Geopolitics Shapes the World to Come

Geopolitics Shapes the World to Come

Our multipolar world and its myriad of geopolitical forces presents us and our clients with a vast, multidimensional array of risks. As bleak as this may sound, geopolitics and its impact on energy also offers a number of opportunities.

Poverty, unemployment and social strife

Energy price increases readily translate into increases in consumer and producer price inflation. This prompts households to cut down on spending, businesses to shut down as they cannot sell their products and services at sustainable prices, and rising unemployment levels perpetuate the vicious circle of recession and inflation. 

What may be seen as healthy belt tightening in affluent countries of the Western world, can in lesser developed countries reduce access to food supplies, electricity or running water.  Eroding living conditions could lead to large-scale social unrest and profound changes on the political scene, challenging international relations and shaking the world order even more then currently experienced.  Energy supply has been used by countries such as Russia as a vector for power projection for many years now and is currently used as a weapon of war not only against any single country, but to challenge the global status-quo.

Climate change

Assuring the security of energy supply requires rearranging existing energy production and delivery infrastructure around the world to reflect the new geopolitical reality.  Whilst in the long run it may bring about much coveted decarbonization and decrease in greenhouse gas emissions, in the short and medium term this would require increased levels of production and shipping of raw materials, energy carriers, parts and equipment virtually around the globe to build the requisite infrastructure.  This, in turn, means increasing the carbon footprint and global pollution, degrading the environment and accelerating the climate change processes.

Business risks

An increased volatility of energy prices (and resulting volatility of virtually all price indices that are impacted by energy prices) means increased levels of business risks for all entities undertaking any kind of business activity.  From oil traders through manufacturers to crop farmers, everyone can suffer or benefit from this as the maxima for both upside and downside will increase. 

This development will increase the demand for risk management services and all kinds of hedging or risk transfer instruments.  To some extent, this will require the assistance of modern technologies, such as artificial intelligence and big data. 

Energy asset prices

If the increases in energy prices are not a temporary feature but are there to stay (which might also result from factors other than geopolitical forces), it follows that price of assets used for energy generation, transmission and distribution will increase as well to in line with cash flows, they generate until a new cost-benefit equilibrium is reached.  The side effect will be increased competition for raw materials, parts, equipment, services and labour as everyone will be rushing into the energy sector to benefit from rising asset prices.  This effect can already be seen to a large degree in the field of renewable power generation and storage.

Technological advancement

The challenges of energy security in the light of global geopolitics, compounded by the demands of decarbonization to thwart adverse climate change present a vast spectrum of opportunities for innovators who can advance new technologies in energy production, delivery, storage, management and saving.  Whilst the invention of a breakthrough technology that could be deployed on a large scale to change the way the entire world operates is unlikely (although not impossible), there is a lot of room for incremental advances that, given increasing energy prices, will make research and development expenditures worthwhile for successful entrepreneurs.

Global development

It is estimated that the global scale decarbonization effort requires capital expenditures worth USD 1 billion every day until 2050.  This does not include the cost of responding to geopolitical challenges which, as far as energy is concerned, have been briefly outlined above.  This presents a huge challenge for business, governments, financial institutions, and individuals who all form a kind of global labour force tasked with making this change happen. It also offers tremendous opportunities for growth and development, for making the world a better place, more prosperous and healthy, and one that can offer more benefits to more people. 

GrECo – Making change happen

Geopolitics will still be a major factor impacting global energy markets and energy security across the world. However, if the world population manages to turn these challenges into opportunities, then increased prosperity and improved distribution of wealth across the planet could turn geopolitical forces into everyone’s favour. 
 
As all these processes will be impacting the global risk landscape in a major, perhaps unprecedented way, the years to come will be a challenging and hopefully rewarding time for the risk management and insurance community worldwide.  Our role during this time of change in the global economy and technology, prompted to a large degree by energy geopolitics and climate change, is to help make the transition process smooth and predictable to the fullest extent possible for those entrepreneurs and institutions that will be responsible for making this change happen.

Pawel Kowalewski

Practice Leader Power & Renewables Division

T +48 507 085 066

Related Insights

Geopolitics Shapes the World to Come

Our multipolar world and its myriad of geopolitical forces presents us and our clients with a vast, multidimensional array of risks. As bleak as this may sound, geopolitics and its impact on energy also offers a number of opportunities.

Read More …

Geopolitics and Energy are Closely Intertwined

For the past years and certainly since 24 February 2022, we have had many opportunities to witness the power of geopolitics, its decisive impact on domestic and international politics and the supply of energy throughout the world. 

The geopolitical flow of energy

As far as the sources of energy are concerned, we must take a closer look at their primary and secondary dimension:

Primary sources of energy are those that are extracted (such as natural gas) or captured (such as solar energy), whereas secondary sources of energy refer to the products that derive from the transformation of primary sources.   Electric energy is a typical secondary source as it is the product of transformative processes such as controlled combustion of natural gas in a thermal power plant or conversion of solar energy into electric current within a photovoltaic power panel. 

Then there are the facilities that ensure the production and supply of primary and secondary energy – for example, refineries, power plants, electricity grids for transmission and distribution.  The infrastructure for production and delivery must be built and maintained in good order.  This requires parts and machinery to be produced from raw materials, most of which are available only in certain parts of the globe, and which need to be extracted, processed and shipped (often through many different countries) to factories (some of them being located in other parts of the world) and then transformed into OEM parts and equipment, which are shipped to the final destination (crossing once again many state boundaries). 
 
This constant flow of various forms of energy, raw materials, intermediate products, parts and machinery as well as the security of energy is dictated by physical and human geography – and its barriers.

Case in point: Coal vs. Clean Energy

An interesting example is Europe’s import of coal on a mass scale.  Under immense pressure from the European Union, financial institutions and a vast number of generously bankrolled activist pressure groups, many governments decided to scale down coal production, effectively not allowing any investment in developing new production infrastructure.  As with most extractive industries, the lead time from the investment decision to commencement of commercial operation is several years, especially when public procurement is required. 

Russia’s military invasion of Ukraine prompted a sharp increase in wholesale gas prices (approximately by a factor of three within several days). The ensuing uncertainty then prompted an increased demand for coal (a natural gas substitute for heating and power generation) both from businesses and private households as the demand could not be met by the decreasing domestic production. 

At the same time, several widely used coal transport routes become inaccessible because they originated in or passed through Russia or the war zone in Ukraine.  Wholesale coal price indices rose sharply as a result of skyrocketing global demand and contracting supply. For example, the ARA index often used by EU traders rose by about 140% in seven days since 23 February 2022 and in December 2022 traded at approximately a 30% premium from that day. But that was just the beginning. 
 
The additional demand from Poland alone, estimated at around 10 billion metric tons in 2023 (the equivalent of around 170,000 Panamax or up to 50,000 Capesize carriers), is putting significant stress on the existing transport infrastructure, including seagoing vessels, inland transit carriers, port terminals, transhipment and storage.  This infrastructure is generally finite and cannot quickly be scaled up: for example, there is a limited number of available dry cargo vessels or sea terminals capable of unloading and handling large amounts of coal. 
 
As is always the case, the vastly increased global competition for finite extraction and transportation resources translates into price increases and high levels of volatility until a new equilibrium is reached.

The security behind energy supply security

As far as the security of the supply of energy is concerned, we must consider two aspects.
 
First, there is the physical availability, which in simple terms answers the question whether a requisite amount of energy can be delivered to the destination in the required form and quantity.  For example, in December 2022, a large part of Ukraine was deprived of electric energy because both power plants and the delivery infrastructure (transmission and distribution grids) were, to a large extent, destroyed or captured by Russian military. 
 
Second, even if physical availability can be assured, the cost at which energy can be obtained by end users can be very expensive, making the use of energy either uneconomical (for businesses that cannot pass on increasing costs to end users) or adding an undue burden on the cost of living, eroding living conditions, causing poverty and social unrest which, in the end, might bring about political changes both locally and on a large scale.  For example, because of the Russian aggression against Ukraine, the Western world is moving away from purchasing and using Russian hydrocarbons. The resultant sharp increases in market gas prices through 2022 have caused many energy-intensive businesses across Europe to fail or to temporarily scale down production, as has already happened to the fertilizer industry.
               
Because of complex value and supply chains linking geographically remote points of production and delivery of energy to the end user in requisite form and at acceptable cost, the entire global energy system is subjected to forces that themselves are the product of many geopolitical vectors.  Notably, the situation in Ukraine has not only negatively affected the energy security and energy supply in many countries, especially in Europe, it may also cause profound ripple effects in the entire world.

One of the victims of rising energy prices is the fertilizer industry. The concentrated production of fertilizers and its increase in prices will eventually affect food production around the world. In the short term, this will lead to possible food shortages.  Add to this the limited number of crop exports from Ukraine (before the war Ukraine was the world’s major producer of foodstuffs) which could have far-reaching effects in poor countries that rely on cheap imports. 

Bleak future?

What seems to be a local event might easily have global consequences and energy, being the equivalent of the pulsating human blood stream, is the means that can spread and exacerbate negative consequences around the globe.

Pawel Kowalewski

Practice Leader Power & Renewables Division

T +48 507 085 066

Related Insights

Geopolitics Shapes the World to Come

Our multipolar world and its myriad of geopolitical forces presents us and our clients with a vast, multidimensional array of risks. As bleak as this may sound, geopolitics and its impact on energy also offers a number of opportunities.

Read More …

The Price Cap on Russian Oil – Implications on Insurance

The Price Cap on Russian Oil – Implications on Insurance

Many insurers including insurance brokers will now be able to provide insurance services for Russian crude oil shipments to countries which are not part of the Price Cap Coalition provided that the price of the Russian crude oil cargo from the time it is loaded until it has cleared customs at the port of destination is at or below $60 per barrel.

The EU, G7 and Australia (the “Price Cap Coalition”) have recently introduced legislation and guidance effective 5 December 2022 intended to maintain the supply of Russian oil to world markets whilst at the same time reducing Russia’s earnings from its oil exports (the “Price Cap Scheme”).

Under the Price Cap Scheme, various insurers including insurance brokers will now be able to provide insurance services for Russian crude oil shipments to countries which are not part of the Price Cap Coalition provided that the price of the Russian crude oil cargo from the time it is loaded until it has cleared customs at the port of destination is at or below $60 per barrel (the “Price Cap”). A separate price cap will be introduced on 5 February 2023 for Russian petroleum products.

Ships with Russian crude oil on board on the 5 December commencement date may continue to lawfully perform the voyage even if the cargo has been sold at a price above the Price Cap if the voyage will be completed and the cargo offloaded by 19 January 2023.

Rules for insurance of Russian oil shipments

Insurers, insurance brokers, shipowners and charterers will now be required to check the price of Russian oil cargoes on board ships they own, charter or insure. These checks will take the form of contractual attestations provided by their contractual counterparties stating that for the relevant period the price will not exceed the Price Cap.

A Cargo owner or shipowner or Charterer that intends to transport Russian crude oil cargoes after 5 December will now need to provide its insurance service providers with an attestation that it will not for the duration of the period of insurance carry Russian oil cargoes which have been sold at a price that for the period during the voyage has exceeded the Price Cap. This attestation will be required for all types of Marine insurance.

Insurance cover for the carriage of Russian crude oil loaded after 5 December 2022 and petroleum products loaded after 5 February 2023 is dependent on various insurers complying in full with the requirements of the price cap schemes, including the provision of appropriate attestations. Insurers will be required to withdraw cover where there are reasonable grounds to suspect that the carried cargo was purchased at a price greater than the price cap..

Price Cap is part of the sanction regime

Under the Price Cap scheme, those persons that are subject to the jurisdiction of the EU, G7 and other coalition partners such as Australia will be prohibited from transporting and/or providing services (including insurance services) that enable the transportation of Russian origin crude oil and oil/petroleum products unless it has been sold at or below the Price Cap. The prohibition on services provided by a service provider based in an EU, G7 or other coalition partner jurisdiction extends to shipments by or to third countries that are not part of the EU / G7 coalition and to that extent will have an extra-territorial effect.

Please note that various price cap schemes largely mirror each other but there are significant differences between them. For example, the period during which the Price Cap must apply to benefit from the EU Price Cap scheme is longer than under the equivalent UK and US legislation. Under the EU scheme even where the oil has cleared customs at the third country destination in circumstances where it then “…becomes seaborne again without being substantially transformed into a different good in line with non-preferential rules of origin. (i.e. without being refined) … the price cap will still apply.”

Again, parties are expected to obtain appropriate attestations of cargo price the nature of which will depend on which Tier they fall into. The definition of the Tiers by the EU is the same as that adopted by the UK and US with shipowners and various insurance service providers identified as Tier 3 Actors. Parties are required to keep records of Price Cap transactions for five years.

For example, shipowners are considered Tier 3 Actors by all three jurisdictions. As such, a Shipowner must obtain a contractual commitment from its contractual counterparty – usually the charterer – that its counterparty has committed not to purchase Crude Oil or Petroleum Products above the Price Cap. Such an Attestation may be a stand-alone document or included within a wide contract.

Validity of cover as long as Price Cap is respected

Various stakeholders should note that from 05:01 GMT 5 December 2022, insurance cover for Russian Crude Oil Price Cap cargoes is conditional upon the unit price of the Russian Crude Oil supplied or delivered, or being supplied or delivered, being at or below the Price Cap. To comply with the Price Cap scheme insurers are required to withdraw cover in circumstances where there are reasonable grounds to suspect that the Price Cap attestations provided are false and/or where the cargo is sold after the voyage has commenced at a price greater than the Price Cap. Where a breach is identified after loading vessels may be left uninsured and without access to normal banking services for an extended period whilst the authorities determine how best to dispose of the cargo.

First reactions concerning insurance

According to Business Insurance online of December 12th, 2022, Russian insurer Ingosstrakh declined to insure oil cargoes not compliant with the price cap. Insurance will only be available on the same requirements as for the “Western” insurers.

Turkey’s maritime authority said it would continue to block the passage of oil tankers without appropriate insurance letters, adding that the insurance checks on ships in its waters was a routine procedure, with a focus on transit through the Bosporus Strait or calls at Turkish ports.

Andreas Krebs

Andreas Krebs

Head of Insurance Mediation Services

T +43 5 0404 229

Kristo Ristikivi

Group Practice Leader Cargo

T+372 506 9809

Related News

The Winter is coming: Can renewables break dependence on Russian gas?

One thing is clear – Europe needs to cover gas demand with alternative sources. The EU energy security is compromised if there is no diversification to cover Russian gas imports.

One thing is clear – Europe needs to cover gas demand with alternative sources. The EU energy security is compromised if there is no diversification to cover Russian gas imports. EU gas imports account for over 1,500 TWh and need to be switched into an alternative source.

Energy security concerns are sparking lively debates not only in the politicians’ offices, boardrooms, and conferences. This topic has made its way to family dinner tables, parties, and pubs. There are wild stories to be heard with opinions being polarised and swaying in both directions. Although it may seem that we are facing the impossible task of shifting from fossil fuels to renewable energy sources, public polls actually show a high degree of consent (9 out of 10 Europeans agree) regarding the EU’s energy policy priorities to ensure secure, clean, and affordable energy for all Europeans, according to a new Eurobarometer survey published by the European Commission.
 
The main questions are evolving around the feasibility of energy transition and the corresponding timeline. It is not a matter of if, but how and when. Our Energy, Power & Mining team looked closer into this issue.
 
As of March 2022, 85% of the EU gas demand was imported. Thereof 34% came from Russia and only 17% from Norway. The dependency on Russian gas has grown significantly within the EU, some countries being fully dependent on the single source, as the diagram below indicates.

Source: GlobalData, Eurostat

Over 30% of the imported Russian gas is being used for power and heat generation, and an additional 25% is used by the residential sector followed by industrial production with 21%. It is hardly a surprise that Russia’s ability to weaponise energy only accelerated pressure on consumer prices, global supply chains and the labour market.

The road towards alternative energy sources

One thing is clear – Europe needs to cover gas demand with alternative sources. The EU energy security is compromised if there is no diversification to cover Russian gas imports. EU gas imports account for over 1,500 TWh and need to be switched into an alternative source.
 
The International Energy Agency (IEA) has elaborated a 10-point plan for Europe. The plan is divided into 4 major action fields as follows:

Gas oriented actions

  • No new gas supply contracts with Russia (15 bcm contracts to expire by the end of 2022, and 40 bcm by the end of the decade.)
  • Replace Russian gas with gas from alternative sources (30 bcm from other countries)
  • Minimum gas storage obligations to enhance market resilience (higher injection will add to gas demand and push up the prices.)

Energy efficiency oriented  actions

  • Speed up the replacement of gas boilers with heat pumps (reduces gas use for heating by an additional 2 bcm in a year)
  • Accelerate energy efficiency improvements in buildings and industry (reduces gas consumption for heat by an additional 2 bcm a year)
  • Encourage a temporary thermostat adjustment by consumers (reduce gas consumption by 10 bcm a year(!))

Renewables oriented actions

  • Accelerate the deployment of wind and solar projects (could bring the gas use by 6 bcm)
  • Maximise generation from existing low-emission sources such as bioenergy and nuclear (can bring 70 TWh reducing 13 bcm of gas use in electricity)

Market oriented actions

  • Enact short-terms measures to shelter vulnerable electricity consumers from high prices
  • Step up efforts to diversify and decarbonise sources of power system flexibility

Research shows that the successful implementation of the plan can eliminate the demand for Russian gas by 2030. The renewable share of Energy has been growing steadily since 2004 currently reaching 23%. Hydrogen is perceived as a support to the gas sector. Renewable Energy Directives (RED) are assessing the possibility of installing blending obligations for increasing the sustainability of the European gas system from currently 1% to 20%, but not without major grid and infrastructure adjustments.

Apart from reducing the dependency on Russian gas, which now seems possible, there are various other aspects of the energy transition to consider as well. But for the moment, keep calm and follow the plan. So far so good.

What about the risks?

We read and hear surprisingly little about the uncertainties, unknowns, and associated project risks of such undertaking. Known unknowns are what drive many scientific experiments, business intelligence and data analytics and refer to information whose existence is someone aware of but does not possess. They can also represent potential risks. They can also represent potential risks. Far worse are the unknown unknowns, pieces of unidentified information, or “things  we do not know that we don’t know”.

The plan addresses several items, which carry inherent limitations in their nature and can, therefore, be considered severe project risks. For example, selling and installing 30 million heat pumps in the shortest term possible is a challenge even without limited manufacturing capacity globally, supply chain pressure and logistical difficulties.
 
Accelerating renewable energy generation capacity (EU requires over 900 TWh additional capacity by 2030) seems extremely unlikely for the reasons mentioned above and impossible without the addition of new manufacturing facilities, ideally closer to home, and not overseas. This means that technical and technological sacrifices will need to be made to accomplish the colossal task in a very short period. Furthermore, new personnel must be hired and trained to a very high standard demanded by the ever-increasing complexity of the renewable generation machinery (especially wind turbines). The recent crises caused by post-COVID shortages of staff in European road transport and air travel industries demonstrate just how difficult is to mobilise and ensure the supply of qualified labour to meet the demands of the green energy business.
 
Also, the grid, gas transport and storage infrastructure will require more than a major overhaul to adopt hydrogen blending due to the physical and chemical properties of hydrogen (highly corrosive, existing networks were not built with that in mind).
 
Lastly, it would be interesting to read the estimates of the capital expenditure required to upgrade the entire EU’s transmission and distribution grid systems to accommodate the change of topology coming from the replacement of a small number of centrally dispatched generation assets (located near the largest industrial electricity users) by a large number of distributed renewable sources located across the entire continent and in the neighbouring seas.
 
Until then, Europe will have to keep its coal-fired plants going (for example, Germany has already initiated a legal proceeding to abolish the prohibition of operating thermal coal plants beyond 2022-23).
 
Besides, 2030 is still 7.5 years away, yet the winter will be upon us in just a few months.

Related Insights

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Rethinking the Energy of the Future

Rethinking the energy of the future

Insurers are faced with a big challenge during the energy transition: The past loss experience on which they have based their forecast models can no longer be used for predictive future scenarios. On top of that, new risks will emerge.

We are at the crossroads of the fastest and most profound disruption the energy sector has seen since the beginning of the indus- trial revolution. It is an irreversible process driven by key technologies: solar power, wind power and battery storage systems. Hydrogen and bioenergy are still underrepresented because their technological progress is only in its infancy. We yet have a long way to go because a successful energy transition, i.e. a 100% substitution of fossil fuels with renewable energy, including green hydrogen, hydropower and biomass, might only be reached by 2050.

An analysis conducted by RethinkX, an independent think tank, has shown that 100% clean energy from a combination of the above-mentioned sources is both physically possible and economically affordable. And this is just the beginning. Coal, gas, petroleum and nuclear assets will become stranded during the 2020s because investing in these technologies will no longer be rational.

The role of insurance

Insurers are faced with a big challenge during the energy transition: The past loss experience on which they have based their forecast models can no longer be used for predictive future scenarios. On top of that, new risks will emerge as technological developments associated with solar, wind and battery storage infrastructure advance even more rapidly.
 
It may become more difficult to put a price tag on physical risks because the transformation from hazard to exposure to damage and its manifestation in cash flows will be hard to model. According to a Harvard Business Review research, onshore and offshore large risk losses amounted to 60 billion USD in the last 30 years.
 
Insuring renewable energy should present an intuitive alternative to fossil fuels. Indeed, prospects for insurers look very promising. However, the renewable energy sector must still grow considerably to replace the revenue generated by the fossil fuels sector. To date, renewables still play a minor role in the worldwide energy insurance sector, which generates roughly 14 billion USD in premiums each year. Renewable energy insurance only generates an estimated 500 million USD in premiums per year.
 
Insurers are in the business of taking risks, yet they also need to make a profit. They allocate capital, using historical data and other factors to calculate the right mix of aggressive and conservative risks, and tend to balance both frequency and severity. This does not mean that solar power and other renewables are unattractive to the insurance industry. On the contrary, renewables are the future of insurance just like they are the future of energy. Insurers are therefore challenged to understand, model, and price policies more effectively, especially as alternative energy continues to evolve.
 

Rocky road

If energy transition is to succeed in the next 32 years, two goals will have to be reached:

  • The renewable share of electric power would have to increase from currently 15%-20% to 100%
  • The share of electricity in the global energy mix would have to increase from currently 18% to 100%;

This means that the current renewable production would have to increase by a factor of 60!

The American climatologist Ken Caldeira has estimated that we would need to develop the equivalent of the energy produced by a nuclear power plant every day in a fifty-year time span. At the current rate however, the energy transition will take 363 years.

Although renewable energy has clear benefits with respect to reducing greenhouse gas emissions, it has some inherent limits. Five major obstacles would have to be overcome on the road to energy transition:

  • Space: Regardless of wind, solar or battery storage, these facilities require large areas of land. Solar parks and wind farms are usually placed on agricultural land and therefore can cause land shortages, a displacement of the population, and they have a negative impact on biodiversity.
  • Resources: The dependency on huge amounts of material and natural resources such as steel, concrete or rare natural metals accelerates the rapid depletion of our planet’s resources. Economics teach us that these supplies will not be depleted because prices increase, and technological innovation will enable the use of poorer quality ore to maintain production levels. However, obtaining poorer quality ore means more invasive and energy-intensive methods. The outcome is a vicious cycle: to produce more energy, more metals are necessary, and to produce more metals from low-grade ore requires more energy. Already there are bottlenecks in the production facilities for solar modules, wind turbines, blades, transmission and distribution lines.
  • Transmission: We are used to having electricity when we need it. Since it cannot be stored, it must be consumed when it is produced. Wind and solar energy, which are available when the wind blows, and the sun shines cannot meet these two conflicting demands.
  • Non-substitutability: Renewable electricity cannot replace all the benefits of liquid fuels. For example, batteries simply cannot meet the energy needs of heavy machinery, aircraft or merchant ships. Certain industrial processes simply require liquid fuels, e.g. the manufacture of steel, plastics and fertilisers. For other industries that rely just as heavily on uninterrupted, smooth production processes, such as aluminium and cement production, intermittency is a serious stumbling block because stoppages damage the infrastructure.
  • Financing: Given the poor financial returns and major risks associated with renewables, the energy sector remains cautious. For a successful transition to occur, about 14 trillion USD in investments in solar and wind energy would be needed by 2030. But spending in the battery sector will not exceed 10 billion USD, including research and development.

We are dealing with the “known unknown” phenomena, as the new energy system that emerges will be much larger. Its architecture will be completely different and will operate in a yet unknown way. One of the most unique characteristics of the new system will be its ability to produce much larger amounts of energy – a superabundance of clean energy.

This energy will be available at near-zero marginal cost throughout the year for nearly all populated areas of the world. Computers and the internet serve as an example. The marginal cost of information has been slashed and hundreds of new business models were created only to transform the core of the global economy

There’s a need for Risk Management 4.0 

Businesses are cautioned to not only rely on industrial insurers as some, to date insurable risks, could suffer the same fate as cyber insurance. Just think about climate change or coverage against natural disasters. Besides, there are many – often new – risks which cannot be insured and which change just as rapidly.

Industrial companies must increasingly come to grips with future risks, strengthen their risk management in the process and place it at the top of their agenda. This, however, means more than just implementing the risk improvement measures which insurers impose upon them – something which almost all market players have propagated at an inflationary level, and which only addresses the past. It is rather a matter of defining future risk changes, determining their possible consequences for one’s company and preparing accordingly – a forward-looking risk management 4.0, so to speak.

A partner who not only focuses on mere risk transfers but acts as a risk adviser, who sends out the right signals and provides expertise through a know-how pool can create real added value for industrial companies. By working in tandem with clients the insurance partner can help to meaningfully shape the future in an ever more complex, interconnected, and fast-moving world.

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Related articles

Geopolitics Shapes the World to Come

Our multipolar world and its myriad of geopolitical forces presents us and our clients with a vast, multidimensional array of risks. As bleak as this may sound, geopolitics and its impact on energy also offers a number of opportunities.

Czytaj dalej …

Are you ready for free electricity?

Europe is massively investing in Renewable energy production. Detractors of these technologies have a lot of compelling arguments and one of the most relevant is the energy availability: What if there is an instant surge in demand? What if everyone in England starts their kettle at half-time during the Euro’s final and there is no wind and no sun energy available?

Adjustment of energy production and consumption

This problem is not a small one. Failure in system capacity caused the 2019 blackout in England. A lightning event at a major production site and successive failure to maintain the grid frequency between 49.5Hz to 48.8Hz, as the system needed more than 2,100MW replacement capacity and only 1,000MW was available, caused a partial shutdown of the grid. More than 1 Million users lost electricity for 45 minutes. Indirect damage lasted over two days as train were still suffering from delays 48 hours later. Part of the incident was blamed on the Electricity System Response.

This event paved the way to a complete reshuffling of the energy production properties and technical requirements and new energy production tenders in the UK. One of the most important improvement required was that the speed of response must be faster than 0,5s from electricity request to input in the grid. Obviously, with no control over wind and sun, how can renewable energy producers face such challenges?

The role of energy storage

The solution resides in energy storage technologies. The most common are the battery storage facilities but there are many different options already in use that can be divided in three groups: electrical, electrochemical and mechanical.

Source: DNV GL AS (Safety, operation and performance of grid connected energy storage systems, October 2017, DNV GL AS)

Each of these types of storage represents new challenges, new technologies, unknown risks and a very steep learning curve – for the insurance sector. Clearly, pumped hydro and room temperature battery represents intrinsically distinct risks requiring unique risk management strategies. Massive capital will be deployed in these technologies in the coming years, as the Green Deal will accelerate renewable energy production development and accentuate their main problem of energy availability.

The new Super Power paradigm

In order to tackle this problem, the grid’s reserves must be equal to 3 days of consumption. With that in mind, we can already foresee an incredible energy paradigm shift materializing: Super Power. This revolution in our energy capacity will translate into more energy production than can be used and consequently, free energy at moments when energy storage is at full capacity and that there is more energy produced than consumed, as shown in the image below.

Source: RethinkX

This could lead heavy electricity consumers to maximize their energy needs according to these periods and develop new real time production processes that will allow to lower their operation costs. Cryptocurrency mining could feed exclusively on the excess energy production.

The paradigm change will materialize as “maximizing rather than minimizing energy use, because it is not harmful to utilize electricity generated from sunshine and wind but rather it is harmful to let it go to waste” . Maximizing energy use could also lead to new economical business model such as converting Seawater into drinking water.

This new paradigm, Super Power, will change the energy consumption scenery drastically and lead to upheavals that we cannot even foresee. As insurance brokers, we must investigate the horizon to better understand our client’s vision and help them find new and innovation solutions. We can therefore adequately support your company growth in the energy production and storage sectors even more when implementing new technologies.

Related Insights

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Sustainability – a game changer?

Consequences for the risk landscape and property insurance

In order to achieve the EU’s climate and energy goals by 2030, an action plan has been developed which directs investments towards sustainable projects and activities as the most important measure and which at the same time makes an important contribution to the achievement of the UN Sustainable Development Goals. Sustainability is therefore becoming an increasingly important goal for companies, which will also have a radical impact on the risk landscape and, subsequently, on insurance management. With a view to property insurance, the following changes in particular are emerging.

European Green Deal

The EU’s Green Deal strategy includes opportunities for companies and states alike to secure stable economic development through successful investments in sustainable technologies and alternative forms of energy. In addition to measures mitigating climate change, there are also objectives to make the world a cleaner and healthier place again. In many ways, this means a shift from traditional to alternative technologies. One example is decarbonization, i.e. phasing out coal as the first measure, followed by abandoning the use of fossil fuels for industrial processes, heating, and as operating means of transport. Most of these steps have an impact on the future employment situation in all areas of fossil fuel production and will also entail new risks from the switch to new technologies and the availability of alternative resources.

The EU Taxonomy Regulation defines the criteria for sustainable investments and at the same time requires from financial institutions (including insurance companies) to model and quantify the effects of ESG factors (Environmental Social Governance), in particular climate change, in their regular Solvency II stress tests and report on the results.

ESG changes the insurance industry

Some insurers have already started to restrict their portfolios to “clean energy” and are therefore no longer providing capacities for coal-fired power plants, for example. The Axa Group, Allianz SE, Aviva plc, Generali Group, Münchener Rückversicherungs-AG (Munich Re), Scor SE, Swiss Re Group and Zurich Insurance Group recently founded the Net-Zero Insurance Alliance (NZIA), which aims to move their underwriting portfolios to net zero greenhouse gas emissions by 2050. Insurers can individually decide how to achieve this goal – as potential measures were among others listed

  • the definition of underwriting criteria for the most greenhouse gas intensive activities in the underwriting portfolios or
  • Integration of independently defined, company-specific net-zero and decarbonization-related risk criteria into risk management frameworks

However, ESG does not only play an important role in insurance company’s investment and underwriting strategies – it has also been recognized that ESG factors in industrial insurance could in future be an important source of information for assessing corporate risks. For example, a study by Allianz Global & Corporate Solutions found that “ESG parameters have predictive power and provide useful information for effective risk analysis”.

As a leading risk management and insurance consultant, we accompany our clients in the implementation of their ESG goals and are happy to support them in all transformation processes towards more sustainability by analyzing the changes in their risk landscape and develop tailored solutions, e.g. for property insurance for alternative energy generation.

Related Insights

Rudolf Schiel

Competence Center Manager Property

T +43 664 822 27 58

Offshore Wind Insurance

Companies investing in the offshore wind sector need a risk partner with the knowledge and experience to deliver tailored risk advisory and insurance solutions. In addition, having an insurance partner capable and experienced in managing finance parties’ expectations and working with all interested parties in the setting of realistic and reasonable insurance requirements within the debt facility agreements is crucial – a skill set which GrECo have market leading expertise in. Choosing the right insurance advisory and placement partner will have a significant and long-term impact on the legal, procurement and insurance strategy, with the target of reducing costs and maximizing insurance and risk management solutions.

Supporting the entire lifecycle

We have the knowledge, experience and commitment to provide clients with in-depth, specialist offshore wind expertise. We work with offshore wind projects to offer contractual risk allocation, project and financial risk management analysis and create insurance strategies that enable our clients to protect cash flow and secure scarce capital across the entire offshore wind lifecycle (Bidding, Consent, Development, Procurement, Construction, Operation and Decommissioning.)

Innovative solutions backed by long-term experience

GrECo is independent, privately-owned company; as such our success and reputation depend on strong partnership with each client. GrECo is able to deliver an innovative, holistic approach to offshore wind project risk and insurance in the local and international insurance markets, underpinned by committed service excellence, a thorough understanding of the offshore wind project’s challenges and complete cost transparency for the solutions proposed.

GrECo together with partners have a proven track record of meeting client’s risk management and insurance requirements, offering deep sector knowledge and service excellence throughout the lifecycle of major renewable energy projects to project developers, operators and investors.

Related Insights

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Michał Olszewski

Director – Energy & Mining Specialty at GrECo Poland

T +48 22 39 33 358

#FutureEnergy: Market Update Q2 2021

This is a series of articles related to the news and development of the global energy sector with focus on Europe, Russia & CIS. The Group Practice Energy, Power & Mining comprises of dedicated group of risk and insurance professionals providing risk and insurance related advice to the companies active in broader energy sector.

Foreword

In this edition of our quarterly update we decided to reflect on the changes to the insurance market for conventional power and renewable energy during the past several months.

A lot is being written, said and analysed on this matter. We tried to provide insights from the broader financial services industry, which will shape the insurance market in the future while the energy sector is undergoing significant reforms.

According to the BP Statistical Review, energy consumption in Europe (including Russia) fell by 1.1% in 2019, between 2008 and 2018 energy consumption in Europe contracted by 0.7%. Energy consumption in developed markets such as a North America and Europe has been steadily declining in contrast to growth in the emerging markets. The decline in energy consumption is set to continue in 2020 as the Covid-19 outbreak coupled with the economic downturn across Europe will weaken energy demand, and in the medium and long run, demographic changes in Europe, in particular a rise in the share of its ageing population, will continue to cause a decline in Europe’s global share of energy demand. On the other hand, as fossil fuels will be phased out from the fuel mix of the European Union, United States and other developed economies, the demand for electricity will keep growing, making investments in the power generation, transmission and distribution systems grow at an ever faster pace.

Several countries in the region have pledged to invest in developing their renewable energy sectors and have set internal greenhouse gas emission targets supplementing those set in the 2016 Paris Agreement.

The energy sector has reduced CO2 emission by 63% since 1990s, according to the report published by Energy Research Partnership. In an article which appeared on Business Insurance on March 16, 2021, Swiss Re pledged to exit all exposures from thermal coal in OECD countries by 2030 and the rest of the world by 2040. The move goes together with the investment policy to achieve net-zero emission by 2050. The reinsurer is one of the founding members of the United Nations Convened Zero Asset Owner Alliance, which includes global carriers like AXA, SCOR, QBE, Generali, Munich Re etc., who are likely to follow suit. The Alliance is representing USD 5,6 trillion assets under management and shows unified action to align portfolios addressing Article 2.1c of the Paris Agreement.

Assuming all projects proceed as planned, the current pipeline of projects will deliver 170.6GW of generating capacity in Europe in 2020-2024. Installed capacity is expected to peak in 2023, with 47GW projected to be installed as new capacity.

Europe – Power Generation, Construction Project Pipeline, Top 10 Countries by Value and Stage (US$ million)

Source: Global Data

Europe – Power Generation, Construction Project Pipeline by Type, Value and Stage (US$ million)

Source Global Data

Focus on Wind Projects

There are several important factors contributing to the sharp rise of rates and deterioration of coverages offered by international re/insurance markets from 2019.

  • Projects are getting larger and more complex. This increases severity of risks significantly.
  • Natural catastrophes occur more frequently and are more severe in nature. This is the reason for concern for the insurers and is rated as top 5 risks according to the Allianz Risk Barometer.
  • Defective products, design and quality control losses are on the rise.
  • Supply chain complexity, just-in-time production and interdependencies are more likely to cause project delays.
  • Political tensions, sanctions, compliance and political violence has become one of the top concerns for project risk managers.

All of them are the result of operation of market forces. At this point it is important to keep in mind that the overall performance of an individual insurer, or the market, is the combination of the result on underwriting activity and investment activity. Continuing underperformance results in either re-underwriting of the existing portfolio or complete withdrawal from writing certain classes or business (or less often, winding down of the whole company). It is also important to understand that the insurance market, unlike many other financial markets (such as public equity and fixed income markets) is not transparent and objective market information is not available usually other than at very high granularity information made available by national regulators and industry trade associations.

Market Performance and General Underwriting Considerations – Hard Phase of the Insurance Cycle

The rating of Engineering and Construction classes of business for Onshore Wind would depend on the following factors:

The Profitability of the entire Insurance Industry

2020 was a year of continuing deterioration of underwriting result and net result. For example, in the Lloyd’s market which provides substantial reinsurance capacity to insurers worldwide, the underwriting loss was GBP 2.67 billion, down from GBP 538 million of loss in 2019. As the investment return also contracted significantly, the market ended 2020 with a total loss of GBP 887 million, down from a profit of GBP 2.53 billion in 2019. As in practical terms it means the erosion of capital across the market, the result is the pressure for immediate action by their shareholders or the Society of Lloyd’s (or any other regulator). The Lloyd’s combined ratio (measure of underwriting profitability) was 110%, however, excluding losses from Covid-19 it was down to 97%, still a very poor result for the entire market. It is estimated that the total amount of underwriting losses suffered by re/insurance markets worldwide were in excess of USD 100 billion across 2020.

Withdrawal of Underwriters from writing certain Classes of Business

Since 2019 this affected Marine Cargo, Engineering and Construction as well as Renewable Energy. It was driven either by Lloyd’s which has the power to accept or reject individual syndicates’ business plans, or the insurers’ own management as a result of changes in their risk appetite. There have also been withdrawals of capacity from major MGAs writing Renewables business such as Pioneer, which unfortunately had to be placed into run-off. Having said that, there have been some new insurers launched across 2020 and 2021, taking advantage from improved rating environment and not burdened with previous years’ losses. Several existing markets have also successfully raised new capital to support their business in the hardening market.

Reinsurance Considerations

The market consensus is that the 1/1 2021 treaty renewals for Power and Renewables sector were higher than a year earlier. Also, the restructuring of treaty provisions, in many cases insurers are no longer protected by their obligatory treaties with respect to active loss attrition on their books. This will affect both direct insurers and facultative reinsurers alike.

Portfolio Rebalancing

For the companies that chose to continue providing coverage this took the form of:

  • Increasing rates – from 10-30% year-on-year on loss-free accounts to 90-100% or more for troubled insureds. Similar adjustment took place across 2019 with 25-50% typical rate increases or even upwards of 100% for complicated or distressed accounts.
  • Deterioration in the length and breadth of coverages provided, increased deductibles and decreased sublimits for certain perils.
  • Decreasing line sizes at renewal, sometimes significantly, or
  • Not offering renewal terms for distressed accounts. For example, according to one reputable London market, their retention rate of Renewables accounts was around 40% in 2020.

Accounts Performance

With the trough of the pricing cycle for Onshore Wind in the Summer months of 2018, 2020 was yet another year which brought about deteriorating claims and reserves development experience for the Renewable Energy insurances. For example, the adverse development of losses incurred in 2018 moved the loss ratio for that period for an initial estimate of 66% to 80% as of 2020, which made the 2018 year of account unprofitable. This of course needs to be reflected in rating adjustments for insurances sold in future years.
Notable causes of rating increases for Onshore Wind projects typically include:

  • Natural Catastrophe losses – even though no spectacular losses occurred throughout 2020, smaller scale catastrophes give rise to increasing loss activity.
  • Ageing of the fleet – increasing number of attritional losses and the need to replace ageing assets with modern technology, which is affected by costs, materials and labor inflation.
  • Constant upscaling and upgrading process of generators, which make them significantly larger and more expensive, also in terms of replacement and re-erection costs. Also, the boundary between the upscaled and the prototypical becomes ever more blurred as a result of the process.
  • Adequacy of “old” deductibles is being questioned by insurers, as it the view of many they no longer reflect the specifics of new technologies and substantially larger and more powerful units.
  • Concerns about the performance of the Engineering and Construction book – it has been noted that the contractors may be taking on too much workload (due to fast-increasing demand) which causes them to rush some projects to the point where there is a perceived increase risk of losses in the construction phase. In fact, data from some markets show that for 2020, contractor error losses amounted to about 36% of the quantum of all wind losses. As a result, the construction phase attracts the highest rating increases in the wind farm life cycle. The same applies to the increase in deductibles required by insurance markets. Unfortunately, the increasing demand pressure on major contractors makes them unwilling to give concessions to their clients as their order book is filling up quickly as old conventional assets are being phased out, making their bargaining position ever stronger.
  • The Covid-19 pandemic affected some routine claims handling (such as inspection dismantling, re-erection), risk engineering, as well as manufacturing processes. This affects both loss settlement times and – more importantly – the quantum of Business Income (BI/ALOP/MLOP/DSU/MDSU) losses.

Diminishing Returns on Investing Activity

For many years, deficiencies in the performance of the underwriting function would normally be corrected by returns on the investing activity. It used to be normal that in certain classes of business combined ratio of 110% was accepted for prolonged period (meaning that on every USD100 of premium there were losses and costs of USD110 incurred). With negative interest rates environment prevailing for a prolonged time and increased asset price volatility this is no longer the case and the insurers are pushed towards technical (underwriting) profitability.

Related Insights

Zviadi Vardosanidze

Group Practice Leader Energy, Power and Mining

T +43 664 962 39 04

Blackout all over Europe, and then?

A pan-European power and infrastructure failure, a so-called blackout, would bring our society to the brink of collapse within a few days.

Neither the people nor the companies or the state are prepared for these kinds of wide-spread utility failures. We are living in a dangerous state of false security. But how realistic is this scenario and what would be its consequences?

The European power grid is one of the most reliable in the world. From a risk calculation perspective, the likelihood of a complete failure is very low, as this sort of event has never happened in Europe. However, the challenges to secure grid operation and the risk of major disruptions or failures have been increasing for many years. There are many reasons for this. They range from a power market that knows no physical limits, to an energy revolution that ignores systemic interrelationships and only calls for the replacement of individual elements, to new vulnerabilities arising from increased connectivity.

First phase of the blackout

A disruption can spread across large parts of Europe within seconds. It could take a week before the entire European grid system is working reasonably again. However, that is just the first phase of a blackout that grid operators have been anticipating for years. Emergency power generators are often used in other areas as a security measure. However, they can only cover a fraction of actual requirements. Performance is usually highly overestimated and susceptibility highly underestimated in this situation.

Second phase of the blackout

The second phase of the blackout until telecommunications services (fixed and mobile networks, internet) are working reasonably again is also completely underestimated. A recovery period of at least a few days should be anticipated due to expected hardware damage and overloads. The duration of the power failure is decisive here.
The longer the power failure lasts, the more difficult and time-consuming it is to reboot these systems. This means that neither the production nor the distribution logistics or sale of goods are possible. Fuel logistics would not function either. There are simply too many – and often ignored – dependencies in supply logistics and many of these are transnational. Just two examples of many:

  1. in a local power failure, a key network component loses its configuration and the entire IT network and telephone system no longer work;
  2. a necessary online connection to the cash register drops out at a petrol station being supplied with back-up power and prevents fuel from being distributed.

Third phase with time-consuming restarts

A chain is only as strong as its weakest link. Supply bottlenecks lasting several months are to be expected as a result of serious damage and total failures in food production, food processing and food distribution. This means that time-consuming restarts are also to be expected in phase three.

As an Austrian security research study has shown, around one-third of the population thinks it will be self-reliant for a maximum of four days. For an additional one-third, the figure is seven days. However, it will only be possible to restart on a broader scale in the second week at the earliest.

Generally speaking, employees and members of the emergency services or companies are not much better prepared and organised than the rest of society. However, if people are in crisis at home and are starving, they will not come to work to reboot the systems or to maintain an emergency supply. This is the start of a vicious circle.

Help the people to help themselves

Helping the people to help themselves is the main basis for all other necessary measures. Only when as many people as possible are able to keep their heads above water for at least two weeks will a rapid and extensive restart be possible.
However, there is a lack of awareness of this because there is hardly any risk and safety communication, usually out of misconceived consideration. “We don’t want to unsettle people,” is a recurring statement.But it is precisely this appeasement that provides for early escalation and uncontrollability.
A population that is self-sufficient is essential for any type of interruptions in supply and a prerequisite for a resilient society. In order to ensure that more and more people take precautions, it is essential to issue safety communications and information openly and honestly. It remains to be seen whether the coronavirus crisis will cause a change in mindset in the long term.

Herbert Saurugg, MSc
Präsident der Österreichischen
Gesellschaft für Krisenvorsorge
T +43 660 3633896
praesident@gfkv.at
www.krisenvorsorge.jetzt

Related Insights

Rudolf Schiel

Competence Center Manager Property

T +43 664 822 27 58