Climate change is costly for business

We’re approaching the end of the hottest year on record. While future projections of temperature rise anticipate a new era of climate disruption, climate-change-driven disruption to business is happening, now. The critical importance of understanding the connection between climate change and the resilience of supply chains in today’s interconnected world was the topic of testimony I recently presented to the US Senate Budget Committee. Supply chains are already feeling the effects of a warmer, wetter and more volatile climate – effects that hit the bottom line. The Carbon Disclosure Project (CDP) warns that environmental supply-chain risks could cost companies $120bn by 2026.

The US derives substantial economic value from global trade. In 2022, the US bureau of economic analysis estimated that exports contributed $3 trillion to US GDP, while imports on the other hand provide many of the raw materials, commodities and products that are required for economic production, and a healthy and robust economy.

Supply chains are vulnerable to the effects of climate change

The US economy is dependent on a complex global web of interconnected supply chains. While the network of global trade routes may appear robust from the outside, supply chains are vulnerable to the physical effects of climate change. Material physical risks can include damage to facilities, reduced production and disruption to global trade routes.

The direct impact of extreme weather events can cascade through supply chains, affecting the flow of commodities and goods to regions and sectors, leading to increased costs to business and to the broader economy. When supply chains are disrupted, it can often induce a sharp increase in global commodity prices, particularly for goods and commodities that are scarce or subject to concentration risk at some point throughout the supply chain. This became evident during the COVID-19 pandemic where shortages in certain products and raw materials led to price increases and supply-induced inflation.

Microchip production in Taiwan is vulnerable to climate change

The vulnerabilities of product supply chains to climate-related events should not be underestimated. Take one compelling example: the microchip industry. Taiwan is the world’s largest producer of microchips, accounting for over 60 per cent of the global supply of semi-conductors and about 90 per cent of the world’s most advanced microchips. As a small island nation in the middle of the South China sea, Taiwan is highly vulnerable to the impacts of climate change. The island is located on the typhoon belt and is frequently hit by storms, which cause widespread flooding and damage to factories.

The fabrication of microchips is an energy-intensive process. It is also highly water-dependent, requiring large quantities of water for cleaning and etching silicon wafers. As energy and water are two critical inputs into the production of microchips, the production process is becoming increasingly vulnerable to the effects of climate change. Climate scientists warn that global warming may produce fewer but stronger storms, which can cause greater damage and give rise to water scarcity due to more severe droughts.

The concentration of microchip production is a threat to business

This could have severe consequences on the production of microchips in Taiwan – one manufacturing plant located in the Southern Taiwan Science Park, alone, consumes 138,000 m3 of water per day, which is equivalent to the daily usage of a city of nearly half a million people. Just consider the possible impacts to a shortage of supply. Microchips are integral to a wide range of goods, from iPhones and vehicles to military hardware. Economic research estimates that microchips are used as an input into one quarter of all manufacturing sectors, which, in turn, account for 39 per cent of all US manufacturing output. Even though microchips typically account for only a small fraction of total input costs, scarcity of microchips can halt production. The long lead time and high investment costs required to develop new chip fabrication centres therefore raises concerns about vulnerabilities to the economy and to national security.

Supply chain disruptions can cause cascading impacts to the economy

Disruption to the import of critical components can interrupt production processes, which then has a knock-on effect to exports. Imagine the cascading impacts on US exports that depend on microchips within production processes – multiple sectors across the economy could be severely disrupted with consequential economic impacts.

The manufacture and supply of microchips is just one example of how the growing physical risks from climate change will impact the trade of critical goods across and within US borders. Corporations are starting to realise the business imperative of mitigating and adapting to climate risks and accelerating their progress towards net zero.

What can businesses do to minimise supply-chain risk?

There are several ways to build a more resilient supply chain.

  1. Increase onshore production. Increasing the domestic production of microchips will reduce the concentration risk from existing major microchip manufacturers, namely from Taiwan.
  2. Source supplies from areas that have low physical risk from climate change. Identify locations of production in the world that are at the least risk from physical climate change.
  3. Diversify existing suppliers. Increasing the number of suppliers across a larger geographic region will reduce risks from extreme events and increase resilience to future climate change.
  4. Diversify existing supply routes. The supply route of critical parts and commodities can be just as important as where the product or commodity is sourced. Sea ports represent a bottleneck in supply chains where a damaged port can seriously impede the transport of goods through the economy.
  5. Increase inventory and buffers. Buffers for critical components mean that inventory can be drawn down when supply chains are impacted.
  6. Reuse and recycle components. Encourage existing manufacturers to reuse and recycle old components to increase the supply of parts available, while also minimising waste.
  7. Require manufacturers to assess and disclose their material climate-related risks. The active disclosure of climate-related risks increases awareness throughout stakeholders and addresses the issue of asymmetric information, allowing for improved decision making.

We are living in the era of climate disruption. Positive business transformation to enable the decarbonisation required for sustainable growth is key to surviving and thriving in a low-carbon economy. The consequences of not addressing climate change are increasingly evident – and too financially disruptive for companies to ignore.

• Read the Risilience report Preparing for climatic business disruption