Understanding Global Weather Perils: Heat & Energy Risk
Descartes Underwriting
A new generation of insurance that builds resilience against climate, cyber, and emerging risks
Summers are progressively becoming hotter for Americans in every region of the country.
From New York to Los Angeles, there are many counties where summers have become significantly hotter over the past 130 years, exceeding the average warming levels caused by the burning of fossil fuels. This finding comes from an analysis of federal data by US climate scientist Brian Brettschneider.
On average, summers across the United States are now about 0.8°C (1.5°F) hotter than they were in the late 19th century. However, this average masks the more extreme increases experienced in certain locations. In many areas, summertime temperatures have risen by up to 2.8°C (5°F), indicating a more dramatic warming trend.
This variation is due to several factors, including regional climate dynamics, urbanization, and local environmental changes. Urban areas, for example, often experience more significant warming due to the urban heat island effect, where concrete, asphalt, and other infrastructure absorb and retain heat more than natural landscapes. Additionally, local geographic and meteorological conditions can amplify the impact of global climate change, leading to more pronounced temperature increases in certain regions.
This national trends map from NOAA illustrates how July maximum temperatures have changed across the United States from 1991 to 2020. The map shows red and orange areas indicating regions where July temperatures have increased, with the darkest red showing the highest rise of up to 2.0°F per decade. Notably, the northern U.S., including parts of the Pacific Northwest, northern Rockies, and northern Plains, have experienced significant warming.
In contrast, white and blue areas indicate regions with either a decrease or no significant change in July temperatures. Some scattered areas in the central and eastern U.S. have even seen slight cooling.
Overall, the data indicates a general warming trend across most of the country during July over the past 30 years.
Extreme heat significantly impacts energy companies in states with independent power grids, by driving up electricity consumption and straining the grid's capacity.
During heatwaves, the demand for electricity spikes as households and businesses ramp up air conditioning usage to cope with soaring temperatures. This surge in demand can lead to grid overload, where the infrastructure struggles to keep up with the increased load, potentially resulting in blackouts or brownouts. Energy companies, responsible for maintaining reliable service, must then take urgent measures to balance the supply and demand, often at great cost.
One of the primary challenges faced by energy companies during extreme heat is managing the financial implications of higher electricity prices. In independent power grids, like the Electric Reliability Council of Texas (ERCOT), energy prices are highly sensitive to fluctuations in demand. As consumption rises, so do the spot market prices for electricity. Energy companies may be forced to buy additional power at these elevated prices to meet the increased demand. For companies locked into power purchase agreements (PPAs) at fixed rates, this can lead to significant financial losses. They must purchase expensive spot market energy while selling it at lower, pre-negotiated prices, squeezing their profit margins.
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Moreover, extreme heat can exacerbate the wear and tear on power generation and transmission infrastructure. Power plants and transmission lines operating under high temperatures are at greater risk of failure, necessitating costly repairs and maintenance. The risk of equipment failure can lead to more frequent and prolonged outages, further straining the grid and increasing operational costs for energy companies. Additionally, these companies must invest in upgrading their infrastructure to improve resilience against future heatwaves, which requires substantial capital expenditure.
Parametric Case Study: Utilizing Parametric Insurance to Mitigate Revenue Losses for Energy Companies During Heatwaves
A major electricity provider in a state prone to heatwaves, implemented a parametric insurance policy to safeguard against revenue losses. The policy was structured to trigger if temperatures exceeded 108°F during the pre-agreed risk period. Payouts escalated based on the severity of the heat, with incremental increases as temperatures rose, culminating in a 100% payout of the policy limit when temperatures reached or exceeded 115°F.
Scenario: In July, a severe heatwave hit, with temperatures soaring above 108°F. This resulted in several power plant failures and increased the need to buy spot market energy at high prices producing further losses from PPAs .
Outcome: Upon triggering the parametric insurance policy, the power company received a payout of $3 million. This quick injection of funds, often within 5 days, allowed the company to:
The parametric insurance enabled the power company to maintain operational stability and financial health despite the extreme weather conditions.
Conclusion
Parametric insurance with heatwave cover provides a robust solution for energy companies facing financial risks from extreme temperatures. By offering predictable, swift, and flexible payouts based on predefined triggers, this type of insurance helps companies manage revenue losses and maintain stability during heatwaves.