Managing risk through analytics: some fresh perspectives for the power industry

Industry Insights
Typography

Introduction – a catastrophic hurricane season

This year’s Atlantic hurricane season has brought a great deal of devastation to the Caribbean region and parts of the US. Puerto Rico faced three major hurricanes in a row, with the first Category 4 hurricane (Maria) to cross the country since 1932. With wind speeds reaching up to 160mph, Maria caused extensive damage to the island and its infrastructure including its power distribution network.The hurricanes have prompted interest in ways of shifting island power grids toward greater reliance on renewable energy and greater power preservation techniques. Centralised power grids have showed deficiencies in resilience to storms and experts consider that smaller diversified grids could provide a solution and lower costs. Rebuilding the same type of power infrastructure could mean similar damage and destruction in the future and such reinvestment could prove unsustainable in the long run.The impact of the recent hurricanes on the US power sector was also significant. Harvey caused outages to substations, power plants and transmission lines in Texas and along the US Gulf coast. Damage was caused by both the devastating wind forces and the widespread flooding, which some considered to be a ‘1 in 500 year’ loss event (i.e. a 10% chance of this loss occurring within 50 years)At its peak, over 10,000 MW were offline, fuel supplies were affected and personnel were not able to reach power generating facilities. Hundreds of high-voltage transmission lines, including several 345kV lines and more than two hundred smaller lines experienced storm-related outages. Outages were also reported for wind turbines which normally shut down at 55mph winds.In the aftermath of such events companies often turn their attention to resilience. The best way to achieve this is through a holistic approach to risk - from analytics through insurance to managing the broader enterprise risks.

The changing risk profile of the power industry

A more complicated energy mix

The changing power industry risk landscape is forcing power companies to radically re-think their business and operating models. We have seen players moving to a more ‘retail’ oriented mentality and investing in new technologies to reshape customers’ experience. As the commercial viability of different renewables evolves, the energy mix is getting more complex. Companies are spreading their bets and this has significantly impacted their Capex and Research & Development (R&D) spending. There have also been increasing challenges to market position from several fronts: deep-pocketed oil and gas players seeking greater downstream presence and agile tech players and start-ups deploying technology to gain an edge.

Hard & Soft Risks

A power company’s risk register will typically describe certain “harder” risks using financial measures and other, “softer” risks using qualitative measures.Most companies employ analysts to measure particular “hard” risks such as commodity prices, bank loan interest rates, bond rates and currency fluctuations. Where financial instruments are available and cost effective, they will then decide the extent to which they wish to pay to hedge these risks.These “hard” risks are characterised by an abundance of data and mature yet constantly developing risk transfer markets. Analysts working in these areas look at historical experience, economic factors and exposure metrics to project how these risks are likely to develop over the coming months and years, and the range of volatility around these average expectations.“Soft” risks tend to arise from many, volatile and opaque contributory factors, often including human behaviour such as financial crime, fraud, changing regulations and sanctions. Senior management, investors and local regulators want evidence that the company has a real understanding of both its upside and downside risks, with proper reference to the company’s risk appetite.Power companies are therefore increasingly asking the following questions along the transformation journey:

  • Our company is a very different organisation now - how has this changed our risk profile? Is my insurance strategy still appropriate?
  • As our reliance on technology deepens, what does this mean for our cyber risk? What does this mean for our reputational and operational risk?
  • As our company evolves, what would happen if our employees’ skills and capabilities do not realign to changing business needs?
  • Are senior leaders fluent in the new realities of the business? How are the portfolio changes impacting the organisation’s culture?

Quantifying Risks

“Our company doesn’t need heavy-duty analytics - we’re insured”“Our company doesn’t need heavy-duty analytics - we’re insured”Insurance is just one means of risk management; while not addressing many of the key risks that power companies face, it can provide a financially efficient form of risk transfer for a range of risks from property to liability to D&O.Today’s processing power is sufficiently advanced and cheap to enable actuaries and catastrophe analysts to model more risks. The insurance industry is increasing its reliance on analytics to help them understand risks and to set pricing guidelines for their underwriters.Fortunately, the power sector increasingly has access to the analytical power and information to address this concern. Growing databases of client and industry loss and exposure information and sophisticated analytical and catastrophe modelling tools are enabling better risk models to be created, allowing companies to objectively answer the key insurable risk questions:

  • What is the loss profile of the risks: how many losses are expected each year (frequency) and how large will they be (severity)?
  • Are our assets and operations exposed to catastrophic hazards and climate risk and if yes, what could be the potential financial impact?
  • How much risk should we retain, how much insurance should we buy and what should this insurance cost?
  • How can I reduce my risk costs through alternative policy structures and risk mitigation?

Credits: Power and Renewable Energy Market Review 2018

 

 

 

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