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Analysis

Interplay Between Insurance, Risk Management and Offshore Safety

Wed, 01/25/2012 - 08:59

Juan Carlos Zepeda Molina, President of Mexico’s upstream regulator, the Comisión Nacional de Hidrocarburos (CNH), is sceptical that promoting the right culture is enough to ensure safety in the oil and gas industry. “I am much more inclined to believe in the power of incentives,” he explains. “What we saw after Macondo is that the international industry hasn’t invested as much in safety and containment as it has in exploration and production activities. The reason for this is simple: as a result of investing in E&P, companies get the results and profits they need. But that link is not so clear when talking about safety. Companies ask themselves, ‘Where is my profit? How do I see my profit and loss change if I invest in new containment capabilities?’ The answer to these questions informs their view of investment in safety.

“This short-term view is not only a problem within Pemex. It is also a problem in the private sector, fuelled by the fact that there is no direct connection between investment in safety and profit and loss results. That is why, after so many decades, technology in containment and safety hasn’t improved enough.” As an example of this attitude, Zepeda Molina points to the fact that initially the only containment solution for Macondo blowout were relief wells (capping stacks were not available at that time but were developed later to contain this disaster), the same technology that was used in 1979 to contain Mexico’s Ixtoc-1 spill. “Why has the technology changed so rapidly in other areas in the oil sector, but not in safety and containment? The reason again is that companies are driven by profits, and investing in safety does not provide clear profits. So, what is the answer? For me the answer is not cultural. The answer is correct regulation. As regulators, we should provide a legal framework so that companies have the incentives to invest in safety.”

Creating the incentive for companies to invest in safety, according to Zepeda Molina, means requiring them to buy insurance before they begin a project. “If these companies are forced to face the price of the risk, then they will define their portfolio more wisely. In the weeks after the Macondo blowout, the insurance premium for deepwater operations increased by 100%. Even in shallow water, it increased 30%. People realized that the risk was much higher than premiums had previously suggested.

“The problem with this proposal of mandatory insurance is that in many countries, such as the US, insurance is not required. Industry regulators only ask companies to show financial responsibility, which can be proved by either presenting an insurance policy, or showing the regulator a balance statement that proves solvency. But to allow companies to work on projects without insurance misses the point. By allowing a company like BP to self- insure, regulators are not forcing the company to see and understand the price of risk in the market. It is important that you force companies to go out there and face the risk. They call it a cultural problem, but it is not. There is only a lack of incentive because the regulation is not in place.”

Zepeda Molina is aware of how controversial his views are in the oil industry. “Opponents say it is not possible to force full insurance on the oil companies because the insurance market cannot bear that risk. If you force full insurance, the insurance rate will go through the roof and many small companies will be priced out of the market.” However, he believes that full insurance is a necessary step to take, despite the problems it might cause: “The risk is already there, and we are all bearing that risk. The only thing we can try to do is allocate it correctly.”

In order to avoid a short-term collapse of insurance markets, the CNH President suggests catastrophe bonds, used by governments to raise capital in case of a disaster, as one alternative for creating an industry insurance policy through the financial markets. Such ideas have been discussed by the industry, as has creating a pool of capital so that the industry can insure itself, based on the risk profile of each specific project.

Under current safety and insurance regulation, CNH requires Pemex to insure for oil spills, well containment and blowouts, but does not require full insurance. Although Pemex has been insuring its projects for a number of years, it will create a separate insurance policy for deepwater of its own accord without intervention from the regulator. “At this point,” explains Zepeda Molina, “we just require that they cover all aspects and provide to us the reasons or methodology to define their coverage. We are trialling a system whereby we ask Pemex how they think they should insure, and how they are assessing project risk. After this, we provide feedback to the company.” As well as insuring itself, Pemex now requires that its contractors provide their own insurance.