Here, in an exploratory analysis, S&P Global Ratings tests the potential of new alternative data sets and how they might enhance our dialogue with rated U.S. public finance entities regarding future physical climate risks, the possible range of exposures, and how the rated entities have adapted or plan to adapt.

There are some inherent uncertainties associated with climate science, including those related to the crystallization and severity of climate risks--like water stress, wildfire, and sea level rise. Given these uncertainties, we do not consider the scenarios we apply as the base case for rated U.S. public finance (USPF) entities. The exposures to physical risks we describe do not take into account adaptation efforts that USPF entities have implemented or may implement in the future. However, using multiple scenarios has the potential to enable a better understanding of the range of possible exposures that USPF entities face. That knowledge may facilitate and enrich the dialogue with USPF rated entities about their views of climate risks, including what measures (if any) they are taking or plan to take to build resilience. Based on that dialogue, we can formulate opinions about how well prepared the rated USPF entities are for different futures, while potentially contributing to the debate about the need for a greater breadth and depth of disclosures.

To illustrate the application of these datasets, we leverage the power of Climate Change Physical Risk data from Trucost (part of S&P Global) to apply scenario analysis and advanced analytics to explore the physical risk exposures for USPF against certain physical climate risks. Trucost's data is derived from publically available information, licensed datasets, and its own models.

We have long articulated the impacts of physical risks, themselves manifesting as chronic, longer-term shifts in climate patterns or acute risks from extreme weather events (see the Related Research at the end of this article) and described how our criteria and ratings can capture the dual threat of both chronic and acute physical risks when those risks are sufficiently visible and certain and actually or potentially material (see "Credit FAQ: Understanding Climate Change Risk and U.S. Municipal Ratings," Oct. 17, 2017, and "How Our U.S. Local Government Criteria Weather Climate Risk," March 20, 2018).

Physical risks may pose a particular threat to the creditworthiness of many issuers within public finance where locations are fixed, and the risk cannot be diversified away, therefore, management must determine how best to address the needs and costs associated with adapting to these risks. Disclosure of these potential effects and actions to mitigate are an important input into our assessment of management's planning and, as such, we have incorporated these into our view of municipal exposure to chronic and acute physical risks, where material to the overall credit profile. Needless to say, recent events, including the COVID-19 pandemic, have helped to (re)focus the minds of investors and decision-makers to the possible severe impacts of a "green swan" event (a potentially financially disruptive climate event), which itself has highlighted the need for enhanced analytics and greater foresight of both chronic and acute physical risks.

Here, we first describe the role of climate projections in scenario analysis before applying Trucost's Climate Change Physical Risk data to an analysis of USPF. We illustrate the increasing exposure of U.S. counties to water stress and heat waves, high wildfire risk in western and southeastern states, and sea level rise and river flooding, particularly in Louisiana, before we describe how better data can provide greater visibility about the range of possible future exposures to physical risks. This can facilitate and inform dialogue with USPF entities regarding how those risks are and will be managed.

Climate Projections And Their Use By Financial Actors

While many USPF entities are familiar with the impacts of acute risks (such as extreme weather events), for some, other significant physical risks may emerge over the medium to longer term, timescales that are sometimes longer than those of many issuers' financial forecasts. At the same time, the precise timing and severity of impacts remains uncertain. This uncertainty is a challenge for local governments in understanding the potential impacts of physical climate risks and the steps required to build resilience. Scenario analysis has long been used as a tool to build organizational resilience and to identify risks and opportunities before they emerge. However, its use for assessing climate-related risks and opportunities by many municipal issuers is not common or is relatively new, particularly for smaller entities.

The Task Force for Climate-Related Financial Disclosure (TCFD) suggests using available scenarios from the Intergovernmental Panel on Climate Change (IPCC) Fifth Assessment Report (AR5), that reflect a broad range of possible greenhouse gas (GHG) emissions pathways (termed Representative Concentration Pathways or RCPs; see box below) and that were developed using different possible social and economic futures, when undertaking scenario analyses. These RCPs describe four possible end-of-century pathways of GHG emissions whereby each scenario fixes the amount of GHG concentration in the atmosphere resulting in an associated change in global average temperature (compared with the 1986-2005 historical baseline). In our analysis we apply three of the scenarios to gauge how physical risks for certain climate hazards may evolve in the U.S. We do not use the RCP6.0 scenario, largely due to the availability of data.

For local governments working to build resilience to climate change, including sea level rise and river flooding, the selection of climate scenarios may be an important consideration given the relatively higher costs associated with designing assets to be resilient to a RCP8.5 world. As summarized by Carbon Brief, much research focuses on RCP8.5 as a business-as-usual scenario, suggesting that this is a likely outcome if society does little to curtail its GHG emissions. However, the nuances of that scenario are important as, for example, RCP8.5 is the only scenario that includes no policy-driven mitigation. While it is useful to incorporate such extreme scenarios in sensitivity testing, it is hard to imagine a world now, given countries' commitments to the Paris Agreement, where fossil fuel use expands intensively in the future even in the absence of new mitigation policies. Moreover, the falling costs of renewable energy technologies worldwide have added much needed momentum to the low-carbon transition, information that was not available at the time the RCPs were developed. Our view is that using a range of scenarios can be beneficial when testing potential future exposures and local governments' resilience strategies and in risk assessments, with the associated range of costs and resilience benefits captured as best possible.

It is noteworthy in the U.S. municipal market that no significant initiatives have occurred to standardize reporting for public entities that face similar climate risks, despite their unique role as essential service and infrastructure providers. Absent an industry or sector standard, best practice, or regulatory requirement, we expect the focus will increasingly be on improved disclosure by issuers or independent data providers, allowing for comparative analysis and a demonstration of progress toward stated climate policy objectives.

Based on current commitments to reduce GHG emissions as captured through countries' Nationally Determined Contributions (NDCs), this equates to a global temperature increase of more than 3°C by the end of the century, which is consistent with a pathway someway between RCP6.0 and RCP8.5. Due to the lag in the climate system owing to historic GHG emissions, even if countries were to immediately cut emissions now, warming would therefore still continue. That said, it is argued by many stakeholders that ambitious and targeted actions are required now to limit the global temperature rise, and it is further argued by some that local governments must take action to realign themselves to a low-carbon future. This is particularly important as global economies begin their (green) recovery following the COVID-19 pandemic.

With this in mind and aligned to best practice, our analysis reflects a range of RCPs--RCP8.5, RCP4.5, and RCP2.6 (where appropriate and available)--and focuses on both chronic and acute event risks over the next 30 years.

Water Stress And Heat Waves Are On The Rise In The U.S.

Local governments, utilities, and other public finance entities face challenges associated with chronic physical risks such as increasing exposure to water stress, wildfire, and heat waves. These risks vary across the U.S. Here, we present the results of our analysis that uncovers U.S. counties with greatest potential exposure. These potential exposure measures can facilitate a dialogue with rated issuers. Notwithstanding that there is uncertainty regarding exactly what the climate impact will be, when risks might crystallize (and at what cost), this analysis can lead to greater understanding about the adaptation measures needed to build resilience as well as which actions USPF entities will decide to take to manage their risk exposure. Additionally, the chronic nature of some climate risks means that there could be time for governments and issuers to build resilience through adaptation or financial planning that may, over the long term, help to mitigate the potential impacts to credit. However, the crystallization of multiple events in a single year and/or consecutive years may hasten the responses that are required by governments and issuers.

Our analysis focuses on the potential changes in physical risk levels from various hazards under three of the RCPs, to understand what adaptation actions might be needed from USPF entities in light of climate change. Across the U.S., the greatest changes over the next 30 years could be a rise in water stress in half of U.S. counties under both RCP4.5 and RCP8.5 and heat waves in one-fifth of them under RCP8.5 (or one-tenth under RCP2.6). There could be a corresponding fall in cold waves in counties where heat waves rise while flooding could increase in some regions like New Jersey and decrease in others including California and Oklahoma, under both RCPs.

Water stress is a widespread concern, with 38% of counties scoring 100, the maximum risk score on our scale, and half of the counties having high risk with scores of 70 or above in 2050 under both RCP4.5 and RCP8.5 (see chart 1). A greater score on this scale means that water demand is likely to outstrip the renewable supply and so water resources could deplete over time. This is problematic for those counties that draw significant resources from those with greater supply and may necessitate a shift toward groundwater supplies when surface water supplies decline, increasing production costs. Water supply constraints are a concern for many in USPF. For example, water supplies will impact urban planning for local governments, which could in turn impact enrollment trends for school districts and other government services. It's also concerning for some utilities with thermoelectric power, which account for 34% of county water use according to latest figures from U.S. Geological Survey. On the positive side, 89% of the drop in water withdrawals in the U.S. between 2010 and 2015 is attributed to decreased demand from thermoelectric power. Counties in Texas, among the fastest-growing nationally, will see the greatest change in water stress over the next 30 years according to the data under RCP8.5 and RCP4.5, posing a challenge for economic development and municipal infrastructure planning if these scenarios come to pass.

Chart 1

Across the U.S., heat waves would also increase in frequency under RCP2.6 and RCP8.5 and across all states. A 5-point increase in score indicates about an extra week of heat waves annually by 2050 compared to current local conditions. Over 70% of counties in Alaska, Arizona, Nevada, New Mexico, and Wyoming see more than a 5-point rise in heat wave risk under RCP8.5. The picture changes very little under RCP2.6 for most of these states except Alaska and Wyoming, where the risk dramatically drops. In fact, no Alaskan counties see heat wave risk change under RCP2.6. While not as widespread, the same sort of trend is observed in the other northern states excluding New England. In Maine, about half of counties could expect an extra week of heat waves by 2050 even under RCP2.6. The rest of New England states could see a quarter or fewer counties with an extra week of heat. The economic impacts of heat waves are well known. Studies have shown that heat waves can reduce worker productivity, particularly for outdoor workers such as construction workers but also office workers, and can increase electricity prices as demand rises and production efficiency drops. For issuers in USPF, the costs could be significant. Indeed, one particular study by Deryugina and Hsiang (2014) found that a weekday above 86°F (30°C) costs an average county $20 per person (hot weekends have little effect), net of any adaptation actions, while each additional warm day (75°F-80°F or 24°C-27°C) reduces an average county's total income per capita by nearly $15.

On average (taking into account scores from all counties), southwest states including Arizona, Nevada, and New Mexico are the most exposed to heat wave risk (see table 1). In fact, counties in New Mexico could see up to an extra month of heat waves in 2050 under RCP8.5, while counties in Arizona, Nevada, and Utah could see up to an extra three weeks of heat wave compared with current conditions. There is notable county variation within the state scores (as the maximum scores in the table show). In particular, island nations, including Hawaii, Honolulu, Maui, and Kauai, are significantly exposed to an increase in heat wave risk, which feeds into our understanding of the area's overall exposure to environmental risk as part of its overall credit picture.

Table 1

Our analysis reveals Florida could have the counties with the greatest exposure from physical climate risks using Trucost's composite physical risk score, which includes all hazards. Regarding heat wave risk, three-quarters (75%) of the top 20 counties for change in heat wave risk are in Florida (see table 2). Heat waves can be damaging for physical assets, but are also associated with drops in productivity, and increasing demands on air-conditioning and cooling systems. In these counties, the score changes by more than 30 points (equivalent to an additional 40 days of heat wave per year by 2050) on the risk scale, from current levels. Under RCP2.6, the point difference is about half as much over the 30-year period. In practice, this means these counties could experience one to three months of abnormally high temperatures more each year than they experience today, depending on mitigative actions taken globally to limit emissions. Increasing heat waves and other physical risks may challenge the state's long-term positive migration trends, tourism activity, and overall economic productivity, affecting tax revenues as incorporated in the overall environmental risk.

Table 2

Wildfire In The Western And Southeastern States Is Already A Risk

Areas of high exposure to the risk of wildfire, mainly to forests and grasslands, are concentrated in two broad U.S. regions: The West and Southwest (see chart 2). The results mostly correlate with historical incidences of wildfire, and there does not appear to be a dramatic rise in this risk between now and 2050 even under the most extreme RCP8.5 scenario due to the high starting point for many counties. Indeed, many counties in western and southeastern states achieve the maximum score of 100, the maximum risk on our scale, in 2050 under both RCP8.5 and RCP2.6.

Chart 2

By our findings, only 16 counties, located in Oregon, Wyoming, Montana, Minnesota, and New Mexico, have an increase of more than 10 points on our 1-100 scale under RCP8.5 (see table 3). Recent wildfires have had significant impacts in New Mexico, including the 2011 Las Conchas Fire, which generated the biggest local erosion event in approximately 1,000 years. Dry seasonal winds also exacerbate Southwestern states' exposure to wildfire risk, meaning that adaptation actions may need further strengthening. In the Northwest, natural resources play a key role in the economy. Climate change, including wildfire risk, could put jobs in the sector and sales revenues at risk, as highlighted by the Fourth U.S. National Climate Assessment. In our analysis, only one county (Douglas County in Oregon) has an increase of more than 20 points, suggesting this area may face further challenges. In 2017, the Eagle Creek fire along the Washington-Oregon border led to the closure of Highway 84 and adjacent railway, increasing transportation costs and hurting the local economy, as well as tourism and small businesses in the region.

Table 3

Wildfires may be caused by natural sources (for example, lightning or ignition of dry vegetation by the sun) or human sources (like unattended campfires). Plus, many other factors contribute to the number of wildfires in an area in any given year, including how high summer temperatures are, how low precipitation is, and wind conditions. Research suggests that there is a strong relationship between temperature and fire extent, particularly in the U.S., with warmer years generally having greater fire extent (principally due to fuel aridity) than relatively cooler ones, since the early 1980s. On a global level, other factors are at play including the frequency of human-set fires for agricultural conversion, particularly in Africa and Southeast Asia. In the future, many experts agree that climate change will have a bigger effect in areas outside the tropics than human-caused factors. While the long-term change in climate that may increase the risk of wildfire events is relatively visible, it is not possible to precisely predict where and when specific wildfire events will happen and what damage they may cause. By their nature, wildfires (like heavy summer rainfall events in many parts of the world) are highly localized. Notwithstanding this, the potential increasing exposure over time highlights the importance of dialogue and learning about how entities within these areas consider these risks and what measures they have in place or not to reduce wildfire risk.

We also note that the wildfire projections have not yet factored in changes in winds, which can fuel their intensity and are a challenge to model with the current science. Counties in California are already at the top end of the scale now, with 12 counties scoring 100, and a score of 90 in Solano County. That county's score rises to 98 in 2050 under RCP8.5. This could also be obscuring some of the likely changes in intensity that we could experience over the next 30 years. We have previously seen wildfire risk in California affect our credit ratings. A summary and discussion of some of our rating analysis can be found in the following commentary: "California Public Power Utilities Face Disparate Physical And Credit Exposures To Wildfires," Aug. 4, 2020.

Sea Level Rise And Flooding Are Large Risks For Louisiana

Changes in sea level and flooding will pose different challenges to USPF entities. Sea level rise is a chronic risk, with many municipalities and communities seeing increased exposure (and impacts) over time, while flooding is an acute risk brought about by extreme precipitation and storms. The responses needed to reduce the risks associated with these hazards often require different approaches, timescales for action, and risk tolerances.

NASA has been tracking change in global sea level rise since 1993 using satellites and, as of March 2020, it has risen by 3.7 inches (9.4 centimeters). The data shows that California, Georgia, Louisiana, Massachusetts, New Jersey, South Carolina, Texas, and Virginia have all experienced sea level rise. There is local variation in sea level rise owing to coastal topography and levels of protection, and the state with the highest number of affected counties is Louisiana under both RCP4.5 and RCP8.5 (see table 4). While the global average rise has been 3.7 inches since 1993, Louisiana's Grand Isles in Jefferson has risen by 10 inches (26 cm).

Table 4

Parishes in Louisiana (counties in the state are called parishes) are also more highly exposed to river flooding than their counterparts in other states when looking at scores averaged across all counties by state. However, there is variation at the county level. Municipal entities in flood-prone counties could face increasing costs associated with constructing new buildings and infrastructure that are resilient to climate change, as well as the costs associated with maintenance and retrofit, weakening the tax base or risking damage to it. Flood insurance rates could rise and place increasing burdens on homeowners and reduce associated market values of properties. Authorities can use this data to assess the financial resilience of their communities and in planning to increase their ability to adapt. Restrictions through regulation on land use and zoning could also factor more prominently in planning decisions, leading to reduced services in highly exposed counties.

Table 5

The physical risks datasets are measures of potential future exposure to certain climate hazards and do not take into account adaptation efforts that local governments have implemented or are carrying out now or in the future. For example, efforts are underway in Louisiana to adapt to sea level rise and river flooding. The state issued its last coastal flooding master plan in 2017.

Recently in June 2020, the state presented its latest update on the technical modeling of coastal flooding. The state will use this updated modeling to formulate its next adaptation plan scheduled for release in 2023. The latest update in economic damage modeling incorporates estimated destruction to over 750,000 exposed structures in addition to roads, vehicles, and crops. They also incorporate displacement costs associated with the repair phase following a coastal flooding event and projected losses in sales and rent.

How Data Can Enhance Transparency Of Environmental Risks for USPF Market Participants

Creditworthiness can weaken when environmental risks, including physical climate risks, are material and not, in our view, mitigated by other credit factors such as capital and financial planning and coordination with other government entities. Enhanced analytics can provide greater transparency for market participants to identify and analyze potential longer-term risks and facilitate a dialogue with entities that are potentially exposed across USPF in the following ways:.

• Ongoing analysis of the adequacy of the entities' planning and response to growing environmental threats, including adaptation and mitigation plans, affecting financial and operating management across a variety of municipal asset classes;
• The potential long-term economic and demographic consequences, including the impact on tax bases;
• The adequacy of reserves or financial capital to respond to potentially increasingly volatile environmental conditions; and
• The potential impact on balance sheets as a means for financing adaptation and mitigation projects.

In the future, there may be additional opportunities to gather further insights through the development of value-at-risk metrics, which seek to assess estimated impacts to a variety of areas, such as revenue and tax base sensitivity, property values and economic activity, productivity, and demographic trends. Embracing the availability of granular spatial data and emerging technologies, such as machine learning, may also further serve to enhance our credit analysis as it relates to physical climate risks (see "Space, The Next Frontier: Spatial Finance and Environmental Sustainability," Jan. 22, 2020).

Increased transparency surrounding these risks also presents an opportunity for issuers to demonstrate the benefits of existing or planned adaptation actions. For example, even though a city may have a comparatively high degree of exposure to physical climate risks as identified by metrics, a proactive, flexible climate adaptation plan could serve to support credit quality if the plan is adhered to and costs associated with implementing the plan are transparent, well known, and affordable. When assessing these risks it is also important to consider the balance between service provision and investment in adaptation projects given the uncertainty associated with climate modeling and maturity of resilience benefits from such investments (see "Plugging The Adaptation Gap With High Resilience Benefit Investments," Dec. 7, 2018). We understand that public entities and not-for-profit enterprises have to balance these longer-term pressures with competing priorities and resource constraints. Much like our approach to analyzing the long-term impacts of retirement liabilities, an understanding of management's assumptions, plans, and financial capacity to address chronic and acute physical climate risks may increase over time in terms of their importance to overall credit quality. Enhanced analytics and metrics may enable us to gauge managements' proposed, or in-flight, actions to adapt to or mitigate physical climate risks and compare those actions to the potential magnitude, timing, and expected duration of such risks.

Also, given the diversity of USPF issuers, a consideration of a variety of data sources, including enhanced analytics related to physical risks, will likely provide valuable transparency to the municipal market and enhance dialogue with rated entities about how they are preparing for and managing current and future physical climate risks.

Related Research And Criteria

S&P Global Ratings research

• Through The ESG Lens 2.0: A Deeper Dive Into U.S. Public Finance Credit Factors, April 28, 2020
• Space, The Next Frontier: Spatial Finance And Environmental Sustainability, Jan. 22, 2020
• 2019 Update Of Institutional Framework For U.S. Local Governments, Oct. 22, 2019
• The Role Of Environmental, Social, And Governance Credit Factors In Our Ratings Analysis, Sept. 12, 2019
• Climate Change: Can Banks Weather The Effects? Sept. 9, 2019
• When U.S. Public Finance Ratings Change, ESG Factors Are Often The Reason, March 28, 2019
• For Water Utilities, ESG Is Just Business As Usual, Dec. 12, 2018
• Can U.S. Utilities Weather The Storm? Nov. 8, 2018
• Through the ESG Lens: How Environmental, Social, And Governance Factors Are Incorporated Into U.S. Public Finance Ratings, Oct. 10, 2018
• How Our U.S. Local Government Criteria Weather Climate Risk, March 20, 2018
• Credit FAQ: Understanding Climate Change Risk And U.S. Municipal Ratings, Oct. 17, 2017
• The Heat Is On: How Climate Change Can Impact Sovereign Ratings, Nov. 25, 2015
• Climate Change Will Likely Test The Resilience Of Corporates' Creditworthiness To Natural Catastrophes, April 20, 2015

Other research

• Understanding Climate Risks At The Asset Level: The Interplay Of Transition And Physical Risks, Trucost, Nov. 25, 2019