Physical climate risk work has moved from coloured maps to auditable numbers. Screening a portfolio in broad regional bands no longer satisfies IFRS S2, ESRS E1 or California’s SB 261 — nor a lender, an insurer or an acquirer doing diligence. What replaced it is an asset-level method: hyper-local hazard data at the facility’s coordinates, vulnerability assessed against the specific processes inside the fence, and the results carried into valuation as expected losses rather than as narrative. This guide sets out that method for manufacturing portfolios — the hazard taxonomy, the expected-annual-loss architecture, the business-interruption arithmetic, and the tier-N supply-chain mapping where most of the real exposure hides. (Two companions: physical risk for data centers, and the insurance-to-write-down pathway in our stranded-assets guide.)
The frame: scenarios and horizons
Run the assessment on CMIP6 projections under three Shared Socioeconomic Pathways — SSP1-2.6, SSP2-4.5 and SSP5-8.5 — because each planning decision lives on a different clock:
| Horizon | Window | Decisions it informs |
|---|---|---|
| Near term | 2026–2030 | Operating budgets, insurance placement, immediate supply-chain resilience |
| Medium term | 2031–2040 | Mid-life plant upgrades, CapEx sequencing, supplier consolidation |
| Long term | 2041–2060 | Useful-life and depreciation policy, greenfield siting, terminal value |
Hazard data must resolve to the asset — grid scales around 0.05° (≈5 km) are the working standard — because micro-geography decides outcomes: two plants in the same river basin can sit metres apart in elevation and categories apart in risk.
The hazard taxonomy
Acute hazards arrive as events; chronic stresses arrive as drift. Both belong in the same register.
Acute. Pluvial and fluvial flooding — evaluated at 100- and 500-year return periods against depth thresholds that map to damage mechanisms (as working heuristics, ~0.5 m reaches electrical infrastructure; ~1.5 m begins displacing heavy equipment). Tropical cyclones and storm surge — Category 4/5 wind fields plus surge height against roof, cladding and outdoor-storage tolerances. Wildfire and smoke — WUI proximity for direct exposure, and particulate episodes for the indirect one: extreme smoke events force filtration and cleanroom responses well beyond the fire perimeter.
Chronic. Wet-bulb heat — the combined heat-humidity measure that governs both human labour and evaporative cooling. Labour productivity falls steeply as wet-bulb temperatures climb through the low 30s °C; occupational work/rest regimes are specified in WBGT standards rather than wet-bulb directly, and 35°C wet-bulb stands as the physiological survivability limit for sustained exposure. Baseline water stress — the WRI Aqueduct ratio of withdrawals to renewable supply: High above 40%, Extremely High above 80%, with allocation caps and tariff escalation following the classification. Thermal efficiency degradation — the quiet tax: gas turbines lose roughly 0.5–0.7% of output per °C above their 15°C ISO rating, and chillers, cooling towers and steam systems derate on the same physics.
| Hazard | Working metric | Assets most exposed | Mechanism |
|---|---|---|---|
| Pluvial/fluvial flood | Peak depth at 100-yr return | Fabs, automotive assembly | Sub-fab equipment inundation; cleanroom loss; short circuits |
| Wet-bulb heat | Consecutive days in low-30s °C Tw | Heavy industry, textiles, outdoor refining | Labour capacity loss; cooling-tower derating; electronics trips |
| Water stress | Aqueduct BWS (>80% = extreme) | Pharma, wafer processing, beverages | Intake rationing; recycling CapEx; output constraints |
| Storm surge | Surge height above MSL | Coastal chemicals, port terminals | Corrosion; tank displacement; logistics shutdown |
| Thermal shift | Days above 40°C dry-bulb | Precision machinery, plastics | Cooling energy surge; material warping; grid trips |
From hazard to value: expected annual loss
The valuation bridge is the catastrophe-modelling identity: Expected Annual Loss = Σ over hazards of ∫ probability(h) × vulnerability(h) × exposed value. Probability comes from the hazard curves; vulnerability is the damage function for this asset type at that intensity (a cleanroom’s curve looks nothing like a warehouse’s); exposed value is replacement cost plus the gross margin the asset carries. EAL then enters the DCF where it belongs — as a deduction inside free cash flow, alongside the adaptation CapEx the risk justifies — and into terminal assumptions through shortened useful lives.
One discipline separates credible practice from decoration: do not charge for the same risk twice. A common practitioner shortcut adds a blanket “climate premium” to WACC on top of EAL-adjusted cash flows. If expected losses already sit in the cash flows, a general discount-rate premium double-counts them; a premium is defensible only for the residual that cannot be modelled — and it should be argued as such, in the open, rather than applied as a band. Auditors probe this seam, and they are right to.
Impairment follows the same evidence. Under IAS 36 and ASC 360, physical hazards are impairment indicators: chronic stress shortens useful lives (accelerating depreciation), recurring events can strand a facility outright where retrofit cost exceeds remaining discounted cash flows, and the recoverable-amount test prices what is left. The mechanics are in the companion guide; the manufacturing-specific point is that the inputs — EAL curves, derating schedules, water rationing scenarios — are engineering artefacts, and the audit file should contain them, not summaries of them.
Business interruption: the larger number
Structural damage is usually the smaller loss; downtime is the larger. Working form: BI exposure = (downtime days × daily fixed costs) + (lost units × unit margin) + surge costs. Surge costs are where inexperienced models fail: spot electricity during scarcity events can multiply several-fold (ERCOT-style pricing makes the arithmetic vivid), emergency water arrives by tanker at punitive rates, and air-freight premiums replace every weather-broken shipping leg at once. A facility can be physically untouched by a regional event and still post its worst quarter of the decade through this line alone.
Insurance layering for what remains
As carriers reprice or exit (the retraction mechanics are detailed in the stranded-assets guide), industrial portfolios increasingly carry risk in three layers. Parametric cover takes the fast-liquidity slice — payouts on objective triggers, typically within weeks, no adjustment process. Traditional property/BI programmes carry the insurable core, at repriced terms. The residual — risks no market will write — goes to an enterprise self-insurance reserve, sized off tail loss (a common formulation: the high-percentile expected tail loss minus maximum commercial payouts). That reserve is real capital standing idle against weather, which is why it belongs in the valuation conversation and not only the insurance one: it is a cash drag with a climate cause, and Phase-gated adaptation spending is how it shrinks.
Tier-N: where the cascade starts
Owned-asset analysis is the smaller half of manufacturing exposure. The 2011 Chao Phraya floods remain the canonical lesson: Thai industrial estates inundated, the global hard-drive industry — concentrated there — short for quarters, and OEMs on other continents stopped by a component they did not know was geographic. Map the tiers with the same hazard screen as owned assets:
| Node | Hazard | Bottleneck | Mitigation |
|---|---|---|---|
| Wafer fabrication (tier 2/3) | Water stress, heat | Continuous ultra-pure water demand — millions of gallons a day for a large fab; intake cuts force throttling fast | Closed-loop recycling; dual-region supplier qualification |
| Specialty polymers (tier 1) | Gulf Coast hurricanes | Single-source precursor and resin capacity — the 2021 Texas freeze idled resin production for months | Safety stock (~60 days on critical grades); alternate synthesis agreements |
| Barge freight | Low river water | Rhine/Mississippi draft limits — low water at critical gauges can halve barge loads or worse | Dynamic modal-shift contracts; secondary-hub inventory |
| Port terminals | Storm surge, wind | Cranes suspend operations well below hurricane-force winds; multi-day closures queue vessels for weeks | Port diversification; pre-negotiated off-dock storage |
The recurring structure: concentration that was purchased as efficiency reprices as fragility. Dual-sourcing, buffer stock and modal-shift contracts all cost money in ordinary years — the EAL framework is what lets a company show, in numbers a CFO accepts, what those costs buy.
Frequently asked questions
What is Expected Annual Loss, in one sentence?
The probability-weighted average of what physical hazards will cost an asset per year — hazard probability times asset vulnerability times exposed value, summed across hazards — used as a cash-flow deduction in valuation and as the sizing basis for insurance and reserves.
Should we add a climate premium to WACC as well?
Not on top of EAL-adjusted cash flows for the same risks — that double-counts. A discount-rate premium is defensible only for identified risks that cannot be modelled into cash flows, and the file should say which risks those are.
How is wet-bulb temperature different from the heat index we use for worker safety?
Worker-safety regimes are generally specified in WBGT (wet-bulb globe temperature), which adds solar load to the wet-bulb reading. Wet-bulb temperature itself governs evaporative cooling performance and marks the physiological limit — sustained exposure near 35°C wet-bulb is not survivable. The two metrics are related, not interchangeable, and conflating them produces wrong thresholds in both directions.
Our plants are fine — why map suppliers the same way?
Because the cascade does not respect your fence line. The 2011 Thailand floods stopped production on other continents through tier-2 and tier-3 concentration. Supplier nodes get the same hazard screen, the same scenario set, and mitigation priced through the same expected-loss logic.
Sources: CMIP6 / SSP scenario framework; WRI Aqueduct 4.0 baseline water stress; catastrophe-model EAL architecture (hazard × vulnerability × exposure) as standard practice in insurance and climate-valuation literature; IAS 36 / ASC 360 impairment frameworks; Sherwood & Huber on the 35°C wet-bulb physiological limit; case record: 2011 Thailand (Chao Phraya) floods and hard-drive supply shock, February 2021 Texas freeze petrochemical/resin outages, Rhine low-water episodes 2018/2022. Thresholds identified in the text as working heuristics are engineering rules of thumb, not standards; asset-level conclusions require asset-level engineering data.