Emissions scenarios

What Is Emissions Scenarios?

Emissions scenarios are plausible representations of future greenhouse gas (GHG) emissions over time, developed by scientists and economists to explore potential pathways of climate change and its associated impacts. These scenarios are fundamental tools in climate finance and risk management, providing a framework for understanding potential future environmental conditions and their implications for economies and financial systems. Rather than being predictions, emissions scenarios serve as "what-if" models, illustrating how different societal, technological, and policy choices could influence the trajectory of global emissions. They are crucial for guiding investment decisions and developing strategies for sustainability in a changing climate.

History and Origin

The concept of emissions scenarios gained prominence with the increasing scientific understanding of climate change and the need to project future warming. Early scenario development efforts were often associated with the Intergovernmental Panel on Climate Change (IPCC), which began synthesizing climate science in the late 1980s. The IPCC's assessment reports have historically used various sets of scenarios, evolving from the IS92 scenarios to the Special Report on Emissions Scenarios (SRES), and more recently, Representative Concentration Pathways (RCPs) and Shared Socioeconomic Pathways (SSPs). The IPCC's Sixth Assessment Report (AR6), released in stages from 2021 to 2023, presents five potential future scenarios, incorporating complex modeling that considers the rate at which human activities reduce GHG emissions, alongside socioeconomic factors like population growth and land use²⁰, ²¹, ²². These scenarios underscore the critical need for global mitigation efforts, particularly in line with international agreements such as the Paris Agreement. The Paris Agreement, adopted by 195 parties at the UN Climate Change Conference (COP21) in December 2015, established a legally binding international treaty aimed at limiting global warming to well below 2°C, preferably to 1.5°C, compared to pre-industrial levels.
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Key Takeaways

• Emissions scenarios are hypothetical future pathways of greenhouse gas emissions, not predictions.
• They integrate scientific, economic, and social factors to project different climate outcomes.
• These scenarios are vital for assessing climate-related financial risks and opportunities.
• Major institutions like the IPCC and IEA develop and utilize various sets of emissions scenarios.
• They inform strategic planning for governments, businesses, and financial institutions.

Interpreting Emissions Scenarios

Interpreting emissions scenarios involves understanding the assumptions underlying each pathway and their potential implications for economic and physical systems. Typically, scenarios are categorized based on their projected temperature outcomes by a specific future date, often by 2100. For example, the IPCC's SSPs range from highly ambitious scenarios that limit global warming to 1.5°C (SSP1-1.9) to scenarios reflecting continued high emissions, potentially leading to warming of over 4°C (SSP5-8.5). Ea¹⁷ch scenario outlines different levels of carbon pricing, technological advancements, and policy responses.

In a financial context, interpreting these scenarios means evaluating how different emissions pathways could translate into transition risk (e.g., policy changes, technological disruption, market shifts) and physical risk (e.g., extreme weather events, sea-level rise) for assets and portfolios. For instance, an "orderly transition" scenario, characterized by early and coordinated climate policies, might imply lower long-term physical risks but higher short-term transition costs for carbon-intensive sectors. Conversely, a "disorderly transition" scenario, with delayed or uncoordinated policy actions, could lead to abrupt and more severe economic shocks, while a "hot-house world" scenario, with minimal mitigation, would result in significant physical impacts. Un¹⁵, ¹⁶derstanding these nuances is crucial for strategic forecasting and adaptation.

Hypothetical Example

Consider a large diversified investment fund analyzing its portfolio management strategy in light of climate change. The fund decides to stress test its holdings against two distinct emissions scenarios:

1. Scenario A (Orderly Transition): This scenario assumes aggressive global policy action, rapid technological advancements in renewable energy, and a significant increase in carbon taxes by 2030, aiming to limit global warming to 1.5°C.
2. Scenario B (Fragmented World): This scenario posits delayed and uncoordinated climate policies, continued reliance on fossil fuels in some regions, and limited cross-border collaboration, leading to global warming of 3°C or more by 2100.

Under Scenario A, the fund might project that its investments in fossil fuel companies would face significant write-downs due to declining demand and rising compliance costs. Conversely, its holdings in renewable energy infrastructure, electric vehicle manufacturers, and sustainable agriculture would likely see substantial growth.

Under Scenario B, the fund might anticipate higher short-term returns from its fossil fuel investments due to lack of stringent regulation. However, it would also project increased physical risks, such as disruptions to supply chains from extreme weather events, higher insurance costs for real estate assets in vulnerable areas, and potential declines in productivity across various sectors due to escalating climate impacts. By examining these divergent outcomes, the fund can assess its overall exposure to climate risks and opportunities and adjust its asset allocation accordingly.

Practical Applications

Emissions scenarios are extensively applied across various financial and regulatory domains. Governments use them to set national climate targets and inform long-term energy planning. Regulators and central banks, such as the European Central Bank (ECB), employ emissions scenarios in stress testing exercises to assess the resilience of the financial system to climate-related risks. The ¹³, ¹⁴ECB's climate stress tests, for example, incorporate both short-term disorderly transition scenarios and long-term hot-house scenarios to evaluate banks' vulnerabilities to carbon price shocks and physical risks.

Cor¹¹, ¹²porations utilize emissions scenarios to develop climate strategies, set decarbonization targets, and evaluate capital expenditure plans, particularly in energy-intensive sectors. They inform decisions on research and development for low-carbon technologies and strategic shifts in business models. Investors integrate these scenarios into their due diligence processes and risk assessments, influencing asset valuation, portfolio construction, and engagement with companies on climate-related issues. The International Energy Agency (IEA) publishes its "World Energy Outlook" annually, providing detailed emissions scenarios that project global energy demand, supply, and emissions trajectories under different policy assumptions, such as the Stated Policies Scenario (STEPS) and the Net Zero Emissions by 2050 Scenario (NZE). Thes⁸, ⁹, ¹⁰e detailed outlooks are critical for understanding the potential pathways of global energy systems and their implications for financial markets.

Limitations and Criticisms

Despite their utility, emissions scenarios have several limitations and face criticisms. A primary concern is that they are not predictions but rather simplified representations of complex future pathways, meaning actual outcomes may deviate significantly. They rely on numerous assumptions about socioeconomic developments, technological breakthroughs, and policy implementations, which introduce considerable uncertainty.

Ano⁶, ⁷ther limitation is the difficulty in translating macro-level emissions scenarios into granular, actionable insights for specific companies or financial assets. The models underpinning these scenarios often operate at a global or regional scale, making it challenging to assess localized impacts or direct financial exposures. Furt⁴, ⁵hermore, some scenarios may underestimate the severity of certain physical climate risks or fail to fully capture potential "tipping points"—thresholds beyond which small changes can lead to abrupt, irreversible shifts in the climate system. Critics also point to potential biases in scenario design, where outcomes might be too "benign" or "implausible" in certain cases, especially when used for financial risk analysis. As a r³elatively new application in finance, the methodologies for integrating climate scenarios into standard financial models are still evolving, and data gaps remain a significant challenge.

Em¹, ²issions Scenarios vs. Climate Risk Stress Testing

While closely related and often used in conjunction, emissions scenarios and climate risk stress testing serve distinct purposes. Emissions scenarios are the foundational "inputs" or frameworks that describe plausible future trajectories of global greenhouse gas concentrations, technological change, and policy environments. They outline the broader context of how climate change might unfold. For instance, an emissions scenario might describe a future where global carbon emissions fall rapidly due to aggressive policy implementation.

Climate risk stress testing, on the other hand, is an analytical process that applies these emissions scenarios to specific financial entities or portfolios. It involves evaluating how a bank's loan book, an insurer's underwriting portfolio, or an investment fund's assets would perform under the conditions stipulated by a particular emissions scenario. The stress test translates the environmental and economic assumptions of a scenario (e.g., carbon prices, physical damage from extreme weather, shifts in consumer preferences) into direct financial impacts, such as changes in asset valuations, credit defaults, or profitability. Therefore, emissions scenarios provide the "what if" narrative, while climate risk stress testing quantifies the "what happens to my finances if that what if occurs."

FAQs

What is the main purpose of emissions scenarios?

The main purpose of emissions scenarios is to provide a consistent framework for analyzing potential future climate conditions and their implications, helping policymakers, businesses, and investors understand a range of possible climate-related outcomes without predicting a single future.

How do emissions scenarios differ from climate predictions?

Emissions scenarios are not predictions; they are hypothetical pathways based on different assumptions about societal development, technological progress, and policy choices. Climate predictions, conversely, would attempt to forecast a single most likely future climate outcome.

Who develops emissions scenarios?

Key organizations that develop emissions scenarios include the Intergovernmental Panel on Climate Change (IPCC), the International Energy Agency (IEA), and various academic institutions and research consortia. These bodies often collaborate to ensure scientific rigor and consistency.

How are emissions scenarios used in finance?

In finance, emissions scenarios are used to assess climate-related financial risks (both transition and physical risks) and opportunities. They inform climate stress tests, portfolio analysis, strategic planning, and corporate disclosures related to climate change, helping organizations prepare for potential future impacts on economic growth and asset values.

Are all emissions scenarios focused on reducing emissions?

No, emissions scenarios cover a range of possibilities, from those with aggressive emissions reductions (e.g., aiming for 1.5°C warming) to those assuming little to no action, which could lead to significantly higher global temperatures. This spectrum allows for a comprehensive assessment of potential futures.