Energy sector risk mitigation problematic as investor ESG aims grow

In its annual energy market review, which was completed prior to the oil market collapse, Willis Towers Watson concluded that investors' key concerns about risks in the energy sector are mostly related to climate change and ESG initiatives. The consulting firm said the oil price war and the reduction in demand for hydrocarbons due to the COVID-19 pandemic will have significant impact on future energy industry risk management strategies. Officials said that a satisfactory ESG rating will be “critical” in enabling energy companies to attract and maintain the support of key stakeholders in the future. “In these unprecedented and uncertain times, there is no denying the past 12 months have been challenging ones for the energy industry,” said Graham Knight, head of global natural resources at the consulting firm. “Climate risk and wider ESG factors will have a significant impact on the future of the industry, and today’s energy businesses must commit to incorporating ESG standards and climate change into their risk mitigation strategies to ensure a sustainable future.” Going into the pandemic the industry was already on a shaky ground. The industry has had benign loss years in upstream, according to Willis Towers Watson with only three losses in excess of $100 million during 2019. Downstream had a significant number of losses over $100 million with one major loss significantly above $1 billion. From an energy insurance market perspective, there is no denying that the last 12 months have been challenging ones for the energy industry and their brokers, according to Knight. From an insurer’s perspective the upstream market remains profitable in overall terms, yet premium income levels are still low by historical standards. Certain subsectors, such as offshore construction have been hit by attrition losses, according to the report. The portfolios of downstream and liability insurers remain firmly in the red and the way back to profitability is uncertain. In Willis Towers Watson’s report, the firm said that creating an effective climate risk mitigation plan is proving difficult for the industry, but is not impossible. The cost of the risks are not small. The team said that transition risks occur as societies move toward a zero-carbon economy, but it could be argued that these risks are now being felt as crude prices plummet and contracts even turn negative for the first time in history. Nearly half or 49% of annual global GDP – more than $39 trillion – is now covered by regions of net zero targets, according to the latest analysis from the Energy and Climate Intelligence Unit. In turn investors have a growing concern over the viability of high carbon business models in an increasingly carbon constrained world. Fuel companies are expected to risk wasting $1.6 trillion of expenditure by 2025 if they base their business on emissions policies already announced by governments instead of basing it on international climate goals. Notably, in the U.S. large public pension plans including the California Public Employees’ Retirement System, California State Teachers’ Retirement System and New York State Common Retirement Fund have each announced ambitious sustainable investing programs. According to Willis Towers Watson, shareholders are increasingly aware of the influence financial institutions have in the energy transition. They point to the UN Principals for Responsible Investment initiative representing investors with more than $80 trillion in assets. Investors, they said, are increasingly putting pressure on banks to end the financing of fossil fuels and some banks are responding with targets. BNP Paribas, for instance, is looking to phase out all financing to the outstanding loans related to thermal coal by 2030 in the EU and 2040 for the rest of the world. “While it is still too early to forecast exactly how these factors will play out in the months ahead, the potential effects on the energy industry are obvious reduced capital expenditure, a reduction of exploration and production activities, lower refining markets and lower business interruption valuations,” added Knight. “It will also have a knock-on effect on premium income levels for an insurance market that remains unprofitable for most lines of business.”

Energy sector risk mitigation problematic as investor ESG aims grow

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