E. User Perspectives on Decision-Useful Climate-Related Financial Disclosures
3. Portfolio Manager’s Perspective on a Utilities Company
The AES Corporation operates as a diversified power generation and utility company. It owns and operates power plants to generate and sell power to customers, such as utilities, industrial users, and other intermediaries. The company also owns and operates utilities to generate or purchase, distribute, transmit, and sell electricity to end-user customers.
Figure 77
Excerpt from Sustainability Report
ỉrsted, Sustainability Report 2018, p. 9
The Task Force on Climate-related Financial Disclosures 84
A
Introduction B
State of Climate-Related Financial Disclosures C
Adoption and Use of the TCFD Recommendations D
Disclosure of Strategy Resilience Using Scenario Analysis
E
User Perspectives on Decision-Useful Climate- Related Financial Disclosures F
Initiatives Supporting TCFD
Appendices
Introduction
The focus of this review is to assess AES’s disclosure of strategy and consideration of climate- related scenarios in its November 2018 AES Climate Scenario Report. In this report, AES assesses its portfolio through stress tests using three climate-related scenarios, providing information in alignment with the TCFD recommendations, and notes that it is the first publicly-traded owner of utilities and power companies in the U.S. to do so. As part of this report, AES extended the commitment to building a sustainable organization by reducing its carbon intensity (tons of CO2/MWh) by 70 percent from 2016 levels by 2030.
AES also expressed how it is fundamentally shifting its portfolio in a manner that both reduces carbon intensity and exposure to carbon price risk. Ultimately, four Clean Energy Growth Platforms are determined to be core to its strategy: renewables, energy storage solutions, liquefied natural gas (LNG), and energy efficiency.
Disclosure Example: Strategy
To stress test58 its portfolio, AES identified third-party scenarios covering varying degrees of climate-related transition and physical risk. AES used the International Energy Agency’s (IEA) 2017 World Energy Outlook (WEO) for transition risk scenarios, and for physical risk scenarios, they selected the Representative Concentration Pathways (RCPs) established by the
Intergovernmental Panel on Climate Change’s (IPCC) Fifth Assessment Report (AR5). The three stress test scenarios are a “Business as Usual Scenario” of 3-6C, a “Greener Scenario” of 2-3C, and a “1.5-2C Scenario” in line with the TCFD recommendation on Strategy (Figure 78).
AES developed its climate resilience stress test to provide an in-depth financial analysis assessing the sensitivity of gross margin across its entire business—from every individual plant, up through its strategic business units. The results of the stress test show simulated gross margin across the three scenarios for both 2030 and 2040, with a large reduction in conventional power and clean
58 Stress testing is a form of scenario analysis.
Strategy
Describe the resilience of the organization’s strategy, taking into consideration different climate-related scenarios, including a 2°C or lower scenario.
Figure 78
Excerpt from Climate Scenario Report
AES, AES Climate Scenario Report, p. 6
BUSINESS AS USUAL SCENARIO 3-6°C
Current Policies Scenario (CPS) | 6.0°C
GREENER SCENARIO 2-3°C New Policies Scenario
(NPS) | 2.7°C
1.5-2°C SCENARIO 1.5-2°C
Sustainable Development Scenario (SDS) | 1.5-2.0°C
RCP 8.5 | 3.2-5.5°C RCP 6.0 | 2.0-3.7°C RCP 2.6 | 0.9-2.3°C
STRESS TEST SCENARIOS SELECTED AES SCENARIO
CONVENTION TRANSITION RISK (IEA WEO 2017 scenarios) PHYSICAL RISK (IPCC AR5 scenarios) IMPLICATIONS FOR BUSINESSES
INDICATIONS OF WHAT THE WORLD WOULD LOOK LIKE IN 2040
Increased physical risk Increased transition risk
•Global carbon levels increase by 30%.
•Fossil fuels continue to generate 60% of the world’s power generation.
•On a trajectory for sea level rise of 0.5-1.0m, more heat waves and changes in rainfall patterns by 2100.
•Fossil fuels are modestly reduced to half of the world’s power generation.
•Renewables share of total generation increases from 30%
in Business as Usual to 40%.
•On a trajectory for sea level rise of 0.32-0.63m.
•Global carbon levels decrease by 55% compared to Business as Usual.
•Renewable power doubles to 63%
of global generation.
•Energy efficiency reduces overall carbon emissions by 44%
compared to the Greener Scenario.
The Task Force on Climate-related Financial Disclosures 85
A
Introduction B
State of Climate-Related Financial Disclosures C
Adoption and Use of the TCFD Recommendations D
Disclosure of Strategy Resilience Using Scenario Analysis
E
User Perspectives on Decision-Useful Climate- Related Financial Disclosures F
Initiatives Supporting TCFD
Appendices
energy platforms constituting a significant majority of gross margin under all scenarios and timeframes (Figure 79). The stress test highlights the effectiveness of the company’s efforts to mitigate climate-related risk given the decreasing portion of its margin that is directly exposed to carbon pricing as the company moves from the simulated Business as Usual Scenario of 3-6°C to the 1.5-2°C Scenario.
In addition, on page 6, AES states that its “portfolio is not only resilient, but positioned for growth”
and explains underlying rationale using potential carbon prices and estimates of carbon-exposed margin (Figure 80, p. 86). This addresses the TCFD recommendation to describe strategic
resilience, taking scenarios into account, and provides confidence to readers of the Climate Scenario Report due to the inclusion of specific examples. Additionally, AES provides an
evaluation of three types of its business including the strengths of each and the impact to each in a 1.5-2°C scenario. Under a 1.5-2°C scenario AES will continue to be a leading provider of
renewables and by 2040, conventional power (fossil fuel and hydro) will make up a small portion of its portfolio. Even under such scenario, these fossil fuel plants that will continue to operate under PPAs will continue to receive capacity payments and are expected to continue to provide reasonable returns.
Figure 79
Excerpt from Climate Scenario Report
AES, AES Climate Scenario Report, p. 7
2030
2018
2040
SIMULATED GROSS MARGIN ACROSS THE THREE CLIMATE SCENARIOS
Direct Carbon Exposed Margin for Conventional Power Other Conventional Power Gross Margin
Regulated Utilities
Clean Energy Growth Platforms
Business as Usual Scenario (based on IEA’s CPS)
Greener Scenario (based on IEA’s NPS)
1.5-2°C Scenario (based on IEA’s SDS)
Direct carbon exposed margin largely refers to energy sales from fossil-fired plants that are selling power on the merchant market or plants that are contracted in a way thatdoes notallow for a carbon price pass-through to an off-taker. Please seeTransition Risk Resiliencefor more information.
The Task Force on Climate-related Financial Disclosures 86
A
Introduction B
State of Climate-Related Financial Disclosures C
Adoption and Use of the TCFD Recommendations D
Disclosure of Strategy Resilience Using Scenario Analysis
E
User Perspectives on Decision-Useful Climate- Related Financial Disclosures F
Initiatives Supporting TCFD
Appendices
Disclosure Assessment: Strategy
The AES climate resilience stress test is especially valuable to users of the Climate Scenario Report because AES was able to separately assess three different scenarios instead of just one. It is useful to see the potential results of more than one scenario because the stress tests are not intended to be treated as forecasts, either within the company or by readers of its disclosure.
Instead, the scenarios show that AES has given serious consideration to making its strategy resilient to various future climate-related risks and opportunities.
The stress tests demonstrate to users that AES has enhanced its resilience by taking three strategic actions: a fundamental shift in its portfolio to clean energy sources and services,
geographical diversification of its exposure, and strong PPA contracts that protect margin. Specific descriptions of AES’s strategic actions to address climate-related risks and opportunities are decision useful because they allow users to assess how the company is positioning itself to mitigate carbon policy risks while ensuring a continued focus on predictable cash flows and strong revenue and margins.
Not only does AES provide an assessment demonstrating that its strategy is likely resilient, it also provides several key weaknesses to consider and recommendations to improve stress tests, including:
Detailed and consistent visibility into assumptions and outputs across all three scenarios;
Greater country level (and sub-country) specificity;
Increased clarity around assumptions for energy storage and energy efficiency; and
Quantitative likelihood or probability measures for severe weather events.
Describing weaknesses and recommendations for improvement can provide confidence to users that AES has taken the assessment seriously and intends to continue assessing the resilience of its strategy in the future. Furthermore, in the future, as third-party established scenarios are enhanced, AES has committed to look to update its modeling and stress tests to take these enhancements into account.
Figure 80
Excerpt from Climate Scenario Report
AES, AES Climate Scenario Report, p. 7
OUR PORTFOLIO IS NOT ONLY RESILIENT, BUT POSITIONED FOR GROWTH Given our modest exposure to direct carbon risk and our pivot toward Clean Energy Growth Platforms, transition risk can enhance our upside potential.
The stress test highlights the effectiveness of our efforts to mitigate climate change risk given the decreasing portion of our margin that is directly exposed to carbon pricing as we move from the simulated Business as Usual Scenario (3-6°C) to a 1.5-2°C Scenario. In the results that follow, direct carbon exposed margin refers to margin that has the potential to be directly and negatively affected by, or has been subject to, a price on carbon. Even in the 1.5-2°C Scenario, where carbon prices reach
$125/tonne for emerging economies and $140/ tonne for advanced economies by 2040, our direct carbon exposed margin is virtually zero. Under this scenario, our existing thermal plants are considered to be retired at the end of their anticipated useful life or contracted for reliability with the off-taker bearing the cost of carbon. The majority of the margin from these plants comes from capacity
payments, which are not directly carbon exposed. These payments are essentially for availability and are received regardless of the amount of energy generated. However, these plants have indirect carbon exposure if the credit quality of our off-takers deteriorates due to carbon pricing.
The Task Force on Climate-related Financial Disclosures 87
A
Introduction B
State of Climate-Related Financial Disclosures C
Adoption and Use of the TCFD Recommendations D
Disclosure of Strategy Resilience Using Scenario Analysis
E
User Perspectives on Decision-Useful Climate- Related Financial Disclosures F
Initiatives Supporting TCFD
Appendices
Conclusion
Overall, the AES Climate Scenario Report is comprehensive in its approach to disclosing the resilience of its strategy, including potential strategic actions, while taking into consideration different climate-related scenarios. The disclosure provides decision-useful information by describing specific information on stress testing scenarios and AES’s current and future strategy.
In addition, the Climate Scenario Report demonstrates that AES takes climate-related issues seriously and is dedicated to preparing its business for the future.