Energy insurance trends

Business interruption

One of the most significant trends over the past five years has been the steady increase in business interruption claims as a proportion of the total loss arising out of an insured incident. Energy companies are buying more business interruption cover as refining and processing margins maintain their healthy levels in the US. Among the other key drivers are abundant inexpensive feed stocks, complex supply chains and a trend for clients to seek independent consulting advice.

The increasing cost of business interruption claims is also linked to the complex and sometimes heavily concentrated supply chains in the energy sector, concentration of risk never being a favorable recipe to an insurer. Supply and demand levels for refined hydrocarbons and petrochemicals are increasing and with many suppliers and consumers heavily relying on their timely delivery, associated production and distribution risks can be covered by elaborate insurance programs.

Energy insurance covers are normally arranged on a "package" basis by specialist insurance brokers for upstream, midstream, and downstream exposures, with the latter sector dominating business interruption. Energy insurance packages typically include covers for onshore property, offshore property, time element (business interruption), well control/redrill, and third-party liabilities (including pollution clean-up).

Production operations are also growing more complex and interrelated in other ways. For example, there can be three or four oil fields all feeding into one offshore processing facility. As a result, one event can impact many facilities and lead to claims for a number of insureds. The same is true for onshore oil and gas gathering facilities. Generally, the trend is for more claims from large, interrelated installations where there are complex interdependencies to understand.

As business interruption claims have become more complex, more time and resource is required to both prepare and settle them, with both insureds and insurers employing teams of experts to quantify the losses. A mini cottage industry has evolved to handle complex business interruption losses involving loss adjusters, accountants, engineers, schedulers, and attorneys to provide specialist legal advice on the correct interpretation of the complicated contractual and policy language.

Physical damage

Physical damage exposures are also growing in the energy sector, such as increased production/processing volumes, more sophisticated technology, larger scale equipment, and bigger vessels that operate in more extreme environments. The potential for greater-value physical damage losses has been around for a while, but insurers are now beginning to see such claims come to fruition.

For example, the cost of larger support vessels and specialist equipment rises as the exploration and production operations move into deeper water. With the cost of vessel spreads running as high as $2M (€1.47M) per day, it does not take long to rack up a big bill should they be called upon to carry out insurance repairs. However, some insurers would point out that, while values have been increasing, insurance policy deductibles and waiting periods have not kept pace in the current hyper-competitive insurance market.

Impact of changing technology

Cutting-edge technology has always been present in the energy sector as companies are looking to drill deeper, better and longer - it's a natural part of the industry's development. Today, technological developments continue to drive energy operators into uncharted waters. Insurers continue to keep abreast of technological developments. Take well control insurance; it provides cover against surface and underground blowouts, being one of the few covers (if not the only one) against a purely occupational hazard.

When new technologies are introduced into the sector they often impact claims, making them yet more complex and expensive. Advances in sub-sea technology are allowing energy companies to operate in ever deeper water, but pipelines in deep water are much harder to access and repair.

The energy industry's increasing reliance on technology is also a risk. For example, floating production, storage, and offloading (FPSO) units typically use global positioning systems (GPS), which could potentially be disrupted by massive solar storms. Rigs, FPSOs, onshore refineries, and pipelines all rely on information systems and networks, which create cyber exposures. These facilities are increasingly exposed to property damage and business interruption from malicious cyber-attacks, operator error or data corruption.

It is not just the insurance claims sector that faces challenges with new technologies. In order for insurance underwriters to determine an appropriate insurance premium a risk must be measurable in terms of frequency and severity. However, due the uncertainties associated with new technologies along with a lack of true historical information, major challenges exist in the underwriting of energy risks.

Emerging territories

New technologies and higher oil prices are also leading oil companies to operate in new areas, including much more challenging environments, such as deeper waters and more remote locations.

One area which will almost certainly challenge energy claims handling in the future will be oil and gas exploration in the polar regions. The Arctic has huge untapped oil and gas reserves, but drilling in the extreme conditions poses a whole host of technological, operational, and environmental challenges. The Arctic environment gives rise to huge challenges, with some areas only accessible for a few months of the year. The long-term effects of the cold and ice on drilling rigs and FPSOs are largely unknown, while the remoteness of operations would make it difficult to remedy issues in the event of a claim incident. Pollution could also be an issue because oil breaks down differently at lower temperatures.

Closer to home, advancements in hydraulic fracturing technology have also opened up tight shale oil and gas basins in the US on a massive scale. However, the scramble to extract and get the product to market in the quickest way possible has already led to some noticeably large insurance claims.

Vast potential reserves are found in other countries, such as China, Argentina, and the United Kingdom, and it remains to be seen how they will be fully developed. One interesting development relating to remote emerging territories is the move to floating liquefied natural gas facilities to allow the exploitation of offshore gas fields that were previously too distant for traditional onshore gas processing. These projects are the product of huge dollar investments that will create risks at the very limit of world insurance capacities.

Oil sands are another frontier for the energy insurance sector. Developments in Canada are already generating significant insurance claims, exacerbated by the long northern winters prolonging repair operations.

Emerging markets

The energy sector is becoming more global as emerging markets become more important as both consumers and producers. Large reserves are being opened up in Brazil as well as parts of Asia Pacific and East Africa.

Operating in new, and often remote, parts of the world has implications for the cost of claims. When drilling and producing in the North Sea or Gulf of Mexico operators and their contactors have easy access to lifting equipment, support craft, and even spare rigs for relief wells. But in emerging markets, such equipment may have to be mobilized from far away. Even in Australia, if there is a fire on an FPSO, it might have to be towed to Singapore or Korea for repairs, which results in a higher repair bill and prolonged downtime with regard to time element related risks.

In addition, another challenge posed by many emerging areas is that there can often be greater legal and political uncertainty due to a lack of precedent and challenges in interpreting laws. Similarly, certain countries suffer notorious customs delays and other bureaucratic impediments, all serving to enhance both physical damage and business interruption insurance claims.

Catastrophe claims and large losses

The global energy insurance claims sector was relatively benign in the early part of 2014, at least in terms of loss frequency and a lack of catastrophes.

Since the spate of hurricanes in the Gulf of Mexico in 2005 and 2008 - which included the devastating hurricanes Katrina, Rita, Gustav, and Ike - there have been relatively few large catastrophe losses. Catastrophe losses have not been a major concern for the energy sector in recent years and are far less of an influence on claims activity than in the past. According to AGCS, storm damage accounts for just 2% of claims by value in the energy sector.

However, when there are insurance claims in the oil and gas industry, they can be very large indeed, and the cost of those claims has been rising. Excluding natural catastrophes, claims appear to be increasing in severity, and when it comes to energy claims, we can be talking very large numbers. The average claim in the energy sector is in excess of $25M, according to AGCS.

There were no significant losses during the first five months of 2014, but from early June there were four loss incidents in a month (refineries in Siberia, India, Thailand, and a chemical complex in the US), all of which are now in the process of preparation and investigation. There were also a number of large losses in 2013 including an ethylene plant in Louisiana and a refinery in Argentina.

Emerging risks -- fracking

Hydraulic fracturing is an emerging risk in terms of media interest, but the process has actually been in commercial usage since 1949 in the US. Although an established technology, its recent development in new regions to exploit tight shale oil and gas reserves has brought it into the media spotlight, fuelling a highly charged debate about its risks and benefits.

From an industrial insurance perspective, and when carried out to best practice standards, fracking presents risks that are comparable with other land-based conventional oil and gas extraction techniques. However, while it shares many of the same risks as conventional approaches, it can also introduce new risks, such as exposures for liability or damage to specialized equipment.

Therefore, as with other complex extraction processes, fracking requires a holistic and comprehensive risk management approach, which should consider not only the risks posed by the fracking operations, but also the extended social and environmental impact of such operations in the local area.

To date, insurers have not seen disproportionate claims activity arising from fracking, but they are monitoring developments in this industry closely, and regard efficient risk management as the key to preventing future claims from such operations. The risk of blow-out from the fracking process is relatively small, although there are some heightened risks associated with the increased concentration of topside equipment used to generate the pressure required. Effective risk management is the priority as with all complex industrial processes, because prevention is always better than the cure.

The risk of drilling and fracking previously inaccessible shale oil and gas is typically no greater than traditional onshore oil exploration, but fracking does involve additional risks such as for equipment and transportation - with each fracked well requiring as many as 2,500 tanker trucks of fluid transporting, often through areas not accustomed to industrial traffic.

The future

The oil and gas industry has always involved high value / high risk exposures - both physical and commercial. The risks associated with exploration and production grow as technology allows us to migrate to previously physically inaccessible reserves.

Transporting and storing the newly-found wellstream fluids have given rise to previously insurmountable challenges, all of which have been overcome in some of the harshest environments on the planet.

The processing and refining of the crude hydrocarbons to produce fuels, oils and petrochemical products continues to involve more complex methods and the marketing of such products is involves equally intricate commercial arrangements between suppliers, manufacturers, and customers alike.

All the foregoing require carefully-designed equipment and arrangements to avert or minimize potential loss incidents, both physical (e.g. loss prevention devices, emergency controls, etc.) and systematic (risk management, contingency planning, etc.).

Figure 1 shows how fire and explosion claims have dominated the numbers in the five years between 2009-2013, both in terms of the number of claims and their respective values. The current year's large losses also support that trend, all of which goes to demonstrate the importance of loss prevention techniques.

About the author

Chris Dye has been involved in oil and gas insurance claims for more than 34 years. A graduate geologist, he initially worked offshore as an insurance warranty surveyor. Since that time he has been involved in some of the largest energy claims to hit the insurance market including Piper Alpha and Macondo. He is currently a claims director for Allianz Global Corporate & Specialty concentrating on upstream, midstream, and downstream energy losses with associated business interruption exposures.