Squeezing the grid: the increase in the demand for electricity has strained the utility industry's ability to deliver power as reliably as it once did. Risk executives have several options at their disposal, none of which is a panacea

On Aug. 14, 2003, the largest blackout in North American history left more than 50 million people in nine states and parts of Canada in the dark. Only $180 million of the losses were insured, according to Insurance Services Office Inc., in part because many business interruption policies don't cover power outages.

That left consumers and businesses on the hook. The blackout cost the United States between $4 billion and $10 billion, according to the Electric Consumer Research Council.

For the most part, the nation's power grid is reliable. "The power grid is still a fairly reliable system--about 99.99 percent reliable, in fact," says Daniel O'Neill, a director with Atlanta-based Navigant Consulting, which advises companies on utility transmission/distribution reliability. "However, as our reliance on electricity continues to increase, it is arguable that we, as a nation, are expecting even greater reliability. As such, the grid needs to become even more reliable."

More competition in the electric power industries has resulted in thinner profit margins for many energy providers, leading producers to invest less in upgrading the power grid. In addition, the demand for power has gone up.

According to the U.S. Department of Energy, total U.S. electricity use in 1975 was about 1.8 trillion kilowatt-hours, while investment in transmission capacity was about $6 billion. By 2000, usage almost doubled to more than 3.5 trillion kwh, while investment had dropped by roughly two-thirds to just over $2 billion.

The utility industry plans to spend an additional $4 billion to $7 billion over the next five years to upgrade the power grid, according to research conducted by GF Energy, a Washington, D.C.-based utility industry consulting firm.

"In general, the nation's power grid has historically been reliable and has been working well," says Roger Gale, CEO of GF Energy. "However, like everything else, it has served its time, and we are now in a new era that depends on centralized systems, not a decentralized system such as is the ease with the existing power grid."

To address the needs of their employers, O'Neill suggests that risk managers conduct assessments to determine the requirements for continuity of service. Assessments should cover all three segments of the power grid.

The first segment is power production, or the wholesale energy market. The second segment is the transmission lines that move energy from production to local distribution of the electricity. The last segment is the local power distribution network. That's where local utility companies take high-voltage energy and deliver it in low voltages to homes and businesses.

EXPOSURES COME IN FOURS

Risk managers should consider four areas when assessing exposure to power outages: redundant systems, diesel-powered backup generators, third-party risk partners and hydrogen fuel cells. Many companies already have one or both of the first two systems in place.

* Redundant Systems. "The first line of protection is dual or redundant distribution feed from the local utility company, including automatic throw-over switches," says O'Neill. In such cases, if one feeder line fails, service is automatically provided by a second line. "This is common in hospitals and other facilities where power is particularly critical," he says. Redundant systems may be more readily available in some areas of the country than others. Large cities are more likely to have redundant systems than rural areas.

* Diesel Generators. These are economical ways to back up a portion of your power needs. Denver Water takes full advantage of this basic technology. The utility has three major operational areas of concern when a power outage occurs: the administrative complex, the water treatment plants and the network of pump stations that pump water to about 30 percent of the city. "We frequently lose electrical power in the Denver area either due to heavy, wet snows or lightning strikes," says Jim Crockett, Denver Water's manager of risk and benefits. To ensure backup power, the department relies on diesel generators. A 2-megawatt stand-by diesel generator serves the administrative complex. It has a 4,000-gallon capacity, which can be refueled by the utility's own diesel fuel, or from deliveries. The utility has also installed 1-megawatt to 2-megawatt stand-by diesel generators at its pump stations. Plus, each water treatment plant has a 2-megawatt stand-by diesel generator."

* Third-Party Risk Partners. According to GF Energy's Gale, commercial and industrial customers need to manage their power risk issues by working with utility companies willing to share risks. "These are companies that are willing, for example, to take the fuel volatility risk for natural gas, to help companies manage their loads more effectively by shifting loads," he says. This is a growing business, according to Gale. Constellation Energy in Baltimore, for instance, offers risk-managed contracts for commercial and industrial companies. That allows risk managers to breathe easier, knowing that they have a partner sharing the risk for power dependability.

* Hydrogen Fuel Cells. These represent a technology that may someday take the place of diesel generators. First, they are much cleaner then diesel. "In fact, many companies are installing them now in locations where they are unable to get permits to install diesel generators due to environmental constraints," says Ken Wicker, editor of Power Magazine in New York, a utility industry publication. One drawback is that they are expensive. A company called Fuel Cell Energy installs cells for the equivalent of about $4,500 per kilowatt, says Wicker. Another company offering fuel cell technology is Hydrogenies Corp. "Hydrogen fuel cells can replace a large portion of the batteries and all of the diesel generators, because the fuel cells utilize the best of the battery and generator technologies," says Jonathan Dogterom, business development manager, since fuel cells are emission-free and can be used indoors.

Five Questions To Ask Prospective Energy Insurers

Only some carriers have what it takes to address the complex, potentially catastrophic risks of the energy industry. Answers to the following five questions can help you zero in on insurers that are up for the task now--and for the long term.

1. What is the carrier's financial performance? Financial strength ratings are key indicators of stability, but look deeper for additional insight. Examine the overall financial performance of any prospective carrier and its parent company. A stable carrier will demonstrate solid financial performance, including return on equity that is consistently on par or above that of its peers.

2. Is the carrier consistent? To find a carrier that will be with you for the long term, assess whether the carrier is consistent in both its commitment and approach to energy risks. Look for continuity in lines of business underwritten, risk selection, capacity levels and pricing. These are the hallmarks of underwriting integrity--and the polar opposite of opportunistic underwriting, which should be avoided at all costs. After all, why pay a premium that is 20 percent less than the next lowest bidder this year if it will be 40 percent higher next year?

3. How well does the carrier know your business? If a carrier has years of experience writing risks in your industry segment--whether you're in oil refineries, offshore rigs, power generation or another energy sector--it knows how to underwrite and price risk in a way that will protect you and be sustainable.

4. Does the carrier's reputation precede it? When you know a carrier's insurance professionals are specialists in both energy risks and insurance, you will have a level of comfort and trust going into your transaction that while intangible is yet invaluable. Insurance professionals who are truly "plugged in" to your industry ask the right questions and have obvious technical expertise. There is no learning curve to overcome, so your carrier's service and underwriting begin at a higher level--and will elevate quickly from there, resulting in solutions that are more meaningful.

5. Are the carrier's services truly valuable to you? If your operation is international, as most energy operations are, you can benefit from an insurer with international service capabilities as well. Such an insurer can provide everything from advice on emerging-markets exposures to insights on the litigation environment of various locales. Also pivotal is claims service that anticipates roadblocks to fast recovery and plots to overcome them before a loss occurs--rather than the traditional approach of waiting until obstacles present themselves and then dealing with ways to get around them.

With the right answers to these questions, you can be prepared to embark on a long-term and satisfying relationship with a carrier that is willing and able to handle your complex energy risks.

--Robert T. Pulka, Senior Vice President, Onshore Property, Zurich Global Energy

JOHN WILLIAMS, an Indiana-based writer, can be reached at riskletters@lrp.com.

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