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Global energy firms face changing world of risks


Global energy companies have assets and revenues larger than many national economies—and huge, diverse risks to match. One week the peril may be a raging windstorm. The next, it could be a rogue dictator.

Companies in the oil and gas industry, even under less-than-catastrophic conditions, need complex insurance programs and highly customized coverage to protect their earnings and assets.

But circumstances during the past few years have been extraordinary. Energy companies are dealing with natural disasters that industry experts fear are gaining in strength and with political risks that seem increasingly intense and widespread.

Last year, companies with Gulf of Mexico oil installations suffered $15 billion (€11.7 billion) in offshore damages from Hurricanes Katrina and Rita, according to a May energy market report from London-based broker Willis Group Holdings Ltd. This year's hurricane season was anticipated with dread, but it has been quiet in comparison.

"We're in a time when clients both upstream and downstream are holding their breath," said Phillip Ellis, London-based chairman of the global energy practice at Willis. "The industry was prepared for a worst-case scenario this season."

Since the disastrous 2005 hurricane season, energy companies have had to view their Gulf of Mexico exposures through new eyes—because insurers are. For example, now underwriters more frequently consider such storm-worthiness determinants as the age of oil drilling platforms in the Gulf and their height above the water before deciding how much they are willing to risk. Older and shorter platforms were more likely to be destroyed by the massive waves created by last year's intense hurricanes.

Underwriters this year are also dividing the Gulf Coast into blocks—some 50 square miles and some 100 square miles—and setting aggregate limits on how much capacity they will sell in each block, said Tim Fillingham, chairman of the natural resources group with broker Aon Ltd. in London.

So far, Mother Nature has been merciful in 2006, producing far fewer named storms than last year as of late September. However, the season does not end officially until November 30.

Merciful, too, has been the economy. With the high price of crude oil, major energy multinationals have seen enormous increases in revenue and profits. A Congressional Research Service report put total profit of the nine biggest integrated energy companies at $116.4 billion in 2005, up 36.4% from 2004.

As a result, those companies are in a better position to retain risk. "Most companies have come down to the decision that they'll take a hit," said Willis' Mr. Ellis. "The industry feels better able to sustain hits than they have in the past."

Although, on occasion, the decision to purchase coverage is not based on a company's financial reserves, said Thomas G. Kaiser, New York-based president of Arch Insurance Group's business divisions that handle marine, energy, aviation and construction risks. "A lot of companies that are very rich just feel better going in front of their own boards saying they bought insurance."

And energy companies still face the threat of production stoppages, which ring up greater financial losses and drive up the cost of business interruption coverage.

Mr. Fillingham said the underwriting community has been most concerned with placing tighter limits on contingent business interruption coverage because of the unpredictable costs of covering the losses of customers forced to close their plants because the insured supplier company shuts down its operations.

Profitable times themselves present risks. The price of oil and increasing demand has the entire energy industry working at a fever pitch. Growth in demand is coming not just from U.S. markets but also markets such as India and China, which by itself represents 38% of the total worldwide growth in oil demand, according to the U.S. Energy Information Administration in Washington, the U.S. Department of Energy agency responsible for energy statistics.

With drilling rigs, pipelines and refineries humming away at full capacity or even above it, machinery can be stressed an d scheduled maintenance delayed, leading to breakdowns, production stoppages and potential business interruption risks.

As Gulf Coast reconstruction continues, labor and machinery are harder to find, driving up the cost of repairs.

The high price of oil also is making techniques for extracting oil from new reserves more economical—for example, oil-laden sands in Alberta, Canada. But those new resources carry with them fresh risks as "prototype technologies," said Mr. Kaiser. Indeed, two of the seven worldwide energy losses last year that exceeded $100 million involved Albertan oil sands, according to Willis' report.

Still, intentional human action may present a greater risk. From Bolivia's attempts to nationalize the hydrocarbon industry to Chad's recent expulsion of ChevronTexaco and a Malaysian oil company amid the potential for widening war in the Middle East, the threat of political action is what most worries some analysts.

Those with Middle East assets right now may have good reason to be nervous about their risk profiles.

"It's pretty obvious that the war in Lebanon shook a lot of nerves," Mr. Ellis says. "There's also a focus with Iran and its nuclear program and what actions the West takes."

Some risks in unstable countries can find underwriters—though sometimes at prohibitively expensive rates—but some cannot. Ralph Mucerino, president of AIG Global Marine & Energy in New York, said it is difficult for companies—except for contractors covered by the U.S. Defense Base Act—to find coverage for assets in Iraq, for example. Covering assets in Iraq is also complicated by administrative difficulties, such as a lack of adjusters.

Furthermore, the volume of oil moved through the energy infrastructure, the still-high, but easing oil prices and the risk of an attack mean that covering business interruption may be too risky for any underwriter

"If we talk about crude oil offloading infrastructure at a port in the Middle East, for physical damage, you can find markets that will write that," Mr. Ellis said. However, business—interruption coverage "for something like that is unlikely."

Another long-term risk stems from pressure being applied by governments to reduce emissions of greenhouse gases.

The Kyoto Protocol adopted as part of the United Nations Framework Convention on Climate Change binds 35 signatory nations and the European Union to reduce greenhouse gases and avert global warming.

Within that framework, countries in excess of their allotted carbon dioxide—equivalent emissions can come into compliance by purchasing credits from signatories that emit less than their allotments. Companies, too, are permitted to buy and sell credits on the market.

The energy insurance sector is now trying to determine the level of risk presented by a company's failure to reach its carbon emissions targets, reducing the number of carbon credits on the open market—potentially constituting a business interruption cost— or possibly exceeding its allotment, forcing it to buy credits from elsewhere.

"Is it really [business interruption]? Is it insurable, or is it uninsurable?" asked Mr. Mucerino.

James R. Pierce Jr., Houston-based managing director and chairman of the global marine and energy practice at Marsh Inc., said that after the initial shock, energy companies have come to terms with the new marketplace. "Buyers are prepared now, when they weren't nine months ago," he said. "They're expecting to pay more. They're expecting to retain more risk."