Core Council Business Under Radical Uncertainty

Dr. Geoff Wells

Academic Director, Sustainable BusinessInternational Graduate School of Business

University of South Australia

Uncertainties in climate science

• Early stage of development

• Role of climate factors; cascading uncertainty

• Feedback effects

• Prediction of ecosystem risks

• Adaptive and technological responses; fertilisation of crops

• IPCC process

• Rebuttal

Uncertainties of human impacts

• More dramatic IPCC scenarios

• Human impacts: first level effects

• Human impacts: second level effects

• Distributional effects

• Mass movements of people

Uncertainties of economic analysis

• Time horizon

• Averaging and assumptions

• Range of business-as-usual estimates

• Mitigation cost estimates

• Critique– Other scenarios– Overstating costs of climate change– Understating costs of mitigation– Uniquely low interest rates

• Overall judgement of Stern Review

Council Business Under Climate Change Uncertainties

Relevant management frameworks

• Local Government Act 1999– Strategic management plans– Annual business plans and budgets

• Australian Accounting Standard #27– Component functions and activities of local

government– Depreciation of non-current assets

Climate impacts & risks• Increased erosion, landslides, sinking of ground

surface, disruption and damage to buildings and public utilities or other infrastructure caused by global warming impacts.

• Increasing incidences of respiratory illness, heat mortality, and other public health impacts associated with climate change.

• Impacts to private lands or resources that detract from commercial uses such as recreation, e.g. loss of use of property used for skiing, tourism based on coral reefs, or terrestrial wildlife.

• Impacts to agriculture, including decrease in agricultural water supplies, lower water quality, increase in agricultural operational costs (fuel, pesticides, fertilisers), and increase in food prices.

( Ross, C, Mills, E & Hecht, S 2007, Limiting liability in the greenhouse: insurance risk-management strategies in the context of global climate change, Public Law & Legal Theory Research Paper Series, Research Paper No. 07-18, UCLA School of Law.)

Climate impacts & risks

• Impacts to lands or resources that detract from resource consumptive uses (e.g. timber production).

• Mobilisation of chemical wastes, sewage, petroleum products by natural disasters. Post-event mould after flood events.

• Poor financial performance or other consequences of businesses' failure to reduce carbon emissions or to reduce risks attributable to climate change.

• Interruptions to operations, communications, transportation, or supply chains due to failure to prepare for extreme weather events. 

Climate impacts & risks

• Economic losses to businesses due to failure to prepare for weather-related disruptions of energy, water, or other utility services.

• Weather extremes involving changes in precipitation, ice, temperature, or visibility have impacts on vehicle accident incidence, which, in turn, includes a component of liability insurance losses.

• Cross-border economic damages arising from new regulations or taxes, policy on carbon markets. 

• Risks associated with supply-side energy measures to reduce greenhouse-gas emissions, e.g. from use of nuclear power, hydrogen, or carbon capture and storage. 

Climate impacts & risks

• Impacts on ecosystems: degradation of habitats, increased threats to species, changes in geographical distribution, changes in locations of parks and reserves.

• Impacts on demographics: – Significant population movements, away from higher

temperatures and water deficit, towards lower temperatures and water availability.

– Demographic cascades from relocation of industry.

– Potential for significant numbers of climate change refugees from Pacific nations.

Financial Analysis

Handling Uncertainty

Four Levels of Uncertainty

Courtney, H 2001, 20|20 foresight: crafting strategy in an uncertain world, Harvard Business School Press, Boston, MA.

Level 1: A clear enough future

• Business strategists face opportunities where the range of possible future outcomes is narrow enough that this uncertainty doesn’t matter to the decision.

• Point forecasts can be developed that are precise enough for strategy development.

• Future path of main drivers relatively clear.

• Market not prone to external shocks or internal upheaval.

.

Level 1 tools

SITUATIONAL ANALYSIS TOOLS

END PRODUCTS DECISION-MAKING MODEL

Traditional tools:Business diagnostics Porter’s Five Forces.

SWOT analysis.

Discounted Cash Flow/NPV valuation models.

Forecasts of key value drivers under different strategic assumptions.

DCF valuation of alternative models.

Choose the strategy that maximizes the organisation’s objective.

Level 2: Alternate futures

• Set of possible future outcomes that are mutually exclusive & collectively exhaustive (MECE), one of which will occur (cf. multiple choice).

• Analysis can help establish relative probabilities but can’t tell you which one will occur.

• Most common business strategy challenge.

Level 2 toolsSITUATIONAL

ANALYSIS TOOLS

END PRODUCTS DECISION-MAKING MODEL

Traditional tools, plus:

Decision-tree analysis.

Scenario-planning.

Game theory.

Complete description of a MECE set of scenarios:

--industry structure, conduct, performance in each scenario

--dynamic path to each scenario, including trigger events or variables

--relative probabilities of each scenario

--valuation model for each scenario

Analysis of probabilities and payoffs.

Decision analysis.

Level 3: A range of futures

• A range of possible future outcomes can be identified, but no obvious point forecast emerges.

• Strategists can only define a representative set of outcomes within the range of possible outcomes (set is not MECE).

• Unstable macroeconomic conditions—unpredictable GDP growth, inflation and interest rates, currency fluctuations, etc.

Level 3 tools

SITUATIONAL ANALYSIS TOOLS

END PRODUCTS DECISION-MAKING MODEL

Traditional tools, plus:

Scenario-planning.

Game Theory.

Latent demand research techniques.

System dynamics models.

Techniques based on option-pricing models.

Complete description of representative set of scenarios.

Analysis of probabilities and payoffs.

Analysis of strategy impacts on probabilities within the range of outcomes.

Qualitative decision analysis.

Level 4: True ambiguity

• Uncertainties are unknown and unknowable.

• Analysis cannot identify the range of potential future outcomes or scenarios within that range.

• Not possible to identify all the relevant variables that will define the future.

• Limitless range of future outcomes.

• Typical of new political, scientific, technological developments and environments.

Level 4 tools

SITUATIONAL ANALYSIS TOOLS

END PRODUCTS DECISION-MAKING MODEL

Fore-sighting.

Analogies and reference cases.

Simulation.

Complete set of what you would have to believe statements to support different strategies.

Supporting analogies and reference cases.

Key market indicators.

Getting comfortable with what you would have to believe.

Handling Uncertainty in BCA

BCA benefits categories

Benefits

Use

Direct Indirect

Non-use

Option Existence

Scenario analysisIssue of concern

Horizon year

Related elementsincl stakeholders

Location instructuring space:

Focus on highimpact/lowprobabilitysegment

Events

Combinations ofextremes

3-4 scenarios

Clusters

Underlying forces

Priorities 2-3

Ranges &extremes of forces

Locate elementsof other quadrants

in scenarios

Scenario events,timelines,causalities

Review highimpact/ low prob

segement forscenario coverage

To Scenario/Decision

Decision analysisScenarios

Businessstrategies

Business idea

Lower-levelstrategies or

decisions

Current strategy

Contemplatedstrategy

Range ofalternativestrategies

Matrix evaluationStrategy/scenario

payoffs

Rank Str/Scencombinations

Filter Str/Scencombinations

Swing weighting ofStr/Scen

combinations

Weightedaggregate scores

of Str/Scencombinations

Matrix ofaggregate scores

to evaluaterobustness

Sensitivityanalysis

From ‘Scenarios’

To Simulation

SA Water RiskAssessment

Guide

Probabilistic risk analysisPriority businessstrategies/actions

Key factorsaffecting

outcomes

Modelling offactors/ Influence

diagram

ROI Factors

Preliminarysensitivity analysis

on factorsTornado diagrams

Elicit probabilitydistributions

Factor/Years

Perform thesimulation

NPV calculations

Sensitivityanalysis on results

of simulation

Comparealternative

courses of actions

Investmentoptions

Plot distributionsof alternatives

Stochasticdominance

analysis

Mean-standarddeviation

Utility functions

Modellingdependencerelationships

InvestmentDecision

From ‘Scenarios/Decision’

Modelling uncertainty

Populationsize

Total Animals

Annual catch

rate ofincrease

Prob BandsMechanics

ThresholdMechanics

Loss rate

DistributionVariations

Currentpopulation

size

Rmax

z

K

removals

removal rate

Uncertainty & decision-making

• The precautionary principle

• Radical uncertainty and irreversibility– Converting radical uncertainty to subjective risk

– The conservative maximin decision rule

– Keeping options open

– Increasing the resilience of the system

• Integrating and aggregating– The strengths and limitations of modelling

– Deliberative decision-making

– Approaches to coordination

– Emergent decision-making