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Power: At an energy crossroads

By Lyo Foo | October 4, 2022

The fallout from Russia-Ukraine, hyper-inflation, climate change and understanding the risks of an ongoing energy transition have created a complex environment which power companies and insurers will need to navigate for years to come.
Climate|Risk & Analytics|Medioambiental|ESG and Sustainability
Climate Risk and Resilience|Geopolitical Risk

The global energy market feels like it is at a critical crossroad, with the energy crisis following Russia’s reduction in gas flows to Europe dominating headlines in recent weeks. The events unfolding will also be felt in Asia where demand for energy is most acute. Given the region’s strong economic growth, Asia is expected to account for most of the world’s energy demand through to 2040.

Compared to a year ago, the global energy picture has become much more complicated. The Russia-Ukraine crisis is prompting an adaptation in energy strategies as Europe look to reduce dependance on Russian fuel while dealing with energy prices that are rapidly rising.

This means massively scaling up in renewables, while also investing in new and expanded fossil fuel infrastructure and supplies, including coal, to make up for demand in the short to medium term.

No doubt the Russia-Ukraine conflict will have a major impact on the trajectory of the world’s energy transition, but there are other factors which are adding to a more complex risk environment. These factors not only influence the power sector globally but also the power insurance market on which the industry depends on to operate.

Three other major challenges

Firstly, the energy transition has not only led to a major shift towards renewables and battery storage, but also additional new technologies that will support ongoing thermal power generation. Key elements of this shift will be the development of CCUS (carbon capture, utilisation and storage) and Hydrogen.

Secondly, rising inflation has a significant impact on the insurance market with claims becoming more severe in recent times due to factors such as higher property and asset values and more complex supply chains.

Thirdly, the effects of climate change are profound on the power sector not only in terms of operational impact and damage to assets but also in terms of output, particularly in respect of hydro power. The lack of reliability in terms of hydro is only serving to exacerbate power market pricing tension created by the global energy crisis.

Implications on the power insurance market

Aside from dealing with legacy challenges, the key issues outlined above will place new pressures on the insurance market, including in Asia. Not only does it need to understand and develop solutions for the new or developing risks, it also needs to understand those risks enough to create a sustainable market for these emerging or growing sectors.

Adjusting to the new reality of ESG

The current conditions in Europe have created pressure on generators to bring back or increase coal-fired output in line with governments’ emergency energy strategies. This is unlikely to be short-lived, and it will be important to see how insurers’ ESG principles adjust to this new reality. This will also have implications for Asia, where there remains a high dependency on coal to meet the region’s soaring demand for energy.

Nevertheless, the Climate Transition Pathway framework introduced by WTW can serve as a long-term solution for coal power companies. While it guides organisations in planning their transition to a low-carbon economy, such accredited framework also provides insurance companies and financial institutions a consistent approach to identifying business with robust low-carbon transition plans that are in-line with their ESG guidelines.

Clean energy transition

In Asia, lowering emissions from existing coal facilities is heavily dependent on new and expensive technologies. While CCUS, Hydrogen and Battery Storage are expected to proliferate over the coming years, there remains little true understanding of these risks to date. As much as they may want to support the energy transition, the insurance market will not bear risks it is not able to fully assess.

Bridging this knowledge gap is critical, and buyers that require bespoke and comprehensive cover to ensure projects are bankable, will need to start work now with their brokers and their engineers.

Rising inflation

The insurance market is becoming increasingly aware of the impact of inflation on its exposures. Hence, property values need to be reviewed and benchmarked with the company’s broker to ensure that they are adequate. For those risks where insurers have under-valuation concerns, Average Clauses are increasingly being applied.

Thus, it is important for power companies to have a good understanding of the rate most applicable to their sector and location, and to be able to explain this to insurers, so they have greater confidence in the values declared.

Climate change

It is becoming increasingly apparent that climate change is having a profound effect on companies’ risks, both short and long term. To ensure continuous insurance coverage, power companies need to accelerate their energy transition and keep up with the ESG principles that insurers increasingly have espoused.

At the same time, monitoring of climate change related exposures and understanding implications for future investment in the business will be critical for power companies. With higher frequency of significant weather events happening in recent years, insurers need to see that prudent investments have been made by power companies to manage their exposure to climate risk which would have an impact on insurance costs.

Companies will have to show their intent in mitigating the greater risk with funding allocation, and lastly implementation within a reasonable timeframe.

The way forward

Strong underwriting governance remains a feature of the power market and this can only be expected to increase rather than soften in the future. Therefore, buyers and their brokers have an obligation to understand the scale of this challenge and to put in place robust risk management strategies that will enable buyers to understand how all of these factors could play out within their respective organisations.

Meanwhile, the focus on ESG highlights the risk of ineffective long-term investment strategies that fail to keep pace with the energy transition and the increasing demands of consumers, employees and investors.

The impact of this will be catastrophic for those that underestimate its pace and impact - loss of market share, stranded assets, a lack of investment, an inability to secure support for insurance programmes, a miscommunication of progress to NetZero, reputational damage - all these elements ultimately lead to failure.

With this confluence of factors, there has never been a more important time for power companies to engage fully with their risk intermediary across all of their organisation’s activities and levels, so as to successfully navigate the challenges of the coming years.

A version of this article originally appeared in StrategicRISK Q3-2022 special report on Climate Change.

Author

Head of Power, Natural Resources Asia, WTW

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