Newsletter Sign-up

By CYRIL TUOHY, managing editor or Risk & Insurance®

Prior to the April, 20, 2010, Macondo oil spill, the claims record of the energy industry was not seriously affected by deep-water drilling, according to David Sharp, an expert on deep-water drilling insurance coverage.

The last big offshore pollution event involving a well blowout before the Macondo Oil Well was in 1969, when a blowout in the Dos Cuadras field off the California coast spilled as much as 100,000 barrels into the ocean.

More than 42 years have elapsed between the Dos Cuadras incident and the Macondo disaster, and energy underwriters had not spent much time focusing on coverage terms and pricing for pollution arising from offshore wells, risks contained in specific policy forms known as operator's extra expense coverage, Sharp said. "All of this changed as a result of the Macondo loss."

The accident has only encouraged even more insurance carriers to change their pricing approach, which some were doing before the disaster, Sharp said. Carriers were already changing their formula-based pricing models. Those models had carriers tacking on a surcharge on wells with more severe risk profiles, for one based on a percentage of the capital expenditures of the well, Sharp said.

This, in turn, has raised questions of whether the insurance industry can provide enough coverage as rig operators "have decided that a higher limit is more appropriate," up to six times the capital expenditure of the well, Sharp said.

"This capacity issue will become even more serious if insureds also decide that they need a dedicated limit for pollution," Sharp said.

Sharp's analyses are contained in a report titled Drilling in Extreme Environments: Challenges and Implications for the Energy Insurance Industry. Sharp, in independent consultant, co-authored the report with Andrew Rees, a Lloyd's director.

The report was released in September by Lloyd's, a major reinsurer of offshore drilling risks.

Property damage claims and business interruption losses have also affected the insurance capacity for oil wells in production, as the market for liability coverage underwent a contraction in the aftermath of the accident, Sharp said.

Insurers are also looking into revising their pricing models with respect to pollution liability, Sharp said.

Previously, a surcharge was included in the rating calculation for pollution coverage, and there was "generally no discernable rate applied for pollution." Insurers charged premiums for a layer of insurance coverage rather than applying premium proportionately over different insurable liabilities. "This practice has clearly raised concerns following Macondo," Sharp said.

Experts appear divided over the likelihood of another Macondo well disaster. Of the 50,000 wells drilled around the world since 1947, only one on the scale of the Macondo blowout has ever occurred, some experts say.

Before Macondo, there were an estimated 14,000 deep-water wells drilled around the world without a major incident.

Other experts believe the risk of a similar incident is closer to 1 in 43. That's because since 1993, only 43 other wells drilled are as complex as the Macondo well, one whose wellbore was unstable.

The deeper the well, the more unstable it is likely to be -- due to crushing pressures and colder temperatures. The first deep-water well was in more than 1,000 feet of water in 1975, Rees said. The current water-depth record was set earlier this year at 10,194 feet off the east coast of India.

"The absence of similar losses to Macondo in deep water does not necessarily preclude further losses in the future," write Sharp and colleague Andrew Rees, in the report.

Citing previously published research by the Deepwater Horizon Study Group, a total blowout, a total rig loss and the loss of well control for 87 days, as happened with Macondo, "was not even considered possible," the Lloyd's report said.

The Macondo Oil Well spilled the equivalent of an estimated 5 million barrels of crude oil into the Gulf after a malfunction of a key piece of equipment known as a blowout preventer.

The ensuing explosion aboard the rig took the lives of 11 workers before the well burned and sank to the bottom of the ocean in 4,992 feet of water.

October 15, 2011

Copyright 2011© LRP Publications