Energy Market Review, April 2016

The challenge of global instability: how can the energy industry respond?

April 2016

The phrase “The Perfect Storm” is possibly the most over-used cliché in describing business landscapes, but in truth no other term really comes close to identifying conditions in the Energy insurance markets as we move further into 2016.

From both a supply and demand perspective, the outlook for insurers continues to look bleak; while the majority will no doubt find a way to trade through the current business environment, we believe there will come a time when, for some, their continued participation in this sector will come under review – it’s just that nobody knows exactly when that will happen this will happen.

What are the factors that make up this “Perfect Storm”? From a supply perspective, there simply remains too much capital available from the global (re)insurance market. For the tenth year in a row capacity has increased in both the Upstream and Downstream markets, fuelled by the availability of competitively-priced Treaty and Facultative Reinsurance.

This capacity needs feeding, and individual underwriters remain under pressure to deliver the premium income targets that providers require to justify their investment in this sector. With no meaningful withdrawals during the last 12 months, competitive pressures have intensified still further; the steady softening in both markets continues unabated, despite recent losses in the Upstream sector and the continuing decline in rates to new record levels in the Downstream sector. The same dynamics are generally also in play in the Liability, Construction and Terrorism markets.

But it is perhaps on the demand side that the insurance markets are facing an ever bigger challenge. The reduced risk management budgets brought about primarily by the collapse in oil prices that we described in some detail in last year’s Review have had an even bigger impact in 2016, as programme limits have reduced and self-insured retentions have increased.

As a result, the available premium income pool continues to be eroded, particularly in the Upstream sector where the lack of new projects and the scaling back of major drilling operations have made their own contribution to a significant overall reduction in premium since this time last year.

Prioritization of Oil & Gas Cost Savings Opportunities

So while the need for product innovation in the marketplace remains as urgent as ever, the focus for both buyer and seller this year has been on price – the buyers have been forced to cut costs, while the sellers have had to compete even more fiercely for the reduced pot of premium available.

Faced with this predicament, insurers have had to choose between a strategy of retrenchment, waiting for a market upturn as others eventually withdraw, or maximising market share, in the hope that the premium income earned will be sufficient to enable them to continue to trade.

Although at face value this is all good news for the beleaguered energy industry, as prices continue to fall we should all remember that the market has provided a stable platform to enable the smooth transfer of risk in a predictable and manageable fashion. It goes without saying that any scenario which severely impacts this balance will have negative consequences for all parties involved.

In this review

In addition to our usual insurance market analyses—Upstream, Downstream, Onshore Construction, Political Violence/Terrorism, and Liabilities—our Energy Market Review this year focuses on six areas where new approaches to risk management and workforce solutions are being developed that may help the industry develop such strategies. These are:

  • Optimising human capital risk: the debate today is less about a ‘War for Talent’ and more about re-structuring, right sizing, sustainable workforce planning, managing performance and reducing workforce costs.
  • Mitigating cyber risk exposure: proper risk quantification is now essential if energy companies are to approach the decisions about addressing this exposure with the most effective deployment of capital.
  • Managing regulatory risk: quick access to protection for Directors is now required in the event of a regulatory breach and a consequent investigation or claim against them.
  • Navigating the geo-political landscape: as new geo-political threats are identified, so must scenario building, modelling and risk mitigation measures, while the energy industry continues to expand into regions which are becoming increasingly volatile.
  • Meeting the environmental threat: latent environmental liability in the industry is being increased at a time when money to mitigate this risk is in short supply. Specialist insurance products can address this threat in part, but the lessons of both Macondo and the recent mining disaster in Brazil suggest that more advanced risk transfer mechanisms, featuring limits in excess of what is offered by the conventional insurance market, are increasingly needed by the energy industry.
  • Taking a fresh look at Alternative Risk Transfer (ART). At the end of the Review, we examine some of the modern ART products that are now being developed and how parametric solutions in particular might become more familiar tools in the modern risk manager’s armoury.