NGFS Climate Scenarios For Central Banks And Supervisors

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Network for Greening the Financial SystemNGFS Climate Scenariosfor central banks and supervisorsJune 2020

AcknowledgementsThe Network for Greening the Financial System (NGFS) is a group of 66 central banksand supervisors and 13 observers committed to sharing best practices, contributingto the development of climate and environment‑related risk management inthe financial sector and mobilising mainstream finance to support the transitiontowards a sustainable economy.The NGFS Climate Scenarios were produced over a period of 6 months by NGFSWorkstream 2 in partnership with an academic consortium from the PotsdamInstitute for Climate Impact Research (PIK), International Institute for AppliedSystems Analysis (IIASA), University of Maryland (UMD), Climate Analytics (CA) andthe Swiss Federal Institute of Technology in Zurich (ETHZ). This work was madepossible by grants from Bloomberg Philanthropies and ClimateWorks Foundation.Special thanks is given to lead coordinating authors: Thomas Allen (Banque deFrance), Cornelia Auer (PIK), Ryan Barrett (Bank of England), Christoph Bertram (PIK),Antoine Boirard (Banque de France), Leon Clarke (UMD), Stéphane Dees (Banquede France), Ryna Yiyun Cui (UMD), Jae Edmonds (UMD), Jérôme Hilaire (PIK), ElmarKriegler (PIK), Theresa Löber (Bank of England), Jihoon Min (IIASA), Franziska Piontek(PIK), Joeri Rogelj (IIASA), Edo Schets (Bank of England), Carl-Friedrich Schleussner(CA), Bas van Ruijven (IIASA) and Sha Yu (UMD). Thanks is also given to contributingauthors: Cristina Angelico (Banca d’Italia), Rie Asakura (Japan FSA), Ivan Faiella(Banca d’Italia), Philipp Haenle (Bundesbank), Craig Johnston (Bank of Canada),Federico Lubello (Bank of Luxembourg) and Simone Russo (Central Bank of Malta).Comments were gratefully received from Brian Hoskins (Imperial College London),Jason Lowe (U.K. Met Office) and Laszlo Varro (International Energy Agency).NGFS SCENARIOS2

OverviewContents4Transition1. Overview of the scenariosScenarios in detail:113. Physical risks194. Economic impacts255. Future development31Physical2. Transition risksEconomicAnnex:6. References35Development3ReferencesNGFS SCENARIOS

Overview1 Overview of the scenarios

OverviewObjectives and frameworkThe NGFS Climate Scenarios explore the impacts of climate change and climate policy with theaim of providing a common reference framework.   The NGFS Climate Scenarios (the scenarios) have been developed to provide a common starting pointfor analysing climate risks to the economy and financial system. While developed primarily for use bycentral banks and supervisors they may also be useful to the broader financial, academic and corporatecommunities. This document provides an overview of the key transition risks, physical risks and economicimpact of climate change.NGFS Climate Scenarios Framework   The first iteration explores a set of eight scenarios which are consistent with the Framework (Figure 1)published in the First NGFS Comprehensive Report. The set includes three representative scenarios, whicheach cover one of the following dimensions:– Orderly: Early, ambitious action to a net zero CO2 emissions economy;– Disorderly: Action that is late, disruptive, sudden and / or unanticipated;–  Hot house world: Limited action leads to a hot house world with significant global warming and, as aresult, strongly increased exposure to physical risks.   These scenarios were chosen to show a range of lower and higher risk outcomes. A 'too little, too late'scenario with both high transition and physical risks was not included in the first iteration.   A key guiding principle of the project has been embracing the uncertainty inherent in scenario modelling.This has been captured in two ways. Firstly, five alternate scenarios have been published to help usersexplore how specifying different key assumptions would change the results. Secondly, for each scenario,multiple models have been used to provide a range of estimates.Source: NGFS (2019a).NGFS SCENARIOS5

OverviewRepresentative scenariosThe Orderly and Disorderly scenarios explore a transition which is consistent with limitingglobal warming to below 2 C. The Hot house world scenario leads to severe physical risks.   Hot house world assumes that only currentlyimplemented policies are preserved. NationallyDetermined Contributions are not met. Emissionsgrow until 2080 leading to 3 C of warming andsevere physical risks. This includes irreversiblechanges like higher sea level rise.scenarios to the FrameworkGt emissions / yearHigh80Too little, too late3 C 70Disorderly6050DisorderlyTransition risks   D isorderly assumes climate policies are notintroduced until 2030. Since actions are takenrelatively late and limited by available technologies,emissions reductions need to be sharper than in theOrderly scenario to limit warming to the same target.The result is higher transition risk.EmissionsRepresentative Scenarios403020100- 102020Orderly1.5–2 C   Orderly assumes climate policies are introduced earlyand become gradually more stringent. Net zero CO2emissions are achieved before 2070, giving a 67%chance of limiting global warming to below 2 C.Physical and transition risks are both relatively low.Mapping of the representativescenarios to the NGFS matrixMapping of the representative20302040Orderly (all GHGs)Disorderly (all GHGs)Hot house world (all GHGs)20502060Hot houseworld2070Orderly (CO2 )Disorderly (CO2)Hot house world (CO2)OrderlyLowHot house worldPhysical risksHighSource: IIASA NGFS Climate Scenarios Database, using marker models.NGFS SCENARIOS6

OverviewAlternate scenariosFive alternate scenarios have been produced to explore different assumptions, such as differenttemperature targets, policy responses and/or technology pathways.   Scenarios also differ in their assumptions aboutthe level of CO 2 removal (CDR) technologydeployment. These negative emission technologiescould be limited by innovation or investmentbottlenecks. The Orderly and Disorderly scenarioseach have an alternate with limited and full CDRavailability, respectively.   A n alternative scenario that explores highphysical risks has also been included. It assumesthat governments implement further policiesconsistent with Nationally Determined Contributions(NDCs), making it less adverse than the Hot houseworld scenario.Carbon dioxide emissionsAlternate 1.5 C Scenarios50Mapping of the alternatescenarios to the FrameworkGt CO2 / yearHighDisorderlyToo little, too late1.5 ClimitedCDR4030Transition risks   The scenarios include two alternate 1.5 C pathways(left chart). In both, CO2 emissions need to reach netzero around 2050 to limit global warming to 1.5 Cwith a 67% chance. This reduction in emissions ismuch more rapid than in the Orderly scenario, leadingto higher transition risks.Mapping of alternate scenariosto the NGFS matrix20102 C delaywith CDR1.5 Cwith CDR2 ClimitedCDR0- 102020NDCs203020402050Orderl y (2 C wi th CDR)1.5 C wi th CDR1.5 C wi th l imited CDROrderlyLowHot house worldPhysical risksHighSource: IIASA NGFS Climate Scenarios Database, REMIND model.NGFS SCENARIOS7

OverviewEconomic impacts at a glanceScenarios differ markedly in their economic impact, with significant uncertainty in the size ofthe estimates for both transition and physical risks.   Modelling the economic impacts from climate change is subject to significantuncertainty and extensive academic debate.   In the Orderly scenario a significant amount of investment is needed to transitionto a carbon-neutral economy. Impacts from transition risk in the scenariosare relatively small (4% GDP loss by the end of the century).10Per cent GDPCumulative GDP impact from transition riskCumulative GDP impact from transition risk-2-4-6-8   Some studies from the wider literature suggest that the impacts could besmaller, or even positive, given the rapid reduction in the cost and increaseddeployment of new technologies. Still, all users of energy and emitters of carbonwill be affected, with major fossil fuel exporting regions most at risk.   In the Hot house world scenario impacts from physical risk result in up toa 25% GDP loss by 2100. However, these estimates are also subject to a numberof limitations. They typically do not adequately account for all sources of risk,including low probability high impact events, sea level rise, extreme events andsocietal changes like migration and conflict.-10203021002050OrderlyDisorderlySource: e:IIASANGFS ScenariosPortal,markermodels.0Per cent GDPCumulative GDP impact from physical riskCumulative GDP impact from physical risk-5Rangegiven modelspecificationand climateuncertainty-10-15   As a result, damages in this scenario will be larger than models suggest, particularlyin regions with lower resilience and capacity for adaptation.1  Measured as deviations from baseline economic growth assumptions. See slide 13 for details.-20-2520302040205020602070208020902100Hot house worldSource: PIK calculations based on damage function model specifications from the wider literature.Source: PIK calculationsbasedliteraturedamage estimates.See slide 29for onfurtherdetails.NGFS SCENARIOS8

OverviewTransmission channelsClimate risks could affect the economy and financial system through a range of differenttransmission channels.   Physical risks affect the economy in two ways.–  Acute impacts from extreme weather eventscan lead to business disruption and damagesto property. Historically these impacts wereconsidered transient but this will change withincreased global warming. These events canincrease underwriting risks for insurers and impairasset values.–  Chronic impacts, particularly from increasedtemperatures, sea levels rise and precipitation, mayaffect labour, capital and agriculture productivity.These changes will require a significant level ofinvestment and adaptation from companies,households and governments.Transmission channelsClimate risks to financial risksClimate risksEconomic transmission channelsTransition risks   Policy and regulation   Technologydevelopment   Consumer preferencesMicroAffecting individual businesses and householdsPhysical risks   Chronic ivity, sealevels)   Acute (e.g. heatwaves,floods, cyclones andwildfires)Businesses   Property damage and businessdisruption from severe weather   Stranded assets and new capitalexpenditure due to transition   Changing demand and costs   Legal liability (from failure tomitigate or adapt)Households   Loss of income (from weatherdisruption and health impacts,labour market frictions)   Property damage (from severeweather) or restrictions (fromlow-carbon policies) increasingcosts and affecting valuationsMacroAggregate impacts on the macroeconomy   Capital depreciation and increased investment Shifts in prices (from structural changes, supply shocks)   Productivity changes (from severe heat, diversion of investment tomitigation and adaptation, higher risk aversion)   Labour market frictions (from physical and transition risks)   Socioeconomic changes (from changing consumption patterns,migration, conflict)   Other impacts on international trade, government revenues, fiscalspace, output, interest rates and exchange rates.Climate and economy feedback effectsFinancial risksCredit risk   Defaults by businessesand households Collateral depreciationMarket risk   Repricing of equities,fixed income,commodities etc.Financial system contagion   Transition risks will affect the profitability ofbusinesses and wealth of households, creatingfinancial risks for lenders and investors. They willalso affect the broader macroeconomy throughinvestment, productivity and relative price channels,particularly if the transition leads to stranded assets.Underwriting risk   Increased insured losses   Increased insurance gapOperational risk   Supply chain disruption   Forced facility closureLiquidity risk   Increased demand forliquidity   Refinancing riskEconomy and financial system feedback effectsNGFS SCENARIOS9

OverviewModelling frameworkThe NGFS Climate Scenarios provide a range of data on transition risks, physical risks andeconomic impacts. This is produced by a suite of models aligned in a coherent way.   Phase I of the NGFS Climate Scenarios delivered a set of harmonised transitionpathways, chronic climate impacts and indicative economic impacts for eachof the NGFS Climate Scenarios. Multiple models were used to obtain a range ofresults for each type of risk. This data is available at the IIASA and ISIMIP portals.   In Phase II the NGFS will continue to work with academic partners to refinethe scenarios, including adding acute climate impacts and expanding the setof macroeconomic indicators.NGFSNGFS suitesuite ofof modelsmodels approachapproachTransition riskTransitionpathwaysIntegrated AssessmentModelsSummary of the key aspects of Phase I from the Technical DocumentationComparisonChronic climate impactsScenarios2Orderly (Representative: Immediate 2 C with CDR [GCAM].Alternate: Immediate 2 C with limited CDR, Immediate 1.5 C with CDR)Disorderly (Representative: Delayed 2 C with limited CDR [REMIND].Alternate: Immediate 1.5 C with limited CDR, Delayed 2 C with CDR)Hot house world (Representative: Current policies [MESSAGE].Alternate: Nationally Determined Contributions)ModelsModels participating in the ISIMIPproject.33 Integrated Assessment Models(REMIND-MAGPIE 1.7-3.0, GCAM 5.2,MESSAGEix-GLOBIOM 1.0)DatabaseISIMIPIIASAOutputsChronic climate change impactsincluding temperature,precipitation, agricultural yields.GDP impacts calculated separatelybased on 3 damage functionsEnergy demand,energy capacity,investment in energy, energy prices,carbon price, emissions trajectories,temperature trajectories, agriculturalvariables, GDPTimehorizonAll variables are projected on incremental steps of 5 years, up to 2100Physical riskTemperaturealignment1.5 C, 2 C, 3 C Chronic climateimpactsGeneral CirculationModelsAcute climateimpactsNatural CatastropheModelsMacroeconomic impactsGlobal Macroeconomic ModelsTransition pathways2  Marker models were chosen for the transition pathways of the representative scenarios but not the alternatescenarios. Refer to the Technical Documentation for further details on each scenario.3  Frieler et al. (2017).NGFS SCENARIOS10

Transition2 Transition risksScenarios in detail

Approach   The NGFS Climate Scenarios have been generated by well-established integratedassessment models (IAMs): GCAM, MESSAGEix-GLOBIOM and REMIND-MAgPIE.These models have been used extensively to inform policy and decision makers,feature in several climate change assessment reports4 and some have also beenused to assess risks to financial portfolios.5Structure of the REMIND-MAgPIE framework   IAMs are useful for scenario analysis because they provide internally consistentestimates across economic, energy, land-use and climate systems. However, theyare also subject to some limitations and simplifications, for example their abilityto endogenously capture big changes that could arise from sudden policy shifts.   The adjacent figure provides an illustration of how different systems interactin the REMIND-MAgPIE modelling framework. The assumptions used in eachof the modules all have a bearing on the projections produced by the model.   This section provides an overview of some of the key background assumptionsand outputs of the NGFS Climate Scenarios. See Technical Documentation forfurther details.Source: NGFS Climate Scenarios Technical Documentation.4  IPCC (2014). IPCC (2018). UNEP (2018a).5  UNEP (2018b). Battiston (2019).NGFS SCENARIOS12TransitionTransition pathways are modelled using Integrated Assessment Models, which combine economic,energy, land-use and climate modules to provide coherent scenarios.

Socioeconomic assumptions   Socioeconomic pathways are key backgroundassumptions in climate scenarios. These assumptions,such as GDP, population and urbanisation, havebeen standardised by the academic communityas the Shared Socioeconomic Pathways (SSPs).The SSPs also provide detailed narratives regardingtechnological advancement, internationalcooperation and resource use.6Global GDP growth in SSP2Absent transition and physical risksTrillion USDGlobal population growth in SSP2Absent transition and physical risksPer cent4%400   All scenarios are currently based on the ‘middle ofthe road’ assumptions provided by SSP2 to ensurethey are comparable. In this SSP global populationgrowth is moderate and levels off in the second halfof the century. GDP continues to grow in line withhistorical trends.   A limitation of the SSPs is that they do not includethe impacts from physical risks on these backgroundassumptions. This includes socioeconomic changesrelated to migration and conflict.6  For an overview of the SSPs, see Riahi et al. (2017).Billions6%6002%200020202040GDP PPP206020800%2100Annual growth rate (RHS)Source: IIASA NGFS Climate Scenarios Database, GCAM model.Per 0602080-1%2100Annual growth rate (RHS)Source: IIASA NGFS Climate Scenarios Database, GCAM model.NGFS SCENARIOS13TransitionAll scenarios make a background assumption that social and economic trends continue in linewith historical trends.

Policy and technology assumptions   In the IAMs used to produce the NGFS ClimateScenarios, shadow emissions prices are a proxyfor government policy intensity.7 The prices arecalculated to be consistent with a pre-definedtemperature target (e.g. 67% chance of limitingglobal warming to 2 C). This is a simplification. Inreality, governments are likely to pursue a rangeof different policies. This means carbon prices willdiverge from model optimal levels.   Another key assumption is the timing of policyaction. This has a significant impact on the emissionsprice level that is required to achieve a giventemperature target, as illustrated in the left chart.Emission price developmentRepresentative scenarios800Emission price development across modelsOrderly scenarioUSD (2010)/t CO2300USD (2010)/t CO2700600200500400300100200   Emissions price trajectories will also vary acrossmodels (right chart) due to other underlyingassumptions such as the costs of new technologiesand the extent to which they are deployed.10020202030Orderly7  Emissions prices are defined as the marginal abatement cost of anincremental ton of greenhouse gas emissions.Disorderly20402050Hot house worldSource: IIASA NGFS Climate Scenarios Database, using marker -MAgPIESource: IIASA NGFS Climate Scenarios Database.NGFS SCENARIOS14TransitionAssumptions related to policy action and technology development are a key driver of thescenarios and the results between models.

Carbon dioxide removal assumptions   Carbon dioxide removal (CDR) refers to directremoval of carbon dioxide from the atmosphere,for example by combining bioenergy with carboncapture and storage (BECCS) or through land-relatedsequestration (e.g. afforestation). Currently, CDRtakes place on a negligible scale.   CDR assumptions play an important role in IAMsbecause they help determine whether, and how,climate targets can be met. For example, if CDRwere deployed on a large scale, it is possible thatfossil fuel emissions could stay higher for longer,or a lower climate target could be reached sooner.   Some of the NGFS Climate Scenarios, includingthe representative Orderly scenario, assume fullavailability of CDR technologies. Other NGFS ClimateScenarios, including the representative Disorderlyscenario, assume negligible CDR availability,reflecting that there are challenges to achievingthe necessary investment and deployment.Sources of carbon dioxide removalSources of carbon dioxide removalCarbon dioxide emissions with full andlimited carbon dioxide removal500Gt CO2 / yearGt y206020802100Orderly with limited CDRSource: IIASA NGFS Clim

and supervisors and 13 observers committed to sharing best practices, contributing to the development of climate and environment‑related risk management in the financial sector and mobilising mainstream finance to support the transition towards a sustainable economy. The NGFS Climate

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