An Integrated Approach to Offshore Energy Risk Management

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An Integrated Approach to Offshore Energy Risk Management
The offshore energy industry faces an increasing range of threats and disruptive forces
which naturally translates into significantly increased exposure for underwriters insuring and
reinsuring that business. Events such as Macondo have thrown offshore energy underwriters
into the spotlight, but this insurance class, like most of the specialty classes, is also prone to
political, economic, cyber, credit and business interruption risks.
In this article we explore the energy risk panorama today, highlight underlying risk volatility,
the potential outcomes resulting from offshore energy risk aggregation and call for a more
integrated approach to underwriting risk management by the insurance industry.
Before we explore the perils and hazards that threaten the energy sector, we will begin with
an overview of the economic headwinds that confront the sector in 2015.
Impact on Energy Insurance Pricing
Goldman Sachs reported the price of Brent crude oil fell below $57 per barrel on the 14th
July, following the lifting of economic sanctions on Iran. Goldman Sachs said: “Oil exports
from Iran could rise as much as 60% by the end of this year, which would exacerbate the
oversupply situation in the global oil market. Combined with slowing demand growth from
Europe and Asia, this will likely reinforce the downward pressure on the oil price.”
Goldman Sachs currently expects Brent crude oil prices to average $58 in 2015, and $62 for
2016.
At the same time, the investment banking giant reported: “far greater concerns are with the
high breakeven costs of current upstream developments. Shell remains committed to its
costly Artic exploration project, which has a breakeven cost of around $100 per barrel. BP is
using a breakeven target of $80 per barrel in deciding new investment projects, whilst Shell
is said to be using $70.”
What does this backdrop mean for the energy (re)insurance industry and its ability to
achieve profitability across such a difficult ratings environment? The prevailing view is that
energy insurers are likely to come under renewed pressure at renewals as oil companies
look to cut costs in response to a slump in oil prices.
Energy Reinsurance Aggregation Risks
"Oil prices are already being felt in the energy insurance market, according to Richard
Palengat, Class Underwriter at AEGIS London, the Lloyd's arm of Bermuda-based energy
mutual Associated Electric& Gas Insurance Services Ltd. "We see it when we talk to insureds
and it will not be long before we see it in capital expenditure as well as in insurance
renewals," he said."
In this environment, reinsurance underwriters will also be taking note of how these
challenging market conditions will impact on their energy reinsurance pricing and energy
reinsurance aggregation models.
According to Allianz Corporate Global & Specialty (AGCS), which released its Global Claims
Review 2014, authored by Chris Dye a claims director for AGCS, in 2014 the cost of energy
insurance claims continued to increase due to escalating dollar values combined with
“increasingly complex and interrelated risks.”
These complex and inter-related risks are leading organisations to digest and analyse a
higher volume of data every year, which is particularly important in the accident-prone oil
and gas industry. With the combination of increasing operations and lower oil prices, taking
advantage of valuable data is vital, not only to lower costs, but also to mitigate risk while
improving safety.
Energy companies need to be fully productive and reduce downtime to stay competitive in
the global economy. This means that energy companies (and their underwriters) need to
understand the return on investment of managing data, because according to a study from
Oracle, poor data management can cost major oil & gas producers up to almost a quarter of
their annual income.
The energy sector relies on high quality risk management standards to meet the challenges
it faces but what are the major challenges that cause sleepless nights for offshore energy
underwriters and their boards?
In Extremely Deep Water?
Lloyd’s of London says that as drilling moves into more extreme environments, the technical
and operational challenges will increase. Both the costs and the risks of offshore drilling
increase in deeper waters. The issues faced are significant and complex. As AGCS notes:
“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.”
The energy sector’s growing dependence on technology is also a risk as floating production,
storage, and offloading (FPSO) units frequently use global positioning systems (GPS), which
opens up the possibility of disruption by massive solar storms. Energy installations and
equipment all rely on information systems and networks, which create cyber exposures such
as being exposed to property damage and business interruption from malicious cyberattacks or simple human error.
As, oil exploration and production is moving to deeper waters, the consequent worsening of
environmental conditions, either places mooring systems under higher dynamic loads or
requires more reliance upon Dynamic Positioning. Furthermore, as more FPSO and FSU
installations are being utilized there is a higher risk of shuttle tanker/FPSO collisions.
The Growing Importance of Export Controls in Oil & Gas
Export controls are regulations that support national security policies and prevent the
proliferation of weapons of mass destruction and related terrorist activities. Due to the sharp
rise in terrorist activities and developments in technology, governments and industry have
sharpened their focus. There has been a surge in enforcement, particularly around dual-use
goods (for example, goods that are designed to a commercial end but can also be repurposed for military use.)
The tightened export regulations impacting the oil and gas industry stem from the Iraq
Supergun incident when drill piping was exported to that country. Export control regulations
have subsequently been a major focus of the oil and gas industry with compliance
procedures assuming new importance.
Political Risk Aggregation: Sanctions
Lloyd’s Sanction Checking procedures state that “Managing Agents should undertake a
sanctions risk assessment, for the purpose of assessing the risk that international sanctions
pose to their business, and to identify which aspects of their business are the most exposed.
The risk assessment should then drive the sanctions controls in place across the business,
which in turn will inform the managing agent’s Sanctions Policies and Procedures. It would
be best practice for the risk assessment to be endorsed by the board, or the relevant board
committee.”
Lloyd’s says the Counterparty risk, needs to be monitored carefully: “including if the
transaction involves a number of counterparties (for example, in reinsurance; a reinsured
and an underlying insured, or under a marine policy; a ship owner, manager, charterer and
consignee) who may be unknown to the underwriter at the time of binding the risk.”
Clearly, credit and political risk is an important and growing risk in such an environment,
which will require careful monitoring on the part of energy (re)insurers.
The risks raised above are connected risks, which aggregate within the energy class and
require an integrated approach to underwriting risk management. It will become increasingly
important to have real-time knowledge of underlying accumulated exposure at the time of
risk pricing, to encourage more informed risk selection decisions based on better data
quality.
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