Deep diveSustainability
Climate scenario analysis explained: from physical and transition risk to financial effects
Climate scenario analysis tests how a company's strategy, assets and finances would fare under several plausible climate futures, rather than predicting one. It separates physical risk from transition risk, borrows reference scenarios from bodies such as the NGFS, the IEA and the IPCC, and moves from qualitative narratives to quantified effects only where the numbers would change a decision or a disclosure.
On this page
- Why climate risk is assessed with scenarios rather than forecasts
- Physical and transition risk terms used in scenario work
- The mechanism from exposure screening to financial effects
- Choosing reference scenarios from NGFS, IEA and IPCC sources
- Qualitative first, quantitative where a number changes a decision
- A hypothetical manufacturer with a coastal plant and carbon-heavy inputs
- Where climate scenario models mislead
- Questions and answers
- Sources
Why climate risk is assessed with scenarios rather than forecasts
Climate risk combines two uncertainties that no forecast can resolve: how fast governments, technologies and markets will move, and how severe the physical changes will be. Their likelihood, magnitude and timing are uncertain, which is why IFRS S2 frames scenario analysis as a way to explore a range of outcomes and a company's capacity to adjust or adapt2.
A good scenario exercise therefore asks questions a forecast cannot. Would this plant still earn its cost of capital if carbon prices rose sharply this decade? What happens to supply if a key port floods more often? Which strategy holds up across all the futures, and which only works in one? ColdAI's climate risk offering is built around this kind of physical and transition risk assessment, with adaptation strategies and financial impact quantification7.
Physical and transition risk terms used in scenario work
- Acute physical risk
- Event-driven hazards such as floods, storms, wildfires and heatwaves that damage assets or interrupt operations and supply.
- Chronic physical risk
- Longer-term shifts such as rising sea levels, higher average temperatures and changing rainfall that erode productivity, water availability or asset value.
- Policy and legal risk
- Carbon pricing, emissions limits, product standards, disclosure rules and litigation that raise costs or restrict activities.
- Technology risk
- Lower-carbon substitutes that make existing products, processes or assets uncompetitive or stranded.
- Market risk
- Shifts in customer demand, input prices and the cost or availability of capital as the economy decarbonizes.
- Reputation risk
- Loss of customers, employees or investors because of how the company's climate performance or claims are perceived.
- Climate resilience
- A company's capacity, strategically and operationally, to manage climate-related risks and benefit from opportunities, including adapting to transition and physical risks2.
- Time horizon
- The short, medium and long periods over which effects are assessed, ideally tied to asset lives and planning cycles rather than chosen for convenience.
The mechanism from exposure screening to financial effects
- Frame the question
Which decision or disclosure the analysis serves, and the horizons that match asset lives.
- Screen exposure
Locate sites, suppliers, products and markets, and flag those exposed to hazards or carbon-cost drivers.
- Write narratives
Describe how each chosen scenario would play out for the business, in words, before any modeling.
- Quantify drivers
Apply hazard data, carbon prices, demand and input-cost paths to the material exposures only.
- Translate to financials
Express results as effects on revenue, costs, capital spending, asset values and financing.
- Decide and disclose
Feed results into strategy, capital allocation and resilience disclosure, then revisit with the planning cycle.
Choosing reference scenarios from NGFS, IEA and IPCC sources
| Question | NGFS scenarios | IEA World Energy Outlook | IPCC SSP-based pathways |
|---|---|---|---|
| Built for | Central banks and supervisors exploring physical and transition risk together3 | Analysis of energy policy, supply and technology | Assessing climate science across emission pathways5 |
| Scenario set | Orderly, disorderly, hot house world and too-little-too-late families3 | Current Policies, Stated Policies and Net Zero Emissions by 2050 in the latest edition4 | Illustrative pathways from very low to very high emissions, built on Shared Socioeconomic Pathways5 |
| Strongest on | Consistent transition and physical variables in one framework | Energy demand, fuel mix and technology deployment by sector | Physical outcomes such as temperature, rainfall and sea level |
| Best used for | Transition risk and financial sensitivity across policy paths | Demand and price drivers for energy-intensive or energy-supplying firms | Physical hazard projections for asset-level exposure |
| Watch out for | Regional granularity that may be too coarse for one site | Little physical-risk content | No policy narrative; sites need downscaled hazard data |
Most companies combine sources: a transition set for policy and market drivers and a climate-science pathway, downscaled through hazard data, for physical risk. Record which version of each scenario you used, because publishers update them.
Qualitative first, quantitative where a number changes a decision
IFRS S2 requires a company to use scenario analysis to assess its climate resilience with an approach commensurate with its circumstances, judged by its exposure to climate-related risks and the skills and resources available to it12. In practice that means a simpler qualitative approach for limited exposure, and quantitative modeling where exposure is high and the capability exists2. The first set of ESRS points in a similar direction for physical risk, expecting high-emission scenarios to be considered, and asks for transition analysis that includes a scenario consistent with limiting warming to 1.5°C6.
Quantification works best asset by asset. For physical risk, combine site coordinates with hazard projections and convert expected damage or downtime into repair costs, lost output and insurance cost. For transition risk, multiply emissions or energy use by carbon-price and energy-price paths, and adjust demand for products with lower-carbon substitutes. The results then belong in the same language as the accounts: impairment indicators, useful lives, provisions, capital plans and financing terms.
Repeat the work on the planning rhythm. The IFRS Foundation's factsheet says a company assesses resilience annually but need not redo its scenario analysis every year, updating it at least in line with its strategic planning cycle2. Where a physical hazard also drives supply-chain or political risk, link the work to geopolitical scenario planning so the two exercises share assumptions.
A hypothetical manufacturer with a coastal plant and carbon-heavy inputs
Where climate scenario models mislead
Treating a scenario as a forecast
Early signalResults are presented as the expected outcome, or one scenario is labeled most likely.
MitigationPresent the range, and judge strategies by how well they hold up across it.
Choosing scenarios that flatter the strategy
Early signalOnly mild scenarios are modeled, or the high-warming case is dropped as unrealistic.
MitigationInclude at least one severe physical case and one fast, disorderly transition case.
Stopping at the fence line
Early signalPhysical analysis covers owned sites but ignores key suppliers, ports and customers.
MitigationScreen critical value-chain locations with the same hazard data, even if only qualitatively.
False precision
Early signalSingle-point loss figures carried to several significant digits.
MitigationReport ranges, state key assumptions and show which inputs move the answer most.
An exercise disconnected from planning
Early signalThe analysis is done for the report and never reaches the capital plan or risk register.
MitigationAssign each material finding an owner and a decision date in the planning process.
Questions and answers
What data does a first climate scenario analysis need?
A register of sites with coordinates and replacement values, a map of critical suppliers and logistics routes, emissions and energy use by activity, revenue by product and market, and the current capital plan. Hazard projections and scenario variables come from public or licensed sources. Most of the effort goes into the internal asset and supplier data, not the climate models.
Do smaller or less exposed companies need quantitative scenario modeling?
Not necessarily. IFRS S2 allows an approach commensurate with a company's exposure and capabilities, and the IFRS Foundation describes qualitative analysis as an acceptable simpler approach. What matters is that the choice is reasoned, documented and revisited as exposure or capability grows.
How is climate scenario analysis different from general scenario planning?
It uses externally published, internally consistent climate and policy pathways and links them to physical hazards and carbon-related cost drivers, often for disclosure. General scenario planning builds bespoke narratives around any uncertainty. Many companies run both and share assumptions, for example on energy prices or trade restrictions.
What are the main limits of climate scenario models?
Transition scenarios are built for system-level questions and can be coarse for one company. Damage functions and hazard projections carry wide uncertainty, especially for compound events and tipping points. Scenarios also update between editions. Treat outputs as structured inputs to judgment, and say clearly what the analysis cannot show.
Sources
- IFRS S2 Climate-related Disclosures — IFRS Foundation · checked 10 October 2026
- Factsheet: Climate resilience and climate-related scenario analysis requirements in IFRS S2 — IFRS Foundation · checked 10 October 2026
- NGFS Scenarios Portal — Network for Greening the Financial System · checked 10 October 2026
- World Energy Outlook 2025 — International Energy Agency · checked 10 October 2026
- Climate Change 2021: The Physical Science Basis (AR6 Working Group I) — Intergovernmental Panel on Climate Change · checked 10 October 2026
- Commission Delegated Regulation (EU) 2023/2772 as regards sustainability reporting standards (ESRS E1 Climate change) — EUR-Lex · checked 10 October 2026
- Sustainability: climate risk offering — ColdAI