Episode Transcript
[00:00:00] Speaker A: Welcome to the Trade Securely podcast. I'm Janet Eastman. And on this episode, we're going to drill down into the energy sector to look at the current state of the market and to investigate how receivables insurance actually can be used by energy companies to clear credit and manage risk. We have three guests, two of them are from Allianz. Josh Steele is head of underwriting for energy at alliance. And Ryan Wimberley is senior vice president, regional head of direct sales for bank and energy. And our third guest is Kevin Sullivan. He is first vice president with an energy specialty at OneSource.
Okay, so to get things started, Josh, how about you give us an overview of the current state of the energy market, maybe some bankruptcy stats, whatnot.
[00:00:45] Speaker B: Okay.
[00:00:46] Speaker C: What we're seeing in the current state of the energy market is flat commodity prices, natural gas at an all time low. In addition to the stubborn sustainability of crude, maintaining flat pricing, we're also seeing counterparties that continue to have strong earnings. And because of that, the interest in trade, credit, insurance, is stagnant over the past year or so.
But just because the energy market is stagnant and counterparties have very strong balance sheets, it does not keep them immune from a default. In the energy industry, defaults are relatively low percentage wise compared to other industries, but that does not protect them from the unforeseen risk. And a lot of the unforeseen risks that we've seen over the past couple of years involves the environment. The first one is from 2021. Down here in Texas with winter storm Yuri, we saw a very large co op, Brazos, go insolvent. Basically within five days, there was a weather event that forced all time lows. In fact, all 254 counties across Texas at one point was below freezing, which had never happened before. This put extreme strain on the grid, which caused emergency pricing on natural gas to skyrocket. Because of this, Brazos was not immune to a default. In addition to that, we've seen a couple of others out in Hawaii as well as on the west coast. When it comes to wildfires pg and e, they had a very strong balance sheet before. Unfortunately, because of the California wildfires and civil suits, they were forced to go chapter eleven and defaulted. We're seeing that potentially with the wildfires that happened in Maui, as well as the wildfires that happened in Oregon over the past two years. So just because a company has a very strong balance sheet does not make them immune for unforeseen circumstances that could drive them into a state of insolvency.
[00:03:13] Speaker D: Wow.
[00:03:14] Speaker A: And it looks like things can happen really quick.
[00:03:16] Speaker C: Very quick, very quick.
[00:03:18] Speaker A: Okay, so let's, let's talk about what type of energy companies should be considering receivables insurance. I'm going to open this up to the floor. Whoever wants to jump in on this one and talk about it, I'll start.
[00:03:31] Speaker B: I think it's really anybody who's moving a commodity, regardless of where you are in the supply chain, there's a value prop that could be applicable to you. So I know we'll talk a little bit more about this later on in the podcast. But while it's called trade, credit insurance, it's not really about the insurance. It's about how we can help you trade at higher levels or clear capacity from your balance sheet.
So again, we'll talk more in depth later in the podcast. But regardless of what commodity is being moved and where you are in the supply chain, there's a potential that trade, credit, insurance, or our sister products might add some value to your operations. I'll turn it over to Kevin or Josh if they want to add to that.
[00:04:14] Speaker D: Yeah, for sure. Thanks, Ryan. And I would echo what Ryan's saying. Josh very clearly outlined the case for trying to protect your balance sheet. But to Ryan's point, we're really targeting a lot of energy companies not only to drive higher margin sales for their traders and their commercial groups, but also from the liquidity perspective, where with rates going up significantly over the last two years, the cost of posting collateral is up significantly as well. And so were seeing a lot of energy companies looking to say, okay, maybe I was posting 100 million of collateral before. If rates were one, 2% wasnt that big a deal. Now theyre starting to have a lot more eyeballs trying to save costs from a collateral perspective.
[00:04:55] Speaker A: Okay, Josh, do you have anything to add there?
[00:04:59] Speaker C: Yes. In companies when it comes to energy, companies that have fixed price contracts are very valuable and solid candidates for trade credit because they're looking to protect their mark to market risk and the risk moving forward where they lock into these long term contracts and they could be exposed in the event that the commodity were to go down and their counterparty were to go insolvent. If they would have to sell that on the open market, they could have that mark to market or spread loss risk type loss. With Tradecredit, we have an endorsement that protects them from the spread loss risk and mark to market risks as well.
[00:05:44] Speaker B: And I'll just add to that, Josh. So the endorsement covers them on both sides. So it covers them on both purchase and sale of the mark to market risk so they can cover both sides of the supply chain on that.
[00:05:55] Speaker A: Okay, okay.
[00:05:56] Speaker C: And on the power side, we're seeing more and more requests to cover long term purchase power agreements as well, where the provider is looking to lock in a PPA for five, eight to ten years and they're looking to mitigate that risk.
[00:06:13] Speaker A: Okay. Okay. So let's talk about some of the misconceptions that companies do have about receivables, insurance for the energy sector. What are they? You must hear them all the time. So Kevin, let's start with you for sure.
[00:06:28] Speaker D: I think Jahaj alluded to it earlier where defaults in the energy space, especially in North America, have been relatively few and far between. And when some of the bigger ones, like a PG and E, is a great example, when they have defaulted, it's been prepackaged default where all the creditors end up being made whole. So ultimately a lot of people say, a lot of the credit groups we talk to in large energy firms will say, oh, we don't have any losses, so why would we get credit insurance? And we've really tried to, working with Allianz and a few other underwriters over the last decade, really tried to reposition the product as, okay, you may have zero losses, but maybe you can be selling now to counterparties that your credit team aren't as comfortable with and those sales can be more profitable. They're higher margin sales. So that's really what we're trying to drive the product.
[00:07:15] Speaker A: Okay.
[00:07:16] Speaker B: Right. So if we're talking to the credit team, right, they, they may have a very strict credit policy with private or non investment grade counterparties. Allianz as the example, because we're here, we're AAA rated company, right? So if we can wrap that asset and guarantee it, even the non investment grade that now becomes effectively AAA rated risk because of our guaranteed backing it. So it helps them pursue sales, as Kevin alludes to that, perhaps they wouldn't have been too keen on pursuing without wrapping that asset.
[00:07:53] Speaker A: And that basically grows their business. If they can cover that and protect that, they can grow their business.
[00:08:00] Speaker B: That's the idea. I mean, so you hear insurance, right? You think of a reactive product.
So our value prop, especially in the energy space, is almost entirely a proactive product. Yes, it is the peace of mind if something like winter storm Yuri comes about. Sure it's an insurance product, but really what it's intended to be is a proactive tool to help our clients grow their business in various ways.
[00:08:23] Speaker A: Okay, Josh.
[00:08:24] Speaker C: In addition, it helps with concentration risk with receivables. In the event that our policyholders are using a bank to lend off their receivables, those receivables may be excluded. If the concentration risk is there, we turn an intangible asset into a tangible asset, making the bank or the lender much more comfortable in lending on that ardennead.
[00:08:50] Speaker B: Okay, so, Janet, from my side, if we could summarize it, you asked what the biggest misconception is. It's that it's insurance. That's the biggest misconception. It's not. It's meant to be a proactive tool for their company.
[00:09:03] Speaker A: So let's talk about how trade credit insurance differs from other tools that the energy sector may be using. What else is out there? What are they using?
[00:09:15] Speaker D: So currently, Jen, a lot of, I would say over the last ten years, a lot of international trades get made using letters of credit. So the buyer will post a letter of credit. The challenge with that is letters of creditor typically collateralized via their working capital facility. So if you're a buyer posting $100 million for accrued cargo that's being carved out of your working capital facility, which really handcuffs you from a liquidity perspective, what we're trying to do is we've created products called demand payment bonds or on demand bonds. They go by different names, and we'll have that as collateral in lieu of a letter of credit. So what we'll do is we can have the buyer post a bond where, in the event of a default, that bond can get called in lieu of a letter of credit. And what that does is they tend to be a little less expensive than what someone's paying for LC fees. But more importantly, they free up all of that liquidity that is currently being supported with the letter of credit. So that's been very popular over the last eight years or so. We've really seen demand for those increase.
[00:10:19] Speaker A: Okay.
[00:10:19] Speaker C: And when it comes to letters of credit as well, you've seen it across the globe with rising interest rates, letters of credit can be impacted by the increase in interest rates. It costs more for a bank to lend, whereas the on demand bonds that Kevin was mentioning are not tied to interest rates.
[00:10:41] Speaker A: Okay, Ryan, do you have something to add?
[00:10:43] Speaker B: No, no, I think they hit the nail on the head. I mean, really what we're trying to do is, in lieu of, if you're a supplier as well, it works that way too, right. If you're having your counterparties post either cash or collateral, it allows you often to open up terms to them. Really at no additional risk to you, so it allows you to offer friendlier terms to your customers as well. But I think they summarized everything.
[00:11:09] Speaker A: Okay, fair enough.
[00:11:11] Speaker D: Industry wise. If I can jump in here.
[00:11:12] Speaker A: Sure.
[00:11:13] Speaker C: Yeah.
[00:11:13] Speaker D: Probably the largest gains are on the midstream side of the pipeline side. Most pipelines will force producers that are shipping product through their pipes to post significant amounts of collateral to secure their space in the pipes. So it makes a lot of sense if they can, if the individual producers can freeze up their working capital, they can do what they do best and drill more holes, produce more product, which then makes them a better credit from the midstreamer's perspective. We're also seeing it on the power side, where a lot of the isos independent system operators around North America force anyone that wants to participate in their markets to post collateral, and it can be significant collateral. And so what we're having is those participants post bonds in lieu of letters of credit to help free up their working capital.
[00:11:59] Speaker B: I would say the power space right now for us is probably growing at the fastest clip. I mean, Josh, correct me if you see it differently from an Allianz perspective, but that's my feeling.
[00:12:11] Speaker C: No, 100% agree.
[00:12:14] Speaker A: Okay. Okay. I want to ask Josh what an underwriter actually looks at and looks for when you're considering companies.
[00:12:23] Speaker C: Well, what we look at is, first off, we take into consideration the industry, the strength of the counterparties, the potential exposure, the tenor of the exposure, whether it be a short term, one time supply or if it's a repeating supply over the course of twelve to 24 months. We also look at where the, or where the supply is going.
What country? If it is a aa rated country, they are going to have a much more favorable rate than, say, a de rated country. At Allianz trade, we ensure, we classify countries as AA through DA being the United States, AA being, I'm sorry, AA being the United States, Europe d being some american countries, south african countries, mainly third world, undeveloped countries. And so when you have a policyholder that is supplying into these markets, you are going to see an increased cost to ensure that cargo or to ensure that supply.
[00:13:38] Speaker B: I would also add to that from the carrier's perspective, we're looking at the credit practices of our client as well, and that plays a major part in our comfort level with the relationship. So that's a big part of it as well.
[00:13:53] Speaker A: I want to talk about forward selling, and to be honest with you, this is a little bit murky for me. So let's talk about the risk of forward selling. And if you issue a policy to a company that's forward selling in the energy market, and the buyer goes bankrupt. How's this claim calculated, and where does it go from there?
[00:14:13] Speaker D: The energy sector has been great to do deal with over the last ten years, because some energy and some of the commercial people and some of the energy traders are more of the savviest traders in the world when it comes to commodity trading. And so they're always looking to innovate and to push the envelope a little bit. And it's been nice where the credit insurance world can be, I would say, a little less on the innovative side. So it's been nice to sort of work with a lot of our major clients to create some new products. And one product where there was a lot of demand was the spread loss risk product that Josh alluded to earlier, where ultimately you can go up, I've seen them go up as high as eight to ten years, where if you enter into a fixed price contract for that price over that ten year period, let's say in year three, your buyer defaults, and then you have to go and renegotiate and sign a new contract at a lower fixed price based on what's happened with that commodity over that period. You can then claim for the delta between the original contracted value and that second reduced value contract that you have to do it. And the nice part is you can do it for the remainder of that term. So in this case, if it was year three of a ten year contract, you could essentially claim for the remaining seven years on that. And what Ryan had mentioned earlier, too, is that also works on the supply side. So if you were procuring supply to then onward sell, and your supplier defaults and can no longer perform and provide you with a commodity at the certain price that you wanted it at, and then all of a sudden you have to go to the open market and pay more for that commodity, you can then file a claim for the delta between the original value and that increased value on the supply side.
[00:15:49] Speaker A: Okay. Okay.
Anybody have anything to add to that? Are we good?
[00:15:55] Speaker C: Nope. Perfect.
[00:15:56] Speaker A: Okay, so I want to talk about a real life story here, because I think this is where people are going to maybe really understand how all of this may work. So, Kevin, I think that you guys have a client that you both worked with, both alliance and onesource. Can you outline this real life story and share how it all works?
[00:16:20] Speaker D: For sure, yeah. Thankfully, we have lots of clients that we work together. Okay. But, yeah, one in the power sector. That's fairly recent, I guess we're just working on over the last few months is we use a number of different products that Allianz has to offer. So the first was trade, credit, insurance, where we were able to ensure their nine largest buyers. And there were significant summertime receivable levels where their exposures were all, say, nine figures. So in aggregate, there were significant exposures there where we could then insure them and work with our clients bank to get 90% to 95% the value of the insured receivables and have payment made from the banks. The nice part there is they could then pay for their supply with money that they're getting from the bank based on the size of these receivables. So that was on the TCI side. We were also able to get a demand bond facility in place for them, where they could then post some of their collateral obligations to various isos they were able to use to post that.
It's worked out well for them. It's freed up, I want to say, getting close to nine figures of working capital for them, being able to use the bond facility, as opposed to posting either cash or letters of credit.
[00:17:35] Speaker B: So the idea there, Janet, I mentioned before, sister products, and Kevin has gotten. He's described the on demand payment bonds quite well. The idea is to help our client from supply, from their purchase, down through their supply. Right. So we're helping on both sides of the supply chain for them. And that's a perfect example of how we help on both sides. That's an ideal client, right? Somebody that we can help both as procuring supplies and selling.
[00:18:01] Speaker A: Okay, I want to ask this question, and it may be silly, but how hard is it to get people in the energy market to be interested in this product?
[00:18:18] Speaker D: Initially, it was a grind. Okay. I started a firm back in 2011 to focus specifically on energy in western Canada.
And it was before Allianz was interested in doing energy. And it was a real struggle because there wasn't a whole lot of history in Europe. The product, I would say, was a little bit more mature. But on the pure energy commodity side, there wasn't a lot of underwriting capacity available. And kudos to Allianz, who were known back the time as Euler Hermes. They really stepped in North America and helped drive a lot of innovation and really started to build demand. But it was slow, and it's taken, I would say, ten years to really get a critical mass of global and north american wide energy companies using the product. And I'm happy to say that I would say a majority now do use a product or one of our products in one way, shape or form.
[00:19:13] Speaker A: Okay. And when you're talking about energy and you're in western Canada, Kevin, so you're talking about oil and gas and things like that. Does solar energy, any of that stuff come into your picture frame?
[00:19:30] Speaker D: Oh, for sure, yeah. We'll try to work as much as we can with all forms of energy and with some of the renewables and say, the inflation reduction act in the US, creating a lot of potential opportunity there with the government, we've had to get very creative. A lot of the underwriters have really put a focus on trying to support more sustainable, greener type initiatives.
And with that, it's been very helpful, because a lot of the renewable companies that are set up without the help of an inflation reduction act or other, some form of government prop, then they really, because they're new companies, there's not a whole lot from a credit evaluator to sink their teeth into. So without the support of a lot of underwriters, a lot of these projects simply wouldn't get done. So we are seeing a lot of demand on that side. Now, that's not to say there isn't still significant demand from more traditional oil and gas firms. And one area where we've struggled a little bit is actually finding enough capacity from all of the underwriters to meet the demand as it grows. And that's especially prevalent on the demand bond side, where it seems I'm constantly trying to go out and get new sureties to provide capacity to meet the demand.
[00:20:47] Speaker B: Okay, so, Janet, from our side as a carrier, the Allianz side, what we say internally, just to make it really simple for folks in terms of, hey, when should we bring an opportunity to our energy team, which is what Josh and I are comprised of, it's any company that's moving a molecule or an electron, we should have a conversation with them. It's that simple. Now, again, it could be anywhere on the supply chain. It could be from upstream all the way down to retail. We have solutions that could potentially be a fit at least worth discussing.
[00:21:18] Speaker A: Okay.
[00:21:19] Speaker C: And also other items that have really come into play over the past two to three years. Carbon offsets and carbonous credits. Companies are using these items to basically go net zero and to meet their very aggressive sustainability goals. And we have determined that carbon credits as a whole are a service. And so in the event we have our prospects or policyholders that are physically supplying carbon credits to their counterparty, we can ensure that in the event of a default, we can insure it in the event of an exchange going under. It's strictly a one party to another party physical supply, but we are seeing more and more requests to ensure carbon credits in this space.
[00:22:12] Speaker A: Okay, is there anything else that you guys want to share as part of this podcast about the energy market and receivables insurance?
[00:22:21] Speaker D: Well, one topic I think we should just touch on briefly is in a struggle we've had over the last, I would say, five years, and I alluded to it a bit earlier, is, I would say, dwindling capacity. The credit insurance world globally is heavily driven by three major european companies, Allianz, Atreides and Copas. And a lot of the big reinsurers are european based. And there's a very strong push in Europe over the last five years from an ESG perspective, to really, I would say, pull support for a lot of more traditional oil and gas companies, fossil fuel providers more than anything else. And obviously coal. Coal most, I would say underwriters globally have not supported coal over the last five, if not longer, ten years. But what we're starting to see now is some underwriters, now that they've got, say, five years of data to look at and say, hey, you know what? We've actually, just by pulling and not supporting a lot of these companies, we haven't really made a huge impact globally on emissions. And in fact, if you look at something like coal, demand for coal globally in 2023 was the highest it's ever been. And so it's, there's now a lot of data coming out saying that maybe just pulling either banks pulling financing or underwriting, pulling support for oil and gas producers might not be the fix we need. This is more of a demand issue than a supply issue. If there's going to be global demand for relatively inexpensive energy, someone is going to fill that supply. So now we're seeing some underwriters and banks say, you know what, maybe it's going to be more impactful from an emissions reduction perspective if we work with legacy oil and gas producers, sometimes even coal producers, to have them provide their products, but limit emissions as effectively as possible and come up with a realistic plan, company specific realistic plan, to say, okay, these are the emission targets that we're going to hit. So we'll continue to provide inexpensive fossil fuel hydrocarbons to a lot of the developing world where the demand is coming from. But there is a realistic, I would say, transition plan there to lower emissions.
The nice part about that from the credit insurance realm is we are seeing now capacity come back from some underwriters who are starting to view that more holistically.
[00:24:42] Speaker A: And going forward, I mean, let's be honest, the world is just going to need more and more energy. So who knows what's going to happen, right?
[00:24:50] Speaker D: Oh, precisely, yeah. And I mean, ultimately, people are coming to the conclusion that the transition will probably take a little longer than what some people were hoping for. But as long as we have the population we have on the planet and we're trying to lift as billions of people out of poverty, the only way to do that is through inexpensive energy.
And currently we don't have the technology to replace fossil fuels on that front.
[00:25:16] Speaker C: Speaking of technology, it's not only population that we need to worry about, but it's also AI.
In the United States right now, only 3% of all power Gen is dedicated to AI. In the next six years, five years, by 2030, that's going to be 8% of all power generated in the US is going to be dedicated strictly for AI. You need power to, or you need electricity to power these data centers, to power these places that are generating the AI. And that's going to be a very large strain on our power grid. So being able to support and come up with innovative solutions to protect these power companies that are generating the power is going to be key for not only our growth in the US and Canada and North America, but also for growth in poverty nations, Europe, all across the globe.
[00:26:25] Speaker B: Okay, and Janet, I'll answer your original question, which is what? Are there some misconceptions that you want to clear up? I've said it already, but I'll say it again. So I want to get rid of the insurance piece of it, especially in the energy space that's applicable in other verticals that we work in. But in the energy space in particular, this is really about clearing credit and creating capacity. It's not about the insurance. 99% of the time, as I said before, sometimes it comes in and it's nice then, but this is really about clearing credit and creating capacity.
[00:26:59] Speaker A: Okay, gentlemen, I think we're pretty much almost out of time, but I really appreciate you guys taking the time to talk to me about the energy space and receivables insurance.
And thanks very much for joining me.
[00:27:13] Speaker B: Thanks, Janet.
[00:27:14] Speaker D: Thanks, Janet.
[00:27:15] Speaker C: Thanks, Janet.
[00:27:16] Speaker A: Ryan Wimberley is senior vice president, regional head of direct sales bank and energy at Alliance. Josh Steele is head of underwriting energy at Allianz, and Kevin Sullivan is first vice president, energy specialty at OneSource. Thanks to you for watching the Trade Securely podcast. You can find out more about the receivables and Insurance association of Canada on LinkedIn and on X. And you can also check out our YouTube channel, which is called trade securely. I'm Janet Eastman. Thanks for watching.
