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Risk Management Can We?. Presented by Dan C. Jones Clinical Assistant Professor University of Houston May 20, 2009 Energy Risk USA 2009. Lets see how well we have done. 1937- New London, Texas Natural Gas explosion is school over 200 killed

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risk management can we

Risk Management Can We?

Presented by

Dan C. Jones

Clinical Assistant Professor

University of Houston

May 20, 2009

Energy Risk USA 2009

slide3
1937- New London, Texas

Natural Gas explosion is school over 200 killed

Now use t-butyl mercaptan or thioplane

slide4
1989- Exxon Valdez

Spilled 10.8 million gallon of crude of coast of Alaska, Prince William Sound

Now require double hull crude carriers in all US ports

March 2009 Korean vessel found a drilling rig lost after IKE, Double Hull prevented any spill

slide5
2004- Explosion BP plant Texas City

Extensive damage. BP admitted fault but ignition came during recovery cycle but fatalities due to location of work trailers

slide6
2005- Hurricane Katrina & Rita
  • Failure of flood gates New Orleans
  • Inadequate wave clearance & offshore platforms for class 5 storm
  • Inadequate response FEMA
slide7
2008- Hurricane Ike

Class 2 winds offshore

Class 5 storm surge Galveston Bay and Trinity Bay

Now referred to as Integrated Kinetic Energy

over 2,000,000 million customers lost power. Unforeseen especially by CenterPoint.

slide8
1984- Bhopal India- Union Carbide pesticide plant

300 killed, thousands injured release of 42 tons of methyl isocyanate

Plant was not following safety and operating guidelines of Union Carbide

slide9
1986 Chernobyl, Ukraine explosion released more than 400 times the radioactivity than with atomic bombing of Hiroshima

Built a sarcophagus a cover for the reactor

That and Three Mile Island incident stopped any nuclear construction, in US in 1970’s. Now 4 projects being considered in Texas

slide10
2002 Approved repository site in Yucca Mountain Nevada

Operational 2010, to be sealed 2035

Repository in solid rock 1000 feet underground and on average 1000 feet above water table

Holds 77000 metric tons of waste

Plulonuim-239 has half life of 24000 years

Cost $9 billion

2010 budget includes no funding for Yucca Mountain

Present 100 nuclear plants-20% of electricity

30 plants in planning stage

slide11
Asbestos- Alaska Pipe Line recognition Asbestosis and mesothelioma but was used in shipbuilding in 1940’s

Used by the Ancient Greeks because of its soft and pliant properties- the miracle mineral

Over 80 companies involved with asbestos have filed for chapter 11 beginning with Johns Mansville

slide12
US Air Flight 1549

Sulley Sullenberger

Airbus A 320-214

N10GUS

slide13
1988 North Sea- Piper Alpha Platform

Explosion many workers killed platform severely damaged.

Equipment stacked near crew quarters

Due to economic effort for more production

sempra energy
SEMPRA Energy

Owners of San Diego Gas & Electric- SDGE

2007 Wildfires in California

Have $1.1 billion tower of liability insurance on aggregate basis and now totally consumed.

slide15
But in all my experience, I have never been in any accident… of any sort worth speaking about I have never seen but one vessel in distress in all my years at sea. I never saw a wreck and never have been wrecked nor was I ever in any predicament that threatened to end in any disaster of any sort.
slide16
EJ Smith

Captain-Titanic

1907

slide17
We can add others not directly part of energy but which impact us all

9-11 2001

Enron 2001

AIG 2008

Banking system 2007-08

We do live in a risky world

slide18
Retain and pay from internal funds
  • Control eliminate or minimize losses
  • Transfer usually by insurance but can include contractual transfer
slide19
Insurance Buyer

Insurance Manager

Risk Manager

Director of Risk Management

Enterprise Risk Management

Sustainability Risk Management

risks we have failed to manage
Risks we have failed to manage

Banks

Investment Houses

Merrill Lynch

Lehman Bros

Bear Stearns

All from

Sub prime Credit Crises

Mortgage valued securities

CDO’s- Collateralized Debt Obligations

Credit Default Swaps

AIG- a subject all its own

slide21
ERM

John Hampton- St Peters College

COSO

Failure

new risks
New Risks

Cyber Liability

Gamma- Ray Burst

Nanotechnology

Somalia Pirates

Global Warming

slide25
Raises questions

How do we?

When do we start?

Can it make a difference?

Should we start with education?

uh gemi founding vision
UH-GEMI: Founding Vision

A premier human-capital supplier for the energy industry.

A principal venue to join and develop issues of critical interest to the energy industry.

A research partner for the industry.

major educational programs
Major Educational Programs

Undergraduate Global Energy Management (GEM) Program

Graduate Energy Certificates

China GEMBA program

global energy management gem program
Global Energy Management (GEM) Program

GEM-Professional Program (Option to do a 5 year BBA/MS in Finance)

GEM-Track

Global Energy Management Minor

china gemba program
China GEMBA Program

EMBA program in Beijing and Houston for Senior SINOPEC and CNPC Executives on leadership track

Instruction by UH Faculty in Beijing; Students Come to Houston for a few courses & graduation

gemi conferences workshops
GEMI Conferences & Workshops

Energy Trading & Marketing

Recent Trends in the Power Industry

Petrochemicals & Refining

Bio-fuels

risk management scholarships
Risk Management Scholarships

Bauer- Annual

3- Houston Marine Insurance Seminar

2- Local Chapter RIMS

4- Dedicated Endowments

new courses
New Courses

Carbon Trading- January 2009 EMBA

Petroleum Engineering- Fall 2009

Degree Plan

tier i
Tier I

John Gresham- The Associate

Bermuda Monetary Authority

tier i usa
Tier I- USA

Texas – 3 UT, A&M, Rice

California- 9

New York- 7

Research Funds $150 million plus

tier one committees
Tier One Committees
  • National Competitiveness
  • Student Success
  • Community Involvement
  • Athletic Competitiveness
  • National and Local Recognition
  • Resource Competitiveness
tier one contributions
Tier One Contributions
  • 5,000+ new jobs
  • $129 million in wages to the regional economy
  • $7.5 million in additional state revenue
  • $202 million in local sales
insurance regulation
Insurance Regulation

State Regulation

Federal Regulation

Optional Regulation

Insurance CZAR Candidate

Opinions

insurance patriarchs
Insurance Patriarchs

Maurice (Hank) Greenberg

Warren Buffet

A third one as replacement

slide40
Is ERM the answer?

Is RMI education the answer?

Can Tier I help this conundrum?

Can insurances continue “business as usual”?

slide41
Is the insurance market stable?

Will the regulation applying to insurance, state vs. federal change?

Will we have federal regulation?

Will new leaders become known for the insurance industry?

summary
Summary

We all have risks

Our challenge is to finance the losses that occur

Risk management is the art of selection of the method(s) to pay

We cannot eliminate all risk nor should we

risk assumption
Risk Assumption

Assume risks that are comfortable and predictable

Transfer those risks that could negatively impact your company

Be mindful of the risk bearing capacity of your company

There are limitations- one is Chapter 11

bp april 20 2010
BPApril 20, 2010

BP Blow out

Maccando Blow out

Deepwater Horizon Blow out

Vessell - $575,000,000

11 deaths

17 injured

gulf issues energy
Gulf Issues/Energy

BP Pollution Liability

Liability

Force Majors

Insurance

No Insurance

Available Limits

Inspections

Regulation

energy insurance and risk management finance 4397 7397

Energy Insurance and Risk ManagementFinance 4397/7397

Professor Dan C. Jones

C.T. Bauer College of Business

slide47
Risk financing vs. Risk management
  • Risk and the world
  • As a society, always sought to reduce uncertainty-tribes/clans
  • Business but an extension and risk is at heart of ALL business operation
  • Decisions cross borders and industries-harm to stakeholders

FINA 4397/7397

slide48
Language of risk & insurance
  • Risk
  • Speculative risk
  • Pure risk
  • New term-enterprise risk
  • Management of Risks
  • A process
    • Identification and evaluation
    • Exploration of Techniques
    • Implementations and review
  • Current Risk management
      • Losses without gain
  • Holistic approach

FINA 4397/7397

slide49
Fundamentals of risk & uncertainty
  • Risk- variation of outcomes
  • Uncertainty- the doubt from inability to predict future (outcomes)
  • Arises from risk
  • Add managers and becomes complicated

FINA 4397/7397

slide50
Corporate demand for insurance
  • Risk managers assumed risk neutral
  • Assumption
    • Increasing wealth leads to inc. Satisfaction AND
    • Marginal utility constant as wealth increases
  • Individuals risk adverse but
  • Owners / shareholders are not
  • Investors require higher return if unable to diversify or systemic risk
  • CAPM theory

FINA 4397/7397

slide51
Shareholder risk aversion does not explain why corporations buy insurance why?
  • Insurance companies have comparative advantage
  • Insurance can lower cost of financial distress
  • Insurers may have service efficiencies
  • Insurance can lower tax liabilities (property)
  • Regulated industries have higher demand
  • Compulsory insurance laws
  • Financial consideration of stock price

FINA 4397/7397

slide52
Practitioners increasingly taking holistic approach
  • Conceptual and applied economic knowledge continues to expand
  • Private markets can not deal with some societal risks
  • Publicly traded companies undergoing evolutionary changes
  • Resources committed to understanding capacity of capital markets
  • A challenge for ALL

FINA 4397/7397

slide53
Economic development
  • Benefits
    • More competitive
    • Better values
    • Shareholder value increased
    • Cash flow leveling
    • Reduces insolvency
    • Expands credit availability
    • Loss control / risk control
  • Reduced costs results and better able to compete

FINA 4397/7397

slide54
Property rights and economic freedom
  • Right to own real & personal property
  • Right to enter into contracts
  • Right to be compensated for tortious acts
  • Needed
    • A system and a means to enforce
  • Markets are means of exchanging property rights
  • Insurance can not function without defined ownership interests
  • Restrictive - monopolies, insider trading

FINA 4397/7397

slide55
Hard market
  • Soft market
  • Hurricane Andrew
  • 9/11
  • Today

FINA 4397/7397

slide56
Value of insurance company services
  • Pricing, underwriting, claims handling
  • Pricing - statisticians / actuaries
  • Time lag of loss payments and premium payments
  • Competitive premium is of expected losses, expenses, profit
  • Investment return
    • Life companies -calculable
    • Non-life - long tail claims
  • Government treatment

FINA 4397/7397

slide57
Internationalization of business creates internationalization of financial services
  • No one market can provide all needed coverage
    • Oil refineries
    • Oil tankers
    • Off shore rigs
    • Satellites
    • Jumbo jets
    • Environmental impairment
  • National markets benefit
  • Increase competitiveness

FINA 4397/7397

slide58
The financial environment
  • Finance and insurance have much in common
  • Each provide its customers tools for managing risks AND
  • Valuation methods are the same
    • Fair value of the security
    • An insurance policy
    • Based on discounted cash value of future cash flows

FINA 4397/7397

slide59
Same definition of risk- the variation of future results from expected values
  • Rely on same fundamental concepts
    • Risk pooling
    • Risk transfer
  • Therefore we have convergence as insurance company managers, owners and customers must recognize and understand

FINA 4397/7397

slide60
Risk management fundamentals
  • What is risk?
  • Is risk different if building a new plant in Jakarta?
    • Currency
    • Language
    • Training / hiring
    • Laws
  • Separate
    • Hazard risk management
    • Financial risk management

FINA 4397/7397

slide61
Objective of risk management - to contribute to a firms value
  • Factors
    • Unmanaged risk reduce value of firm
    • With increase in risk, cost of doing business increases
    • Results in lower levels expected cash flow
  • Reciprocal is that
    • Reducing risk increases cash flow
    • Increases value of firm

FINA 4397/7397

slide62
Risk assessment
    • Identification of exposure
    • Analyzing to determine potential impact
  • Assets subject to loss
    • Tangible, intangible, human
    • The analysis should answer
      • What assets are exposed
      • What perils can cause harm
      • What are potential consequences

FINA 4397/7397

slide63
Financial loss
  • Property
    • Real property
    • Personal property
    • Intangible property
  • Net income losses (revenue less expenses)
    • Fire losses
    • Auto accident
    • Employee injury
  • Magnitude function of revenue decrease
  • Insurance terms - time element or business interruption because it is time dependent

FINA 4397/7397

slide64
Liability losses
  • Occur when parties assert legal rights
  • Many types - mostly civil in nature
    • Defective products
    • Environmental impairment
    • Injury to employees
    • Breach of contract
    • Profession errors or omissions
  • Huge cost associated with defense even if no liability

FINA 4397/7397

slide65
Personnel losses - human assets
    • Injury
    • Disability
    • Death
    • Retirement
    • Resignation
    • Kidnapping
  • Which consumes most time?

FINA 4397/7397

slide66
External influences broadening scope of risks
  • Globalization
  • Industry consolidation
  • Deregulation
  • Regulatory attention to corporate governance
    • Sarbanes-Oxley
  • Technological progress enabling better risk quantification and analysis

FINA 4397/7397

internal factors
Internal Factors
  • Increased firm value – the emphasis
    • Reduces inefficiencies inherent in traditional approach
    • Improving capital efficiencies
    • Stabilize earnings
    • Reduce expected costs of external capital

FINA 4397/7397

forces creating uncertainty
Forces Creating Uncertainty
  • Technology and Internet
  • Increased worldwide competition
  • Freer trade and investment worldwide
  • Complex financial instruments, notably derivatives
  • Deregulation of key industries
  • Changes in organizational structures resulting from downsizing, reengineering, and mergers
  • Higher customer expectations for products and services
  • More and larger mergers

FINA 4397/7397

slide69
Enterprise Risk Management (ERM)
  • Synonymous with:
    • Integrated Risk Management (IRM)
    • Holistic Risk Management
    • Enterprise-wide Risk Management
    • Strategic Risk Management

FINA 4397/7397

alternatives to insurance
Alternatives to Insurance
  • Retentions
  • Self Insurance
  • Captives
  • Mutual Company
  • Industry developments as alternative
    • Weather
    • Loss portfolio transfer
    • Finite
    • Securitization

FINA 4397/7397

retention capacity
Retention Capacity

Rules of Thumb

  • Shareholders Equity 2 - 3%
  • Pre-tax Earnings 5 - 10%
  • Cash Flow 4 – 5%
  • Total Assets 1 – 2%
  • Earnings 10%

FINA 4397/7397

risk management continuum
Risk Management Continuum

Mitigate

Retain

Transfer

FINA 4397/7397

slide74
1937 – New London, Texas
    • Natural Gas explosion is school over 200 killed
    • Now use t-butyl mercaptan or thioplane

FINA 4397/7397

slide75
1989 – Exxon Valdez
    • Spilled 10.8 million gallon of crude of coast of Alaska, Prince William Sound
    • Now require double hull crude carriers in all US ports
    • March 2009 Korean vessel found a drilling rig lost after IKE, Double Hull prevented any spill

FINA 4397/7397

slide76
2004 – Explosion BP plant Texas City
    • Extensive damage. BP admitted fault but ignition came during recovery cycle but fatalities due to location of work trailers

FINA 4397/7397

slide77
2005 – Hurricane Katrina & Rita
    • Failure of flood gates New Orleans
    • Inadequate wave clearance & offshore platforms for class 5 storm
    • Inadequate response FEMA

FINA 4397/7397

slide78
2008 – Hurricane Ike
    • Class 2 winds offshore
    • Class 5 storm surge Galveston Bay and Trinity Bay
    • Now referred to as Integrated Kinetic Energy
    • Over 2,000,000 million customers lost power.
    • Unforeseen especially by CenterPoint.

FINA 4397/7397

slide79
1984 - Bhopal India- Union Carbide pesticide plant
    • 300 killed, thousands injured release of 42 tons of methyl isocyanate
    • Plant was not following safety and operating guidelines of Union Carbide

FINA 4397/7397

slide80
1986
    • Chernobyl, Ukraine explosion released more than 400 times the radioactivity than with atomic bombing of Hiroshima
    • Built a sarcophagus a cover for the reactor
    • That and Three Mile Island incident stopped any nuclear construction, in US in 1970’s.
    • Now 4 projects being considered in Texas

FINA 4397/7397

slide81
2002
    • Approved repository site in Yucca Mountain Nevada
    • Operational 2010, to be sealed 2035
    • Repository in solid rock 1000 feet underground and on average 1000 feet above water table
    • Holds 77000 metric tons of waste
    • Plulonuim-239 has half life of 24000 years
    • Cost $9 billion
    • 2010 budget includes no funding for Yucca Mountain
    • Present 100 nuclear plants-20% of electricity
    • 30 plants in planning stage

FINA 4397/7397

slide82
Asbestos- Alaska Pipe Line recognition Asbestosis and mesothelioma but was used in shipbuilding in 1940’s
  • Used by the Ancient Greeks because of its soft and pliant properties- the miracle mineral
  • Over 80 companies involved with asbestos have filed for chapter 11 beginning with Johns Mansville

FINA 4397/7397

slide83
US Air Flight 1549
  • Sulley Sullenberger
  • Airbus A 320-214
  • N10GUS

FINA 4397/7397

slide84
1988
    • North Sea- Piper Alpha Platform
    • Explosion many workers killed platform severely damaged.
    • Equipment stacked near crew quarters
    • Due to economic effort for more production

FINA 4397/7397

sempra energy1
SEMPRA Energy
  • Owners of San Diego Gas & Electric- SDGE
  • 2007 Wildfires in California
  • Have $1.1 billion tower of liability insurance on aggregate basis and now totally consumed.

FINA 4397/7397

slide86
But in all my experience, I have never been in any accident… of any sort worth speaking about I have never seen but one vessel in distress in all my years at sea. I never saw a wreck and never have been wrecked nor was I ever in any predicament that threatened to end in any disaster of any sort.

FINA 4397/7397

slide87
EJ Smith
  • Captain-Titanic
  • 1907

FINA 4397/7397

slide88
We can add others not directly part of energy but which impact us all

9-11 2001

Enron 2001

AIG 2008

Banking system 2007-08

We do live in a risky world

FINA 4397/7397