(EnergyAsia, January 4 2012, Wednesday) — Mr Westacott, a former ExxonMobil executive, is Aon Risk Solutions’ Asia Pacific director for energy services.

Q: Your job scope. You have a wide area to cover in the oil and gas sector, from upstream to downstream. How do you assess risks on exploration and production, and on refineries and petrochemical plants? How do all these risks get translated into dollars and cents in setting insurance premiums?

A: My role is to work with Aon energy clients and prospects across Asia, and using my 25 years experience with a major integrated energy company, ExxonMobil, assist them in developing their risk management strategy both in the short and long term and to use the global resources of Aon to deliver solutions and ‘best practice’ in the management of their risk.

With regard to risk assessment the insurance market is segmented into specialist areas along both industry lines (which include areas such as energy, mining, aviation and pharmaceutical) and coverage lines (property, liability , marine and aviation) and the broad industry sectors are further broken down into specialist sub-sectors which for energy includes, upstream and downstream, which are identified within the insurance market as onshore and offshore risks, construction or  operational risks and drilling which will include exploratory, development and production.

This highly specialised segmentation allows the insurance industry to pool expertise and historical knowledge with which to rate the risks presented. The risk profile itself will also include factors outside of industry segmentation including geographical and political risks.

However despite the industry’s ability and desire to price risk purely on technical factors the price is still significantly impacted by supply and demand. The greater the supply of insurance capacity the greater the downward pressure on pricing.

Q: Let’s look at the Gulf of Mexico oil spill of 2010, and the recent Shell refinery fire in Singapore.

A: The implications of the Gulf of Mexico (Deepwater Horizon) spill from an insurance industry perspective include the importance of having an embedded safety culture across the organisation where each individual is charged with stewarding safety and recognising when incidents outside of the norm are occurring and their implications .

The incident has highlighted:

–    the increased risks arising from frontier development (in this case deep water drilling);

–    the interface and potential accumulation of exposures between operator, drilling contractor and rig owner; the fact that the Operator has to fund the costs of the spill 100% despite only have a 65% interest and the extent to which Joint Venture partners, will share these costs;

–    the impact of terms of the joint venture agreement between the partners and possibly court findings on gross negligence or wilful misconduct;

–    the dramatic increase in cost to operators and non-operators when something goes wrong in an untried/untested environment where traditional control methods may not work;

–    the political pressure applied by the US Government to set-up a compensation fund, the Deepwater Horizon Oil Spill Trust to cover third party compensation costs to which BP had to contribute US$20 billion. (which may set pattern for future  governments);

–    insurers will focus on a detailed engineering analysis of the proposed drilling programme, safety regime and risk mitigation methods to provide a level of confidence that the operator has evaluated and is managing the risk.

Q: How much do these risks and costs translate into the cost of oil production — if Brent is at US$110 a barrel, how much of that is insurance? In percentage terms, has the insurance cost been rising on a per barrel basis over the years?

A: I do not believe there is a correlation between the oil price and insurance cost and I’m not aware of anyone benchmarking one against the other, one reason may be that all major corporations take differing views on risk and risk transfer with each adopting differing levels of retentions, captive participation and limits purchased and of course loss history.

Q: How do insurers lay off their risks?

A: Insurers manage their risks through focusing on their specialist area, writing lines within their capacity and writing across multiple uncorrelated insurance programmes. The major concern is the correlated accumulated exposure brought about through risks like Gulf of Mexico windstorm and Tokyo Bay earthquake, where calculating and managing overall exposure across many clients and industry segments is difficult.

Q: Do projects get cancelled because developers fail to get insurance? In the aftermath of the Gulf of Mexico disaster and Fukushima, has there been a spike in insurers rejecting business?

A: Not as far as general risks are concerned, the insurance industry is there to fund losses and has been remarkably resilient during both the recent financial crisis and recent major losses, insurers are reluctant to walk away from business preferring to improve their position through narrowing coverage, increasing deductibles or premiums.

However for those areas where it has been difficult in the short term to quantify their culmulative exposure, such as terrorism after 9/11, and windstorm after hurricanes Katrina and Rita, then the industry has collectively pulled back from offering specific cover, in these cases onshore terrorism and windstorm coverage where they are unable to quantify their overall exposure.

Q: Is the lack of insurance or insufficient insurance a potential threat to future energy supplies?

A: To date I’ve not seen any project delayed due to lack of insurance coverage, although several were known to exceed potential market capacity at time of financial approval.

It could be an issue where external funding is required – obtaining adequate funding without the security of full insurance coverage may deter lenders, however for those major oil companies not requiring external funding it’s probably not an issue.

Q: Insurance risks and issues posed by a range of risks such as Japan’s Fukushima disaster, Libya’s civil war and the oil industry’s exposure, coal mining disasters, acts of piracy.

A: Again this illustrates the range of operational risks faced by industry and to which the insurance market will look to assist in risk transfer, where appropriate.

However as discussed before where insurers are unable to quantify their loss exposure then they will either be reluctant to offer cover or seek to limit the coverage available to ensure it remains within acceptable overall limits and doesn’t pose an unacceptable threat to their balance sheet and shareholders.

Q: Is the energy industry (oil, gas, coal and power) facing rising insurance risks and costs? How much: Quantifiable and in financial terms?

A: The industry may well be facing increased insurance costs but such costs tend to be in those areas where the industry is pushing boundaries, where the risk is relatively unknown (no historical data with which to price probability) or where because of the focus on frontier areas, which may involve deeper water, or in less accessible places the costs of exploration, and development costs and therefore asset values have increased thus increasing insurers exposure in event of loss.

If you were to evaluate similar risks in today’s insurance market versus historical then today’s pricing is probably more competitive. The cyclical nature of the insurance market in particular, pricing and limits, is one reason that buyers need to formulate a longer term risk management strategy that allows them to balance retention, captive involvement and market transfer efficiently depending on the state of the market at any point in time.

Buyers recognise that pricing is cyclical and driven by capacity, as capital leaves the market seeking higher return elsewhere then available capacity falls and premiums increase.

As premiums increase new capital is attracted increasing available capacity and thereby creating greater competition which acts as a brake to premium increases.

Naturally the higher the value at risk and the greater capacity required the less competition exists reducing the buyer’s leverage over price.

However the real question is not necessarily is the price of risk increasing but whether the aggregate level of risk is increasing? I believe that not only is the aggregate level of risk increasing but also that the complexity of risk, as witnessed in Deepwater Horizon and Fukushima, the latter highlighting the global interdependency of supply chains together with the emergence of non-traditional risks such as global pandemics, global warming and terrorism have demonstrated increased levels and complexities of risk not necessarily considered before and raised the issue of how they can best be managed or mitigated.