Drilling Insurance Costs Set To Skyrocket
Impact could dwarf moratorium's
Insurance costs for deepwater drilling are poised
to rise by as much as 50 percent after the
Deepwater Horizon disaster, and the increases are
sharp enough that it could make some exploration
and production projects too expensive no matter
what happens with new regulations in Washington.
As insurers look with horror at the mounting
economic damage in the eight weeks since the
Deepwater Horizon rig explosion, they're
realizing that they didn't fully understand the
risks of offshore drilling.
To make sure their risk is adequately covered,
insurers are raising prices and requiring
offshore drilling clients to buy more coverage.
The move means that no matter what happens with
new regulations after the six-month
deepwater-drilling moratorium, rising insurance
costs will make offshore drilling more expensive.
"These kinds of increases definitely could affect
the development in the Gulf of Mexico," said
Rayola Dougher, senior economic analyst with the
American Petroleum Institute.
Rising costs will be felt most acutely by smaller
companies operating in the Gulf of Mexico, and
the insurance impact could be magnified if
Congress raises the liability cap for economic
damages from oil spills. Marine insurance prices
could also rise as a result of the disaster.
The impact is particularly potent in deepwater,
meaning depths of greater than 1,000 feet, the
areas of the Gulf of Mexico that hold the most
remaining oil reserves.
Drilling in deepwater is more price-sensitive
than other types of oil exploration, because it
requires expensive state-of-the-art equipment,
detailed analysis of hard-to-reach geology and
long planning horizons for projects. Many
deepwater exploration and production projects are
viable only when oil prices are expected to
remain high, so increases in the costs of
drilling could render some projects unfeasible.
Premiums already rising
Indeed, in a June 3 research report, Moody's
Investors Service said that premiums have already
increased by 15 percent to 25 percent for rigs
operating in shallow waters, and up to 50 percent
for rigs in deepwater. Any losses from this
year's hurricane season could further increase
the rates, Moody's said.
Percentage increases on big operations translate
into big bucks. What's more, these figures are
based on insurance quotes and policy renewals
since the April 20 disaster; as the market
watches how long it takes BP to shut down the
well and what comes out in investigations of the
explosion, price adjustments may change.
"We believe that this event will have a
meaningful impact on the market for offshore
energy-related insurance coverages," said James
Eck, vice president-senior credit officer at
Moody's. "Pricing for offshore energy liability
insurance will likely also trend higher as
insurers and reinsurers take stock of their
losses and re-evaluate the complex risks
associated with drilling in deep waters."
In a note about the deepwater moratorium, energy
research firm Wood Mackenzie points out: "Higher
exploration costs in frontier areas of the Gulf
of Mexico -- which are already economically
marginal -- could dampen the exploration
community's appetite for these areas, which form
a vital part of the long-term production
prospects in the region."
In a separate May 2010 note, the company
estimates that a 10 percent increase in
development costs could render seven current
discoveries in the Gulf of Mexico uneconomical
While rising insurance costs are bad news for
energy development in the Gulf of Mexico,
environmentalists laud the fact that higher
insurance rates will better reflect the true cost
David Pettit, senior attorney at the Natural
Resources Defense Council in Los Angeles, said
that oil companies profit from energy production,
but humans and the environment bear the cost of
those activities. The price signal from the
insurance companies will help put the costs back
where they belong.
"Our view is that negative externalities should
be internalized by the industry," Pettit said.
"It's a good thing if the actual costs to human
health and the environment should be borne by the
Dorian Grey, president of offshore for the Global
Marine & Energy division of Chartis Insurance in
Miami, said the Deepwater Horizon explosion is
causing a wholesale re-evaluation of underwriting
offshore energy installations.
Until now, insurers thought that hurricanes were
the biggest risk to energy operations in the Gulf
of Mexico, and they took a kinder view of the
modern floating platforms in deepwater because
they seemed less likely to topple than their
older, less technologically advanced counterparts
in shallow water. Now, they're wondering if they
really had a grip on what they were insuring.
"What this event has shown is that any deepwater
drilling has hazards that perhaps insurers have
not fully appreciated," Grey said. "The costs of
getting control of a well and the technical
difficulties are surprisingly challenging."
Insurers are now asking detailed questions about
the technology and safety records of the
companies they insure when policies come up for
renewal. They're not only charging higher rates,
but upon realizing that it might take longer to
get a well under control than previously thought
while the damage from an oil spill mounts,
they're requiring companies to purchase more
Oil companies typically need to buy insurance to
cover their equipment, "well control" policies to
cover the costs of shutting down a renegade well,
and liability policies to cover damage to third
Large oil companies like BP often "self-insure,"
either covering the risks on their own or going
through a "captive" insurer that deals only with
their risks. But as the oil industry also
contemplates potentially greater economic risks
from a well problem, Grey said he's received
queries from some companies that want to buy
commercial coverage to augment what they would
have covered on their own.
The insurance impact of the Deepwater Horizon
explosion also extends to companies that service
offshore oil platforms or are working on cleanup
Michael Gill, a vice president at the insurance
firm Ironshore, which opened an environmental
insurance practice in New Orleans last year, said
his company has seen that manufacturers of
equipment being used in the cleanup operation, or
companies working on the Deepwater Horizon
well-shutdown or cleanup, have needed special
pollution coverage. "We've seen an influx in the
number of insurance requests," Gill said.
Michael Brown, a 35-year marine insurance broker
who is senior vice president at Ellsworth Corp.,
said marine and energy insurance markets are
If the deepwater moratorium drives rigs overseas,
and boats follow, prices could rise for vessels
that remain because there won't be as many
players in the Gulf of Mexico buying insurance.
Changes in the marine insurance market probably
won't be apparent until the fall, Brown said,
after insurers have had a few months to digest
what happened and when marine insurance clubs in
London begin negotiating their deals for the
"There's an atmosphere of concern," Brown said.
"I would give it until the fall."
Changes in liability limits
While the rig explosion itself has led to higher
insurance costs, changes in the liability limits
in the Oil Pollution Act, the 1990 law governing
oil spills, could magnify those effects.
If Congress increases the liability limits for
economic damages from $75 million to $10 billion,
as has been proposed, energy companies will
probably need to buy more insurance coverage,
further increasing the economic burden on
In recent testimony before Congress, the American
Petroleum Institute said that if the oil spill
liability cap is raised, few companies will be
able to self-insure, as BP had, and the companies
that will most need to buy additional insurance
coverage are the small and medium-sized companies
operating in the Gulf that can ill-afford to do
But NRDC's Pettit said that the petroleum
institute's concerns are misplaced. Right now, if
damages from an oil spill exceed the liability
limits, people will pursue claims in court and
companies either need to have money or insurance
coverage to pay any additional damages since the
liability cap is moot if issues of gross
negligence or neglect are found.
Pettit said the larger societal concern should be
that companies operating in the Gulf have the
financial wherewithal to make it right if
something goes wrong, rather than worrying about
how the cap affects smaller energy companies.
. . . . . . .
Rebecca Mowbray can be reached at email@example.com
A June 3 research report by Moody's Investors Service said that premiums
have already increased:
for rigs operating in shallow waters
for rigs operating in deep waters
Sunday, June 20, 2010
By Rebecca Mowbray
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