Friday, 20 July 2012
Risk management key to Arctic puzzle
New business opportunities in the Arctic as a result of climate change and developments in technology must be carefully balanced against the inherent risks and uncertainties of operating in the planet’s final frontier, according to experts gathered in London to discuss Lloyd’s Arctic Opening: Opportunity and Risk in the High North report.
The consequences of poor risk management at companies operating in the region, and any resultant disaster that caused damage to its environment, would be drastic for all industry looking to explore its business opportunities, the experts agreed.
Given the Arctic’s ecological importance and standing there are unlikely to be any second chances afforded to industry, they warned. One company’s mistake will be felt by all, they explained.
The seemingly inevitable spread of oil and gas exploration in the Arctic registered particular concern. With a lack of regulations in place to fully govern the risk, the actions of energy companies must be kept under scrutiny, the panel of insurers, scientists and researchers said.
Environmental change in the Arctic, which is causing changes such as retreating sea ice, and technology progress, is opening up new opportunities for business in the region.
Opportunities as a result include further exploration of oil and gas and much shorter shipping routes.
“Whilst change is happening I think it is important not to be overtaken by that change but to take a step back as businesses, as governments, and consider the opportunities and risks and weigh the uncertainties. These are really critical for business decision-making, but also critical for governments and policy frameworks that will determine to a large degree how and when development will take place,” Charles Emmerson, Senior Research Fellow at Chatham House and lead author of the report, told the gathering in London.
As such the Lloyd’s Arctic report focuses on three key aspects—opportunity, risk and uncertainty.
Mr Emmerson was keen to stress that the report does not argue against business development in the Arctic, but rather makes a case for development based on sound knowledge and a strong understanding of the risk and uncertainty of Arctic conditions.
“Our knowledge of the Arctic is surprisingly limited and establishing that knowledge base is absolutely key. The conditions and risks associated with those changes can change quite quickly. In terms of Arctic change we are not at the end of the process, it might be that we are very much at the beginning,” he explained.
As Tom Bolt, Lloyd’s Director of Performance Management, pointed out, the Arctic is the last physical frontier on the earth’s surface and as such needs to be treated with care.
He believes the risks can be managed in a way that allows industry to thrive. But, to achieve this will require all of the ingenuity and innovation at the disposal of business and the risk transfer community.
“We need to think about value in a new way, not just financial value but understanding and being sensitive to the environmental values, as well as needing to think about reputational value and the other risks that the Arctic represents. We are here to push businesses that choose to expose their capital in a risk-taking sense to the new risks,” he said.
All of the experts on the panel debate agreed that careful risk planning will be key to managing sustainable growth in the Arctic.
It is a conclusion shared by the report that was launched in Oslo, Norway in April.
“Given the extreme and fast-changing risks facing companies in the Arctic, robust risk management approaches will be vital to allow sustainable economic development and ensure that all stakeholders can benefit from opportunities,” it says.
Robust risk management is critical because the knock-on effects of an environmental disaster in the Arctic would be drastic for every company operating in the region, according to the experts.
In particular they raised concerns over the effects on the energy sector as a whole should one company cause pollution due to an oil spill. This concern runs further than astronomical clean-up costs.
“We are not suggesting in this report that a fuel spill is necessarily more likely to occur in the Arctic than elsewhere. But the consequences if they do are very, very serious and I would say more serious that in other parts of the world,” explained Mr Emmerson.
“There would obviously be environmental consequences but also commercial and political consequences and these consequences would never affect one company. If something went wrong it is not that you just see a few billion shaved from the value of one company, I think you would see projects shut down across the area. So I think the need to look at reputational and political risk in a broader way is going to be absolutely key,” he continued.
These far-reaching consequences would likely result from protest and reprisal from various stakeholders around the world that view the Arctic as a site of outstanding ecological and environmental importance.
“I think this should be driving a very strong interest amongst companies to make sure they are not only managing their own risks and uncertainty but they manage the risk and uncertainty of their peers,” continued the report’s lead author.
Bernt Hellman, Active Underwriter at Skuld 1897, the Lloyd’s marine and energy syndicate, agreed: “If we do not get it right now and an accident or catastrophe occurs then that is it. There is not going to be any willingness, publicly or politically, for a second chance.”
He also believes that the risk industry is not yet ready for full Arctic exploration. It is not an environment in which lessons can be learnt as commerce expands, he added. “It is not impossible to become ready but we shouldn’t do things first and then build up readiness as we go along. As we have said this is not about getting things right for the next season or next year.”
The consequences of an environmental disaster in the Arctic are heightened due to the various jurisdictions that govern activities in the region, the experts agreed. The lack of a single and developed set of regulations to run rule over energy companies’ safety standards is a further concern.
“There is a question of how one moves towards common and high regulations across the Arctic,” pointed out Mr Emmerson.
Whilst the Arctic Council is making moves towards this end it is not yet ready to implement rules.
“I think it is finding its way but there are certainly variations across the Arctic in the way that national rules will impinge on exploration. The case for the Arctic Council, or some other elected body, that can actually apply an appropriate standard of regulation and take that across the whole of the Arctic, is going to be vital. At the moment I still don’t quite see how the council is going to do that. It looks the obvious organisation but they are still not in the position to control that,” said Dr Cynan Ellis-Evans, Head of the National Environmental Research Council, Arctic Office.
The decision to explore the Arctic should not be left to oil companies, said Skuld’s Mr Hellman.
“At the end of the day it is all about authorities and governments. What I would like to see is the Arctic Council come together and put in place a framework and introduce a set of rules. They should be deciding what you (oil companies) have to prove to get a license. Currently there are several different states taking different approaches. It shouldn’t be left to an oil company to decide whether they should go into the Arctic or not, that is something that the public and the interested nations should be doing via their council,” he argued.
However, as Michael Kingston, Senior Associate at law firm Clyde & Co pointed out from the floor, European and global regulators are also struggling to effectively police oil and gas firms. In particular they continue to struggle to ensure that insurance is in place to clean up any large spills.
“The EU has its own issues in trying to come up with a solution and the Arctic Council faces a similar problem. So the fact that people are positively addressing it in relation to the Arctic will hopefully knock heads together to come up with a solution that doesn’t just exist in the Arctic but on a EU and worldwide basis,” he said.
Mr Kingston pointed out that current UK market limits for a spill are only around €250m. With a big incident likely to cost far more in clean-up costs, the question for authorities across the world is how to fill the gap above and beyond this amount.
“That is the problem the EU is dealing with and so, by analogy, is the Arctic Council. The key is to get regulation in place and try and get some sort of agreement, but the question really is an open debate at the moment,” he pointed out.
Experts at the event called on the insurance industry to play its role in protecting the Arctic and future opportunities by pricing risk accordingly and demanding best practice risk management. This would change market practice, some said.
But, as Mr Hellman pointed out, many of the largest oil and gas companies that may venture into the Arctic can self-insure their risks. With the limits currently available this is often their best option.
- Investment in science and research—both by government agencies and by private companies—is essential to close knowledge gaps, reduce uncertainties and manage risks. Arctic economic development can only proceed at a rate that takes into account these factors, that can be measured against environmental baselines and that recognises the primary role of governments in setting frameworks and establishing public policy priorities. Further research is required to ensure future development takes place sustainably and does not cause irreparable damage to the environment.
- Major investment is required in infrastructure and surveillance to enable safe economic activity. In many areas—shipping, search and rescue—infrastructure is currently insufficient to meet the expected demands of economic development. Public/private cooperation is needed to provide this infrastructure.
- Full-scale exercises based on worst-case scenarios of environmental disaster should be run by companies with government involvement and oversight to provide a transparent account of the state of knowledge and capabilities, to foster expertise and to assuage legitimate public concerns.
- Companies have a responsibility and interest in establishing industry-wide standards and expectations for safety and stewardship, through the Arctic Council, through the International Maritime Organisation or through industry associations. Failure by one company will have impacts for others.
- Integrated ecosystem-based management, incorporating the full range of economic factors, is needed in order to avoid one activity harming and displacing others and to take full account of the cumulative impacts of development. Long-term viability should be a key policy consideration for governments, business and other stakeholders.
- The mosaic of regulations and governments in the Arctic creates a multi-jurisdictional challenge for investment and operations in the Arctic. Working through the Arctic Council to promote high and common regulations for Arctic economic activity is key. Both domestic legislation and international agreements should adopt a safety-case analysis rather than a prescriptive approach to risk management. States should provide strong and transparent oversight through appropriate government agencies, aligning risks and incentives for private companies with the broader public interest, and ensuring that private economic interests do not overcome legitimate public concerns.
- Governments should be clear about the purpose and scope of military activities in the Arctic, so as to prevent misunderstanding or miscalculations from developing. At the same time, additional state policing capacity in the Arctic—to police and protect—should be broadly welcomed.
- Given the extreme and fast-changing risks facing companies in the Arctic, robust risk management approaches will be vital to allow sustainable economic development and to ensure that all stakeholders can benefit from economic opportunities. In addition to embedding a risk culture throughout the organisation, adopting best practice standards and implementing practical risk mitigation measures, any comprehensive risk management approach is likely to consider transferring risks as a key part of the strategy.
Managing the risk
Given the complex and often unique risk challenges of the Arctic, all interested parties need to adopt a cautious and highly risk-aware approach to Arctic development.
Governments—singly and together—have an essential role in setting acceptable risk thresholds, monitoring activity and ensuring that knowledge gaps are sufficiently addressed. They will need to ensure that an integrated ecosystem-based approach is taken to development, to avoid the impacts of one activity harming and displacing others. They will also need to take full account of the cumulative impacts of development, as opposed to the impacts of a single project. Governments should insist upon a safety-case, rather than a prescriptive, approach to risk management.
Where activity takes place, corporate risk management is fundamental for companies to work safely, sustainably and successfully. As the report emphasises, there is a wide range of Arctic operating environments that present greater or lesser operational and other risks, but many parts of the Arctic remain extreme. Practices and technologies will need to be continuously updated to reflect a rapidly changing situation, and to ensure that best practice is constantly improved and consistently applied.
Though much research is ongoing and experience from outside the Arctic region may prove useful to operations within it, considerable further research and analysis is required to fully assess the range of hazards of Arctic operations and the vulnerabilities of technical systems, equipment and the Arctic environment to disruption and harm.