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From the frigid North Slope of Alaska to the gale-swept North Sea, oil companies have worked for decades in the harshest conditions that nature can dish out. But the warm waters of the Gulf of Mexico dealt the industry its worst lashing ever as Hurricanes Katrina and Rita ripped through the heart of the U.S. offshore oil patch last year.

A year later, the industry is still recovering from those two storms, which destroyed 115 offshore oil platforms, damaged 52 others and slashed nearly a third of the annual oil production from the Gulf of Mexico. Besides the damage to offshore facilities, the hurricanes also spawned a windstorm of sharply higher insurance rates for companies operating out in the Gulf.

Rates for windstorm coverage in the Gulf of Mexico have doubled, tripled and more, brokers say.

"Clearly, rates on offshore properties have increased dramatically, in some cases probably several hundred percents above where they were. This is fairly specific to Gulf of Mexico windstorm coverage," says John Mizell, practice leader, Willis Risk Solutions.

Along with the higher rates, insurers have insisted on sharply lower limits for windstorm claims, says John Keely, director of the exploration and production practice for Aon, based in Houston.

"It's a bit of a squeeze really. They're paying a lot more for a lot less," Keely says. Companies that last year had $500 million to $750 million worth of coverage with no windstorm limits now face windstorm limits of $100 million to $200 million, Keely says.

"That's a dramatic difference in the level of coverage if you're considering the increase in cost," Keely says.

What has underwriters worried is the sheer magnitude of the havoc wrought by the two hurricanes. Hurricane Katrina, the most costly hurricane to date, caused an estimated $40 billion in insured losses overall, according to the Insurance Information Institute. Hurricane Rita racked up the seventh-biggest losses ever at roughly $5 billion in insured damages.

Aon has estimated the insured losses for the offshore sector at around $10 billion. The total repair bill, however, may range from $18 billion to $31 billion for all the Gulf Coast energy infrastructure damaged by the hurricanes, according to estimates by the Congressional Budget Office.

As the two monster storms swept in, they took direct aim at 3,000 of the 4,000 offshore platforms and 22,000 of the 33,000 miles of pipelines in the Gulf of Mexico.

First, Hurricane Katrina blew through, heavily damaging the single largest producing platform in the Gulf, Shell's Mars platform, which sits in about 2,700 feet of water 130 miles south of New Orleans. Katrina's 170-mph winds and huge waves toppled the 1,000-ton drilling rig that sits atop the platform.

"They found some dead fish at the plus-110 level on Shell's Mars platform," Elmer Danenberger III, chief of offshore regulatory programs for the U.S. Minerals Management Service, said at a press briefing in May. "Gives you a sense of what type of wave heights that were experienced."

On top of that, the storms caused a semisubmersible drilling rig to drag its anchors across two seafloor pipelines that run from the Mars platform to shore.

While Katrina hit hard, Rita hit the offshore oil patch even harder. Six rigs broke free from their moorings during Katrina, and 13 during Rita. Three of Chevron's big deepwater platforms Petronius, Genesis and Typhoon made it through Katrina in good shape. Rita was a different story.

"Typhoon got through Katrina pretty well," Chevron spokesman Mickey Driver says, "but not Rita, so we lost that platform."

The $250 million Typhoon platform was found capsized and drifting dozens of miles from its original position 165 miles southwest of New Orleans.

The sheer fury of the two storms surprised even the most experienced offshore operators.

"This one they learned a lot," says John Felmy, chief economist for the American Petroleum Institute. "They've learned that impacts are much bigger than they had perhaps thought because nobody's out on a rig when this is going on, so you don't really know."

The hurricanes not only heavily damaged offshore equipment, they also blew through the $1 billion per-storm aggregate limit set by the OIL mutual, which counts some of the world's largest oil companies among its members.

"Up until 2005, we never breached the aggregation limit. People probably thought it could happen, but they never realized the magnitude to which it might happen," says OIL's Hutchings.

OIL's members have so far reported losses of $1.97 billion for Katrina and $1.2 billion for Rita.

"The most our members are going to get from us in aggregate is $1 billion in each one of those cases. On top of that, Ivan . . . was worth $580 million to our members. There's close to $2.6 billion in loss recoveries from OIL associated with those three storms," Hutchings says.

Because of the time it takes to repair the damages, it is still unclear what the ultimate losses will be, and how much recovery OIL's members can expect.

"Right now we are paying 25 cents on the dollar for Katrina, and . . . 35 cents on the dollar for Rita," Hutchings says, adding that those amounts are conservative estimates. To rebuild capital, OIL assessed its members two additional premiums totaling $1.7 billion in 2005, and raised $600 million in the capital markets in preference shares.

"The other thing we did for this windstorm season was to reduce aggregation limit back from $1 billion to $500 million. If history were to repeat itself, we didn't want to be in a position whereby we then had to make another special premium call," Hutchings says.

The lowering of limits at OIL has been mirrored in commercial markets.

"In addition to price increases, there's been a real reduction in available capacity," says Mizell at Willis.

Those limits on capacity, however, are only for storm-related damages, and not other perils. For other nonstorm-related perils, such as explosion or fire, there is still plenty of capacity available, says Bertil Olsson, leader of the Willis Energy Practice in Houston. That has led some buyers to opt for split limits between storm and nonstorm coverage.

"They might get a lesser limit for storm damage and higher limit for anything else--explosion, fire, collision--whatever it might be," Olsson says.

To deal with the sharply lower limits on windstorm capacity, oil companies are trying a variety of strategies.

"They're really exploring all avenues. They're looking to see what insurance is available and what they can find at a reasonable price. They're also looking at self-insuring. The third thing that a lot of people are looking at is catastrophe bonds," Olsson says.

While some operators have decided to self-insure their wind exposure, most are still buying some coverage to stay in the market in case the capacity shortage proves temporary and better terms are available in following years, brokers say.

"What some larger companies have done is they've decided to coinsure their own risk or write a percentage of their own risk," Aon's Keely says. "There are buyers out there who have taken as much as 50 percent of their own risk, and only placed 50 percent of an insurance placement in the commercial market."

"Some cannot afford to take a $5 million or $10 million retention or take a portion of their own risk. Whereas others, the very large players, a number of them have decided really not to buy insurance or to buy at a high level," Keely says.

British Petroleum, for instance, is self-insured, spokesman Hugh Depland says.

The higher levels of risk retention facing offshore operators is a sharp departure from past experience, brokers say.

"(Oil companies) take multimillion-dollar dry hole risks every day of the week, and yet when it comes to insurance, the mindset in the past has been to buy insurance down to the lowest possible attachment point. The reason for that was insurance was so cheap," Keely says.

To protect their investments, the oil industry is doing some fine-tuning for their offshore operations. Offshore rigs, however, are already built to take a lot of punishment.

"There's not a whole lot you can do to make these platforms much stronger," Driver says. "Basically, the newer stuff in the Gulf of Mexico got through pretty well."

Chevron has taken steps such as increased protection for the wiring and cabling systems on its platforms. Shell has rebuilt its Mars platform with more and heavier clamps to hold the drilling rig in place after Katrina sheered away 3-inch-thick steel bolts.

The industry also is looking at other measures, such as increasing the number of mooring lines for mobile drilling units to 12 or 16 from eight, and increasing the height above water of so-called jack-up rigs. The Minerals Management Service also is requiring "black box" recorders on mobile rigs.

For Chevron, which took a $1.4 billion hit to its second-half 2005 profits because of the storms, the biggest changes will be in procedures and processes.

"We have a lot of expertise evacuating our people, and redeploying them, and protecting our equipment and getting things back up and running," Driver says. "What we weren't necessarily prepared for is the absolute magnitude of what Hurricane Katrina did."

Along with the offshore damage, Chevron's onshore operations were hit hard, including offices in New Orleans. Its employees who live along the Gulf Coast had to evacuate their families, and many of them lost their homes.

"It took us days and days after Hurricane Katrina to track people down, make sure that they were OK, that their families were safe," Driver says.

Going forward, Chevron has taken steps such as adding backup computers and office space, as well as providing safety and contact information for employees in so-called "bug-out" bags for emergencies.

Brokers say that longer term, the capacity crunch and price squeeze could lead companies to rely less on the insurance market than they have in the past.

"They may not see the advantage of transferring that risk in the future until pricing levels are very much beneath where they are now," Aon's Keely says. "It'll just change attitudes toward risk. It will make them less risk adverse."

While the oil companies seek ways to manage the sharply higher costs of windstorm coverage, and hope that this year's hurricane season proves more moderate, they have one consolation: sharply higher oil and gas prices.

"The oil and gas companies are in a price environment . . . that is extremely high. Their margins are pretty good. If crude had been $20 or $25, instead of $70, it would make a big difference," Olsson says.

MICHAEL FITZPATRICK lives in New Jersey.

September 15, 2006

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