Disclosure of climate change scenario assumptions used in judgements and estimates

Rio Tinto plc – Annual report – 31 December 2021

Industry: mining

1 Principal accounting policies (extract)

Climate change

We have put the net zero transition at the heart of our business strategy: combining investments in commodities that enable the energy transition with actions to decarbonise our operations and value chains. As a result of this, our strategy and approach to climate change are supported by strong governance, processes and capabilities. In 2021, we updated our Scope 1 and 2 emissions targets and now aim to reduce emissions by 15% in 2025, by 50% in 2030 (relative to our 2018 equity baseline) and to achieve net zero emissions by 2050. These targets are aligned with efforts to limit global warming to 1.5°C, which is aligned with the stretch goal of the Paris Agreement. The goals of the Paris Agreement are set out in Article 2, which includes holding the increase in global average temperature to well below 2°C above pre-industrial levels and pursuing efforts to limit the temperature increase to 1.5°C.

We frame the strategic context for the Group through the lens of three scenarios, developed by the Strategy and Economics teams, structured around our analysis of the interplay of three global forces: geopolitics, society and technology.

– In a geopolitics-led scenario, strong nationalistic tendencies hold back global action on climate change, carbon prices remain low (in the range US$0-30/t CO2e) and warming exceeds 3°C by 2100.

– In a society-led scenario, strong global co-ordination of climate policies, supported by high and rising carbon prices (reaching US$130/t CO2e in 2050), accelerates the energy transition and we believe achieves the goal of the Paris Agreement by limiting warming to well below 2°C by 2100.

– In a technology-led scenario, innovation boosts economic productivity and decarbonisation efforts; however, carbon prices remain modest (ranging US$10 to US$75/t CO2e by 2030) and action to limit emissions is insufficient, so warming exceeds 2°C by 2100.

We recognise that the pace of decarbonisation across the global economy is uncertain and that current climate policies in many countries are not yet aligned with stated ambitions. These policy uncertainties are captured in our scenario analysis, which in turn informs the central case carbon price assumptions. We continue to monitor alternative scenarios including ones that limit warming to 1.5°C. For example, the IEA NZE50 assumes higher carbon prices and a much faster energy transition than our scenarios; they also require a higher level of co-ordination in climate policies across sectors and countries. The IEA’s scenario also assumes stronger demand for commodities such as copper or battery minerals that are critical to the accelerated deployment of solar and wind renewables or electric vehicles.

Portfolio strategy

Our scenarios above inform our portfolio strategy, the internal commodity price setting process and strongly influence our critical accounting judgements and estimates. Through our strategy process we test the resilience of our portfolio against each of these three scenarios and conclude that overall, our portfolio is expected to perform more strongly in scenarios with proactive climate action, particularly in relation to aluminium and copper. Our strategy to focus our growth capital expenditure on materials that enable the energy transition is informed by these scenarios. Our ambition is to increase our growth capital expenditure to up to US$3 billion per year in 2023 and 2024, developing new options and finding innovative ways of bringing projects on-stream faster. This includes investment in lithium production at Rincon and Jadar, copper at Oyu Tolgoi and Winu, as well as high-grade iron ore from Simandou.

Accounting judgements

The forecast commodity prices (including carbon prices) are informed by a blend of our three scenarios and are used pervasively in our financial processes from budgeting, forecasting, capital allocation and project evaluation to the determination of ore reserves. In turn, these prices are used to derive critical accounting estimates including as inputs to impairment testing, estimation of remaining economic life for units of production depreciation and discounting closure and rehabilitation provisions. As only one of our scenarios represents the Group’s view of the goals of the Paris Agreement, and because of the policy uncertainties described above, our commodity price assumptions are not consistent with the expectation of climate policies required to accelerate the global transition to meet these goals. In addition to prices, given the significant investment we are making to abate our carbon emissions, we have also considered the potential for asset obsolescence, with a particular focus on our Pilbara operations where we are prioritising investment in renewables to switch away from natural gas power generation, but no material changes to accounting estimates have been necessary. The closure date and cost of closure is also sensitive to climate assumptions but no material changes have been made in the year specific to climate change.

The Group has identified impairment triggers during the year for cash-generating units in the aluminium and copper segments. The Group considers the long-term pricing outlook for aluminium and copper is positive as these metals are critical to the global transition to a low-carbon future. The outlook for iron ore pricing is less certain and depends on the development of low-emissions steel technology. However, considering the high return on capital generated by our existing iron ore asset base, none of our three scenarios would give rise to an impairment today. When measuring the recoverable amount for these cash-generating units, a blend of the three strategic scenarios has been used to forecast the cash flows. As only one of the strategic scenarios represents the Group’s view of the goals of the Paris Agreement, the impairment outcome cannot be described as Paris-aligned. However, in these circumstances, we have also disclosed sensitivity information based on cash flows flexed for sales prices and carbon taxes in the society-led scenario, which has a well below 2°C outcome. These sensitivities indicate that higher recoverable amounts would have been determined if the accounting was aligned with the society-led scenario.

Using a carbon price to accelerate our mitigation action

We are committed to align our future capital expenditure with our 2025 and 2030 Scope 1 and 2 emissions reduction targets. As noted above, we conclude that our targets are aligned with efforts to limit warming to 1.5°C and the stretch goal of the Paris Agreement. To deliver our climate targets, the Group expects to make incremental capital investment of US$7.5 billion over the period to 2030 (approximately US$1.5 billion over the period 2022 to 2024). We also expect our incremental operating expenditure to support the Climate Action Plan to be in the order of US$200 million per year, including research and development initiatives.

For internal approval purposes, a notional carbon price of US$75/t CO2e is now used to drive improvements in energy efficiency across our assets, help to identify new abatement projects as well as incentivise and accelerate the delivery of capital investment in abatement projects and operational improvements. The US$75/t CO2e price is derived from our analysis of carbon mitigation options across our assets (summarised in our Marginal Abatement Cost Curve) – it is unrelated to the prices in our scenarios.