Models were used to model each of the six scenarios. These models typically solve at 5 year time steps to the end of century and provide indicative temperature outcomes based on the level of greenhouse gas emissions. This data can help answer questions like: when will fossil fuel use have to peak and decline? How high would emissions prices have to rise? How much energy-system investment is needed? All transition pathways data can be explored via the NGFS IIASA Scenario Explorer.
Getting started with scenario analysis
In June 2020, the NGFS published a Guide to Scenario Analysis. While pitched at central banks and supervisors, it provides generic guidance on how to assess climate-related risks. The report identified four key steps:
Consider the objectives of the exercise. This could be to assess the impacts on profitability, business models, financial risks or the broader economy.
Select a range of scenarios that best suits the objectives of the exercise and the types of risks to be explored. For example, the Current Policies scenario is best suited to assessing physical risks.
Assess the macro-financial impacts
Often, a qualitative assessment can be just as important here as a quantitative assessment.
Communicate and use results
Scenario analysis can be a useful tool to understand risks and opportunities, identify the implications for strategy and/or policies and pinpoint areas for further research.
In October 2021, the NGFS also published the Scenarios in Action report, which sets out how NGFS Members used and are using the NGFS Scenarios to identify, assess and understand climate risks in their economies and financial systems.
Modelling climate risks
The NGFS data can be used to help size the potential impacts on individual companies and households, as well as the macroeconomy in aggregate. This can further provide a window into potential financial risks and opportunities.
Granular data on energy, land-use, greenhouse gas emissions and temperature (transition pathways), and from physical climate change (climate impact data) from the NGFS can be mapped to assets and economic activities.
Financial impacts on households or companies
Different climate scenarios and warming levels will have different financial impacts on different companies and households depending on their location and characteristics. Further assumptions will likely have to be made to translate climate-related data into financial impacts.
Climate-related risks will also affect the economy as a whole. The NGFS has worked collaboratively with the National Institute for Economic and Social Research to quantify the potential impacts. Changes in the macroeconomic environment should also be factored in when assessing financial impacts on individual exposures.
The financial impacts on companies and households may affect their ability to pay dividends and/or service debt. This will have an impact on financial risks such as credit, market, operational, liquidity and/or insurance underwriting risks for financial firms.