March 2016 Issue
Energy is a volatile business. The price of a barrel of oil – the herald of fat times or lean for the industry – reached a sky-high $100 a barrel early last year only to slide into a mid-$30s hole by Christmas. Tension in the industry has failed to ease in early 2016. In January, Russia and Saudi Arabia discussed cutting production, further burdening the market.
Yet oil prices are just one indicator of the volatility energy companies are facing. They are also exposed to traditional risks, such as natural disasters, fire and explosion and machinery breakdown, as well as modern risks like complex production interdependencies, fluctuating currency exchange rates and cyber attacks.
According to our recent study, ‘Global Claims Review 2015: Business Interruption in Focus’, growing exposures and interdependencies in the industry are affecting large onshore energy claims. Complex and costly business interruption (BI) losses now dominate many large onshore energy claims, accounting for a much higher proportion of large onshore energy claims. Of the five largest claims we saw in the past year, BI featured in at least 75 percent of the claims, and in two instances, it accounted for 100 percent of the claim to the commercial insurance market.
The cost of large energy claims has been rising. Exposures have increased in the wake of larger refineries and petrochemical production facilities, growing interdependencies, and as companies make bigger profits.
BI claims are escalating in importance for insurers. Traditionally, most energy claims were filed as property damage claims, but as costs continue to rise, higher property damage retention levels have been seen. Higher limits of insurance have been needed, thus driving up the percentage of losses now handled as BI. Many new buyers are looking to purchase this insurance for the first time. A recent development has seen more Russian companies buying BI cover, due to changes in market conditions and improvements in risk quality.
The complexity of handing BI claims for the energy sector is also increasing. Claim settling is often lengthy and complex, particularly for onshore energy claims where BI is seen as essential for operators such as refineries and petrochemical plants. The wide range of onshore energy products, the high values involved, interdependencies and price volatilities, and currency fluctuations create unique claims challenges.
The complexity of oil refining and the non-linear relation of profit to throughput (the volume of oil processed) is a notable characteristic of onshore energy claims. Some onshore operations see profits as high as $6m per day. Additionally, indemnity periods purchased by energy companies are typically 12 to 24 months. Disruption of a year or more can lead to significant loss, while even a small partial loss can generate a claim in the hundreds of millions of dollars. Calculation of the loss of profits on a partial loss of production is the most demanding piece.
A small percentage loss of production can still impact overall profits significantly. For example, a refinery may restore 75 percent of production quickly, but profits could still be 75 percent down if the disruption hits the most valuable products. In one such claim, a damaged refinery and petrochemical plant quickly restored oil production after a disruption, but profits remained negligible because the more profitable polypropylene production process was disrupted for months.
Fluctuations in exchange rates and commodity prices are other variables that increase the complexity of the settlement process. A recent loss at a Russian refinery, for example, saw the fall in oil price offset by the Russian ruble’s depreciation against the dollar. The impact of oil price fluctuations can be difficult to measure. Refinery profit margins depend on the price of oil versus the price achieved for the product, and both can vary. The price of petrochemical products typically lags behind fluctuations in the oil price. Initially, falling oil prices may boost profits if product prices remain high, which would mean more, not less, costly BI claims.
Another variable can be seen in growing supply chain interdependencies between companies. For example, clusters of refineries and petrochemical plants in certain parts of the world often supply each other with products. If a plant that is a key supplier to others is disrupted, neighbouring plants are adversely affected.
Interdependencies can also result in complex contingent business interruption (CBI) claims. CBI is indemnity cover bought to compensate for losses incurred due to interruption in a key supplier’s or customer’s business. Energy CBI claims caused by a lack of supply due to damage at the supplier’s premises are becoming more common.
CBI cover, as recent examples show, is important to maintaining stable onshore production. A ruptured gas pipeline and subsequent explosion at a processing plant in Western Australia, for example, caused a disruption to the region’s energy supply, affecting refineries, construction, mining and leisure industries. Insurers recently were notified of potential CBI claims after damage to a gas plant disrupted supplies to several petrochemical plants in the Middle East.
Knowing your customers and suppliers, and ensuring that this information is passed to your insurer will guarantee that you have appropriate cover. Many companies file a claim only to find that they do not have adequate CBI cover.
Natural catastrophes also impact BI claims in the energy sector. Only 6 percent of reported energy claims we saw over €20,000 for accident years 2010-2014 were related to storms (by value, only 4 percent). The figure would be higher in hurricane prone years.
With projections that the current El Niño event will weaken before next hurricane season, 2016 could be an active year. A 2016 study by the National Oceanic and Atmospheric Administration (NOAA), El Niño and La Niña Years and Intensities Based on Oceanic Niño Index (ONI), shows that the last major El Niño event in 1997-1998 was followed by a particularly active hurricane season with 14 named Atlantic storms, 10 hurricanes (three Category 3 or greater). Three storms made US landfall, one of which was Hurricane Georges, the costliest in the region since Andrew in 1992.
Finally, there are fears of a malicious cyber attack against a refinery or petrochemical facility resulting in fire or explosion in the energy sector. Another of our studies, ‘A Guide to Cyber Risk: Managing the Impact of Increasing Interconnectivity’, states that the US Department of Homeland Security recorded 245 incidents involving industrial control systems (ICS) in 2014, with the energy sector reporting most of them.
Given the many vulnerabilities of the energy sector, BI and CBI insurance cover seems to be the stop-gap that an increasing number of energy companies are choosing to keep businesses running. Compared to the past, BI claims are increasing in severity and as a proportion of the overall claim. This trend is expected to continue.
David Wilson is the global head of energy claims at Allianz Global Corporate & Specialty (AGCS). He can be contacted on +44 (0)203 451 3660 or by email: david.wilson@allianz.com.
© Financier Worldwide
BY
David Wilson
Allianz Global Corporate & Specialty (AGCS)
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