7 Critical Risks Impacting the Energy Industry

The energy sector needs to be proactive in assessing its risks, from environmental impact and regulation changes to talent retention and recruitment.
By: | July 26, 2018 • 7 min read
energy industry

From oil refineries to coal mines and nuclear power plants to wind farms, the energy industry plays a big role in how households, businesses and companies, governments, transportation and more function.

Advertisement

Because this is an industry spanning global markets, across international economies and different geopolitical environments, the energy sector isn’t immune to emerging risks. But that doesn’t mean it shouldn’t be ready to face these critical issues as they continue to emerge. The following threats to the energy industry are some of the more important risks to watch in the coming years.

1) Global Warming and Climate Change

Our atmosphere is ever-changing. But in recent years, human activity has had an accelerating impact on how rapidly the climate changes. One of the biggest contributors to the “greenhouse effect” causing global warming is fossil fuel emission — of which, 80 percent of the world’s energy comes from.

The energy sector has worked diligently to curb carbon emissions, and one report from the U.S. Energy Information Administration found that electric power consumption of fossil fuels is at its lowest level since 1994. The report says this is likely due to a shift toward natural gas versus fossil fuels.

“The declining trend in fossil fuel consumption by the power sector has been driven by a decrease in the use of coal and petroleum with a slightly offsetting increase in the use of natural gas,” the researchers wrote.

“Changes in the fuel mix and improvements in electricity generating technology have also led the power sector to produce electricity while consuming fewer fossil fuels.”

One of the biggest contributors to the “greenhouse effect” causing global warming is fossil fuel emission — of which, 80 percent of the world’s energy comes from.

However, despite a desire to burn more effectively, environmentalists are cracking down on the energy sector in the hopes to influence how energy is produced moving forward.

The San Francisco Board of Supervisors, for example, unanimously agreed to a resolution urging the insurance industry to stop insuring and investing in fossil fuels altogether.

The board is pushing the city to screen its potential insurers for investments in coal and tar sands. The board also is encouraging the city to cut ties with insurance companies that insure “dirty” energy projects.

And San Francisco isn’t alone. It’s joining a trend stemming from Europe, where 17 of its large insurers have already divested about $30 billion from coal companies. Other insurance companies have stopped or limited insuring coal altogether, and two insurers stopped insuring for new tar sands projects entirely. The energy sector needs to keep up with how customers wish to consume energy or face a decline in demand.

2) A Rapidly Changing Industry

Another risk the energy industry faces: rapid change.

“This industry has more change going on than most,” said Scott Smith, vice chairman, U.S. power & utilities leader, Deloitte LLP. “It’s a changing workforce,

Scott Smith, vice chairman, U.S. power & utilities leader, Deloitte LLP

changing capital investment, changing how energy is produced all the way through to how it is consumed.”

There’s changing regulatory models as well as some states undergoing deregulation as well as different rates changing, he added, and a push for decarbonization of generation.

Decarbonization, according to Green Tech Media, is “the reduction of greenhouse gas emissions from the electricity sector as a response to climate change. This includes the rapid expansion of variable renewable energy, coal-to-gas fuel switching, solutions for intermittency, and the evolution of power market design.”

“You have a risk of a lot of stranded investments the industry has to deal with,” said Smith. But, he added, “[this industry] is better at change than given credit for. It won’t look the same in 10 years.”

3) Cyber Threats

“What’s going on in the industry is massive capital expenditures. It’s spending a lot for instance on modernization of the grid,” Smith said. He added that there’s roughly $52 billion a year going toward grid modernization as the grid transforms from mechanical to digital.

And while this will bring positives to the energy industry as it enters the digital age, new risks abound. Particularly in cyber.

Energy’s a highly targeted industry, said Smith. He added that it may very well be one of the most targeted industry for cyber attacks, because it impacts a lot of individuals as well as large companies.

In fact, a U.S. Department of Homeland Security recently disclosed information that Russian hackers were behind a series of power outages last year, leaving facilities in a blackout while they accessed utility control rooms.

“In a digital world there exists more opportunity for more bad actors to get into systems. Customers use different ways to connect their home, using smart devices — smart TVs, thermostats, connected refrigerators — they all have a cyber element. People with bad intent have more devices, more entry-points, to get in,” said Smith. “The ability to do harm is increased.”

Dave Venable, VP of cyber security, Masergy, told Forbes he has seen numerous cases of both state and non-state actors targeting energy and other critical infrastructure.

Advertisement

“Many of these systems were designed so long ago that equipping them with modern security countermeasures can be difficult,” Venable said.

He added more needs to be done in regards to the electric grid and that “rapid detection and isolation of intrusions results in higher levels of resilience,” eliminating or minimizing any impacts.

4) Regulation and Public Policy

One risk that has been ongoing in the energy industry is regulation and public policy.

As Smith said, there is a changing nature surrounding power and how it’s generated. With change comes new laws to match. The U.S. Department of Energy has some of the broadest responsibilities in regulating power generation and electric transmission, distribution and retailing across the country. With numerous legal bodies overseeing nuclear, electric, gas, coal, oil, petroleum and more, the energy sector needs to be in-the-know of how its local, state and federal jurisdictions are changing to comply with the law.

5) Tariffs and Trade Tension

“My company,” wrote Dan Eberhart, CEO of Canary LLC, for Forbes, “saw an almost immediate 20 percent increase in the cost of steel when [President Trump’s] tariffs were announced” in April of this year.

Canary, he explained, is one of the nation’s largest, privately-owned oilfield services contractors, and it “spends roughly $10 million a year on imported steel to make wellhead and pressure control equipment, valves and other apparatus used by oil companies in the exploration and production process.”

The U.S. energy industry relies on global steel imports for a majority of its operations. Steel is needed for drilling, for production facilities both on- and offshore, for petrochemical plants, refineries and pipelines. With tariffs in place, the supply chain is impacted, costing energy facilities millions.

By hiking up the costs on supplies, companies will need to cut back somewhere else. And it’s employment that will suffer most.

“The economic consequences of a trade war are a real threat to our employees just as they were starting to see the benefits of the president’s other policies,” continued Eberhart. “Higher supply costs could force us to lay off as much as 17 percent of Canary’s staff of 300 employees.” With less employees, another big risk arises for the industry: a talent shortage.

6) Talent Retention and New Hires

According to a talent crisis survey, “Addressing the energy industry talent gap, where should you put your energy,” KPMG LLP, with contributions from Rigzone, found that nearly 50 percent of the energy workforce will reach retirement age in the next five to seven years.

The report went on to identify several key factors contributing to the talent gap in the energy sector, including inadequately skilled/trained workers, a lack in technical skills required for this continuously-innovating industry, competition over a limited talent pool and a shortage of petroleum engineers.

7) Catastrophic Events

“As an industry utilities are very good at dealing with these events, but we see that there’s, a) more events, and b) there’s more to them,” said Smith.

Advertisement

And he’s right. Looking back at the past year alone, the U.S. had three major hurricanes, unprecedented wildfires, huge mudslides, tornadoes, hail storms and flooding. 2017’s weather-related natural disasters cost the U.S. $306 billion. Hurricane Harvey, which flooded Houston with over 50 inches of rain, totaled $125 billion alone.

And CAT events aren’t just caused by malicious weather; any attack to a facility’s infrastructure — from terrorist-related activity to a mass physical-cyber event — can impact the facility and shut it down.

These events are “going to be seen with greater frequency and severity,” said Smith. “The dollars involved are so much greater.”

When a CAT event rolls through, the energy sector is tasked with getting back up and running. Smith said this has become easier as technology expands and more events occur; the energy industry is able to learn from past events and recover quickly.

“But it’s more than just getting services back after these events. It’s dealing with other aspects such as regulators, insurance companies, different constituents,” he said. &

Autumn Heisler is the digital producer and a staff writer at Risk & Insurance®. She can be reached at [email protected]

More from Risk & Insurance

More from Risk & Insurance

Exclusive | Hank Greenberg on China Trade, Starr’s Rapid Growth and 100th, Spitzer, Schneiderman and More

In a robust and frank conversation, the insurance legend provides unique insights into global trade, his past battles and what the future holds for the industry and his company.
By: | October 12, 2018 • 12 min read

In 1960, Maurice “Hank” Greenberg was hired as a vice president of C.V. Starr & Co. At age 35, he had already accomplished a great deal.

He served his country as part of the Allied Forces that stormed the beaches at Normandy and liberated the Nazi death camps. He fought again during the Korean War, earning a Bronze Star. He held a law degree from New York Law School.

Advertisement




Now he was ready to make his mark on the business world.

Even C.V. Starr himself — who hired Mr. Greenberg and later hand-picked him as the successor to the company he founded in Shanghai in 1919 — could not have imagined what a mark it would be.

Mr. Greenberg began to build AIG as a Starr subsidiary, then in 1969, he took it public. The company would, at its peak, achieve a market cap of some $180 billion and cement its place as the largest insurance and financial services company in history.

This month, Mr. Greenberg travels to China to celebrate the 100th anniversary of C.V. Starr & Co. That visit occurs at a prickly time in U.S.-Sino relations, as the Trump administration levies tariffs on hundreds of billions of dollars in Chinese goods and China retaliates.

In September, Risk & Insurance® sat down with Mr. Greenberg in his Park Avenue office to hear his thoughts on the centennial of C.V. Starr, the dynamics of U.S. trade relationships with China and the future of the U.S. insurance industry as it faces the challenges of technology development and talent recruitment and retention, among many others. What follows is an edited transcript of that discussion.


R&I: One hundred years is quite an impressive milestone for any company. Celebrating the anniversary in China signifies the importance and longevity of that relationship. Can you tell us more about C.V. Starr’s history with China?

Hank Greenberg: We have a long history in China. I first went there in 1975. There was little there, but I had business throughout Asia, and I stopped there all the time. I’d stop there a couple of times a year and build relationships.

When I first started visiting China, there was only one state-owned insurance company there, PICC (the People’s Insurance Company of China); it was tiny at the time. We helped them to grow.

I also received the first foreign life insurance license in China, for AIA (The American International Assurance Co.). To date, there has been no other foreign life insurance company in China. It took me 20 years of hard work to get that license.

We also introduced an agency system in China. They had none. Their life company employees would get a salary whether they sold something or not. With the agency system of course you get paid a commission if you sell something. Once that agency system was installed, it went on to create more than a million jobs.

R&I: So Starr’s success has meant success for the Chinese insurance industry as well.

Hank Greenberg: That’s partly why we’re going to be celebrating that anniversary there next month. That celebration will occur alongside that of IBLAC (International Business Leaders’ Advisory Council), an international business advisory group that was put together when Zhu Rongji was the mayor of Shanghai [Zhu is since retired from public life]. He asked me to start that to attract foreign companies to invest in Shanghai.

“It turns out that it is harder [for China] to change, because they have one leader. My guess is that we’ll work it out sooner or later. Trump and Xi have to meet. That will result in some agreement that will get to them and they will have to finish the rest of the negotiations. I believe that will happen.” — Maurice “Hank” Greenberg, chairman and CEO, C.V. Starr & Co. Inc.

Shanghai and China in general were just coming out of the doldrums then; there was a lack of foreign investment. Zhu asked me to chair IBLAC and to help get it started, which I did. I served as chairman of that group for a couple of terms. I am still a part of that board, and it will be celebrating its 30th anniversary along with our 100th anniversary.

Advertisement




We have a good relationship with China, and we’re candid as you can tell from the op-ed I published in the Wall Street Journal. I’m told that my op-ed was received quite well in China, by both Chinese companies and foreign companies doing business there.

On August 29, Mr. Greenberg published an opinion piece in the WSJ reminding Chinese leaders of the productive history of U.S.-Sino relations and suggesting that Chinese leaders take pragmatic steps to ease trade tensions with the U.S.

R&I: What’s your outlook on current trade relations between the U.S. and China?

Hank Greenberg: As to the current environment, when you are in negotiations, every leader negotiates differently.

President Trump is negotiating based on his well-known approach. What’s different now is that President Xi (Jinping, General Secretary of the Communist Party of China) made himself the emperor. All the past presidents in China before the revolution had two terms. He’s there for life, which makes things much more difficult.

R&I: Sure does. You’ve got a one- or two-term president talking to somebody who can wait it out. It’s definitely unique.

Hank Greenberg: So, clearly a lot of change is going on in China. Some of it is good. But as I said in the op-ed, China needs to be treated like the second largest economy in the world, which it is. And it will be the number one economy in the world in not too many years. That means that you can’t use the same terms of trade that you did 25 or 30 years ago.

They want to have access to our market and other markets. Fine, but you have to have reciprocity, and they have not been very good at that.

R&I: What stands in the way of that happening?

Hank Greenberg: I think there are several substantial challenges. One, their structure makes it very difficult. They have a senior official, a regulator, who runs a division within the government for insurance. He keeps that job as long as he does what leadership wants him to do. He may not be sure what they want him to do.

For example, the president made a speech many months ago saying they are going to open up banking, insurance and a couple of additional sectors to foreign investment; nothing happened.

The reason was that the head of that division got changed. A new administrator came in who was not sure what the president wanted so he did nothing. Time went on and the international community said, “Wait a minute, you promised that you were going to do that and you didn’t do that.”

So the structure is such that it is very difficult. China can’t react as fast as it should. That will change, but it is going to take time.

R&I: That’s interesting, because during the financial crisis in 2008 there was talk that China, given their more centralized authority, could react more quickly, not less quickly.

Hank Greenberg: It turns out that it is harder to change, because they have one leader. My guess is that we’ll work it out sooner or later. Trump and Xi have to meet. That will result in some agreement that will get to them and they will have to finish the rest of the negotiations. I believe that will happen.

R&I: Obviously, you have a very unique perspective and experience in China. For American companies coming to China, what are some of the current challenges?

Advertisement




Hank Greenberg: Well, they very much want to do business in China. That’s due to the sheer size of the country, at 1.4 billion people. It’s a very big market and not just for insurance companies. It’s a whole range of companies that would like to have access to China as easily as Chinese companies have access to the United States. As I said previously, that has to be resolved.

It’s not going to be easy, because China has a history of not being treated well by other countries. The U.S. has been pretty good in that way. We haven’t taken advantage of China.

R&I: Your op-ed was very enlightening on that topic.

Hank Greenberg: President Xi wants to rebuild the “middle kingdom,” to what China was, a great country. Part of that was his takeover of the South China Sea rock islands during the Obama Administration; we did nothing. It’s a little late now to try and do something. They promised they would never militarize those islands. Then they did. That’s a real problem in Southern Asia. The other countries in that region are not happy about that.

R&I: One thing that has differentiated your company is that it is not a public company, and it is not a mutual company. We think you’re the only large insurance company with that structure at that scale. What advantages does that give you?

Hank Greenberg: Two things. First of all, we’re more than an insurance company. We have the traditional investment unit with the insurance company. Then we have a separate investment unit that we started, which is very successful. So we have a source of income that is diverse. We don’t have to underwrite business that is going to lose a lot of money. Not knowingly anyway.

R&I: And that’s because you are a private company?

Hank Greenberg: Yes. We attract a different type of person in a private company.

R&I: Do you think that enables you to react more quickly?

Hank Greenberg: Absolutely. When we left AIG there were three of us. Myself, Howie Smith and Ed Matthews. Howie used to run the internal financials and Ed Matthews was the investment guy coming out of Morgan Stanley when I was putting AIG together. We started with three people and now we have 3,500 and growing.

“I think technology can play a role in reducing operating expenses. In the last 70 years, you have seen the expense ratio of the industry rise, and I’m not sure the industry can afford a 35 percent expense ratio. But while technology can help, some additional fundamental changes will also be required.” — Maurice “Hank” Greenberg, chairman and CEO, C.V. Starr & Co. Inc.

R&I:  You being forced to leave AIG in 2005 really was an injustice, by the way. AIG wouldn’t have been in the position it was in 2008 if you had still been there.

Advertisement




Hank Greenberg: Absolutely not. We had all the right things in place. We met with the financial services division once a day every day to make sure they stuck to what they were supposed to do. Even Hank Paulson, the Secretary of Treasury, sat on the stand during my trial and said that if I’d been at the company, it would not have imploded the way it did.

R&I: And that fateful decision the AIG board made really affected the course of the country.

Hank Greenberg: So many people lost all of their net worth. The new management was taking on billions of dollars’ worth of risk with no collateral. They had decimated the internal risk management controls. And the government takeover of the company when the financial crisis blew up was grossly unfair.

From the time it went public, AIG’s value had increased from $300 million to $180 billion. Thanks to Eliot Spitzer, it’s now worth a fraction of that. His was a gross misuse of the Martin Act. It gives the Attorney General the power to investigate without probable cause and bring fraud charges without having to prove intent. Only in New York does the law grant the AG that much power.

R&I: It’s especially frustrating when you consider the quality of his own character, and the scandal he was involved in.

In early 2008, Spitzer was caught on a federal wiretap arranging a meeting with a prostitute at a Washington Hotel and resigned shortly thereafter.

Hank Greenberg: Yes. And it’s been successive. Look at Eric Schneiderman. He resigned earlier this year when it came out that he had abused several women. And this was after he came out so strongly against other men accused of the same thing. To me it demonstrates hypocrisy and abuse of power.

Schneiderman followed in Spitzer’s footsteps in leveraging the Martin Act against numerous corporations to generate multi-billion dollar settlements.

R&I: Starr, however, continues to thrive. You said you’re at 3,500 people and still growing. As you continue to expand, how do you deal with the challenge of attracting talent?

Hank Greenberg: We did something last week.

On September 16th, St. John’s University announced the largest gift in its 148-year history. The Starr Foundation donated $15 million to the school, establishing the Maurice R. Greenberg Leadership Initiative at St. John’s School of Risk Management, Insurance and Actuarial Science.

Hank Greenberg: We have recruited from St. John’s for many, many years. These are young people who want to be in the insurance industry. They don’t get into it by accident. They study to become proficient in this and we have recruited some very qualified individuals from that school. But we also recruit from many other universities. On the investment side, outside of the insurance industry, we also recruit from Wall Street.

R&I: We’re very interested in how you and other leaders in this industry view technology and how they’re going to use it.

Hank Greenberg: I think technology can play a role in reducing operating expenses. In the last 70 years, you have seen the expense ratio of the industry rise, and I’m not sure the industry can afford a 35 percent expense ratio. But while technology can help, some additional fundamental changes will also be required.

R&I: So as the pre-eminent leader of the insurance industry, what do you see in terms of where insurance is now an where it’s going?

Hank Greenberg: The country and the world will always need insurance. That doesn’t mean that what we have today is what we’re going to have 25 years from now.

How quickly the change comes and how far it will go will depend on individual companies and individual countries. Some will be more brave than others. But change will take place, there is no doubt about it.

Advertisement




More will go on in space, there is no question about that. We’re involved in it right now as an insurance company, and it will get broader.

One of the things you have to worry about is it’s now a nuclear world. It’s a more dangerous world. And again, we have to find some way to deal with that.

So, change is inevitable. You need people who can deal with change.

R&I:  Is there anything else, Mr. Greenberg, you want to comment on?

Hank Greenberg: I think I’ve covered it. &

The R&I Editorial Team can be reached at [email protected]