US Gulf Energy Companies Eye Alternatives to Steep Insurance

Dow Jones Newswires

HOUSTON Sep 11, 2006 (Dow Jones Newswires)

Dominion Resources Inc. (D) won't see a dime of insurance payouts if another hurricane like Katrina or Rita slams into its natural gas operations in the U.S. Gulf of Mexico.

And the company is just fine with that.

"We felt that buying that insurance was nothing more than turning that money over to the underwriters as a gift," Dominion Chief Financial Officer Tom Chewning told analysts in early August.

The Gulf's offshore oil and gas industry is headed toward a clash with underwriters when policies start coming up for renewal this fall. Dominion and others say they've been asked to pay too much for skimpy coverage. Insurers, meanwhile, call the more expensive, slimmed-down policies the new norm in a "hurricane-obsessed" market.

Most of Richmond, Va.-based Dominion's peers saw forecasts of another active hurricane season and purchased coverage anyway. They often paid double, triple, or even quadruple 2005 premiums, for policies that limited damage claims for the first time.

Dominion bought $50 million in catastrophe bonds instead of insurance this year. The bonds act as a loan that doesn't have to be paid back if hurricanes cause severe damage to Dominion's holdings.

Brokers say the oil and gas industry will likely feel less inclined to spend so much next year, particularly if no major storms hit before the end of the hurricane season in November.

But insurers are showing few signs of climbing down.

"Risk has increased, and the price will have to reflect that," said Robert P. Hartwig, chief economist with the Insurance Information Institute, an underwriters trade group in New York. "I would expect the relatively high pricing, terms and conditions of the coverage to remain in place for 2007."

Still Reeling

Insurers say that limiting coverage in 2006 was the only way they could cover the hurricane-battered offshore market at all this year.

In 2005, insurance companies recorded $15 billion in claims for offshore oil gas facilities damaged after Katrina and Rita. The Gulf Coast claims dwarfed the $3 billion in premiums insurers collected from energy clients worldwide that year, according to a May report by Willis Group Ltd., a London-based insurance broker.

"Whatever premiums they've collected over the last five years all got wiped out, and then some," said John Mizell, a senior vice president in Willis' energy department in Houston, in an interview.

Since the 2005 hurricanes, insurance offerings for Gulf Coast energy companies have changed dramatically. Gone are the days of unlimited coverage for hurricane damage, which was common in 2005.

Many of the changes have been driven by reinsurers, the underwriters' underwriters, who provide a safety net when damage claims exceed premium income. The rates they charge for that service can play a major role in the cost and scope of insurance. The major drillers, for example, are now covered for between $100 million and $250 million for the six-month hurricane season, even though a single rig can cost over $300 million to replace.

"The whole nature of the way business in the Gulf of Mexico is insured had to change," said Charles Franks, the lead marine and energy underwriter for Kiln PLC (KIN.LN) in London. "If it hadn't changed, then there would be no capital that would be prepared to expose itself."

Uncertain Future

Some brokers predict that drillers and oil companies, emboldened by a mild hurricane season, will push back on premiums this fall, when the first policies come up for renewal.

"The moment something happens everybody goes into kneejerk mode, and then it starts to moderate," said Tony Mayer, managing director for insurance broker Marsh Inc.'s marine and energy practice in Houston.

Both Smith and Mizell said they believe that insurers and their offshore energy production clients will strike a new balance, somewhere between the 2005 and 2006 rates, and with less restrictive damage caps.

Underwriters appear less willing to compromise.

Lloyd's of London (LYL.YY), the insurance market whose syndicates dominate offshore drilling underwriting, issued a report in June calling on the market to factor in predictions of more frequent, stronger hurricanes into underwriting formulas.

Underwriters and oil and gas companies agree that another major storm would be a disaster for the insurance industry, forcing some insurers out of the Gulf and pushing premiums higher.

"If we lose money again ... I think it would be very hard to develop an argument to have another go next year," Franks said.

Even in a best-case scenario, with no major storms in 2006, insurers plan on holding steady on the 2006 premiums and damage caps, both Hartwig and Franks said.

What's unclear, brokers and insurers say, is whether companies who grudgingly paid for incomplete policies this year can find a way to compromise with insurers equally unwilling to return to the level of coverage they offered in the past.

Some companies may follow Dominion Resources, and walk away from insurance altogether.

But many are stuck buying whatever insurance they can get, either to please shareholders or as a term in loan agreements, Mayer said.

Oil and gas industry representatives at a recent conference appeared to be increasingly dissatisfied with the current status quo, Mayer said.

"Half of the room said this isn't an insurance product anymore," Mayer said. "There was a strong feeling this is not a long-term tenable situation."

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