Introduction to Scenario Analysis

Scenario analysis is a cornerstone requirement of AASB S2 and a powerful tool for understanding climate resilience. This lesson introduces the fundamental concepts, methodologies, and practical applications of climate scenario analysis for business planning and disclosure.

Understanding Scenario Analysis

Definition and Core Concepts

Climate Scenario Analysis A process for exploring the potential implications of different climate futures on an organization’s strategy, operations, and financial performance through the use of alternative scenarios representing different climate outcomes.

Key Characteristics:

Forward-looking: Explores potential future states rather than predicting specific outcomes
Multiple pathways: Uses several scenarios to capture uncertainty and variability
Stress testing: Tests business model resilience under different conditions
Decision support: Informs strategy, risk management, and investment decisions

Scenario vs. Forecasting

Forecasting Approach:

Attempts to predict most likely future outcome
Single point estimates with confidence intervals
Based on trend extrapolation and statistical models
Limited ability to capture structural changes

Scenario Approach:

Explores range of plausible future outcomes
Multiple internally consistent storylines
Considers discontinuities and structural breaks
Better suited for long-term strategic planning under uncertainty

Purpose and Benefits of Scenario Analysis

Strategic Planning Benefits

Enhanced Decision Making

Investment Decisions: Evaluate project viability across climate futures
Strategic Options: Identify robust strategies that perform well across scenarios
Risk Management: Understand potential vulnerabilities and preparation needs
Opportunity Identification: Discover value creation opportunities in transition

Resilience Testing

Business Model Stress Testing: Assess viability under different climate conditions
Supply Chain Resilience: Evaluate supplier and logistics vulnerabilities
Financial Planning: Understand potential cash flow and capital requirement variations
Operational Adaptability: Identify needed operational flexibility and capabilities

Compliance and Disclosure Benefits

AASB S2 Requirements

Mandatory Element: Scenario analysis is required for material climate risks
Strategic Integration: Must show how scenarios inform strategy and financial planning
Assumption Transparency: Key assumptions and methodologies must be disclosed
Regular Updates: Scenarios should be reviewed and updated periodically

Stakeholder Communication

Investor Confidence: Demonstrates rigorous climate risk management
Regulatory Compliance: Meets mandatory disclosure requirements effectively
Stakeholder Engagement: Provides framework for discussing climate preparedness
Competitive Differentiation: Shows sophisticated climate risk management

Risk Management Benefits

Early Warning System

Emerging Risks: Identifies risks before they fully materialize
Interaction Effects: Reveals how different risks compound and interact
Systemic Risks: Helps understand broader system-level changes
Adaptive Capacity: Builds organizational learning and flexibility

Quantitative Risk Assessment

Financial Impact Estimation: Provides order-of-magnitude impact estimates
Probability Weighting: Enables risk-adjusted decision making
Sensitivity Analysis: Shows which variables drive outcomes most significantly
Portfolio Effects: Understands diversification and concentration benefits

Common Reference Scenarios

International Energy Agency (IEA) Scenarios

Stated Policies Scenario (STEPS)

Description: Reflects current policy commitments and announcements
Temperature Outcome: ~2.7°C warming by 2100
Energy Transition: Gradual transition with continued fossil fuel use
Business Implications: Moderate transition pressure, increasing physical risks

Announced Pledges Scenario (APS)

Description: Assumes all announced climate pledges are met in full
Temperature Outcome: ~2.0°C warming by 2100
Energy Transition: Accelerated renewable deployment, significant efficiency gains
Business Implications: Strong transition pressure, manageable physical risks

Net Zero Emissions by 2050 (NZE)

Description: Pathway limiting warming to 1.5°C through rapid transition
Temperature Outcome: 1.5°C warming with limited overshoot
Energy Transition: Unprecedented speed and scale of change
Business Implications: Severe transition risks, minimal physical risks

Network for Greening the Financial System (NGFS) Scenarios

Current Policies

Policy Response: No new climate policies beyond those already implemented
Physical Risks: High chronic and acute physical risks
Transition Risks: Limited transition risks in near term
Use Case: Stress testing for physical risk impacts

Divergent Net Zero

Policy Response: Net zero achieved but with regional variation in timing and policies
Physical Risks: Moderate physical risks with regional variation
Transition Risks: High transition risks with policy uncertainty
Use Case: Exploring coordination failures and policy misalignment

Delayed Transition

Policy Response: Climate action delayed until 2030, then rapid catch-up
Physical Risks: Higher physical risks due to delayed action
Transition Risks: Very high transition risks due to rapid late action
Use Case: Exploring consequences of policy procrastination

Net Zero 2050

Policy Response: Immediate stringent climate policies, global cooperation
Physical Risks: Low physical risks, warming limited to ~1.5°C
Transition Risks: High but manageable transition risks
Use Case: Best-case policy response scenario

Representative Concentration Pathways (RCPs)

RCP2.6 (Low Emissions)

Radiative Forcing: 2.6 W/m² by 2100
Temperature: 1.5-2°C warming
Characteristics: Strong mitigation, early peaking of emissions
Business Context: Paris Agreement achievement scenario

RCP4.5 (Moderate Emissions)

Radiative Forcing: 4.5 W/m² by 2100
Temperature: 2-3°C warming
Characteristics: Moderate mitigation efforts, gradual decoupling
Business Context: Current policy trajectory scenario

RCP8.5 (High Emissions)

Radiative Forcing: 8.5 W/m² by 2100
Temperature: 4-5°C warming
Characteristics: Limited mitigation, continued high emissions
Business Context: Physical risk stress testing scenario

Key Assumptions and Parameters

Economic Assumptions

GDP Growth Pathways

Global Growth: 2-4% annual global GDP growth assumptions
Regional Variation: Different growth rates for developed vs. developing economies
Climate Damages: Economic feedback effects from climate impacts
Technology Progress: Innovation and productivity growth assumptions

Energy System Transformation

Renewable Energy Costs: Continued cost declines for solar, wind, storage
Fossil Fuel Demand: Peak timing and decline rates for oil, gas, coal
Carbon Pricing: Coverage, level, and progression of carbon pricing mechanisms
Energy Security: Geopolitical factors affecting energy trade and supply

Technology Assumptions

Deployment Rates

Renewable Energy: Solar and wind capacity addition rates
Energy Efficiency: Improvement rates across sectors and applications
Electrification: Electric vehicle adoption, heat pump deployment
Emerging Technologies: Hydrogen, carbon capture, synthetic fuels timeline

Cost Trajectories

Learning Curves: Technology cost decline rates with scale
Resource Constraints: Critical mineral availability and pricing
Infrastructure Requirements: Grid, charging, pipeline investment needs
Innovation Breakthroughs: Potential for step-change cost reductions

Policy Assumptions

Climate Policy Stringency

Emissions Targets: National determined contributions and net zero commitments
Policy Instruments: Carbon pricing, regulations, standards, subsidies
International Cooperation: Technology transfer, climate finance, trade policies
Implementation Timing: Phase-in periods and compliance timelines

Sectoral Regulations

Energy Standards: Renewable energy targets, efficiency requirements
Transport Policies: Vehicle emission standards, zero emission zones
Industrial Standards: Emission performance standards, product requirements
Building Codes: Energy efficiency, electrification mandates

Physical Climate Assumptions

Temperature Projections

Global Warming: Different warming levels and regional patterns
Extreme Events: Frequency and intensity changes for heat, storms, drought
Precipitation: Changes in rainfall patterns and seasonal distribution
Sea Level Rise: Rate and magnitude of coastal impacts

Climate Sensitivity

Temperature Response: Climate sensitivity to greenhouse gas concentrations
Feedback Effects: Ice-albedo, cloud, and ecosystem feedbacks
Tipping Points: Probability and timing of critical threshold crossing
Regional Variation: How global changes manifest locally

Proportionality Principle for Different Organizations

Organization Size Considerations

Large Organizations (Group 1)

Full Scenario Analysis: Comprehensive quantitative and qualitative analysis
Multiple Scenarios: Minimum 3 scenarios including 1.5°C pathway
Detailed Methodology: Sophisticated modeling and expert analysis
Regular Updates: Annual review and periodic comprehensive updates

Medium Organizations (Group 2)

Simplified Analysis: Focus on most material risks and time horizons
Standard Scenarios: Use established reference scenarios without customization
Qualitative Focus: Narrative assessment with selective quantification
Proportionate Updates: Updates aligned with materiality and capacity

Smaller Organizations (Group 3)

Materiality-Based: Focus only on clearly material climate impacts
Scenario Selection: Single representative scenario or simplified approach
External Support: Rely on industry or consultant-provided analysis
Phased Implementation: Build capability gradually over time

Sector-Specific Considerations

Climate-Intensive Sectors

High Physical Exposure: Agriculture, tourism, coastal infrastructure
High Transition Exposure: Fossil fuels, cement, steel, aviation
Detailed Analysis Required: Comprehensive scenario analysis expected
Regulatory Scrutiny: Higher expectations from regulators and stakeholders

Climate-Moderate Sectors

Selective Focus: Concentrate on most relevant climate impacts
Industry Collaboration: Leverage sector-wide studies and initiatives
Proportionate Response: Analysis depth aligned with materiality
Efficiency Opportunities: Focus on operational and efficiency improvements

Climate-Light Sectors

Indirect Impacts: Focus on supply chain and market effects
Simplified Approach: Qualitative assessment with selective quantification
Technology Focus: Consider digital solutions and energy efficiency
Stakeholder Driven: Address investor and customer expectations

Geographic Considerations

Australia-Specific Factors

Physical Risk Hotspots: Northern Australia cyclones, southern drought, coastal exposure
Transition Opportunities: Renewable energy resources, critical minerals
Policy Environment: Federal and state policy coordination complexities
International Trade: Export market transformation and carbon leakage

Regional Risk Profiles

Urban vs. Rural: Different risk profiles and adaptation options
Coastal vs. Inland: Sea level rise vs. temperature and precipitation changes
Resource Regions: Mining and energy transformation impacts
Agricultural Areas: Water availability and extreme weather impacts

Practical Application Framework

Step-by-Step Approach

Step 1: Materiality Assessment

Identify most material climate risks and opportunities
Consider relevant time horizons for strategic planning
Assess stakeholder expectations and regulatory requirements
Define scope and boundaries for scenario analysis

Step 2: Scenario Selection

Choose 2-4 scenarios representing different climate outcomes
Include at least one Paris Agreement-aligned scenario
Consider both transition and physical risk scenarios
Ensure scenarios span relevant time horizons

Step 3: Key Variable Identification

Identify variables that most affect your business (carbon price, temperature, etc.)
Understand how these variables change across scenarios
Consider direct and indirect transmission mechanisms
Document assumptions and data sources

Step 4: Impact Assessment

Assess qualitative impacts across business functions
Quantify financial impacts where feasible and material
Consider both risks and opportunities
Evaluate strategic and operational implications

Step 5: Strategy Integration

Use scenario insights to inform strategic planning
Identify robust strategies that perform well across scenarios
Develop contingency plans for different outcomes
Integrate findings into risk management and investment processes

Common Pitfalls and How to Avoid Them

Over-Complexity

Problem: Developing overly complex scenarios beyond organization’s capacity
Solution: Start simple and build capability over time
Best Practice: Focus on most material impacts and clear communication

Under-Investment

Problem: Treating scenario analysis as compliance exercise only
Solution: Integrate into strategic planning and decision-making processes
Best Practice: Allocate sufficient resources and senior management attention

Static Analysis

Problem: Conducting one-off scenario analysis without updates
Solution: Establish regular review and update processes
Best Practice: Monitor key variables and trigger points for analysis updates

Poor Integration

Problem: Scenario analysis disconnected from strategy and financial planning
Solution: Embed scenarios in strategic planning cycle
Best Practice: Use scenarios to inform capital allocation and business model decisions

Building Organizational Capability

Skills and Resources Required

Technical Capabilities

Climate Science Understanding: Basic climate literacy across organization
Scenario Methodology: Understanding of scenario development and application
Financial Modeling: Ability to translate scenarios into financial implications
Risk Assessment: Integration with existing risk management frameworks

Organizational Capabilities

Cross-Functional Teams: Involving strategy, risk, finance, operations, sustainability
Senior Leadership: Board and executive engagement and oversight
External Expertise: Access to climate science and scenario modeling expertise
Stakeholder Engagement: Communication and engagement on scenario findings

Implementation Timeline

Phase 1 (Months 1-6): Foundation

Capability assessment and gap analysis
Team formation and training
Initial scenario selection and scoping
Stakeholder engagement and expectation setting

Phase 2 (Months 6-12): Development

Detailed scenario analysis implementation
Cross-functional workshops and analysis
Initial findings and strategic implications
Board and leadership engagement

Phase 3 (Year 2+): Integration and Evolution

Integration into strategic planning processes
Regular monitoring and updating procedures
Capability enhancement and sophistication
External communication and disclosure

Summary

Climate scenario analysis is both an AASB S2 requirement and a valuable strategic tool that enables organizations to:

Explore climate uncertainty through multiple plausible future pathways
Test business model resilience under different climate and policy conditions
Inform strategic decisions about investments, operations, and market positioning
Comply with disclosure requirements while building genuine organizational capability
Apply proportionality principles that match analysis depth to organizational capacity and climate materiality

The next module will build on this foundation to explore practical GHG accounting and emissions management.

Key Takeaways

✅ Scenario analysis explores uncertainty rather than predicting specific outcomes ✅ Multiple scenarios capture different transition and physical risk pathways ✅ Reference scenarios (IEA, NGFS, RCPs) provide established starting points ✅ Proportionality principles ensure analysis depth matches organizational capacity ✅ Integration with strategy is essential for value beyond compliance ✅ Capability building requires cross-functional engagement and senior leadership support

Scenario Selection Framework

Organization Type	Minimum Scenarios	Complexity Level	Focus Areas
Large (Group 1)	3+ scenarios including 1.5°C	High - quantitative modeling	Comprehensive risk/opportunity assessment
Medium (Group 2)	2-3 standard scenarios	Medium - mixed qualitative/quantitative	Material risks and strategic implications
Small (Group 3)	1-2 simplified scenarios	Low - primarily qualitative	Most material climate impacts only

Practical Exercise

Scenario Planning Workshop: For your organization or a case study:

Assess materiality of climate risks and opportunities across time horizons
Select 2-3 appropriate scenarios based on your organization’s size and exposure
Identify 3-5 key variables that most affect your business across scenarios
Map impact pathways from scenario variables to business outcomes
Develop implementation plan including timeline, resources, and capability requirements
Design integration approach for incorporating scenarios into strategic planning

Consider both qualitative and quantitative approaches appropriate to your organizational capacity and climate materiality profile.