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Political risk insurance a high-stakes gamble for oil, gas companies

Posted On: Jun. 17, 2007 12:00 AM CST

Oil and gas companies, despite being potential targets of political actions or violence that could lead to large losses, are often confident enough in their risk management to operate without insurance coverage that could respond to such losses.

For some energy companies, the cost of political risk insurance from the commercial market or the expense related to self-insurance is not worth the threat of the infrequent yet often severe losses, experts say.

Ironically, the larger the potential target, the more likely it is uninsured.

"Some of the big companies have very large balance sheets and can take on the risk themselves," said Andrew Underwood, London-based head of political risk at Hamilton, Bermuda-based Hiscox Ltd. They may see the cost of insuring political risks as significant, while the possibility of facing claims might not be so large, he said.

It can be a risky strategy, said Mr. Underwood and others in the political risk marketplace. Oil and gas companies sometimes operate in places where governments can have shorter lives than the energy companies' contracts, he emphasized.

But some risk managers, confident in their loss control strategies, are taking the gamble. One claims it is easier to prevent politically related losses than cover them.

"We did a survey to see what was possible in the traditional market," said Petter Kapstad, chief risk officer of Statoil A.S.A. in Stavanger, Norway. "It seems there is little willingness for an underwriter to come up with a price. They ask for more and more information, but don't come up with anything."

Statoil, an oil and gas producer that operates in more than 30 countries, eventually did get coverage quotes, but then found the insurers to be unclear on terms and conditions, said Mr. Kapstad. "Maybe the market is a little bit skeptical," he said, in light of some of recent high-profile incidents such as nationalization efforts in Venezuela.

In lieu of purchasing political risk insurance or funding the risk in its captive insurer, Statoil controls the exposure on a country-by-country and project-by-project basis as part of its enterprise risk management program, Mr. Kapstad said.

MOL Rt., a Budapest, Hungary-based oil and gas subsidiary of the MOL Group, which operates in Central and Eastern Europe as well as Pakistan, is another energy company that has chosen to go bare when it comes to political risk insurance. "As of now, we are not buying any," said Tibor Papp, the company's head of group risk management.

Like Statoil, MOL prefers to manage the losses by preventing them through strict risk management.

The company establishes an investment limit for each country where it operates, taking into account the riskiness of doing business there, Mr. Papp said. If MOL decides it needs to invest more than the limit, it will then consider funding its political risk exposure. That scenario, however, has never developed. "We have not come across a situation where we have had to transfer risk," he said.

MOL investigated the political risk insurance market, but decided it was sufficiently managing the exposure and did not need the coverage, Mr. Papp said.

In the Middle East, there is little appetite among local energy companies to purchase political risk insurance, despite their location in a volatile region of the world. "The appetite there comes from overseas companies and, from them, there is quite an appetite," said Nick Du Sautoy, a director at London-based brokerage Miller Insurance Services Ltd.

"Local companies don't have the same perception of risk in the area as the overseas people," said Mr. Du Sautoy. "They probably don't see themselves as a target for that sort of thing," he said of political threats to their business.

"Frankly, the heavy duty political risk coverages are designed for companies going into such areas," as they are more likely than local operations to be targets of takeovers, contract frustration or political violence, Mr. Du Sautoy noted.

For companies that decide to purchase political risk coverage in the commercial market, insurers say it can be arranged to cover operations in nearly every part of the world. "I would say Venezuela is off-cover," said Thomas Holmes, London-based associate director at Miller Insurance Services. "Generally speaking, in most countries it is available."

But underwriters are more careful about the risks they take on, said Mr. Holmes. "Much more than two or three years ago," he remarked.

"The market has evolved an awful lot in the last 20 years," said Julian Barker, senior underwriter at Lloyd's of London insurer Ascot Underwriting Ltd., the Lloyd's business of New York-based American International Group Inc. "There are a lot more players in the market," particularly among international insurers, he said. "That has led to some degree of competition."

He agreed that political risk underwriters are careful these days and "underwriters' appetites do vary from case to case."

Sources said energy companies generally are doing a good job in assessing the volatility of the regions where they operate. There is, however, some room for improvement, they added.

Mr. Underwood and others suggested that one of the first moves an energy company should make in determining whether to enter a market is to ensure that bilateral investment treaties exist between the company's home government and the country that will host the operations. Such agreements, he said, should declare that the company's assets will not be expropriated or that the company will be fairly compensated if expropriation occurs.

"I'm not sure this has been on their radar," Mr. Underwood said of energy companies, partly because, like nationalization, cases of expropriation have not been commonplace in recent years.

Mr. Holmes said energy companies are among those that sometimes do not give their supply chains enough consideration when assessing political risks. With just-in-time inventory management in place at most companies, keeping supplies moving along the chain is more critical than ever, he said.

"Not everyone is providing it," he said of supply-chain coverage. "Some insureds are not aware that it is available."

Mr. Papp said MOL covers the risk of interruption of oil it receives for processing from Russia by maintaining an alternate supply. "Say there is no Russian crude available," he explained, "we can get oil from the Adriatic coast. It is more expensive and we would prefer to have the Russian supply, but we can get it," he said of the alternate source.

In some parts of the world, risk management is getting a hand from governments that have been forced to step up and help protect the energy industry from threats of political violence.

In Saudi Arabia, for example, the government had to undergo a "radical rethink" of its stance towards extremism, said Neil Quilliam, senior Middle East analyst with Control Risks Group Ltd. in London. "In the past, they have denied they had a problem," he said. "They have had to acknowledge it and retrain their security forces. Now they have much more proactive forces that are protecting facilities and seeking out extremists" that could threaten energy operations, he said.