Drilling advances

One of the downhearted jokes making the rounds during the oft-documented crash of the 1980s had to do with a Houston bank that enticed new customers with their choice of a toaster or a drilling rig. As the story goes, the promotion quickly ran into a snag when the bank ran out of toasters.

For those of us who managed to muddle through that quagmire, we must grudgingly acknowledge—with a reenactment of sorts—the 30-year anniversary of what generally is recognized as the nadir of early 1986, when oil prices plunged to 1974 levels. “Did you hear the one about the drilling engineer, who...?” is, once again, a conversation starter. Scan the most recent analyst calls and you’ll find company executives struggling to come up with unique metaphors and similes for “things aren’t well.” Just as before, multiple sectors are being caught in the rip tide, including one that generally attracts little empathy: Insurance.

Bit of a crisis. With global drilling activity in a freefall, the need for equipment and project insurance goes with it, putting more pressure on insurers whose portfolios are heavily weighted with upstream oil and gas clients. According to Reuters, while most energy companies renew their policies in the first half of the year, the effects of the “worst oil downturn in decades” are already being felt by insurers and reinsurers. On Feb. 10, Reuters quoted Ulrich Wallin, CEO of German insurer Hannover Re SE, as saying “it’s a little bit of a crisis. We will see fierce competition on pricing.”

While Wallin’s “little bit of a crisis” pales in comparison to the present circumstances of battered operators, contractors and service companies, it underscores the depths at which the ripple effects of miserably low commodity prices can reach. “If premium income levels continue to deteriorate, and capacity does not withdraw, at some stage this portfolio is bound to become unprofitable,” Nick Dussuyer, global head of natural resources for worldwide insurer Willis Towers Watson, told Reuters. “It will be interesting to see, at this stage, which insurers will choose to withdraw and which will try and ride out the storm, anticipating a turning market.”

Familiar trajectory. Much like the industry they indemnify, a gaggle of insurance companies jumped at the chance to underwrite upstream polices in lockstep with once-high oil prices that spurred a stampede of newbuild rigs and frenzied drilling activity. Now, with it easier to count the active rigs than those on sabbatical, that beefed-up insurance capacity is no longer sustainable, insurers say.

“A combination of the recent collapse in oil prices, record capacity levels, relatively benign loss records and reduced risk management budgets have all contributed to some of the most competitive energy insurance underwriting conditions for 15 years,” Willis bemoaned late last year in its October Natural Resources Market Review.

In the same review, Willis cited the potential for more M&A activity in 2016 as yet another alarm for those insuring rigs, associated equipment, and the wells they drill. The insurer said, in part, “M&A has become an ongoing trend recently, and will almost certainly mean further consolidation within the energy industry. In consequence, this will mean less premium finding its way into the insurance markets.”

Notably, just as operators were putting off or cancelling new drilling projects when prices began to sour, energy insurance capacity continued to build, according to Reuters. Consequently, as of February, total capital available for insuring rigs, and the like, had risen roughly 10% since oil prices began to slide in late 2014, to around an additional $7 billion, perhaps in hopes of a rapid turnaround, Reuters reported.

However, echoing the widely-held projections of its upstream clientele, the Lloyds Group, in its January 2016 energy insurance quarterly newsletter, warned fellow underwriters not to expect any semblance of a sustained recovery this year. “Premium inflows have continued their downward trend and, while there are some signs we may be approaching bottom, some carriers believe it will be 2017 before we reach the low point. In view of the difficulties, many energy clients are suffering, at least this is one piece of good news, as they struggle with 2016 budget projections.”

Mirror effect. As for the upstream market specifically, Lloyds said that it expects some insurance companies to see revenue from premiums drop by nearly half this year. Once again, mirroring the current state of the global oil and gas market, insurance companies find themselves stuck with too much capacity and not enough demand. And, just as operators continue to hammer contractors and service providers to cut costs, insurers are under pressure to reduce policy rates. “We estimate premium income for many insurers will be down at least 45% for the year. The overhang in capacity is overwhelming the leaders in their previously stated aim to keep year-end reductions to no more than 10%. Many clients gained 15% cuts in their rates, and a small number even attained 20%.”

Meanwhile, though unsupported, Willis said in its October market review that the upstream insurance community is starting to fret over the possibility of increased risks from some cash-strapped independents. “Another potential worry for upstream insurers is whether some medium-capitalized companies, who are now the owners of a significant amount of upstream infrastructure in some regions, have the risk management resources and acumen to ensure that the high safety standards inherent to the working practices of the super-majors will be maintained. To date, there is little evidence of these fears being well-founded, but some apprehension in the market remains.”  

About the Authors

Jim Redden

Contributing Editor

Jim Redden is a Houston-based consultant and a journalism graduate of Marshall University, has more than 40 years of experience as a writer, editor and corporate communicator, primarily on the upstream oil and gas industry.