The London Market Group recently published its Beyond Insurance report with Boston Consulting Group. Looking at 40 clients from four major industries - IT, financial services, consumer and retail, and energy, its aim was to understand the trends disrupting the patterns of risk today.
One external risk dominated all others, however. Climate change overshadows and is connected to all the trends discussed in our report. It was highlighted in the client interviews as a top concern across all industries.
Changing weather patterns
Most large multinational clients highlighted concerns about the impact of natural catastrophes and extreme weather on their operations, increasingly having to review their exposures and mitigation plans (eg broken supply chains, employees not able to work, critical damage to facilities).
The CRO of a consumer goods company in the USA told us that, “Climate change is exposing a lot of our locations to weather and natcat risks that are very difficult to manage if you want to continue operating in the region.”
Clients with both multinational and local operations were particularly concerned about communications and technological disruption that natural catastrophes and extreme weather might cause in their strategic risk scenario planning.
Meanwhile clients in the energy sector expressed concerns about climate change, as more severe weather conditions add additional stress to aging offshore structures, many of which are already approaching their late-life stage.
The CFO of a trading company in Asia said, “The volatility of weather patterns is a key risk for us, which is becoming increasingly difficult to predict. If you’re trying to plan for a long-term investment project, this level of uncertainty is almost prohibitive.”
For renewable energy projects, weather volatility is a key risk when it comes to project finance. A private equity fund focusing on renewable energy projects in Asia highlighted that renewable projects need energy production forecast certainty to get sign off. This is becoming increasingly difficult, as weather patterns are no longer fully predictable over a 20-year investment horizon.
Decommissioning fossil fuel assets
As the world shifts to renewable sources of energy and oil and gas platforms reach the end of their natural lifespans, a large pool of legacy assets needs to be decommissioned.
In the North Sea alone there are $45bn-$50bn of assets up for decommissioning, including approximately 170 oil installations, 10,000km of pipeline and 5,000 wells that must be dismantled where possible and secured to minimise the risk of future pollution. Similar challenges are faced in the Gulf of Mexico, Indonesia and Australia.
In addition, fossil fuel assets nearing the end of their lifespan are often sold to new operators, which adds complexity around the ownership of liabilities once the site is decommissioned. Risk management falls into two broad categories:
Downside protection – smaller or mid-sized companies specialised in late-life operations often lack the diversification and balance sheet strength to absorb significant project overruns;
Clean exit from decommissioning – regulators are increasingly aware of the long-term liabilities that decommissioned oil and gas assets represent and are concerned that the liabilities are adequately backed.
The abandonment and decommissioning of fossil fuel assets are the most critical challenges facing the oil and gas industry today.
Future decommissioning activity exposes energy companies (or specialised decommissioning operators) to long-tail liabilities (eg, environmental liabilities, contingency reserving) and mid-term operational challenges (eg, monitoring of sites), creating a need for expert environmental risk management.
Understanding and reducing carbon footprints
Clients interviewed across sectors and geographies highlighted their CO2 emissions as an increasing risk for their businesses. A key challenge that was mentioned in this context was the precise quantification of direct and indirect CO2 emissions and energy consumption.
Motivated to reduce carbon emissions, interviewees pointed out difficulties in quantifying climate change impacts associated with purchased goods and vehicles, product use, waste disposal, transportation, supply chain, distribution, and employee business travel.
About half of the interviewees mentioned they would welcome ESG consultants to aid their understanding of their own footprint and advise on their efforts to reduce carbon emissions as part of their standard risk prevention services.
As one interviewee put it “While I don’t think it’s possible yet, I can foresee a future where you will be able to get sued for your specific carbon footprint and its direct impact on climate change.”
More than half of global investors are currently implementing or evaluating ESG considerations in their investment strategy, risking a scale-back of investments and reduction of shareholder value if the business is not deemed to meet the minimum criteria.
As many clients pointed out, however, these criteria are fast evolving as the bar for public and regulatory scrutiny keeps rising.
The risk of being called out as no longer being an attractive investment is driving many companies to rethink their ESG strategy. Companies are increasingly concerned about public pressures to publish action plans addressing their emission targets.
However, insufficient in-house expertise to deliver on these issues is slowing down this process, limiting their ability to conform to evolving regulations.
Ultimately, measuring carbon emissions from different sources and estimating energy consumption is a complex and expensive process. Small and medium sized companies are likely to require external expert help to develop and deploy models to measure the full extent of their carbon footprint across the value chain.
Accelerating the green energy transition
Clients interviewed highlighted that the challenges to accomplishing green energy transition goals include the scale of investment, construction speed, extent of land use, and the availability of raw materials.
In addition, most clients in the energy and utilities sector stated that inherent volatilities related to renewable energy sources created pricing and budgeting challenges. The vice president of valuation and risk management at a European utility company commented, “The biggest challenge is the volatility of green energy production – and how to make it cost efficient”.
The large number of renewable energy projects to be built over the next decade will require significant protection capacity to cover construction risks. With inherently weather-dependent production patterns, managing the spikes and troughs of supply and demand of renewable energy at peak times is extremely difficult to plan and reserve for. New hedging mechanisms could provide a way to help manage this volatility.
Only a few years ago the insurance industry was increasingly being asked to justify its relevance. This report clearly shows that we are now positioned to provide essential solutions to serve our customers for the risks they face.
The changes we are seeing in the world represent opportunities for businesses to thrive and grow. They also represent a renewed opportunity for the London market to expand its role in protecting its clients and enabling their growth.
If there are solutions to be found to these challenges relating to risk, they are most likely to be found in London. This is the only place that brings together the breadth of expertise, flexibility of thinking and weight of capital to address the universe of risks that decision makers are facing.
London has always been about innovation and bringing this research to the market is part of that dynamic.
