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17 April 2020Insurance

Climate risk, ESG coupled with COVID-19 poses significant challenges for energy insurers

A new report suggests that climate change risk and environmental social governance (ESG), as well as the challenge faced in loss of demand due to the COVID-19 pandemic, will have a transformative effect on the energy insurance sector.

Analysts at Willis Towers Watson noted that the recent oil price war and the reduction in demand for hydrocarbons as a result of the current COVID-19 pandemic will also have a significant impact on future energy industry risk management strategies.

The last 12 months have been challenging ones for the energy industry. However, it is the issue of climate risk and wider ESG factors that will have a significant impact on the future shape of the industry," said Graham Knight, head of global natural resources at WTW.

"We cannot underestimate the immediate challenge faced in loss of demand as a result of COVID-19 and the impact of the recent oil price war, notwithstanding the agreement now reached by OPEC+ to cut production by 10% of global supply."

While it is still too early to forecast exactly how these twin factors will play out in the coming months, WTW highlighted that the potential effects on the energy industry are "obvious".

It expects reduced capital expenditure, a reduction of exploration and production activities, lower refining margins and lower business interruption valuations.

"It will also have a knock-on effect on premium income levels for an insurance market that remains unprofitable for most lines of business,” it noted.

ESG formed the key theme of the report, which highlighted that the transition to a low carbon economy requires a fundamental reappraisal of energy company climate risk; and achieving a satisfactory ESG rating will be critical in enabling energy companies to attract and maintain the support of key stakeholders in the future.

The report showed that the capacity in upstream market has reached a record level of $8.73 billion from $8.10 billion in 2019. For downstream, the capacity has declined for the second successive year, down to $5.978 billion from last year’s $6.428 billion.

The run of benign loss years in upstream continues, with only three losses in excess of $100 million during 2019. The downstream also shows a significant number of losses over $100 million, with one major loss significantly above $1 billion.

Overall, the upstream market remains profitable, however, premium income levels are still low by historical standards, and certain sub-sectors of the upstream market such as offshore construction, have been hit by attritional losses. For downstream and liability insurers, their portfolios remain firmly in the red and the long road back to profitability is uncertain.

The rating increases are still very modest (2.5-5 percent on average) compared to downstream, which features increases well in excess of 20 percent for virtually every type of programme, and significantly more for refinery and petrochemical business.

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