Research from the Cambridge Centre for Risk Studies shows a 40% increase in risk to cities’ GDP from geopolitics and security over the past four years, totaling almost $140 billion in 2019, the biggest growth of any risk factor. For the energy industry, in particular, recent expert testimony to the U.S. House of Representatives emphasized the close relationship between geopolitics and energy security, noting the pressure on gas supplies from Russia to Europe, owing to the ongoing conflict in Ukraine. This year is likely to be one where nascent trends of geopolitical instability continue to foster uncertainty and hazards in the energy market landscape.
Why the energy industry?
Energy companies have traditionally been particularly sensitive to geopolitical fluctuations. With assets and people spread across the globe, often in locations with tenuous political and security situations, energy companies have been required to grapple with associated risks to investments and operations.
These companies have also historically had fraught relations with governments that seek tight reins on the industry. In the 21st century, such existential threats are perhaps less likely to come from government imposition, but instead from shifts in market forces toward cleaner energy creation and consumption, driven by public awareness of the environmental impact of current practices. As much of the world seeks to move away from fossil fuels, energy companies will need to diversify to survive.
Managing distant time horizons
Companies in the energy sector look at time horizons that are far distant compared to those viewed by other sectors. As an industry whose shape was fundamentally imposed on it over a hundred years ago in 1911, it must look similarly far into the future to see the trends that are likely to shape it going forward.
The Shell Scenarios team are perhaps the most well-known practitioners of this kind of thinking, putting together models exploring the state of the world out to the year 2100. By comparison, the U.K. Ministry of Defence’s quadrennial Global Strategic Trends assessment, which is partly used to inform long-term defense procurement plans, looks 30-35 years into the future, so it is clear that the energy sector is exceptionally forward-looking.
It is an often repeated mantra that forewarned is forearmed. Understanding exactly why the energy industry is affected by geopolitical risks and how to manage its extended time horizons is valuable, but it is only half of the story. To accurately complete the other half, companies will need to know what the key drivers of geopolitical risk are in the shorter term in order to develop a successful risk management approach now.
From political instability to climate change and cyber risk, each of the threats is related but also has its own characteristics that will need to be understood in order that they can be managed. The next blog in this series will look at these drivers in detail, and how they can be viewed and managed by energy companies who want to protect themselves — and who are agile enough to see opportunity in risk.
Next in series: 7 key geopolitical drivers impacting the energy industry