Working with Blowouts, Knock-for-Knocks and Other Oil Patch Oddities

One of the big issues facing small- to mid-size oil and gas operators and contractors these days is the need to determine how much risk they are willing to carry themselves and how much they want to transfer to an insuring organization. Because while coverage for all aspects of exploration and production activity seems to be generally available, the adage, “You get what you pay for,’ is particularly true in the current environment.

Like other lines of coverage, gone are the days when low-ball pricing meant companies competed for customers by seeing who could throw in the most coverage for the price. As Ron McElyea, president of Western Surplus Lines Inc. in Abilene, Texas, put it: “There are … some really good companies, that will offer the same coverage and more enhanced coverages, if you will, but they’re going to get their pound of flesh for it.’

Across the board – in general liability, umbrella and, especially, control of well coverages – rates have gone up dramatically in the past two years. But the good news is that prices seem to have reached a pinnacle with rates stabilizing at a point where carriers are “actually underwriting things,’ according to John Ludwig, director of the energy division of IMA Financial Inc.’s Denver office.

“What we have seen in the last six to eight months … is a changing in the market,’ Ludwig said. “What we’re seeing now are increases just to maintain reinsurance costs. However, we have started to see some differentiation in the market. I won’t use ‘reduction’ because I don’t think that’s the correct term. But underwriters are now looking at risk and being able to differentiate between a good risk and a bad risk. Whereas in the prior 18 months, what they were doing is just inadvertently increasing premiums just because they had to, because of loss issues. If you were a good client you still got a 100 percent increase. Now what we’re seeing is a differentiation.

“You’ve got some flat renewals versus taking on a five or 10 percent increase,’ Ludwig added. “So there is a differentiation in the market. But the other thing that’s occurring from a London perspective is we’re starting to see a few more syndicates deciding that they want to write energy business, which is now telling us that there is some excess capacity in the London market for energy coverages, which is good.’

Standard markets pulled out of the market over the past few years due to losses in the areas of well control, pollution and business interruption, among other things, but excess and surplus carriers have stepped up to the plate, offering coverages for a price, sometimes pulling rates “out of the air,’ according to McElyea.

He added that operators and contractors may be able to find some competitive pricing, “But in relation to what you’re buying, it’s like: ‘Do you want to buy a car with a motor in it, or do you want to buy the car with no motor in it?’ You can get it a lot cheaper without a motor.’

McElyea noted that many insureds and potential clients planning “to purchase energy insurance are having to make some really tough coverage decisions. And my guess is that we have a lot of people out there in the oil patch performing work that probably don’t have even half of the coverages they had the past two years.’

Blowouts, pollution and other hazards
The costliest insurance in the oil and gas sector is control of well insurance; it’s also a necessity. By most accounts, prices for that coverage, which covers damages from the aftermath of a blowout-a generally catastrophic event that occurs most often in the drilling process but can happen to a producing well-have gone up in the neighborhood of two and three hundred percent.

In addition to the costs for controlling the blowout, control of well insurance also covers the costs for re-drilling the well and, in most cases, coverage for pollution caused by the blowout.

“When I first started specializing in the oil business in the ’70s, probably 10 percent of the operators carried that coverage,’ said Robert Carson, vice president of the energy division of Higginbotham and Associates, a regional agency based in Fort Worth. “Now probably five percent don’t carry it. So it’s just become over the last number of years very important. But when you drill in there and you have a blowout, controlling it can be very expensive.’

He said that while an oil operator can go through his whole career without experiencing a blowout, of his 50 some-odd oil and gas accounts almost all have had a blowout during their careers. Losses can be dramatic-it’s not unusual for costs to run into the $10 to $20 million range and up. Offshore catastrophes can go even higher. Carson noted that the biggest single insurance loss ever before the Sept. 11 World Trade Center attacks was an 1988 offshore blowout in the North Sea at a Unical operation.

General liability is another major player in insuring oil and gas operations, with pollution coverage and underground reservoir usually included in the general liability package. Pricing for general liability has also had a dramatic upswing, albeit nothing in the range of control-of-well increases.

Umbrella insurance, the third important coverage for the oil and gas operation, can be tough to find particularly when it comes to covering pollution. “Umbrella liability is probably the biggest problem right now,’ said Marcus Jensvold, president of M.D. Jensvold and Co. Inc., a Houston-based MGA. “The rates for that have probably gone up 200 percent. It’s gotten more restrictive … they were under-priced to start with. In general, the umbrella pricing during the soft market-let’s say from 1990 to 2001 or something-the umbrella rates dropped 80 percent. So they’re making up more ground than the primary carriers are. It’s gotten more restrictive, it’s virtually impossible to find pollution coverage in the umbrellas now for oil field business.’

In the context of operational risks, the physical location of oil and gas operations has little influence on the pricing of policies, with some exceptions. Catastrophic natural perils, like tornadoes and earthquakes can affect pricing, according to Maurice Purslow, head of Zurich Global Energy’s oil, gas and petrochemicals division. “The actual basic rate, if you like, for the operational risk-meaning, if it’s a methanol plant, the basic rate is more or less the same where ever it’s located. It’s only when you start to analyze how it actually operates, the size of the risk, the quality of the risk and the type of insurance risk transfer that they’re trying to buy does the rate start to change. So yeah, if you’re buying a lot of earthquake in California, you can expect to pay more than if you’re buying insurance in an area which doesn’t have earthquake exposure.’

Jensvold noted that in addition to Texas and Louisiana, where the bulk of his clients’ risks are located, his company does business in New Mexico, Colorado, California, Oklahoma, North Dakota and other states. In his experience, the Texas coast can be problematic in terms of control of well insurance, with higher prices not uncommon in counties that border the Gulf of Mexico. “That has to do with pressure,’ he explained. “At 10,000 feet there seems to be more pressure along the coast than there is inland.’

Contract is king
As far as negotiating various coverages for operators and contractors goes, close study of the contract between the oil operator-the entity fronting the money and negotiating the rights to drill a well-and the contractors who drill and service the wells, is essential.

“Most of my time [is spent] working on contracts, because I learned a long time ago the oil business works on contracts-‘Here’s what you’re going to do, here’s what I’m going to do’ and so forth,’ Carson said. “You have to spend a lot of time going through them and knowing who’s responsible for what.’ He added that the contract most often used in the drilling area is the International Association of Drilling Contractors (IADC) form.

That form “has about four different things that are very important,’ Carson said. “The thing that the contractors are afraid of are pollution costs, underground reservoir-in other words they damaged the reservoir and you can’t get to it and it’s going to cost millions of dollars to re-drill the well. That and blowout, those are the main things. Bodily injury is the fourth thing.’

Carson explained that the contract, as far as insurance is concerned, is based on the theory of “the most to gain, the most to lose. The operator’s out there trying to make a fortune, the contractor’s just trying to make a buck using his equipment.’ Therefore, the operator generally will be responsible for the costlier control of well, underground reservoir damage and pollution risks.

“The contractor is responsible for what I term garbage-type pollution-pipe dope or something from the rig, which isn’t going to be real big.’ Carson added.

He said that with general liability the parties operate under a system of “what they call knock-for-knock, which is, the contractor says: ‘I’ll be responsible for my people, you be responsible for your people. No matter who’s at fault, I’m responsible, you’re responsible.”

The contractor, then, takes care of workers’ compensation coverage for the people he hires. But if the contractor’s employee gets hurt, what often happens, Carson noted, is that the employee will get the workers’ comp benefits and then sue the operator. The operator in turn passes the lawsuit back down to the contractor, since the contract says each party will be responsible for their own employees. The contractor’s employee is just that and not the responsibility of the operator.

“For the general liability for the contractor, even though he’s not responsible for blowouts and reservoir damage, he’s still going to have to pay for the injury to his people from the lawsuit … so his insurance goes up,’ Carson said.

What’s an agent to do?
Beyond close scrutiny of the client’s operating contract, how can an agent help her client get the best deal for the money? According to Jensvold, getting an early start on the application is important “because they’re harder to market, harder to get at,’ and they take “a little more time.’

He added that whatever market the agent uses, that market will have an oil and gas supplement that must be filled out completely. Sometimes there are different supplements for the specialty, such as one for the operator or well owner and a separate one for the contractor. Jensvold emphasized that agents should make sure they have the appropriate supplement and that it’s filled out correctly. As far as umbrella coverages go, he said the agent should “expect higher rates and more difficulty to get placed.’

Natural gas rising
In the United States today, drilling for natural gas far exceeds oil exploration, accounting for 75 percent of all drilling activity in the country. And while Texas has the reputation as being the mecca for oil and gas exploration, plenty of other states maintain significant amounts of drilling activity. Texas is at the head of the pack in the number of active rig counts, but Alaska, California, Louisiana, Oklahoma, New Mexico and Wyoming are also leading states for production and exploration, according to Baker Hughes Inc., a provider of global oil field services.

Natural gas exploration has dropped off in California since its hey day in the mid-1980s, but if the California Independent Petroleum Association (CIPA) and its companion organization, the California Natural Gas Producers Association (CNGPA), have their way, gas production in the state will increase. Currently, California produces only 15 percent of the natural gas it uses, but CIPA believes the trillions of cubic feet in gas contained in onshore and offshore reserves could go a long way toward turning that situation around.

The state produced 376.5 billion cubic feet in natural gas in 2002, and the California Division of Oil, Gas and Geothermal Resources estimates around 3.8 trillion cubic feet of natural gas are held in on-shore reserves. Offshore reserves are thought to hold as much as 21 trillion cubic feet of natural gas.

CIPA recommends strengthening the California Natural Gas Policy Act by providing incentives to local jurisdictions, state agencies, and utilities that would encourage development of an infrastructure to take advantage of those reserves. The organization’s proposal includes new tax incentives for California’s utilities and would require those utilities to respond to requests for new well hook-ups within a legislatively mandated timeframe. Counties would be required to process new drilling applications expeditiously under the proposal and a task force would be created in the Division of Oil and Gas to supply the legislature with suggestions on how to increase natural gas production within the state. New tax credits for exploratory drilling and production are also included in the proposal, a summary of which can be found on the CIPA Web site, www.cipa.org.

With a sustained increase in the price for natural gas, along with last year’s energy crisis that produced rolling blackouts and sky-high rates, the group may have a chance at making headway. Natural gas prices hovered in the $5-$6 per million btu range at the end of May, according to the U.S. Energy Information Administration, and are expected to stay at that level or above for the next year. By comparison, at the end of May 2001 spot prices were around $3.5 per mbtu. In addition, last winter was colder than the previous few winters, resulting in much of the gas in storage being depleted.

“If there is any decent exploration it’s probably in the natural gas area,’ Western Surplus’ McElyea said. “Natural gas is much more commercially utilized than oil is in many cases, obviously, because you have manufacturers, people that have gas pipelines in the factories. … I would say the natural gas area has really been much more firm, the prices have stayed up.

“Consequently those contractors specializing in work on natural gas wells, whether its valve replacements, calibration of the various measurement devices for natural gas, we see a lot more of those … contractors that buy insurance than probably even in the oil production.’

Topics California Catastrophe Texas Agencies Excess Surplus Energy Oil Gas Contractors Pollution Mexico