Tipping point for downstream energy?

Paul Sankey, Liberty Specialty Markets’ head of energy & construction, says the downstream energy market needs to do some serious thinking about its profitability.

2017 is expected to be the worst year for operational losses in the downstream energy market since the turn of the century. So far, losses for 2017 and 2018 are estimated at $5 billion and more than $3 billion, respectively. These figures are set against a global premium income for the downstream energy market currently believed to be in the region of $1.8 billion.

Recent loss activity includes refinery events in the US, Germany and Canada, plus a fire at a major petrochemical facility in Saudi Arabia. All these losses included business interruption impacts resulting from extensive property damage.

2018 was the first year since the turn of the century in which four distinct and unrelated operational events have produced combined losses of roughly $3 billion. This figure means the market is loss-making even before smaller attritional events are taken into consideration.

Status quo no longer

What exactly is happening? At a fundamental level, in order to estimate loss frequency and magnitude, the market relies on a relatively predictable frequency of large and attritional events combined with the usual modelling techniques. This allows pricing models to be set which produce a margin to give an adequate return on capital.

However, the experience of the last two years suggests that this may no longer be a reliable approach. In terms of where we go from here, it is clear the market needs to marshal all of its technical experience and knowledge to address this problem.

We need to understand the underlying root causes of each of these events individually, although history suggests that most of their causes have been experienced before by the industry.

If this does turn out to be the case, we will need to dig deeper to examine the sector’s underlying trends in order to better explain the reasons behind recent increased frequency of major events.

External issues may need much more detailed further analysis. Do we need a better understanding of the effects of merger and acquisition activity? What is the impact of governmental and regulatory involvement? What is the impact of operational pressures? And how do changes in workforce demographics affect an organisation?

New thinking needed

One example of the potential pressures produced by improved refining margins could be the predicted impact of the new International Maritime Organisation fuel specifications on global refining margins over the next two to three years.

Most analysts suggest that a significant upswing in refining margins is likely, particularly for highly complex refineries capable of handling sour crudes and converting these into the low sulphur fuels required by the new regulations. This ‘window of opportunity’ may be short-lived but the potential pressures on refinery managers can only be negative in terms of insurance loss frequency and magnitude due to significantly increased business interruption values.

It is very doubtful that any single factor will be the underlying cause of the recent increase in loss activity and magnitude.

However, it is likely that a combination of these have contributed significantly to the loss figures experienced by the market over the last two years and may well continue to do so for the foreseeable future.

As a market providing security and stability for our customers in the downstream energy business, our message has to be simple and clear. We believe the market landscape has changed due to a fundamental shift in loss activity in the business. We cannot go on assuming things will revert to normal and loss activity will somehow magically come back in line with the market premium income.

We need to dig deeper, question everything we do and produce new approaches to risk analysis and technical pricing that can ensure the stability and strength of the downstream energy market for many years to come.

Paul Sankey is head of energy & construction at Liberty Specialty Markets. He can be contacted at: marketingteam@libertyglobalgroup.com