The lenses through which geopolitical risk can be viewed apply to almost every business sector, and the energy industry is no exception. At every stage of the lifecycle of an energy project, new challenges and risks are emerging that, if not managed correctly, can threaten the very viability and long-term profitability of the project concerned. But how do these risks manifest themselves and how can they be mitigated?
Geopolitics high on boardroom agendas Geopolitical risks have always been with us, yet industry dynamics and global trends have caused their importance to rocket up board agendas over the last year. 61% of respondents of the Airmic member survey expecting geopolitical risk to become “harder to manage” in the next three years – 14% higher than the next biggest risk, climate and environmental disruption1.
For the energy sector, exploring geopolitical risks is important, if only because the industry experiences Newton’s Third Law from geopolitical drivers. This law states that when two bodies interact, they apply forces to one another that are equal in magnitude and opposite in direction. The third law is also known as the law of action and reaction2:
Action: In March 2020, we saw Saudi Arabia slashing its export prices after the collapse of an Opec production deal with Russia that had stabilised the market after demand drops as a result of COVID-193.
Reaction: Research commissioned by Lloyd’s suggests that demand in the coal sector is estimated to fall by at least 70% under 2°C compliant scenarios by 20304, and we’re seeing new regions rise to power. Energy classes such as renewables are also creating their own waves, with the promise of energy security and independence changing the power structures of regions and states5.
Unrest outbreaks in previously benign regions Over the last 12 months we’ve seen the ripples of natural, man-made and political upheaval spread far and wide, while environmental, technological and political changes are bringing with them any number of new uncertainties. At a societal level, the outbreaks of mass unrest in Chile, France and Hong Kong have made it clear that political risk events can arise suddenly in regions traditionally seen as risk-free, and the unfolding COVID-19 outbreak has highlighted the fragility of the global system to interconnected events.
At a political and national level, areas that were once regarded as predictable and stable have become volatile, and changes in international policy are bringing new uncertainty to long running conflicts. Many of these countries are prime suppliers of the Downstream energy sector and add a new dimension to the potential for Business Interruption claims. The uncertainty of these issues alone would be enough to keep executives up at night, even before factoring in ongoing attritional losses, aging infrastructure, rising Business Interruption losses and concerns around talent retention and attraction. It has never been more important to consider new ways in which geopolitical risks can be managed more effectively than by simple insurance purchase.
Dialling in on risk Foreseeing trends is often a matter of perspective and sometimes it helps to take a step back and look at challenges with fresh eyes. In the last Willis Towers Watson Energy Market Review6, we introduced you to the six lenses used to explore these nuances and build an integrated view of risk. Think of these lenses as focusing dials on a microscope. There isn’t one answer to viewing geopolitical risk under the lens – every company’s exposure is different, and the real value is in uncovering different perspectives to ask useful questions. Do you want to zoom out for the global macro view, or zoom in to a local issue? If you don’t have the expertise in-house to understand the issues, then who do you need to talk to?
Six lenses – an integrated approach to geopolitical drivers of risk
Organisations need to identify and understand their geopolitical risks and the connections between them in order to mitigate the risks and seize new opportunities, so that:
As our contribution to this Review, we wanted to set out three possibilities that bring these lenses to life, and which can be used to construct bespoke scenarios for clients. This is the approach we have taken across all our Natural Resources Reviews this year, and we would recommend looking at all the reports to understand the sector specific issues and consider how these may create secondary impacts for you.
Areas that were once regarded as predictable and stable have become volatile, and changes in international policy are bringing new uncertainty to long running conflicts. In the release of their ‘10 Conflicts to watch in 2020’ report7, Robert Malley, President and CEO of Crisis Group, summed up the challenge: “the understandings and balance of power on which the global order had once been predicated – imperfect, unfair, and problematic as they were – are no longer operative.”
The music has changed The music has changed, and nobody knows the steps; but when nations are waltzing, the outcomes aren’t bruised toes. Multinational businesses with many operations centres, multiple markets and complex supply lines are going to need to be vigilant to finance the economic and trade risks that are going to emerge as a result.
These changes aren’t just happening at the national level; a local perspective needs to be factored in. Establishing new sites can result in land use conflict and trigger localised political risk,8 and current sites can also serve as focusing points for local and international interest, from climate activism and communities who have been reliant on sites for their livelihoods, as well as local issues9. Both instances can cause reputational harm, investor uncertainty and local security issues.
Factoring in local opinion It is therefore vital that the state of community opinion, politics and the security situation are monitored and responded to, and that political and security risk management are integrated into corporate cultures. Predicting the occurrence and nature of political and social disruptions may seem impossible, but there are a series of different tools in the toolbox. For example, for political risk, threat assessments can make use of recent examples such as attacks on pipelines and oil-processing infrastructure to add additional context to ‘actor mapping’10; and analytics tools such as VAPOR11 allow global companies to assess the financial impact of political risk exposure that can feed into your company’s business continuity planning. While this kind of analysis won’t provide all the answers, red teaming and scenario building with these questions in mind can give you input on the ‘who, how and where’, to move from understanding to action:
As we move into 2020, the energy market continues to experience a backdrop of political volatility, investment inflection points, and an unfolding Environmental Social and Governance (ESG) landscape. Companies must manage a range of policy, investor, and societal pressures to move to a low-carbon energy system while still meeting expected global energy demand over the long term. Energy consumption is still increasing. We are going to need to make full use of digitalisation, robotics and artificial intelligence to increase safety standards and carry out precision extraction and processing that minimises environmental impacts. On the other side, before we reach 2030 we’re likely to see some major climatic events which will accelerate the sense of urgency that policy makers feel they need to instil to change the ways in which we generate power.
C-Suites should wake up to new policy landscape No stage of the energy market is safe from these drivers, and C-Suites need to consider the strategic direction of their businesses against an evolving policy landscape. Being geographically blessed with resources isn’t going to be enough for long-term value strategies – ESG is here, and countries accounting for almost half of global demand have implemented or have plans to enact frameworks aimed at meeting the transition to a low carbon economy.
Fossil fuels need to respond to challenge Around the world we are seeing a gradual shift from policies that have supported oil and gas production to policies that instead are starting to disincentivise fossil fuels, including carbon pricing and the European Union’s Emission Trading Scheme. While these shifts are slow at the moment, the EU is already moving to formalise ESG standards, which is adding to the momentum around coalescing fragmented, voluntary guidelines into formal, regulated standards. An in-depth review of the ESG landscape can be found in the first chapter of this Review; you should take note of what central banks are discussing because change is coming. Quantifying how possible futures will affect companies can allow them to make choices based on their risk appetite, capability and aspirations, and to use existing expertise to create new revenue streams and drive efficiency. The changes are going to vary across the energy sector, but this is the time for risk managers and boards to pivot a risk to an opportunity. This makes access to research and innovative partnerships essential to gauging the energy transition and is already resulting in forward thinking companies exploring new distribution models that have the potential to disrupt them if they stand still12 and investments in digital technologies for faster, safer, more reliable, efficient and resilient production.
With the sector looking to harness digitalisation and technology for efficiency gains and to be more reactive to demand trends, it is essential to understand the strengths and weaknesses of embracing these capabilities. With estimates of unplanned downtime already costing the oil and gas industry an estimated $50 billion each year, being aware of the art of the possible has never been more important for risk managers to ensure scenario planning and business continuity exercises are relevant.
Cyber-attacks Technology has improved resilience to countless threats from an individual level to a societal level. It also facilitated attacks against Saudi Aramco holdings in northern Saudi Arabia in September that initially halved the kingdom’s output13. While the name Refined Kitten might evoke the image of a cuddly pet, Microsoft have announced that is a hacker team, believed to be backed by Iran, that can do things virtually no other known hacker group can do, namely infiltrate the control systems of critical national infrastructure, including oil refineries and electric utilities14.
No one size fits all answer Geopolitical drivers associated with digitalisation and cyber vulnerabilities are deep and varied, which is one of the reasons why cyber risks continue to be at the top of board agendas, and why there isn’t a one size fits all answer. The range of cyber drivers and vulnerabilities is vast, and the need for cyber expertise or a dedicated CISO have never been more crucial for business resilience. Cross sector working groups and access to state-of-the art science can play a role in understanding the art of the possible, and our team is tapping in to this knowledge and bringing it closer to our clients through initiatives such as the Willis Research Network.
Delivering cyber resilience is a core part of effective corporate governance for energy companies. This year we’ve seen energy companies participating in initiatives such as the World Economic Forum Systems and Cyber Resilience working group to produce guidance and principles that will help board members meet the unique challenges of managing cyber risk in the electricity ecosystem. Back in 2017, The Economist published a story entitled “The world’s most valuable resource is no longer oil, but data”15, and this is where the energy sector should be thinking about the decades of information they have on responding to supply and demand dynamics, and how they can secure and use it.
Given the speed, regularity and relative surprise of such events, and the unforeseen decisions, it may be time to reconsider how well businesses really are prepared for the impact of geopolitical events. In one of our recent articles, General Sir Richard Shirreff (former Deputy Head NATO) set out how the military approach to risk management might help the boardroom16, and this should be a question that all mature companies ask themselves. What risks are on the horizon and who can speak to them or be invited in to build awareness and understanding? This is where board composition, NED selection, and trusted advisors are increasingly important to encourage a holistic view that recognises and explores interconnectivity of risks and how these can be pivoted to opportunity. When designing scenarios to build resilience to these changes, energy companies should assemble multi-disciplinary, diverse teams from across the organization. This is the approach that our geopolitical team takes, and it reduces the possibility of blind spots. A classic example of the power of scenario planning is the approach pioneered by Shell. When the 1973 oil crisis hit, Shell was better prepared than its competitors because its management had already considered a comparable scenario17.
Learn from the innovation journeys of other sectors It is also important to consider the opportunities and ensure scenarios explore positive futures. Companies should learn from the innovation journeys of other sectors to think outside the box to create new value in future stranded assets18. As a result of this kind of thinking, innovative companies are investing in new technologies, diversifying their models, and in some cases working with local governments to transform sites into new uses that take advantage of transport links, proximity to transmission lines, and their detailed site knowledge to create renewable energy sites19, gas capture20, battery storage locations21, vertical farms, housing, and tourism, which in turn can reduce regional inequality that can develop into social unrest22. As you read the Review, think about the trends and drivers and ask yourself: are these issues on our list as risks or opportunities, and do we have a plan? Do you want to drive the action, or react to a situation you’re not ready for?
Lucy Stanbrough is Emerging Risks Research Manager for the Willis Research Network at Willis Towers Watson in London.
1 2019 Airmic member survey https://www.airmic.com/news/guest-stories/rethinking-geopolitical-risk 2 https://www.britannica.com/science/Newtons-laws-of-motion 3 https://www.ft.com/content/755663c0-62ad-11ea-a6cd-df28cc3c6a68 4 https://www.lloyds.com/~/media/files/news-and-insight/risk-insight/2020/below2c_insuranceforalowcarboneconomy_deepdives_pdf.pdf 5 IRENA http://www.geopoliticsofrenewables.org 6 https://www.towerswatson.com/assets/pdf/power-renewable-energy-market-review-2019.pdf 7 https://foreignpolicy.com/2019/12/26/10-conflicts-to-watch-2020/ 8 https://doi.org/10.1016/j.erss.2015.06.008 9 https://www.canada.ca/en/environment-climate-change/services/climate-change/task-force-just-transition.html 10 See p.34 http://www.actuarialpost.co.uk/downloads/cat_1/Willis%20Towers%20Watson%20EMR%202016.pdf and p.28 https://www.willistowerswatson.com/-/media/WTW/Insights/2017/09/mining-review2017.pdf for examples from the Energy and Mining markets 11 https://www.willistowerswatson.com/en-GB/Solutions/services/vapor 12 https://www.atlanticcouncil.org/in-depth-research-reports/report/the-role-of-oil-and-gas-companies-in-the-energy-transition/ 13 https://www.reuters.com/article/us-yemen-security-saudi/yemens-houthis-say-they-fired-at-aramco-other-saudi-targets-idUSKBN1ZS1SA 14 https://www.willistowerswatson.com/en-GB/Insights/2019/12/what-you-should-know-about-the-changing-cyber-risk 15 https://www.economist.com/leaders/2017/05/06/the-worlds-most-valuable-resource-is-no-longer-oil-but-data 16 https://www.willistowerswatson.com/en-GB/Insights/2019/12/geopolitical-risk-and-how-experience-of-the-battlefield-might-help-the-boardroom 17 The summer reader’s guide to scenario planning https://www.willistowerswatson.com/en-GB/Insights/2019/08/the-summer-readers-guide-to-scenario-planning 18 https://theconversation.com/coal-mines-can-be-closed-without-destroying-livelihoods-heres-how-124336 19 https://coloradosun.com/2019/05/29/guzman-tri-state-coal-plant-offer/
20 https://www.bgs.ac.uk/downloads/start.cfm?id=1370 21 https://pureportal.strath.ac.uk/files/19668385/RevManuscript_1_.pdf 22 https://www.jbs.cam.ac.uk/faculty-research/centres/risk/publications/geopolitics-and-security/
