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By Gregory DL Morris

The Motiva oil refinery at Port Arthur, Texas, a joint venture of Royal Dutch Shell and Saudi Aramco, vaulted into first place as the largest refinery in North America when a new crude distillation unit was installed in April, more than doubling throughput from 285,000 barrels/day to 610,000. The whole project cost $10 billion.

A more positive surprise took place about the same time on the Atlantic Coast. Delta Airlines raised eyebrows across the business community in May when it struck a deal to acquire the Phillips 66 refinery at Trainer, Pa., just south of Philadelphia on the Delaware River.

Delta's business case is that jet fuel -- at about 40 percent of operating expense -- is its biggest single continuing cost. The airline paid $150 million, about 15 cents on the net asset value dollar of the 185,000 barrels/day refinery, and in a deal with the state government, it assumed zero liability for any potential environmental exposures prior to the deal closing.

Oil refining is a busy sector, but not necessarily a growth sector, both in terms of actual operations and in terms of insurance, said Robert Kuchinski, head of energy and engineered risk for Chartis Global Property, based in New York.

"We had 300 refineries in the U.S. 20 years ago, and just half that number today. Construction on the last greenfield refinery to be built in the U.S. was started in 1973 and the facility went into operations in 1976, but the industry overall actually has more throughput with half the plants as a result of expansions and debottlenecking," he said.

Larger and newer facilities on tidewater have been expanded and upgraded. At the same time smaller, less complex refineries, usually inland, have generally been closed, or used as terminals or blending facilities. There are many exceptions, and a further wrinkle was added recently by the burgeoning supply of shale oil and oil sands from Canada.

"That supply is a curve ball that may change the economics of some inland refineries," said Kuchinski. "The big action in the energy sector is upstream, in exploration and production, and in midstream processing and pipelines.

"But those developments are certainly going to have some effect downstream on refining and marketing. Some refineries mothballed or running at low rates may have new life based on new access to feedstocks," he said.

The influence of oil sands and unconventional development in gas and oil -- especially directional drilling using three-dimensional seismic surveys and hydraulic fracturing -- has clearly created new dynamics in regional feedstock logistics, said Harold Dorbin, senior vice president and project advisory services leader in the construction practice at New York-based Marsh Risk Consulting.

"Not only has that brought new life to existing facilities, but it has given the whole industry the opportunity to take a fresh look at idle assets," said Dorbin. "The Delta acquisition was one really novel development. I have heard that they are taking all the steps to do everything just right because they know they are in the spotlight."

The sector has also seen an accelerating trend toward multiple ownership or investment in a facility.

"In the past, upgrades or debottlenecks have been done by existing, integrated oil companies," said Kuchinski at Chartis. "Many of those changes are now taking place under new ownership."

As more refineries change hands, the demand for reviews of site security, machine and equipment layout, idle equipment care as well as hot work and safety procedures is growing. Such due diligence is an increasing part of the business for Kuchinski's group.

"About a third of our managers and underwriters are engineers," he said. "That is the way we chose to go about our business."

He has 50 engineers on his team to conduct evaluations of insureds' facilities and expansion projects. Another 50 or so work in casualty loss control directly with owners and contractors. A dedicated claims group is the third component, cycling what is learned about actual losses back to the evaluation and loss-control groups.

One example, Kuchinski said, is that, "in many cases during an upgrade, the focus is on the new equipment and process, but not enough attention is paid to wear on pipes and valves in the rest of the plant. Also, multiple expansions and refits over the years tend to increase the complexity and congestion in and around the process units or introduce prototypical equipment. That can lead to loss and casualty."

In practice, however, Kuchinski said, "there is no real line between operations and maintenance in a refinery. The operators always have contractors on-site doing something. It is not just the big turnaround every two years. Little projects are going on constantly."

"Many of the largest global majors are self-insured," said Keith Mattheessen, head of the energy unit in the large-risk division of ACE Risk Management, based in Philadelphia. "The integrated companies who are self-insured still look to the market to provide credit-risk coverage for their balance sheet, as well as regulatory-driven coverage such as workers' compensation, liability and environmental."

Several industry sources reported, for example, that Exxon Mobil retains the first $500 million in property coverage and transfers the rest, while BP is estimated to retain $1 billion to $2 billion.

Midsize or smaller companies, Mattheessen said, cannot handle a big hit to their balance sheets, but neither can they sustain large premiums or deductibles. Profit margins are notoriously thin in oil refining; the bulk of the price at the pump comes from raw materials and logistics costs as well as taxes.

"Typically, we maintain workers' comp programs on-site at all times," Mattheessen said. "We do not usually have special coverage for expansions or upgrades, but there are policies available to be written for special projects, as well as to cover planned and unplanned outages. The majors usually have their own risk professionals in place at the refineries, and we offer risk-control services to support them. Some brokers and independent consultants also provide such services."

Operators may not be obligated to advise brokers or carriers about planned construction projects, but in most cases, all the parties sit down for a project safety review. It is part gap analysis and part schedule coordination.

"We like to see worker safety practices in place, the training curriculum, emergency-response plans and contingencies," said Mattheessen. "We look at all those things to help us determine our comfort level for limits, exposures, attachment points and so forth."

ACE likes to see participation in the OSHA Voluntary Protection Plan. "It is not a requirement," he said, "but we have found that those facilities in the VPP typically have lost-workday incident rates at about half the industry average. And with that, they often won't let contractors on site who don't also have a comparable record."

Government regulations are also requiring upgrades to stay in compliance, and the thinking is that big catastrophic incidents need property/casualty coverage as well as balance-sheet protection on the liability side.

Zurich has a dedicated energy group to handle coverage and risk-management support for normal operations, and a construction underwriting group for major maintenance turns and upgrades, said Scott Rasor, head of construction for Zurich in North America in Schaumburg, Ill.

"Even though they may be happening at a refinery, those types of projects are more akin to typical construction projects in terms of job-hazard analysis," he said.

He stressed the importance of the risk management meeting before the project begins as a way for the underwriter and broker to coordinate with the risk managers for the owners and the contractors. He also noted the importance of dedicated limits for new structures.

Companies usually have a wrap or a master builder program in place, he said. For projects of more than $100 million he also suggested put-in-place construction coverage.

"At that level and above, you are usually talking about a discrete new process or unit," said Rasor, "and the owner and broker need to evaluate the current program to see if it can handle the added exposure for all aspects of general liability, builders risk, equipment and contractors pollution liability.

"We are dealing with very high-value assets, and even if there is not damage, a malfunction can lead to a loss of operations, which can be very expensive," he said.

He also said coverage must accommodate existing operations through the winding down, construction, and restart to continuing operations. "The transitions can be complex, but the coverage has got to be seamless."

That, in turn, often leads to questions about pricing.

"We often find agents and brokers who do not really know the industry well enough to plan and then price a program accurately," Rasor said. "The industry does not want surprises. Capacity is not really a concern, but appetite for uptake can be. If the program is too conservative, the price goes way up. If it is too liberal, there can be gaps or the price may be inappropriate."

For casualty coverage, most refiners are not in the commercial market, said Wellington Stephens, senior vice president at Lockton Cos, the broker based in Kansas City, Mo.

"For primary general liability, there is a very limited market: ACE, Chartis and Zurich for the first layer of risk transfer up to $25 million. Then, you see the same players for the next layer. Once you have placed that first $50 million, then you can bring in the Bermuda market, which is more responsive in this segment than is London."

The largest program he ever placed in refining was $600 million and, Stephens said, he found the European and London markets were not as competitive as Bermuda.

For property coverage, Stephens said, there is plenty of capacity in North America and London, up to $750 million or even $1 billion. "At $500 million, Bermuda comes into play again, but they don't want to write below that level."

One concern owners should bear in mind, Stephens said, is that even though there were no headline-grabbing disasters last year, "we still saw $100 billion in catastrophe losses in 2011 and the market is still very leery of catastrophe coverage, especially named windstorm. Carriers are being very conservative with attachment points and are charging premiums accordingly."

"Making the program comprehensible and digestible to the market is essential in placement," Dorbin said. "That may seem obvious, but there can be a delicate evaluation of thresholds and important insights to risk assessment.

Bringing the discussion full circle, Dorbin said that, even for the largest facilities run by the global majors, there are opportunities for risk mitigation.

"These are very technologically savvy companies with sophisticated process and project controls," he said. "But there are a lot of variations in a refinery, multiple layers of complexity. Even a very large company can have challenges for projects at remote locations."

He also said that, in his experience, it is the midsize projects that have the greatest tendencies to get off schedule or run into problems.

"The biggest projects usually get sufficient money and attention," he said. "The small projects tend to get done as a matter of routine. But the midsize projects can sneak up on people. They might not get the money or attention they deserve."

GREGORY DL MORRIS has covered the oil and gas industry for more than 20 years.

July 24, 2012

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