AASB S2 Scenario Analysis: What Australian Companies Need to Demonstrate

Climate scenario analysis is becoming one of the most important, and often one of the most challenging, elements of Australia’s mandatory climate reporting regime.

Under AASB S2 Climate-related Disclosures, reporting entities are required to assess the resilience of their strategy and business model to climate-related changes, developments and uncertainties. Climate-related scenario analysis is the mechanism used to inform that assessment.

For many organisations, this represents a significant shift.

The task is not simply to produce a set of climate scenarios or describe what might happen under different temperature pathways. The more important question is whether the organisation can demonstrate how different climate futures could affect its business model, assets, value chain, strategy, financial performance and decision-making.

As Australia’s climate reporting regime expands, this distinction will become increasingly important.

Scenario analysis is not a forecast

Climate scenario analysis should not be treated as an attempt to predict exactly what the future will look like.

A scenario is a plausible future state used to test how an organisation might perform under different combinations of physical, economic, regulatory, technological and market conditions.

This matters because climate-related risks and opportunities contain substantial uncertainty. The timing, scale and interaction of physical climate impacts, government policy, technology adoption, energy markets, customer behaviour and capital markets cannot be forecast with precision.

Scenario analysis therefore asks a different question:

If this future occurred, what would it mean for our organisation?

A useful analysis helps management and the board understand where the organisation may be vulnerable, what assumptions its strategy depends on, what options it has to respond and where further action may be required.

AASB S2 reflects this principle by requiring entities to use an approach that is commensurate with their circumstances. The sophistication of the analysis should reflect the entity’s exposure to climate-related risks and opportunities, as well as the skills, capabilities and resources available to undertake the analysis.

This means scenario analysis does not need to begin with an elaborate financial model.

It does, however, need to be credible, explainable and proportionate to the organisation’s circumstances.

What does AASB S2 require?

AASB S2 requires an entity to disclose information that enables users of its general purpose financial reports to understand the resilience of its strategy and business model to climate-related change.

The entity must use climate-related scenario analysis to inform this assessment. The analysis should consider the climate-related risks and opportunities identified by the organisation and use reasonable and supportable information available without undue cost or effort.

Australian legislation also requires climate resilience to be assessed using at least two possible future states. ASIC identifies the two mandated scenarios as:

• a 1.5°C increase in global average temperature above pre-industrial levels; and
• a temperature increase well exceeding 2°C above pre-industrial levels.

These scenarios should not simply appear as labels in a sustainability report. Organisations need to demonstrate what the scenarios mean for their own operations and strategy.

1. Explain why the scenarios are relevant

A strong scenario analysis begins with scenario selection.

AASB S2 requires organisations to explain why the scenarios used are relevant to assessing their resilience. This includes considering whether the analysis covers a diverse range of climate-related scenarios and whether the scenarios address physical and transition risks.

For example, a resources company may need to consider transition variables such as carbon pricing, energy markets, regulation and technology alongside physical variables such as extreme heat, flooding, water availability or bushfire exposure.

A financial institution may place greater emphasis on how climate change affects customers, borrowers, investments and financed emissions.

A food or agricultural business may need much greater emphasis on water, heat, drought, agricultural productivity and supply-chain resilience.

The scenarios therefore need to reflect the organisation’s actual exposure.

Using a well-known scenario simply because it is widely used does not, by itself, demonstrate that the analysis is decision-useful.

2. Define meaningful time horizons

Climate risks operate across very different periods.

Some transition risks may emerge relatively quickly as regulation, customer expectations or technologies change. Physical climate impacts may become progressively more significant over decades, although extreme events can also affect businesses immediately.

AASB S2 requires organisations to explain their definitions of short, medium and long term and how those definitions connect with the planning horizons used for strategic decision-making.

This connection is important.

If an organisation’s capital planning horizon is ten years, but climate analysis only considers the next three years, the analysis may fail to capture risks relevant to current investment decisions.

Conversely, a long-term climate scenario that has no connection to asset lives, strategic planning or capital allocation may produce interesting information without influencing a business decision.

The strongest analyses align climate horizons with matters such as:

• strategic planning cycles;
• asset lives;
• capital expenditure;
• debt and financing horizons;
• major contracts;
• property and infrastructure exposure;
• supply arrangements; and
• transition plans.

3. Assess physical and transition risk

Scenario analysis should test exposure to both physical climate risk and transition risk.

Physical risks may include acute events such as floods, bushfires, cyclones and extreme heat, as well as chronic changes involving temperature, rainfall, water availability, sea-level rise or ecosystem conditions.

Transition risks may arise from changes in regulation, carbon pricing, technology, energy systems, customer preferences, financing conditions or market expectations.

Importantly, the risks should not be assessed as abstract ESG issues.

The analysis should identify where the organisation is actually exposed.

This may involve considering particular assets, facilities, geographic areas, products, customer groups, suppliers or parts of the value chain.

AASB S2 specifically requires disclosure of where climate-related risks and opportunities are concentrated within the business model and value chain.

That makes the quality of the underlying asset, operational and value-chain analysis important.

4. Connect the scenarios to the business model and strategy

This is where scenario analysis becomes strategically useful.

An organisation should be able to explain what the scenarios mean for the resilience of its existing strategy and business model.

Questions may include:

• Could particular assets become more expensive to operate?
• Could the useful life of an asset change?
• Could demand for a product increase or decline?
• Could extreme weather disrupt operations or supply?
• Could insurance availability or pricing change?
• Could customers require lower-carbon products?
• Could new technology alter the economics of the business?
• Could future regulation change operating costs?
• Could the organisation require additional capital expenditure?
• Are there climate-related opportunities the strategy is currently missing?

The analysis should then consider whether the organisation’s strategy needs to adapt.

AASB S2 requires disclosure of the implications of the climate resilience assessment for strategy and the business model, including how the organisation may need to respond to the effects identified through scenario analysis.

That makes scenario analysis much more than a disclosure exercise.

Done well, it becomes a form of strategic stress testing.

5. Establish a credible link to financial effects

One of the most significant developments in climate reporting is the expectation that climate risk should increasingly connect with financial information.

AASB S2 requires information about the current and anticipated effects of climate-related risks and opportunities on an entity’s financial position, financial performance and cash flows.

Scenario analysis can help establish the pathways through which those effects might arise.

For example:

Extreme heat
→ reduced equipment efficiency or worker productivity
→ additional operating expenditure
→ potential effect on margins or capital investment.

Flooding
→ disruption to a facility or logistics route
→ lost production or additional maintenance
→ potential effects on revenue, costs or asset values.

Higher carbon costs
→ increased input or operating costs
→ changes to product economics
→ potential effects on margins and competitiveness.

Customer transition
→ reduced demand for a higher-emissions product
→ changing sales volumes or pricing
→ potential effect on revenue and future investment.

Not every climate effect can or should immediately be reduced to a single dollar figure.

AASB S2 contains proportionality mechanisms where quantitative information may not be required in particular circumstances, including where effects are not separately identifiable or measurement uncertainty is so high that the resulting information would not be useful. Qualitative information may still be required, including identifying the financial statement line items that are likely to be affected.

The objective should therefore be decision-useful financial connectivity, rather than false precision.

6. Document the assumptions behind the analysis

A scenario analysis is only as useful as the assumptions underpinning it.

AASB S2 requires disclosure of information about the inputs and key assumptions used in scenario analysis. These can include assumptions about:

• climate policy;
• macroeconomic conditions;
• regional variables;
• energy usage and energy mix;
• technology;
• time horizons; and
• the operational scope included in the analysis.

Organisations should therefore maintain a clear evidence base explaining where assumptions came from, why particular datasets were selected and how judgements were made.

This is particularly important as climate reporting moves further into formal corporate reporting and assurance.

Australia’s 2026 National Climate Scenario Guidance provides an additional reference point for organisations considering physical climate scenarios, including the selection of emissions pathways, timeframes, climate hazards, models and datasets.

Good documentation also makes the analysis easier to update in future reporting periods rather than rebuilding the process from the beginning each year.

7. Demonstrate governance over the process

Scenario analysis should not sit solely with the sustainability team.

The process is likely to require contributions from functions such as:

• finance;
• risk;
• strategy;
• operations;
• asset management;
• procurement;
• legal;
• sustainability; and
• executive management.

The board and relevant board committees also need sufficient understanding of the approach, assumptions and conclusions to exercise appropriate oversight.

This is particularly important because Australia’s sustainability report ultimately sits within the corporate reporting framework and includes a directors’ declaration. During the transitional period for financial years commencing between 1 January 2025 and 31 December 2027, directors declare whether, in their opinion, the entity has taken reasonable steps to ensure the sustainability report complies with the Corporations Act and AASB S2.

For organisations preparing to report, governance over scenario analysis should therefore include clear ownership, review, challenge and documentation.

Scenario analysis does not necessarily need to be rebuilt every year

AASB S2 recognises that a detailed scenario analysis may align with an organisation’s strategic planning cycle.

For example, an organisation may undertake the underlying scenario analysis every three to five years where this aligns with its strategic planning cycle.

However, its assessment of climate resilience is still required at each reporting date, taking account of updated information and the implications of climate uncertainty for the business model and strategy. AASB S2 requires the underlying scenario analysis to be updated at least in line with the strategic planning cycle.

This makes it useful to build scenario analysis as a repeatable business process rather than as a one-off reporting project.

Common weaknesses to avoid

Several approaches can significantly reduce the usefulness of scenario analysis.

Treating the scenarios as the output.
Selecting 1.5°C and higher-temperature scenarios is only the beginning. The real work is analysing what they mean for the organisation.

Producing a generic list of climate risks.
Risks should be connected to specific operations, assets, geographies, value-chain exposures and strategic decisions.

Using scenarios without explaining why they were selected.
Scenario choice should have a clear rationale connected to the organisation’s circumstances.

Separating climate analysis from finance.
Scenario analysis should increasingly help explain how climate effects could flow into revenue, expenditure, assets, liabilities, cash flows and capital allocation.

Creating false precision.
A highly detailed financial model is not automatically better. Assumptions, uncertainty and ranges need to be transparent.

Treating the analysis as a sustainability-team exercise.
Scenario analysis is strongest when risk, strategy, finance and operational teams are involved.

Writing the disclosure before building the analysis.
The reporting narrative should reflect the underlying process, not substitute for it.

What should organisations be able to demonstrate?

At a practical level, an organisation preparing climate-related scenario analysis should be able to demonstrate:

1. which scenarios were used and why;
2. how the scenarios address both physical and transition risk;
3. the time horizons and operational scope assessed;
4. the key assumptions, variables and data sources used;
5. where material climate risks and opportunities arise across the business and value chain;
6. how those risks and opportunities could affect strategy and the business model;
7. how climate impacts may flow through to financial position, performance and cash flows;
8. how management assessed the organisation’s capacity to respond or adapt;
9. who reviewed and challenged the analysis; and
10. how the evidence and judgements have been documented for reporting and assurance readiness.

The objective is not to demonstrate certainty.

It is to demonstrate that climate uncertainty has been considered systematically, using an approach appropriate to the organisation, and that the resulting analysis is capable of informing real business decisions.

The implications for Group 2 and Group 3 organisations

Australia’s reporting regime is now moving rapidly beyond the first reporting cohort.

Group 2 reporting applies for financial years beginning on or after 1 July 2026, while Group 3 reporting begins for financial years beginning on or after 1 July 2027.

For organisations approaching their first reporting period, scenario analysis should not be left until the sustainability report is being drafted.

It can require time to define scenarios, obtain climate data, understand asset and value-chain exposure, involve operational teams, connect risks to financial pathways and establish appropriate governance.

Organisations that begin earlier also have an opportunity to use the analysis for more than compliance.

The same work can strengthen strategic planning, risk management, capital allocation and organisational resilience.

From disclosure to decision-making

AASB S2 has made climate scenario analysis an important part of Australia’s corporate reporting environment.

But its value should extend beyond the sustainability report.

The most useful scenario analysis helps an organisation understand where it is exposed, how significant that exposure could become, which assumptions matter most and what management could do about it.

That is ultimately the distinction between scenario analysis performed for compliance and scenario analysis used as a strategic management tool.

For Australian organisations, the question is increasingly not whether climate scenarios have been prepared.

It is whether the organisation can demonstrate what it learned from them and how that insight is influencing decisions.