Drilling Down for New Solutions

Call it bad timing. The global energy industry experienced a patch of serious losses from 1998 to 2001, with the Petrobas oil rig sinking off the coast of Brazil in March, 2001 capping off a dismal run of severe claims. This event, which claimed 10 lives and left insurers on the hook for US$500 million, was seen at the time as hugely catastrophic. A series of fires and explosions at refineries in the U.S. and Europe only added to the poor loss experience.

Reinsurers were reevaluating prices in the first six months of 2001 and insurers were rethinking oil and gas exposures, tightening rates and capacity. Then 9/11 hit, and the roof caved in. The insurance capacity for global energy, which was as high as $4.5 billion, dwindled to under $2 billion. Crucial coverages, such as “control of well,” which insures against fires and explosions, dried up. Rates for property and liability skyrocketed, while business interruption became, in some cases, unavailable. In an instant, the energy market’s insurance profile went from poor to terrible.

“In terms of past hard markets, this one is different for a couple of reasons,” says Mark Robertson, manager of risk management for Nexen Inc., one of Canada’s largest energy and oil and gas firms, which has active operations in the Gulf of Mexico, the Athabasca oil sands of Alberta, Yemen and West Africa. “Terrorism coverage, of course, is now excluded. Depending on the worldwide operations of oil and gas companies, this could be a real concern. The other issue was construction insurance. This was not only hugely expensive, but often difficult to get.”

“Oil and gas companies were greatly affected because they deal with only a handful of carriers at the best of times,” says Mark Terrill, president of JB Oil and Gas Ltd., a specialist arm of Jones Brown Insurance Brokers. “Capacity has become a big issue.”

Big bucks

The combination of poor loss experience and 9/11 insured losses left the energy industry looking for alternative insurance and risk transfer solutions. Oil and gas companies are the main players in the global energy industry, which also includes utilities and related firms. Oil companies are divided into onshore property and offshore, or “upstream,” markets. Onshore, or so-called “downstream” companies, are involved in refining, petro-chemical manufacturing and product distribution, while the upstream markets handle exploration, drilling and transportation of crude oil to refineries.

Oil and gas is a $64 billion industry in Canada, with several multinational companies dominating the market. These include many familiar names, such as Husky Energy Inc., Nexen Inc., Nova Chemicals Corp., Petro-Canada, Shell Canada, Suncor Energy Inc. and Talisman Energy Inc. In Canada, the Athabasca region of Alberta represents one of the largest deposits of crude oil in the world, bigger than all the oil deposits in Saudi Arabia. The challenge is extracting the oil from the sand, and several firms have invested billions of dollars in technology and construction to refine oil in the region. For example, the “Athabasca Oil Sands Project” is a joint venture partnership of Shell Canada Ltd., Chevron Canada Ltd. and Western Oil Sands, with a $5.7 billion first phase of construction already operational at a design capacity of 155,000 barrels per day. Nexen also has invested $3 billion in construction of the Long Lake facility near Fort McMurray.

There are, however, sharp differences in the size of companies within the oil and gas industry, with firms measured by their production of barrels of oil per day equivalent (BOE). Below the larger companies are the intermediate and junior firms, who many sources say are most vulnerable to shifting conditions in the traditional insurance market.

The insurance carriers for oil and gas firms include a handful of well-known names – ACE/INA, AIG, Chubb, Commonwealth, Lloyd’s, Zurich, and a few others. All markets have subsequently taken a cautious view of risks in the oil and gas industry. “This is mainly a severity-driven business from the claims point of view,” says Geoff Rubel, senior underwriting officer with Chubb Insurance Co. of Canada. “We don’t tend to get a lot of losses, but when they do come they are typically six-figure claims.” Furthermore, Carlo Petosa, a senior vice president with ACE/INA’s global energy group, points out, “it’s difficult to predict what the loss ratio will be for this industry because all it takes is one or two claims to pop”.

A good loss experience in point was a fire on January 6, 2003 at the Muskeg River Mine in the Athabasca oil sands. A hydrocarbon leak in piping sparked the fire at a treatment plant, which, after being extinguished, caused extensive freezing. The size of the claim, which was filed under a cost overrun and project delay insurance policy, was $200 million. However, the Athabasca Oil Sand Project partners also filed a statement of claim against their insurers for $850 million. The claims settlement process is continuing. It is such losses that create a “chill” in the insurance climate.

Depending on their size, oil and gas companies have used several options to manage their exposures. “Some clients increased retentions, some bought less limit, some stopped buying business interruption, some joined ‘OIL’ and so on,” notes a July, 2003 report from Willis called “Energy Market Review”. OIL Ltd. is a Bermuda-based entity that acts as a mutual insurance company for a select group of larger energy firms, who must have gross assets exceeding US$1 billion. Formed in 1971, “to satisfy the petroleum industry’s need for adequate insurance coverage and limits”, it provides limits of up to $250 million per occurrence, with deductibles starting at $5 million, according to the company’s website. There are currently 11 Canadian companies among OIL’s 87 shareholders.

Robertson says his company joined OIL “mainly due to control of well insurance. If you are in the offshore market, it is pretty much a necessity to join OIL, which provides this coverage for a fraction of the costs of the traditional market.” He adds that membership in OIL has doubled over the past three years due to tough insurance market conditions. “For the bigger energy firms, risk financing and transfer comes down to an issue of cashflow and balance-sheet capability,” says Robertson. “Depending on what makes sense, we have used traditional markets, we have a captive based in Barbados, we have substantially increased our self-retentions and we have used alternative markets. There is no ‘one solution’.”

Alternative options

Other alternative markets exist for oil and gas companies. The Canadian Petroleum Insurance Exchange (CPIX) was formed in 1988 to provide risk and insurance solutions for the Canadian energy industry. It offers general liability, control of well and property/business interruption coverage to more than 248 “upstream” oil and gas companies, with deductibles of $10,000, primary program limits of $10 million and industry reinsurance up to $50 million.

In an interesting development, CPIX recently partnered with JB Oil and Gas to provide broader access to traditional insurance markets. The partnership started last summer. “It’s clear that many of the larger oil and gas companies have other risk financing options, but these require money and sophistication,” says Terrill. “The intermediate companies rely much more on traditional insurance markets to get coverage and they are looking for more choices and greater flexibility.”

The main risks insurers write in the energy industry are property and liability, specifically sudden and accident pollution. Robertson says he has seen capacity coming back into the marketplace recently, “especially in the Bermuda market and with Lloyd’s [of London] corporate capital backing. However, energy companies are looking closely at insurer financial ratings. We want to do business with companies that are at least at, if not better than, our rating.”

In line with general market conditions, there are signs of traditional coverage relief in the energy sector, particularly on
the property side. “We have seen some softening on higher multinational property programs and this is starting to trickle down to the intermediate market,” says Jason Pugi, energy resources manager for Chubb Insurance Co. He notes that the insurer does not write control of well insurance. “But, it is still very risk-specific.”

“Things have gone well in 2002 and 2003 and I think we have seen some flattening and what I would call ‘rate adjustment’ in property, especially in the last quarter of this year,” says Petosa, whose firm also does not cover control of well. “But the insurance market is still jittery. All it would take is one or two big claims for markets to retract.” On the liability market, there is little evidence of rate adjustment. “We have not seen rates come down as quickly on the casualty side,” says Pugi. “There is still claims activity out there.”

Potential movements in pricing are not enough for many risk managers, according to Robertson. “It may be a 5%-10% reduction in property, but that is still a small decrease off a very large number,” he observes. “It is still nowhere near what it was pre-9/11. I think in certain lines, such as construction and control of well, insurers have priced themselves out of the market. And once energy companies are forced to deal outside the traditional market, it is very unlikely those premiums will come back.”

Rate fatigue

Other segments of the oil and gas industry have expressed similar frustration with insurer pricing and coverage decisions. Propane gas producers, operators and wholesalers were hit hard by unilateral insurance decisions to restrict coverage and hike rates, according to Bob Cunningham, managing director of the Propane Gas Association of Canada. “I think there were a lot of misperceptions and misinformation around propane, and at one point, insurers denied coverage to homes that were heated with propane, transporters that delivered propane and even some propane producers,” he adds. “In reality, propane is a lot less dangerous gas than other fuels, and our loss experience shows that.”

Cunningham met with the Insurance Bureau of Canada’s (IBC) “market availability committee” in late June and says he was pleased with the industry’s responsiveness. “But we have only made slight progress. Insurers are willing to provide coverage, but after rate increases of 100% over the past two years, we are looking at yet more in the way of increases next year.”

The national propane gas association is actively looking into alternative solutions, including a captive. Cunningham says the patience of propane companies with the insurance industry is wearing thin. “Our discussions around captives have moved to the front burner,” he notes. Other energy companies, including natural gas producers, petro-chemical product manufacturers and oil and gas firms, are also experiencing rate fatigue. After a history of the commercial insurance market failing to provide adequate coverage and limits on crucial exposures, many oil and gas companies say this latest insurance cycle is an extreme example of “more of the same”. But, insurance sources say well-documented claims severity problems prompted the sharp reaction of the insurance industry to risks in the broader energy market.

Insurers, however, are slowly re-entering the game, in part due to a reduced premium and insured risk pool. They are also buoyed by the relatively positive loss experience in the global energy market over the last two years, especially compared to the 1998-2001 loss experience. “When rates and deductible levels, which are at ten or twenty year-highs, are coupled with breadth of coverage narrower than anything granted for ten years, it is easy to understand why the energy business has become attractive again to underwriters,” notes the Willis energy market review. “After becoming ‘risk-shy’ post-9/11, insurers and reinsurers are once again providing much-needed capacity for energy clients,” the report points out. However, just how long this tentative approach of traditional insurers will last in terms of “dipping their toes” back into the global energy waters is anyone’s guess.