The Effect of Volatility on Power Generation Business Interruption Losses

  • Date03 May, 2023
  • Author Jessica Feola
  • Location LATAM

It is clear to the casual observer that many aspects of the economy are facing volatility. Fuel, energy, labor, shipping – all have experienced unprecedented shortages and price increases because of a myriad of conditions. The Russia-Ukraine war, Covid-19, inflation, supply chain issues and environmental concerns have all contributed to this volatility. This volatility has not only had an impact on everyday life, but it poses risks and new considerations to Business Interruption policies and claims, particularly in the power generation industry.

In terms of shipping costs, while relatively constant during 2019 and about the first half of 2020, costs steadily rose from mid-2020 through the end of 2021. They only began to decline in 2022, but never back down to early 2020 levels. Aside from the costs themselves, worldwide markets have been affected by the issue of increased shipping lead times.

Costs of Shipping since 2019

Similarly, on a worldwide scale, inflation rates rose steadily since 2021. As an example, the following graph illustrates the monthly inflation rates in the US. and U.K.  It is evident that rates have grown in both markets. In fact, data far into late 2022 also show a continued rise in these rates.

Monthly inflation rates US/UK

This volatility can also be observed in many source energy prices, such as natural gas or coal. As the prices of such fuel increase, so does the price of electricity, in turn. The electricity price increases can be observed both when sales occur on the spot market or even sales through a Power Purchase Agreement (PPA), when the consumer price index changes in response to the market, for example. This leads to an overall, worldwide effect on energy prices, wherein while peaks and troughs occur, an overall steady increase in prices is observed over time.

So what effect will volatility have on power generation Business Interruption losses?

The answer depends, in part, on the type of power plant. The current market volatility can have varying effects on margins. For example, while electricity prices rise, the same may not occur in respect of the costs associated with the different types of power plants. Think about how differently market volatility may affect a thermal plant in comparison to a hydro plant or a wind farm. In the case of a fossil fuel plant where both electricity prices and fuel costs are rising, margins may likely not be as affected. However, when dealing with a renewable power plant, where fuel costs are nonexistent or minimal, then margins are likely to increase dramatically. Thus, in the event of an insured loss, the topics of the adequacy of sums insured and potential underinsurance become more relevant than ever.

Current volatility extends beyond energy prices; as a result, any Increase in Cost of Working (ICW) claims may be impacted as well. As described previously, during the height of the Covid-19 pandemic, and later as a consequence of the Russia-Ukraine conflict, the costs of shipping containers spiked tremendously, and backlogs and delays were extremely common. While the situation has begun to partially normalize, the cost of shipping is still significantly higher compared to pre-pandemic levels. As a result of this volatility, if a power plant is offline or at a reduced capacity because of ongoing repairs, any interruption period may likely be longer and costlier than previously experienced. This is due to the combined effects of longer shipping lead times, greater shipping costs and overall greater repair/replacement prices due to inflationary trends.

The above conditions lend strength to the practice of maintaining spare parts. That is, insureds that maintain spare parts are better equipped to respond to loss events and mitigate in a timelier manner while incurring fewer costs.

Issues such as these open the door for interesting discussions about how policies may take different shapes in the future. That is, will the inclusion of extended periods of liability become more common? Also, what role do the different market conditions play in determining “due diligence and dispatch”? That is, what kind of consideration will be given to issues arising as a result of market volatility?

Despite the many unknowns as a consequence of market volatility, there are potential solutions. Among these is education; that is insureds should obtain better information about BI and what BI policies intend to cover and how insured values and losses are computed. Of equal importance is the practice of reporting; that is, insureds should be encouraged to report on their financial and operational results. The reporting should be periodic, frequent, consistent and robust.

Insurers can also engage in the performance of periodic value audits. Furthermore, the inclusion of volatility clauses, average clauses and commodity caps into policy wording can become more common practice.

While energy volatility may be bad news for consumers in the short term, there is evidence of a shifting energy landscape that is more beneficial (both environmentally and economically) to all. Renewable energy will see significant growth in the coming years. The current price volatility of energy will only accelerate it, as it becomes more profitable for plants to produce renewable energy, bolstering investment toward more diverse and reliable sources of energy.

In sum, while there may be negative aspects to the issue of market volatility, we can still see a silver lining.


The statements or comments contained within this article are based on the author’s own knowledge and experience and do not necessarily represent those of the firm, other partners, our clients, or other business partners.

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