By Ernest Eng ,
Regional Specialty Leader Marsh Advisory, and Head of Analytics, IMEA
06/02/2024 · 5 minute read
Climate-induced losses are already material events forcing organizations to develop new strategies and adapt business models to protect their assets and balance sheets.
For instance, in the US there were 376 confirmed weather/climate disaster events with insured losses exceeding US$1 billion between 1980 – 2023.
Extreme weather and natural disasters — including hurricanes, droughts, floods, and heatwaves — can lead to injury and death, property damage, supply chain disruptions, reputational damage, and more. Business leaders across many industries now consider natural disasters as one of the top five risks globally, according to the World Economic Forum’s Global Risks Report 2024.
For the energy industry, climate vulnerability is especially relevant for certain asset classes where building codes may be insufficient given the rising exposure to extreme events. Energy infrastructure is often not designed to withstand more frequent and intense weather extremes, either because of its age, or due to its function. This is one of the driving factors behind the cost multiplication of climate-related losses. Geographical variations in weather patterns add another layer of complexity for multi-site/multinational operators who may have assets exposed to heat stress and coastal flooding/inundation in the Middle East, versus tropical cyclones in Asia or Australia. Companies with direct and indirect exposures in vulnerable regions may experience higher credit and market risks, as well as increased underwriting scrutiny, which can affect operational expenses and profitability.
The reality of climate change means companies have to rethink their infrastructure needs and design. As energy systems become more complex with the integration of different types of technology, infrastructure resilience is no longer only about returning single assets to full operation after a disruptive event. When interdependent parts of a system are affected, the system as a whole is at risk. Incidents such as the recent wildfires in Canada illustrate that restarting the energy system can be delayed by days, possibly weeks, if critical system parts cannot be restarted autonomously.
Proactive risk management may also mean that companies have to invest in additional infrastructure, such as backup systems and flood defense infrastructure.
The number of extreme weather events recorded each year have risen by a factor of five over the past 50 years. The US Energy Information Administration estimates that a high-impact hurricane could result in a temporary loss of monthly offshore crude oil production of about 1.5 million barrels per day (b/d) and a nearly equivalent temporary loss of refining capacity. And Marsh McLennan’s Flood Risk Index shows that 23% of the world’s power generation capacity is currently threatened by flooding, with exposure expected to increase to 37%, 41%, and 48% under the 1.5 °C, 2 °C, and 3.5 °C temperature increase scenarios.
Changes in the intensity and frequency of extreme weather events, as well as seasonal deviations from average weather conditions, affect current and future energy infrastructure, jeopardizing energy security and reliability. Potential impacts on energy systems include blackouts, shutdown of nuclear and thermal power plants due to extended heatwaves or droughts, and changing rainfall patterns affecting hydropower generation. In a recent survey, extreme weather events ranked among energy leaders’ top uncertainty issues in the US and in parts of Asia Pacific, Latin America, and Africa.
Facilities and infrastructure are typically designed for the expected weather conditions where they are situated, which partly explains why the impact of atypical and extreme weather events can be pronounced. Consider, for example, cold weather conditions in Texas in 2021 that led to plant shutdowns, or heatwaves in Europe that led to supply constraints.
Organizations that understand these risks and deploy resilient and adaptable infrastructure design will be best placed to reduce the potential impact of extreme weather losses.
Climate risk assessment scenarios can be challenging due to the unpredictability of weather events and the potential correlation of impacts on the global economy from factors such as involuntary migration, changing land use, and increased urbanization. Nevertheless, given the significance of climate risks and increased disclosures to stakeholders and regulators, these assessments are becoming mainstream as quantification methodologies and access to data supported by academic research continue to improve.
A key priority should be to gain a clear understanding of current and future climate risk as a basis for developing engineering and financial resilience and adaptation plans to provide confidence to all stakeholders including investors, customers, and regulators.
To aid preparedness to respond to potential climate induced losses, Marsh uses a three-step process to analyze the risk and resilience of three primary dimensions – hardware, software, and emergency response.
The energy transition offers the opportunity to develop a more robust and resilient energy industry.
The evolving risk landscape presents new demands for operators, including new regulations and growing scrutiny from investors and other stakeholders. Climate change and the increasing risk of weather-related losses represent an enterprise-wide risk with implications for operations, supply chains, environmental obligations, corporate reputation, and more. To mitigate weather-related losses, organizations are increasingly conducting sophisticated climate risk assessments to evaluate the scale, nature, and complexity of their exposures.
Increasing the resilience of energy infrastructure to safeguard against extreme weather events is no longer optional — it is now a necessity. Energy systems must be smarter, not just stronger; and now is the time for energy leaders globally to focus on aiming to future-proof the assets that power our world.