The Future of Risk: Energy

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Supply chains:
the need for global resilience

Our Experts

Debbie Bennett
Chief Commercial Officer
UK Energy

Chris Bhatt
Chief Commercial Officer
Global Marine

Emma Whitworth
Senior Risk Engineer
UK Energy

Oil and gas companies contend with the constant challenge of a volatile supply and demand market. As COVID-19 continues to erode demand for oil and disrupt global trade, the industry is taking stock of what little it can control, and supply chain management is in the spotlight.

It makes sense that the upstream market felt the pain of the pandemic first as a result of massive oversupply and vastly reduced demand. Operators couldn’t shift their product, so naturally, they have stockpiled, and this shift in supply and demand is reflected in the price of hiring a vessel. Current hire rates for VLCCs are extortionate because companies are using these vessels to store their product offshore. Lower demand and depressed pricing will keep oil stocks high, so firms need to ensure that insurance covers these new ways of working. They also need to manage the increased risk of significant storage levels.

Oil and gas companies will be affected differently, dependent on where they are in the supply chain: E&P companies face very different risks to integrated oil companies who, in turn, have an alternative risk profile to refiners, and so on. Large integrated companies have more control over their costs and can reduce their capital expenditure and continue to diversify. In contrast, the expenses smaller E&P companies incur do not necessarily track commodity pricing. Refiners and petrochemical plants are suffering heavily but may be able to mitigate their exposure if they can adapt and switch their product mix to those that are more in demand.

In addition to the oil and gas supply chain, the industry also relies heavily on supply chains for equipment and services to extract the oil and refine it. Chartering costs, workforce availability, third party contractors, logistics, factory closures and equipment supply all feature on the current list of supply chain woes for the energy industry.

Greater flexibility

Supply chain disruption impacts a company’s ability to manage cashflow and liquidity, and this has implications throughout the value chain. It is, therefore, prudent for oil and gas companies to focus some of their risk management efforts on exploring how they can better utilise their balance sheets to insulate themselves in the future. One option could be to reverse the trend of “just in time” and deploy cash to stock to de-risk the business, increasing inventories to 15-30 days rather than 10-15 and creating backup supply chains for critical parts. In the current oil & gas liquidity crisis this approach will be a challenge however in time we expect a shift to increasing inventories, to provide greater resilience to supply chain disruption.

Firms are responding to the short and long-term issues posed by supply chain disruption in a variety of ways. There has been a ruthless amount of cost-cutting in pursuit of operational efficiency across the industry. However, firms are also investing in their supply chain to mitigate risk. Many are diversifying supply chains and their contractor base while some are choosing to move parts of production closer to home.

In the longer-term, the benefits of greater equipment standardisation in the industry are clear: it offers a consistent approach; suppliers know what to deliver, and it is consequently easier to insure. In the same vein, consistency in the deployment of contractors offers similar reliability to operations. M&A activity is also likely to increase as firms battle cashflow issues and wrestle for market share.

Technological stimulus

The race to replace humans with robotics influences every part of the supply chain: autonomous vessels, driverless trucks, temperature controls and blockchain all provide greater transparency over exactly what happens to the product. It also reduces human error and risk, redeploying the workforce to more high-value activities.

Nevertheless, successful automation of the supply chain is reliant on third parties possessing compatible technology and using it correctly – this involves an inherent cyber risk as firms have no choice but to interface with external systems. Interconnectivity is also an emerging risk for non-damage business interruption.

Given they are operating in such a fast-paced environment where oil and gas companies fixate on the bottom line, technology companies in the supply chain may also struggle to remain current and relevant.

Risk transfer

The vast disruption to business caused by COVID-19, which is not covered in most traditional insurance policies, has alerted many companies to the need to review risks beyond buying insurance. When clients take a broad look at their risk exposures and potential consequences, they could be surprised by their vulnerability to events that aren’t, or can’t be, insured.

“Last year energy clients said their top three emerging risks were: commodity price risk, economic slowdown and accelerated rates of change in market factors. Respondents couldn’t have been more on the money.”

Aon’s Global Risk Management Survey is published every two years, and regularly 30 out of the 50 top risks are uninsurable – these are new and emerging risks that clients are most concerned about, but where insurance products aren’t keeping pace. Last year energy clients said their top three emerging risks were: commodity price risk, economic slowdown and accelerated rates of change in market factors. Respondents couldn’t have been more on the money, and there is significant opportunity for innovation in the insurance market as clients’ risk profiles continue to evolve in this extremely challenging market.

When firms are concerned about accelerated rates of change in market factors, a majority of the time, they are still thinking about insurable risk, which is only a minor part of the risk environment. There needs to be a greater awareness and acceptance that traditional insurance only covers so much. Firms need to look beyond risk transfer; the first step is to review risks and understand them, and Aon can support this with its comprehensive risk mapping services. Risks identified for clients include dependence on legacy software, critical third parties and environmental exposures.

Perhaps the most important paradox is the way in which the greatest risks (e.g., cyber, climate change and pandemics) are linked to important opportunities for the insurance industry to demonstrate its social purpose and confirm its relevance and offer more prevention and stronger protections.

To navigate these paradoxes, industry executives must embrace creative thinking, bold action, and continuous innovation —especially when it comes to technology and data. As challenging (and cost-intensive) as the upcoming investments will be in the near term, they are necessary for long-term success. The upside for individual firms — as well as the entire industry and society as a whole — is well worth the effort. Those firms capable of profound change will be those that enjoy the biggest upside in terms of dramatic growth and sustainable profitability.

Future proofing
5 years

Current circumstances could lead to the increased digitalisation of workstreams

Greater diversification into green energy by integrated oil companies, with a corresponding need to develop new supply chains.

5-10 years

The increased dominance of integrated oil companies will strengthen their ability to create greater efficiencies in the supply chain, elevating disparities within the industry.

10 years

The longevity of equipment will increase as the industry continues to evolve and this will impact supply chains and timelines as the need to approach suppliers for replacements reduces in frequency.

3D printing could also potentially offer low carbon and cheaper parts to the oil and gas industry.

10-15 years

Oil and gas companies will have to evolve their supply chains to meet new demands. The growing middle class in India and Africa will demand more energy stability. We will also see the evolution of model fossil fuels and the renewables supply chain in order to unlock new sources of power.

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