By George Dodd,
In what we all hope is not a sign of more to come after a year that most would like to forget, the US economy was mere minutes away from a potential economic crisis just weeks into 2021. As the power grid and natural gas distribution network in Texas began to crumble under significant demand from Texans simply trying to stay warm and keep the lights on, the power grid was less than 5 minutes from an unprecedented failure that would have plunged Texas into darkness for weeks or even months. With a GDP contribution of $1.8 trillion in 2019, Texas is the nation’s second largest economy (and 10th largest in the world) and represents 8% of the US economy. It’s easy to see how such an event could have easily become a significant economic headwind with potential impacts to financial stability.
Winter Storm Uri and the Texas Blackout was the result of a phenomena known as stratospheric warming, colloquially referred to as the “The Polar Vortex” and is the most recent billion-dollar climate related event. The Texas Blackout underscores the need to view climate change as a financial risk and the urgency to incorporate climate change in resiliency planning.
The Financial Fallout
During the Texas Blackout, 45,000 megawatts of power production went offline, driving wholesale prices from $50 to $9,000 per megawatt hour6. The price spike added $50.6 billion to Texan’s utility bills1 during the week of the blackout, an increase of over $46 billion from the prior week. The cost of property and infrastructure damage could exceed $20 billion. There are likely to be additional costs in the future as lawsuits and economic impacts are quantified. The demand for home heating in Texas caused a sharp reduction in the pipeline pressure necessary to distribute natural gas, causing residents to lose their ability to heat their homes and leading to frozen pipes, property damage and water scarcity throughout the state. Dozens have perished from the power outage, the frigid temperatures, and the water shortage.
While the state’s power grid is not integrated into the larger US network, the energy contributions of Texas are the vascular system of the US economy. Texas produces 40% of the nation’s crude oil, 25% of its natural gas and provides nearly a third of its refining capacity. In short, Texas is deeply integrated into the US economy and way of life.
In addition to the realized and potential financial impacts, the Texas Blackout also has some questioning the current structure of the deregulated power market. A FERC report following the 2011 blackout provided comprehensive, but expensive, recommendations to make the Texas power grid, generation, and distribution more resilient in the face of extreme weather events. Further, Texans are now scrutinizing what they’re paying for, as a recent Wall Street Journal article highlighted that consumers in the Texas deregulated power markets paid more than consumers obtaining power from regulated utilities2. As we have seen historically, the inability of markets to self-regulate is an invitation for more regulation.
Financial and commodity markets did not escape the Texas Blackout unscathed. Spot prices for conventional gasoline rose 8% week over week at New York Harbor and the Gulf Coast and the crude production outage sent WTI and Brent prices to 13-month highs, costs that could be absorbed by consumers and corporates. The debt markets are still absorbing the impacts as utilities may require additional debt financing to support the increased costs from the events, initiating unplanned capital structure changes. It seems likely that the financial fallout may include credit events and bankruptcies.
Early Warning Indicators
The Texas Blackout was the result of a phenomena known as stratospheric warming, colloquially known as “The Polar Vortex”. The polar vortex refers to the normal rotation of westerly winds around the North Pole, while the cold snaps are caused by the collapse or even reversal in the normal rotation of the polar vortex. Stratospheric warming occurs when warm air at lower levels of the atmosphere start to ascend to higher levels, disrupting the polar vortex3. The frigid temperatures that created the conditions for the Texas Blackout were the result of the cleaving of the polar vortex in December 2020.
The conditions that favor the collapse of the polar vortex have historically been correlated with EL Nino and La Nina, additional factors such as Eurasian snow cover and polar ice cap melt are also indicative of the potential for stratospheric warming and the likelihood of temperature extremes that were observed to in the Northern Hemisphere in 2021. Incidence of diminished snow cover and greater ice cap melt are direct impacts from climate change and could lead to more frequent incidence of stratospheric warming, resulting in more extreme temperatures5.
It’s important to note that climate change does not cause these events and it’s not possible to blame any single factor on weather. The bifurcation of the polar vortex is a naturally occurring phenomena, however, much like the wildfires in West Coast of the United States, climate change is likely amplifying ordinary meteorological events to extremes.
What Should Firms be Doing Now?
While it could take many years and countless investment dollars to better prepare infrastructure for the extremes of climate change, there are specific actions that firms can take to better prepare for the next climate-related event.
- Incorporate Climate Change Expectations into Operational Resiliency Planning. The Texas Blackout demonstrated the need to prepare for more severe and prolonged outages. Much like the 2020 California wildfires, climate-related events are more severe and leading to longer outages and downtime. Firms should start planning for these extreme events, both in preparing infrastructure for these events, but also ensuring resiliency in the supply chain. In developing climate informed Business Continuity Planning (BCP) and Technology Continuity Planning (TCP), firms should consider the potential for wider impacts from singular events. For example, firms should account for geographical locations of critical infrastructure and data centers and the potential for a singular event with wider impact or multiple climate related events in close geographical or temporal proximity. People mobility and supply chain considerations should also be accounted for as part of a robust, climate informed BCP/TCP program. Firms should encourage their suppliers and critical third parties to engage in more robust operational resiliency planning. The Texas blackout was exacerbated by the lack of an integrated grid and the ability to source electrons from outside of Texas.
- Integration of Climate Risk into Financial Risk Framework. As climate related events, specifically chronic and acute physical risk events, continue to deepen in frequency, duration and severity, institutions should implement more robust oversight, identification and mitigation of the financial risks posed by climate change. Market risks increase as price uncertainty and volatility deepen in times of catastrophic events. Consumers and businesses alike face heightened credit stress during times of catastrophic events. Catastrophic events are also invitations for fraud and cyber-crime. Establishing more robust oversight to identify and to monitor climate-related risks is critical in risk avoidance.
- Identification of Novel Risk Factors. As noted above, the collapse of the polar vortex was identified by meteorologists in late December. Firms should look to the Texas Freeze and other historical climate related events for other novel risk factors that can provide foresight into the likelihood of experiencing a climate related event. Preparation for a climate related events could be the difference between having enough manufacturing inputs to keep a factory, power plant, or a refinery running or having to idle production. Further to that end, firms should also look to stress the performance of correlations of known and novel risk factors during climate related events.
As COVID lifts and the world returns to some semblance of normalcy in 2021, the new normal could almost certainly continue the pre-pandemic normal of increasingly frequent, stronger, and costlier climate-related events.
Source : https://financialservicesblog.accenture.com/the-texas-blackout-even-climate-related-financial-risk-is-bigger-in-texas