Cost-cutting efforts in oil and gas industry could backfire

Cost-cutting efforts in oil and gas industry could backfire | Insurance Business

Cost-cutting efforts in oil and gas industry could backfire

The global energy marketplace is getting more competitive, forcing companies to streamline their operations. But the same efforts that are designed to keep the business afloat, could ultimately spell their downfall.

Better technology is increasing supply and lowering demand at an unprecedented moment in the global energy marketplace. “The advent of electric vehicles and the growing pressures to decarbonise the transportation sector means that oil is facing significant competition for the first time,” said BP’s chief economist, Spencer Dale, and Bassam Fattouh, director of The Oxford Institute for Energy Studies, in the oil behemoth’s newly released annual long-term outlook.

As a result, companies are streamlining their operations to get ahead, but in doing so are exposing their operations to critical risks.

“There’s no doubt with the digitisation of industry in the global economy, companies have to become much more efficient in what they do to compete,” says Andrew Herring, energy practice leader at Marsh. “At Marsh’s energy conference in Dubai [earlier this month], a refinery CEO stood up and said they’d had to digitise their entire refinery operation to turn a profit at all because of the very competitive global marketplace.”

More and more, companies are integrating and consolidating their operations to maximise their profitability in the new era of competition. While those actions increase profitability and optimisation within the industry, they also expose companies to new levels of contingent business interruption risk, according to Marsh’s report, ‘Rethinking Business Interruption Risks in an Optimized Oil and Gas Industry,’ just released at the firm’s bi-annual energy industry conference.

Greater integration and consolidation of operations – achieved by sharing central utilities, support, or logistics facilities, for example – may look good on the balance sheet, but it creates problems for risk managers. “The effect of both of these is that they remove some of the business resilience,” says Herring. “For instance, if you decide you can do just-in-time management of your supplies to your customers, you can remove the need for large areas of storage of product. That’s going to save you money, but it means if there’s any interruption, you will start losing revenue immediately. You have no flexibility in your operations from that standpoint.”

“It also has the potential to create new critical areas of operation where one unit going down will actually impact whole value chain for your business. You’ll end up with more criticality of specific nodes in the operation.”

Look no further than the case of Millennium, an Australian chemical producer, for evidence that failure to review and understand these new exposures can cause catastrophic damage to your business. The company recently lost a US$10m lawsuit seeking contingent business interruption coverage from its US insurers. The company’s natural gas supplier for a facility in Western Australia suffered an explosion, forcing Millennium to shut down production. But the insurer claimed – and the court agreed – that only the pipeline delivering the gas, not the gas producer, was a direct supplier. “The underwriters would be responsive so long as they understand the risk that exists,” says Herring. “It’s if they don’t know about it that they’re going to impose this restriction to first-party exposures.”

In the new competitive global energy marketplace, Herring says risk managers will have to identify three things in their regular business interruption reviews: “They have to identify where the critical nodes are, what resilience does exist, and any interdependency that’s in the supply chain.”

 

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