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Areeba Khan

Physical climate risks are becoming increasingly systemic and severe. To illustrate this, analysis from the European Environment Agency (EEA) shows that from 1980 to 2022, weather and climate extremes caused EU member states’ economic losses to reach an estimated €650bn, including €59.4bn in 2021 and €52.3bn in 2022.

Rising physical risks impact companies differently based on the geographic distribution of their assets. In this feature, 9fin assesses HY issuers’ vulnerability to such risks.

Extreme weather may go unnoticed as a material risk due to the perception that climate change and its impacts are a medium to long term risk. However, HY firms are increasingly reporting losses and damages as a result of extreme weather. Firms are expected to continue to experience material impacts including supply chain disruptions and property damage as extreme weather increases in frequency and severity.

In June, due to extreme flooding in Switzerland, Novelis, an aluminium producer, reported that its Sierre plant that services clients like Jaguar Land Rover had to halt production. Constellium, an aluminium manufacturer, reported an estimated €135m in damages due to the same flood. Earlier in the same month, Chemours, a specialty chemicals manufacturer, released a statement indicating that it paused production at a titanium dioxide plant in Mexico in compliance with Mexican government regulations to conserve water. A number of HY firms have production sites in Mexico and 9fin mapped out potential exposure to drought risks including Cemex, Thyssenkrupp, Talos Energy, and more.

Investors should be equipped with a robust climate transition plan that demonstrates that a firm has considered its climate-related vulnerabilities and has adapted its strategies to align with climate science. Climate scenario analysis allows firms to identify potential material vulnerabilities as a result of climate change, including extreme weather-related risks (read 9fin’s guide on assessing a climate transition plan here)

Using 9fin’s document search tool, we looked at a number of HY firms that have been impacted by severe weather events and assess the robustness of their climate transition plans.

Financial impact: In 2023, Pactiv reported that Hurricane Ian flooded its Evergreen plant in Florida, however, it did not report the financial impact. In August 2021, Pactiv’s Canton, North Carolina mill was flooded by Tropical Storm Fred, resulting in damage to property, plant and equipment. The mill subsequently experienced an explosion and fire resulting in its closure for several days in 2021. As a result, the company’s food and beverage merchandising segment incurred $7m (p.34) of incremental costs

Scenario analysis: Pactiv has conducted climate scenario analysis using two different pathways including a well below 2ºC scenario and a business-as-usual scenario. Best practice is to conduct analysis on three to four scenarios to ensure diversity and avoid bias. Pactiv found that its two paper mills in Canton, NC, and Pine Bluff, AR are directly exposed to water-related risks as water is essential to its operations. Additionally, it identified eight other facilities at risk of being impacted by acute weather events such as storms, flooding, and tornadoes. Pactiv reports that an extreme weather event could result in approximate additional operational costs from $5m to $50m annually. In addition to property damage and associated operational costs, weather events could also significantly increase labour costs needed to maintain productivity. Costs associated with its business-as-usual scenario could range from $6m to $33m annually

Mitigation measures: Pactiv mitigates impacts through insurance, business continuity, and emergency preparedness processes. It reports that its widespread manufacturing and warehousing footprints allows for production redundancy between sites. Pactiv reports that its scenario analysis will inform its strategy, however, it does not report any adaptive financial planning or initiatives

Financial impact: In late Q2 2024, all operations at Constellium’s Sierre and Chippis facilities in Switzerland were suspended due to severe flooding, resulting in an estimated gross damage assessment of €135m. This assessment is before the consideration of an insurance claim of up to €50m. The flooding will likely cost Constellium €85m (1.17% of FY 23 revenue)

Scenario analysis: Constellium has not conducted climate scenario analysis despite operating in an emissions-intensive industry. But it has conducted analysis on its water-related risks. As of 24 July, 24% of its manufacturing sites (accounting for only 0.2% of water withdrawals) were located in areas of high or extremely high water stress. However, 83% of its sites have a medium to medium-high drought risk

Mitigation measures: Constellium reports that, in 2023, it worked to improve its emergency response. However, the group does not report specific steps taken. Constellium has targets to reduce its water consumption. However, it states that, under 2030 and 2050 pessimistic climate scenarios (details not provided), just under 20% of its water withdrawals will be from areas of high or extremely high water stress, indicating that its exposure to water-stressed areas will increase in the future. Constellium reports limited adaptation and mitigation measures to address its physical climate-related risks

Financial impact: Campari Group reports that most of its revenue is in the northern hemisphere and unseasonably cool or wet weather can affect its sales volumes. Campari reported a number of losses across its operations due to weather events. In the six months ended 30 June 2024, Campari reported a sales decrease of 5.2% in Italy, driven by the pressure on high-margin aperitives, resulting from very poor weather. It also reported a 4.3% decline in Campari Soda sales which it attributed to poor weather in Italy

Scenario analysis: Campari has not conducted climate scenario analysis despite its revenue’s link to weather conditions. Campari reports that it has a tequila production site in Mexico that is impacted by water scarcity which is material given the alcoholic beverage industry’s high consumption of water. Campari does not report if it has mapped its water-related risks (eg. drought, flood) across its production chain. Of the 18 production sites listed on Campari Group’s website, 9fin found that 61% had medium-high to extremely high levels of water stress, 27% had medium-high to extremely high risk of riverine flood, 50% had a medium-high risk of drought

Mitigation measures: The group reports limited adaptation and mitigation measures to address its physical climate-related risks

Financial risk: Floods, drought or frost can have a significant impact on Tereos as crops are used as raw materials. In 2022, Tereos suspended activities of its Severínia sugar and ethanol plant in Brazil following lower crop yields as a result of weather. The primary raw materials used by Tereos are agricultural products, which are inherently subject to weather conditions. In April 2024, the group highlighted that dry weather in Brazil was impacting its production and that yields for 24/25 will depend on rains during the next months.

Scenario analysis: Tereos has not conducted climate scenario analysis to assess its climate related risks. Tereos has 36 (excludes Reunion Island sites which reported no data) sites and R&D locations, 50% of which are located in areas with medium-high to extremely high water stress and 52% of sites had a medium-high risk of drought. Tereos reports measures to reduce water consumption in its Brazilian operations

Mitigation measures: Tereos is exposed to water-related risks, however, it has limited reporting on adaptation and mitigation measures, including the potential financial costs associated with mitigation

Financial risk: In 2023, weather impacts resulted in €232m (0.5%). in losses due to inclement weather in central and eastern Europe which impacted Veolia’s energy activities. Group EBITDA declined by €83m due to weather

Scenario analysis: Veolia has conducted climate scenario analysis using two physical risk scenarios (2°C scenario and an over 4°C scenario), over 2030 and 2050. It identified physical risks (e.g. higher average temperatures, heat waves, flooding, water stress.) Based on the results, annual financial impacts were estimated for the period to 2030 at several tens of millions of euros (e.g. direct impact of higher temperatures) for physical risks

Mitigation measures: Veolia reports that it mitigates its physical risks by (i) the choice of a site’s location in order to limit exposure, (ii) analysis of the various scenarios to enable the implementation of tailored prevention plans and (iii) the development of business continuity plans. Veolia reports limited financial planning regarding extreme weather events, however it indicates that damages are usually transferred to insurance companies

Financial risk: Vistra reported a significant increase in fuel procurement costs due to Winter Storm Uri, Winter Storm Eliott, and Winter Storm Heather in 2021, 2022, and 2024 respectively. The 2021 storm had a material impact on its operations (p.40) and its operational results in 2022 and 2023 were negatively impacted by lower retail volume sales due to the weather (p.63). It’s not just extreme weather that has an impact. In fact, it reported $160m in losses due to mild weather (p.64). There was also a $48m loss (p.61) in adjusted EBITDA due to bill credits it offered large industrial and commercial customers during the storm to incentivise the reduction of power usage in 2023. These credits will be applied in 2024 (about $11m) and 2025 (about $26m). In 2022, the application of these credits resulted in a loss of $319m (p.62), about 10% of 2022 adjusted EBITDA

Scenario analysis: In Q3 of 2022, Vistra engaged with a third party for a refreshed climate risk analysis. Vistra has nine power plants in areas identified as high or extremely high water stress representing 7% of its water withdrawal. The plants are located in regions that are either typically arid, historically susceptible to drought, and/or experiencing higher electricity demands due to significant business development and population growth

Mitigation measures: Vistra reports that it has an emergency preparedness system, however, it does not report the results of its climate risk analysis including its vulnerability to extreme events

There appears to be a slight shift in attitudes towards climate risks.

Research from 2022 indicated that global bond markets often mispriced climate risks, overreacting to short-term events while underestimating longer-term climate-driven trends. Another research paper found that investors are more likely to hedge against imminent climate transition risks (as these are more likely to be made salient by policymakers) and ignore physical climate risks.

However, recent evidence implies this could be beginning to change.

In October 2023, a study by the European Central Bank (ECB) showed eurozone banks are increasingly incorporating climate factors into lending: companies with emission reduction targets enjoy interest rates 20bps lower than those without.

The top quartile of polluting firms faces rates 14bps higher than the bottom quartile. The study found that banks with SBTi-certified targets generally charge higher rates to high-emission companies and lower rates to low-emission ones, factoring in current and future emissions. Similarly, a study by De Nederlandsche Bank (DNB) in August 2024 shows that high-carbon companies are facing higher bond rates as investors demand a premium to offset climate risks.

If the global temperature rise is limited to 1.5°C, annual adaptation investments for the EU and UK are estimated at €40bn. At 2°C, the required investment increases to €80bn-€120bn per year, according to EEA. Global mitigation costs to limit warming to 1.5°C are expected to involve losses to global GDP of between 2.6% and 4.2% in 2050, according to a report by IPCC.

This problem is not exclusive to governments.

Companies are also increasingly expected to face steep financial costs in the future as risks materialise. To avoid the impact of rising costs, companies should make investments in adaptation and mitigation.

Companies generally have taken steps to plan mitigation measures, but adaptation measures are rare. According to the EEA, adaptation in investments significantly reduces economic losses from climate impacts.

Good practice for corporates would constitute highlighting the current and planned proportion of revenue, opex, and capex allocated to mitigation and adaptation measures. There is also evidence that investors are increasing financing of mitigation measures at the expense of adaptation measures; less than 8% of global climate finance is allocated to adaptation measures.

Companies are also facing regulatory pressure to address physical risks. Under the Corporate Sustainability Reporting Directive (CSRD), they are required to assess their exposure to physical climate-related risks, undertake a climate risk assessment, and consider mitigation measures.

The UK Transition Plan Taskforce suggests companies should also consider adaptation measures as part of their climate risk assessments.

We are also seeing global rule-makers demand a more rigorous approach to assessing climate risks. This comes as investors demand more consistency and closer integration between a company’s sustainability reports and financial statements. In particular, the International Accounting Standards Board (IASB) has issued guidelines that ask companies to depict how climate risks impact affect assets, liabilities, equity, income, or expenses.

Although bond markets and investors are increasingly factoring in these risks, we find that a number of HY companies have been undervaluing them.

Insurance coverage clouds risk assessments

In March 2024, the EEA said that climate risks in Europe could reach critical or catastrophic levels by the end of the century. It noted that economic losses from coastal floods alone could exceed €1tn per year.

HY firms are increasingly conducting climate scenario analysis in preparation for the CSRD. However, many firms are still lagging in assessing the potential physical impacts associated with climate change and as a result have not identified potential material risks. Where some analysis has been done the notable gaps in strategy, including adaptation and mitigation plans, diminish the quality and effectiveness of climate transition plans. Through robust climate scenario analysis, firms can adapt their strategies to mitigate the impact of climate change and reduce financial losses.

While some firms, such as Pactiv, have identified the potential costs associated with an increase in extreme weather, many firms’ adaptation plans largely revolve around externalising the cost to insurers. However, insurance alone may not be an ideal long-term strategy.

Extreme weather events like floods, heatwaves, and hurricanes have led to insurers reaching and exceeding record level payouts. In 2023, there were 37 disasters globally. This marked the fourth consecutive year that insurance losses from extreme weather exceeded $100bn.

Investors are rewarding insurance providers for being increasingly selective in dolling out coverage with higher share prices. In the last year, US insurance providers for property catastrophes increased their coverage price by over 30% in 2023. In Europe, insurance premiums have risen 10-12% over the past few years but are expected to continue to increase as extreme weather events become a regularity.

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