Business-not-as-usual: Tackling the impact of climate change on supply chain risk

Authors: Richard Gledhill, Dan Hamza-Goodacre and Lit Ping Low

While climate change and increasing temperatures now seem inevitable, there are high levels of uncertainty about the manifestations and magnitude of their impact. What is certain, though, is that climate change will have a multiplier effect on supply chain risk.

In 2010, Russia suffered a severe heat wave. The resulting economic losses were estimated to be US$15bn as drought and wildfires destroyed crops, particularly wheat. The knock-on effect was export restrictions on wheat in Russia, which contributed to global price increases.

Anticipating and responding to risks is business-as-usual for all sectors. This example is from the agricultural sector. It is one of many one could choose from sectors that are dependent on physical produce, such as agricultural, fuel or mining and metals commodities. These industries are no strangers to dealing with the risks of supply-chain disruption (e.g. wheat shortages), both man-made (export restrictions) and natural (weather, drought, etc.). What is changing is the complexity of the risks, their interdependence with other risks and the wide-reaching, contagious impact they have (e.g. global price rises).

But the other major factor set to exacerbate supply-chain risk is climate change. Often overlooked, climate change adds to complexity. It amplifies or alters existing risks, for example raw material availability (e.g. water, energy) or transport disruption due to extreme weather events. The resulting shocks on the global supply chain can be severe and persistent.

So climate change is a ‘risk multiplier’. But businesses have yet to gain the full measure of its effect on their supply chains. How serious? How soon? How likely? How wide? How to mitigate?

Too late for two degrees?

How serious is the risk of climate change from increased temperatures? It is not such a far-fetched issue as many thought. The latest update from the World Bank is that the global mean temperature has already increased by 0.8ºC above pre-industrial levels. We can also look at estimates of global insured losses from major extreme weather events. In the last two decades losses have increased markedly, averaging tens of billions of dollars annually.

Every year, government representatives from around the world meet at the UN Framework Convention on Climate Change (UNFCCC). They have agreed to limit the average global temperature rise to 2ºC, and identified actions to mitigate, and adapt to, climate change. In spite of these efforts, carbon emissions have continued to rise. In 2011, emissions levels were the highest ever recorded. Can we really limit the temperature increase 2ºC? PwC’s latest Low Carbon Economy Index suggest that based on current progress, this is ‘highly unrealistic’.

One thing is clear though, businesses and governments need to start planning for a world with a changed climate. In particular, industries dependent on food, water, energy or ecosystem services need to scrutinise the resilience and viability of their supply chains.

Which supply chains need to strengthen their links?

What is the likelihood that climate change risk could disrupt certain supply chains? To answer this question, we have analysed the threats posed by climate change to a selection of commodities:

  • agricultural (wheat, maize and rice)
  • energy (petroleum and gas)
  • mining (metal ores)

We have looked at the two major factors that have the greatest influence on risk exposure:

  1. The magnitude of impact of climate change on the commodity:

    This depends on: i) how susceptible a commodity is to the effects of changes in temperature and precipitation, rise in sea levels and occurrence of storms and flooding; and, ii) how able the supplying country is to cope with the potential effects of climate change. This is based on factors such as political stability, governance, macro- and socioeconomic development of a country.

  2. The concentration of suppliers:

    In general, where a commodity can be sourced from a diverse range of suppliers, supply disruption can be lessened as buyers turn to alternative suppliers. Conversely, where a commodity is concentrated in a small number of suppliers, disruption for any one major supplier can have global implications.

Figure 1: Climate change: impacts and diversification, selected key commodities

We have mapped these factors in Figure 1. It shows the extent to which the top five country exporters of these commodities are exposed to climate change impacts (vertical axis), and the degree of global supply concentration of these commodities (horizontal axis).

Rattling the supply chains of rice

Our analysis, which uses projections for the 2040s, indicates the following:

Figure 2: Commodity supply chains at a glance

  • The supply of agricultural commodities (maize, rice and wheat) is more concentrated than that of the other commodities considered (petroleum, gas and metal ores). This is dictated by the climatic conditions in Asia (rice), North America (maize, wheat) and South America (wheat).

  • Rice production stood out as the commodity that is both expected to be affected by climate change and highly concentrated in production. As the impacts of climate change on rice are increasingly felt in South and South East Asia, the global supply of rice could be significantly affected, as buyers have little alternative sources of supply.

  • Maize and wheat are also relatively concentrated in supply, but the effects of climate change on these crops are projected to be relatively less severe. A concentrated supply base for maize means that any disruption to its major producers (from climate change or otherwise) can have a pervasive global impact. Its role as feedstock also means that implications of supply disruptions on global food prices can be significant, as was evident in the US droughts in 2012.

  • The diversified supply of petroleum, gas and metal ores means that supply issues in any one supplier are unlikely to trigger widespread disruptions. The supply availability of these commodities is more likely to be disrupted by other risks than by climate change. These include the finite nature of such resources, technological capacity and politics. But the effects of climate change are likely to interact with these other factors and lead to an amplification of risks globally. Commodity price volatility can be exacerbated not just by more frequent or severe extreme weather events, but also by the accompanying political or policy reactions.

The multiplier effect on a global scale

Figure 3: Supply chain disruptions: the contagion of impacts from a single event

How far-reaching will the effects be? Although the analysis focused on projected impacts, recent events have already demonstrated the ripple- effect globally. Extreme heat waves in Russia and the US, and other extreme weather events such as flooding and hurricanes, showed how one event in a country or region can have repercussions globally.

Multiplier effect needs multilateral efforts

How can organisations start to mitigate the potential disruption on supply chains due to climate change risk? This year, the UN negotiations in Doha concluded with limited progress, with current pledges still falling short of what is needed. Businesses and governments can improve readiness by adopting these three principles:

Don’t view risks in isolation.
Businesses need to identify not just the risks emerging from the impacts of climate change, but how the resulting impacts interact with existing risks.

Start scenario planning and put risk management procedures in place.
Governments and the business community need to start considering risk management plans in a world with a climate change of not just 2oC, but also 4oC or even 6oC. Effects are already being felt in some regions and they are projected to worsen globally.

Collaborate and give greater attention to international resource security.
Competition for scarce resources may intensify, and can be compounded by political and economic developments. Developing a collaborative and sustainable resource management strategy at a global level can help avoid the risks of ‘resource grab’ and conflicts.