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By DAN REYNOLDS, senior editor of Risk & Insurance®

After reading Daniel H. Yergin's Pulitzer-winning book "The Prize," one could come away with the impression that much of modern conflict stems from civilization's search for oil.

Now that push for oil, motivated in part by prices that have rocketed past $100 per barrel, stretches to the Arctic, which on its American and Russian sides is said to contain vast oil and natural gas reserves.

But here is where the game gets particularly risky and enormously costly. For one, according to Simon Boxall, a managing director and head of the energy business in the United Kingdom for Marsh, there is very little infrastructure to support drilling in the Arctic.

Boxall, who has made trips to Greenland to study the risks of a nascent Arctic drilling industry there, said that the cost of just setting up a rig in the frozen north is far more expensive than it would be in the waters off Houston or Aberdeen, Scotland, two traditional and well-established oil towns.

"At the moment they are having to bring their equipment and indeed their personnel very long distances and that's before anything goes wrong," Boxall said. "If something goes wrong, that's a different issue entirely, of course."

We all remember the footage and the frustration as BP struggled to plug its stricken Macondo well in the Gulf of Mexico. Imagine trying to control a blowout in the dead of an Arctic winter with ice and darkness enveloping all.

COSTLY RISK MANAGEMENT

So, as reinsurers reported dramatically higher treaty renewal prices in the offshore energy sector in January and February, those contractors who head to the Arctic Circle can be expected to pay some of the highest prices of all for their insurance coverage.

"Automatically, we are buying a higher limit, and that has an effect on price and the rating will tend to be higher," Boxall said.

As in any oil-drilling venture, the combination of strong regulation and risk management techniques in the Arctic will be key to avoiding catastrophic loss. Boxall reported that regulators in Greenland, where he has most of his experience, are asking for two rigs at the site of each well.

That way, should a rig explosion like that which doomed the Macondo occur, there will be another rig handy to drill a relief well. Regulators in Greenland are also requiring bonds of as much as $10 billion from companies that want to drill.

That means only the biggest oil production companies can afford that sort of stake, and that good risk management will be at a premium.

"That is a sort of financial guarantee that people are looking for that will clearly drive up the cost of business very substantially," Boxall said.

Everywhere you turn in the Arctic there is a different sort of risk. Initial drilling depth has been in the 150-meter to 400-meter range, but with spring drilling season, we can expect drilling in the 900-meter to 1500-meter range.

"And that is going to be driving up prices considerably," Boxall said.

On the Alaska side of the Arctic Ocean, concern from federal regulators has blocked some drilling plans. In Russia, though, the likes of BP and its competitors are reported to be lining up to take their shot with a regime keener to generate revenues and less concerned with the environment.

One thing is certain--the globe's major economies are still failing with their conservation efforts. Cheap reserves are dwindling, and the recent political upheaval in the Middle East is keeping prices high. The appetite on the part of industry to find more oil remains intense.

"Where do we invest next? Where do we get our competitive advantage from?" are the questions energy companies are asking themselves, Boxall said. "So, of course, people are going to be looking at the Arctic extremely carefully."

March 8, 2011

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