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Oil shortages: the next Katrina

Tverberg, a professional analyst for the insurance industry, first outlines the evidence for peak oil, which should be familiar to EB readers. Then follows the most fascinating part -- her analysis of the implications for business and the economy.

Please see the original PDF for complete text and charts. Excerpts from the report follow. -BA

Rising Demand and Unstable Supply
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Declining Discoveries
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Estimating the Peak
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Implications for Insurers

What does all of this mean from an insurer’s perspective? The outcome depends to a significant extent on how soon the oil peak comes and how much preparation is made in advance. If the peak in oil production is still more than 20 years away, and an all-out effort is made in the interim to develop alternative energy sources, there may only be a few short-term disruptions similar to the patterns seen in the 1970s, including spurts of inflation, less driving caused by shortages of fuel, a shift by consumers to smaller vehicles and home heating disruptions. These impacts disappeared when the supply resumed.

If there is a long-term mismatch of supply and demand, there is likely to be greater discontinuity, and the economy may take new directions. We need to understand the risks and decide whether there is a need to prepare for some of the more adverse scenarios.

New Industries

To make up for the eventual decline of oil and gas as energy sources, whole new industries will emerge or expand to meet society’s needs. The U.S. has built no new nuclear power plants in almost 40 years. Any expansion brings new risks. The development of terminals and ships to transport liquefied natural gas will add highly explosive structures, potentially close to populated areas.

Many of the alternative fuel industries are hardly more than experiments at this time. If the huge amount of oil currently used is to be replaced, astronomical growth will be needed. The property/casualty insurance risks associated with these new industries will grow just as rapidly. Insurers that take on these new risks will need to be extraordinarily nimble to properly price and underwrite these new exposures.

Existing Products

Just as important as properly evaluating new risks will be discerning changes affecting existing risks. As new industries replace old ones, there will be layoffs and possibly bankruptcies among existing businesses. These could affect workers compensation claims and bond guarantees. Disruptions relating to energy supply may trigger business interruption coverage.

There may also be new types of toxic torts that emerge. A medical examiner in Alberta recently reported a high number of illnesses (including leukemia, lymphomas and autoimmune diseases) in a community near where oil sands are being extracted. If oil produced in the future includes a higher level of pollutants than in the past, this could increase both workers compensation and liability claims.

In personal lines, the models using past experience will need some imaginative supplements as well. The auto manufacturing industry has demonstrated the ability to bring new products to market in record time — three years or less — so the insurance industry needs to be just as nimble in evaluating any shift in car mix.

If gasoline becomes very costly, living in outlying suburbs may become less attractive. Oversized homes, wherever located, may become expensive to heat and maintain. Prices of these homes may fall and they may become difficult to sell. Homes may stand empty for extended periods. Costs for goods that need to be transported, including food, could experience large increases.

Could an industry with $500 billion in premium volume lose $50 billion (10%) in a single year from sudden oil shortages? It seems quite possible. A surge in inflation and the accompanying upturn in interest rates would amount to a triple blow in the form of investment losses, underwriting losses and additions to reserves to settle claims. The combined effect could easily outstrip the one-year cost of Hurricane Katrina for the U.S. insurance industry.

Other Effects

The operation of insurance companies could be affected as well. Sharply higher gasoline costs and diminished supply could greatly increase the use of carpooling and telecommuting. Changes to the physical plan of companies may also be needed.

On the investment side, there is likely to be just as much disruption. Interest-rate surges will result in lower bond market values, and increased bankruptcies may add to capital losses. New businesses may present opportunities for stock market investment. Stock market volatility may be high in an uncertain environment....

While the laws of supply and demand will generally explain what will happen to oil and gas prices, the changes could be more dramatic than logic would predict. There could also be attendant worldwide political problems if conflicts arise over who gets the largest share of the existing oil supply.

What Can Insurers Do Now?
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Alternative Energy Sources (sidebar)
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Gail E. Tverberg is a senior consultant with Towers Perrin in Atlanta. She specializes in property and casualty insurance and has managed a wide range of assignments, including ratemaking, reserving, financial modeling, captive feasibility and tort reform evaluation. She is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.

 

Editorial Notes: This article is written for an audience of insurance executives who are not familiar with peak oil. In addition to its web version, the article will appear in Emphasis Magazine (published by Towers Perrin), to be distributed to insurance executives in late June. -BA

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