The Summit

Beacon Hill Associates A publication of Beacon Hill Associates
Cover Feature

The Oil & Gas Sector: Strong or Unstable?

The insurance market that insures energy companies is undergoing continuing change. Some of these changes are driven by the risks themselves and others by the broader pressures the industry faces.

The energy sector continues to be one of the most exciting spaces in the insurance industry. Dynamic growth, high profile and controversial technologies, and the potential for the United States to be a global leader in energy production all lead to a highly charged environment. 

Graphic: Davide Bonazzi - Salzman Art

There are very few industries where the value of the end product is watched as closely as the cost of a barrel of oil, or ones where a fluctuation of a few dollars can send pundits into a frenzy predicting the demise of the industry.

For the agents and brokers working in this sector however, the reality is that much of this activity is business as usual. Oil and gas has been a boom and bust business for as long as we’ve been extracting oil from the ground. As would be expected from a mature industry, there are methods to smooth out the ride as prices rise and fall. Understanding this flow and managing agency expectations is the key to writing successful energy business.

While the hype surrounding oil and gas is not particularly new, the insurance market that insures energy companies is undergoing continuing change. Some of these changes are driven by the risks themselves and others by the broader pressures the industry faces. Understanding these issues will enable agents and brokers to better assist their clients in building solid insurance programs.

For quite some time, standard carriers have controlled a larger amount of the oil and gas business. Traditional CGL coverages with sudden and accidental Pollution have been available for all elements of the process, from upstream to midstream and downstream. In today’s more competitive, aggressive insurance industry, these traditional carriers are facing new competition on a monthly basis. As the excess capacity in the insurance industry fights to find a return, carriers are entering the oil and gas arena seeking opportunities. This is having two specific effects. First it is broadening coverage. Where carriers traditionally only offered sudden and accidental Pollution coverage, they are now offering non sudden and gradual coverage as well. This is a significant broadening of coverage that has not been lost on the risk managers at many of the largest petroleum companies. Requirements for this coverage are becoming more common. The second effect is a dramatic increase in capacity coupled with a reduction in rate. More carriers competing for the same business results in lower prices and higher limits being offered. Again, this change dramatically benefits insureds, and as with the type of coverage available, this increased capacity is also being required more often.

When assessing the relative value of these benefits, it remains important to be comfortable with the size and security of the carriers offering the coverage. While some of them are excess and surplus carriers, many are the E&S arm of very reputable carriers with excellent A.M. Best ratings and reputations.

It is also critically important to be comfortable with the underwriting expertise at the company as well as their claims management. Experienced underwriters will understand where your insured has been, and where they are heading. They will know the oil and gas business and be able to understand the needs of the client. Similarly, claims expertise in the oil and gas industry will lead to far better resolutions in the event of a loss.

So while carriers are offering broader coverage for less money, agents and brokers need to be very cognizant of the merits of those deals relative to the carriers making them.

While it is important to have good carriers willing to provide the best coverages being offered today, it is also important to see where the market is heading. With all the publicity attached to the price of oil, it is important to understand how the industry handles those fluctuations. As the price of oil drops, many insurance carriers worry that their insureds will shrink or even go out of business. The truth is that as one part of the industry contracts or slows down, another part grows. Balance in insureds is important to the carriers as well as to the industry.

One of the most fundamental points to understand is that oil and gas production is two different things, and the price of a barrel of crude oil does not reflect the natural gas industry. While one may move down, the other may remain solid or even improve. Currently, a barrel of oil is significantly off of its recent high, but natural gas remains very strong.

The oil and gas industry is broken into three distinct phases; upstream (production), midstream (storage), and downstream (refining). Through many years of boom and bust, the industry has become adept and shifting resources to where they will be the most meaningful. So, when the price of a barrel of oil drops, production may slow but midstream increases. The industry then stores oil in vast tank farms waiting for prices to increase again. When they do, the oil is sold to refineries who generate the finished products needed.

What this means for the contractors and facilities in the energy space is that there is always work to be done. Insurance carriers try to balance their books to reflect the different elements of this relationship, and brokers who know this space do the same thing.

Moving into the end of 2015 and into 2016, we expect to see continued stabilization. Oil prices will remain fairly flat, leading to a slowdown in production and refining, but a continued growth in the midstream space. Natural gas production shows no signs of letting up, and our expectation is to see continued growth in that segment of the market.

In spite of all of the press hysterics, the oil and gas business in the United States has never been healthier. At the same time, dynamic growth in the insurance industry is enabling these risks to purchase the best coverage they have ever been able to, at prices they have not seen before. For agents and brokers who really know this space, there are great opportunities to differentiate themselves through partnering with high caliber carriers to bring the best to their clients.

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