Five growing risks that put pressure on energy companies
Energy companies face higher risks, while many insurers have ample capacity and a hunger for new business. Yet many oil and gas explorers and producers still find it hard to get essential cover for key areas of their operations, notes a newly-issued report.
The paper, entitled ‘Taking cover: How an insurance shortfall leaves the energy sector exposed’, is written by Nick Dussuyer, global head of natural resources industry, at insurance broking and risk advisory group Willis Towers Watson. He examines the risk challenges faced by energy companies, and suggests solutions to help deliver the protection needed.
Dussuyer notes that energy companies face increased and increasingly complex risks, including the crash in oil prices that has disrupted business models, the move toward drilling in more remote and environmentally sensitive areas, and attacks from cyber criminals. With budgets under pressure following the collapse in oil prices, companies are also likely to be addressing the risk management challenge with fewer resources.
He questions how should they respond and whether insurers are doing enough to assist them? As a major broking group, Willis’s experience suggests that in some key areas where energy companies are exposed, the insurance products offered fail to provide the protection needed. Five features of the energy industry’s current situation will dominate its approach to managing risk.
Business models must adapt to changing conditions – largely due to the collapse in oil prices. Companies are reducing costs where possible by reviewing strategies, slashing capital expenditure, and mothballing stranded assets to protect future earnings. Mergers and acquisitions are taking place to develop synergies and cost savings. Transferring risk in this environment must be as efficient as possible, particularly with risk management budgets also under pressure.
The industry increasingly operates in a globalised environment. The past decade has seen companies expand from their regional comfort zones into unfamiliar areas of the world with unfamiliar regulatory regimes. This requires companies to understand an ever-growing list of responsibilities under contract and carries heightened supply chain risk. The Japanese earthquake of 2011, for example, showed the damage that disruption to the supply chain can inflict. Added to physical loss or damage at the supplier’s site, other causes of disruption include supplier insolvency, power outages, political unrest, IT failures, labour disputes, transportation problems and pandemics. All pose risk in a world where companies are searching the globe for lower-cost supplies and operate “just-in-time” procurement strategies to keep inventory costs low and stocks at minimum levels.
The need to manage human capital. The oil price collapse has caused thousands of redundancies, but if a company loses its most experienced workers – often among the first to go because they are closer to retirement or the most expensive – it can also lose the skills and knowledge needed to sustain business and then build it when the economic cycle turns. Retention of talent as profits fall, or at least measures to ensure that accumulated knowledge passes to younger employees, is thus a priority. With the legal and regulatory duty of care bar rising in recent years, companies must also ensure that employees operate in as safe an environment as possible. Political unrest, the remoteness of locations, infectious diseases, and workplace accidents are among the risks they need to counter. The fatalities when terrorists occupied the Armenas gas facility in Algeria in 2013 evidenced how hard this can be.
Climate change and care of the environment – particularly when energy companies are venturing into environmentally sensitive areas such as the Arctic in search of resources. Failure to comply with legal and regulatory environmental requirements for clean energy and lower hydrocarbon emissions can hit a company’s balance sheet, share price, and reputation hard, as witnessed by car manufacturer Volkswagen’s emissions scandal. Its UK car sales in the UK alone have fallen by 20% since the exposure. The consequences of an environmental catastrophe are seemingly limitless. To date, the cost to BP of the Deepwater Horizon blowout and explosion stands at over US$50bn, enough to ruin oil companies not in the super-major league.
Impact of new technology. Access to big data from the internet along with advanced analytics helps companies make better decisions. The Internet of Things, which embeds electronics, software, sensors, and network connectivity within various machines and infrastructure, can improve operational efficiency while lowering costs. But the internet also brings risks, such as a major incident caused by a cyberattack. Globally, it is estimated that cyberattacks against oil and gas infrastructure will cost companies US$1.9bn by 2018. With industrial control systems used by the energy industry now routinely connected to the internet, it is possible to visualise an attack causing an energy disaster on the scale of Piper Alpha or Deepwater Horizon. Further risks arise from the development of new technology within the industry. Fracking for shale oil and gas, for example, raises the environmental legal liability risk as the process requires a continual supply of water to be injected into wells. The more sophisticated the technology in the control rooms that operate the drilling, the greater the potential for technology failure.
For energy companies to realistically be able to transfer risk in these areas, three imperatives will need to be addressed:
Make better use of data: Big data and powerful analytics can help insurers better understand and assess an energy company’s risks. Algorithms now exist that help insurers assess the likelihood and severity of an oil spill more accurately, as well as the clean-up costs. Better use of big data should facilitate the wider, fuller provision of cover against cyberattack and supply chain disruptions.
Collaborate more: Energy companies spend considerable resources assessing their vulnerability to cyberattack, but are reluctant to share their knowledge, admit to vulnerability or even that they have been subject to an attack. Few willingly share their risk mitigation plans for fear of helping would-be attackers, yet greater sharing of information with their insurers could help them get the cover they need. The same goes for drilling risk.
Innovate to compete: Ironically the current market dynamics mean insurers are reluctant to offer much-needed cover in energy companies’ key areas of risk, but their premium base is under attack, prices are falling and they are hungry for more business. This competitive dynamic will be the most important catalyst for change, prompting insurers to develop innovative, keenly-priced products that make better use of data and collaboration.
Insurers are awash with capital thanks to a relatively benign claims environment since 2011 and higher capitalisation requirements. Also, with interest rates and risk-free returns so low in alternative assets, there is growing investor interest in the insurance sector. Capacity for upstream energy insurance has almost doubled in five years, from just under US$4bn in 2010 to more than US$7bn in 2015.
Oversupply is starting to affect both the reinsurance and primary markets, but it is clear that competing on price alone will not provide a long-term solution to the market’s predicament. Rather, insurers need to build stronger, more highly valued relationships with their clients.
In some instances – such as windstorm cover – that might mean lowering premiums where they cannot be justified for what has become a captive audience. But often it will mean finding innovative ways to ensure energy companies get essential cover, adding value to their clients’ operations and generating premium income for themselves as a result. Looked at another way, insurers’ failure to provide cover in today’s super-competitive market exposes not only energy companies’ business to risk, but their own business too.