management report, climate change TCFD disclosures

Tesco PLC – Annual report – 27 February 2021

Industry: retail

Task Force on Climate-related Financial Disclosures

TCFD.

Task Force on Climate-related Financial Disclosures

We recognise climate change as the biggest environmental threat the world faces, posing particular risks to our business and supply chains. We impact the climate in our own operations and supply chain. We continue to develop our work on climate change and include information on this in several sections of this year’s reporting. In addition to this TCFD report, we provide additional information in principal risks and uncertainties and our Little Helps Plan report. We also consider the potential financial impacts from climate change in the viability statement on page 38 and the impairment note on page 147, based on our initial phase of scenario modelling which is described below.

Strategy

In June 2017, Tesco publicly committed to implementing the TCFD recommendations. In 2018, we conducted a materiality assessment in consultation with relevant climate experts across the business.

Our assessment prioritised the key business categories (based on contribution to Group sales) with the greatest potential climate-risk exposure, (based on consideration of factors including the complexity and locations of supply chains for different products). Across the financial years 2018/19 and 2019/20, we carried out initial scenario analysis for the produce and animal protein categories as well as our UK property estate, which represents the vast majority of our Group space. In the current year, we included the grocery and prepared foods categories as well as soy, a key commodity in animal feed.

Risks assessed included impacts of severe weather events, chronic weather changes and climate transition (e.g. policy changes, reputational risks, market shifts, etc.). To date, our scenario analysis has focused on the trading impacts of climate change in our largest market, the UK, and we used the results to prioritise our areas of focus. This initial phase of scenario modelling does not quantify the mitigating actions which we would look to implement to address and minimise the adverse impacts from climate change. The modelling is intended to provide illustrative examples of the areas of the business which could be most exposed to the effects of climate change.

Looking ahead, we plan to expand our initial analysis beyond trading impacts to cover further potential risks and opportunities, e.g. those relating to capital investment, technology and people as well as additional product categories.

Our current climate risk assessment methodology assesses the risks and opportunities we may face in 2030 as a meaningful medium-term timeframe for risks and opportunities to emerge, and to reflect our typical business planning cycles. We will look to expand this to include both shorter and longer timescales.

We assessed risks and opportunities in 2030 under a 4-degree scenario and a 2-degree scenario. Our scenarios were developed in 2018, based on those developed by the Intergovernmental Panel on Climate Change (IPCC).

The 4-degree scenario focuses on systemic failure to address climate change. It assumes limited policy or regulatory support for decarbonisation and focuses on several significant physical climate risks: chronic climate change, leading to reduced agricultural productivity in some regions, raising prices of raw materials or reducing supply volumes; and increased frequency and severity of extreme weather events, disrupting our supply chain or causing damage to our assets.

The 2-degree scenario focuses on a world which rises to the challenge of tackling climate change and limits global warming to below 2°C. This scenario focuses on transition risks associated with the rapid changes needed by 2030 to cut emissions in line with the Paris Agreement, including: carbon pricing and low-carbon land management practices, increasing manufacturing and raw-material costs; and changes in consumer behaviour and consumption patterns, leading to potentially significant changes in demand for certain product categories.

Tesco’s business strategy provides a degree of resilience to some of these risks, particularly the physical risks. For example, our diversified supply chain approach helps to provide some resilience to the impacts of climate change on particular areas; and our large physical store footprint, national reach and multi-channel business provide some resilience to potential local flooding hotspots.

Scenario analysis results and mitigations

The table opposite describes the potential modelled impacts from the animal protein and UK property business areas, based on our initial phase of scenario modelling. This analysis is provided as an illustrative example of the potential effect of climate change on our business. The financial impacts are highly sensitive to the assumptions used for modelling, and are quantified in the table below as the potential annual profit impact we could face as a business each year by 2030, before we take any mitigating actions. The impacts described are those arising from potential regulatory changes (e.g. a carbon tax on livestock emissions and carbon pricing policies). Given that the initial analysis showed the other impacts to be less material to Tesco, and noting the potential for significant variation depending on the assumptions used, we have not separately quantified the smaller impacts.

Our scenario modelling is underpinned by several key assumptions, principally that the assessed risks are based on a scenario before we take actions to mitigate the modelled impacts. The modelled risks under the 2-degree and 4-degree scenarios are mutually exclusive; we have not assessed a situation where physical and transition risks occur in parallel. The first iteration of our scenario modelling assumes the business remains static, including our operating model, current sourcing practices and sourcing volumes. Finally, we assume that the potential costs from climate-related risks are fully absorbed by the business, with no pass-through to our customers.

Animal protein

Our animal protein assessment focused on beef, chicken, lamb, pork and milk in key sourcing countries; the UK, Ireland and New Zealand. Our assessment (under the 2-degree scenario) included analysis of how regulation and fiscal measures (including taxation) may be employed in future to promote a low carbon transition in livestock production.

Beef accounted for the largest financial impact identified due to its high carbon footprint per unit of production. Milk and chicken also had significant impacts due to the large volumes sourced. The UK and Ireland were particular risk hotspots due to the high volume of beef and milk sourced there.

Transitioning to a low-carbon economy will probably require changes in consumer diets. Meat and dairy production uses 70% of agricultural land and emits 14.5% of greenhouse gases globally. Growing public concern for the environment is expected to drive a shift in demand from animal-based to plant-based proteins. Research conducted in 2020 found that 70% of Tesco customers are actively trying to reduce their intake of meat, while 80% want supermarkets to do more to help, including offering healthier and more sustainable options.

We are adapting our product portfolio accordingly. In September 2020, we became the first UK retailer to set a sales target for plant-based meat alternatives, committing to a 300% increase in sales by 2025. In parallel, we are shaping our sustainable diets strategy to reflect the role of plant-based protein alongside ‘less and better’ meat, including early-stage trials on alternative sources of feed. This falls under our ambition of delivering healthy, sustainable and affordable food for all.

Property

Our property assessment focused on our UK estate. Results identified changing regulation and fiscal measures and extreme weather events as having potential impacts on our business.

Under the 2-degree scenario, robust carbon taxes could lead to higher compliance costs. To mitigate this risk, Tesco continues to invest in renewable energy, energy efficiency and new technologies to monitor energy use. We already use 100% renewable electricity across the Group. We continue to increase sourcing via power purchase agreements (PPAs), including a new partnership with Low Carbon, which generates new renewable electricity and helps to green the National Grid. We are replacing retired assets, including fridges, with more efficient models, installing doors and aerofoil in all stores, and exploring heat-retention systems for recycling refrigerant energy.

Extreme weather can impact stores by disrupting operations by damaging assets or increasing running costs, and through loss of sales due to closure or transport disruption. While the results showed elevated flood risk to stores by 2030, the financial impacts were not considered significant.

Produce

Our produce assessment focused on 20 types of fruits and vegetables sourced from six countries. Results indicate physical climate risks in our produce supply chain, and some potential opportunities for further investigation. Long-term changes in temperature and rainfall patterns will adversely impact production by 2030. The most impacted countries assessed will be South Africa, Egypt, Spain and Peru. Higher UK temperatures and rainfall by 2030 could support a longer growing season, potentially increasing yield for certain crops if other growing conditions are also favourable. However, there would need to be significantly higher demand for this to translate into increased revenue.

Changing agricultural farming practices and land use were identified as key risks under the 2-degree scenario, potentially impacting production costs by 2030.

While the potential direct financial impact on our produce supply chain may not be major, impact on product quality and availability could be, and mitigating these risks requires cross-industry and public policy action. As part of our sustainable agriculture strategy, we are strengthening supplier requirements across areas including biodiversity, soil health, emissions reduction and water management.

Soy

The main use of soy is as animal feed (75% of global production) due to its nutritional benefits. As the world population increases, so too will the global demand for meat and other animal proteins. The associated increasing demand for animal feed is driving an expansion of soy cultivation, leading to the loss of native vegetation in South America’s Amazon and Cerrado regions.

Tesco primarily sources soy feed from South America. The assessment findings identified that local political uncertainties may give rise to continuous deforestation and infringement of indigenous rights in the region. Alternative sources of soy have less protein content, potentially impacting livestock production, poultry in particular. More soy may therefore be required to meet production volumes.

Tesco is committed to zero-net deforestation in our sourcing of soy. Our UK soy strategy goes beyond certification to a commitment to source from verified zero-deforestation areas by 2025. We are also supporting the development of alternative animal feed proteins, such as insects.

Beyond our supply chain, we work collectively at an industry level and with other stakeholders (such as NGOs and governments), recognising that developing a sustainable soy market requires effective collaboration. Tesco is actively engaged in all relevant industry initiatives, including the Consumer Goods Forum (CGF), Forest Positive Coalition of Action, Soy Transparency Coalition and the UK Roundtable on Sustainable Soya. We are also co-chair of the SoS for the Cerrado Manifesto.

Grocery and prepared foods

We selected 15 key ingredients of our biggest-selling grocery or prepared foods products for our grocery and prepared foods category assessments. Results identified extreme weather events and changing regulation and fiscal measures as the drivers of potential impacts, all of which were financially relatively small.

Changing temperatures and precipitation in certain countries can improve or damage growing conditions for raw ingredients, having a knock-on effect on their availability. However, we found the associated financial impacts not to be significant, given the diversity of sourcing origins for most ingredients.

Our sustainable agriculture strategy not only helps to build supply chain resilience and embed sustainable production practices within changing landscapes, it also helps secure the sustainable supply of ingredients for the future.

Risk management

The identification and management of climate change risks follow our established risk-management process, of which the key elements are set out on page 31. During the year, we assessed and evaluated risks relating to climate change as part of the review cycle, and they were discussed by the Executive and Audit Committee. As shown on page 32 this assessment concluded climate change was a standalone principal risk (previously managed within the responsible sourcing and supply chain risk and the brand, reputation and trust risk). As a principal risk, climate change has been assigned an Executive Risk Owner, the Chief Product Officer. It will be monitored by the Executive and Audit Committee to ensure it is embedded in strategic decision-making. The Executive Committee will also oversee its effective management and mitigation through our policies, processes, practices and performance, a summary of which is set out on page 34.

You can also find consideration of the key financial risks associated with climate risk in our viability scenario analysis on page 38 and on our annual impairment testing process on page 147.

Governance

The Corporate Responsibility (CR) Committee is our Board-level body responsible for overseeing the Group’s social and environmental obligations as outlined within the Little Helps Plan (LHP), our sustainability framework, including those relating to climate change. The Committee currently meets three times each year and receives regular updates on our LHP commitments and performance. This year, the CR Committee received an update on TCFD, broader business updates on the LHP, and standing updates on emerging external trends and developments. From 2021/22 onwards, the CR Committee will consider climate-related risks as a standing agenda item and will be attended by colleagues from our product function, recognising the area’s strategic importance.

As discussed above, the Chief Product Officer will be the Executive Risk Officer for climate change. He will lead the policy development of the climate change agenda and bring additional executive oversight to this important strategic issue. Updates will be tabled for discussion at the Executive and Audit Committees in line with our risk review cycle.

The Chief Financial Officer will maintain oversight of our climate-related financial activities and reporting, sponsoring the TCFD working group that includes colleagues across our climate, risk management and finance teams to maintain day-to-day oversight of these areas.

Metrics and targets

In May 2017, Tesco announced science-based climate targets for our own operations and supply chain. Our operational targets are aligned with the Paris Agreement’s aspiration to limit global warming to 1.5°C. We surpassed our 2020 Group target to reduce absolute emissions from our operations by 35% vs 2015/16 levels, achieving -37% in FY 2019/20, or -50% rebaselined for continuing operations. We are on target to meet our further reduction targets of 60% by 2025 and 100% by 2050 (2035 for our UK operations). We have met our 2030 target of sourcing 100% of our Group electricity from renewable sources 10 years early.

Our science-based climate change targets for our supply chain include explicit targets for manufacturing and agricultural suppliers – recognising the different approaches required to reduce emissions in both areas. We are currently reviewing opportunities to expand our work on scope 3.

Our carbon reporting follows the Greenhouse Gas Protocol and is third-party verified by KPMG. Our climate change metrics and other environmental targets are disclosed in our full LHP report available on our website.

In December 2020, we completed an updated carbon footprint analysis across our UK business using the latest available emissions factors and requirements. This data enables us to determine more granular emissions profiles across our product categories to inform our strategy and risk-management process. We are currently undertaking a review of our science-based targets to further strengthen our decarbonisation roadmap and the metrics we use to assess climate-related risks and opportunities. We are also considering any further metrics to help monitor our progress in managing climate-related risks and opportunities.

Next steps

As described above, our priorities for the year ahead include expanding our scenario analysis to impacts beyond trading and to shorter and longer timescales, and further embedding our considerations of climate-related risks and opportunities into our business activities, including measuring our progress.