Expert Risk Articles

Low Margins for Error

As oil reserves are being depleted, drilling for oil is becoming more and more challenging, forcing new drilling operations in perilous locations. The risks associated with such undertakings are resulting in new safety precautions and best-practices.

The world’s soaring demand for energy is sending oil and gas prospectors into ever-deeper waters. While exploration and production challenges are generally magnified, mitigating risks is paramount. After the Deepwater Horizon spill, industry and governments have improved safety best practices.

The age of easy energy is over. This is particularly true of oil. Easily accessible reserves are either dwindling or subject to greater political uncertainty. With the International Energy Agency expecting 1.7 billion cars on the world’s roads by 2035, double today’s total, the world demands new discoveries.

Deep Water Drilling

Oil companies have responded by exploring extreme environments, often ones where reserves were previously considered unrecoverable. Technological advances and rising oil prices have turned tantalizing prospects into attractive investments. Perched on the leading edge of developments are deep-water offshore platforms, whose oil production has soared from virtually nothing in the 1980s to eight million barrels a day in 2010, almost 10 percent of global consumption, according to energy analyst Douglas Westwood.

This is despite the Deepwater Horizon (or Macondo) disaster in April 2010, which killed 11 workers and spilled 4.9 million barrels of oil into the Gulf of Mexico. Just two years later, the US government’s latest auction of Gulf leases raised US$1.7 billion, more than five times the amount in 2011. Deep-water drilling is back in demand.

“There is a massive opportunity for offshore projects to provide increased supply,” agrees Paul O’Neill, Global Head of Energy at Allianz Global Corporate & Specialty (AGCS). “Deep water is a significant contributor.” The industry generally defines deep water wells as those drilled in over 1,000 feet of water and ultra-deepwater wells as being over 5,000 feet below the surface. The current record is 10,194 feet, set off India’s east coast in 2011.

The first deep-water fields were drilled in the Gulf of Mexico in 1975 and 1986 respectively. Further finds in the Gulf and off the coasts of West Africa and Brazil
have concentrated a drilling boom in this geological “Golden Triangle.” There have also been colossal natural gas discoveries off Australia and in the Eastern Mediterranean, while China, Indonesia, the Philippines, and India are promising prospects.

Exploration operations have been facilitated by improved seismic mapping, advanced drilling techniques, and larger drilling rigs or ships needed to drill wells to 35,000 feet and beyond. On the production side, innovations include installing the processing equipment that separates oil, gas, and water directly on the seabed, and giant Floating Production Storage and Offloading (FPSO) vessels – often converted tankers – equipped with processing, storage and export capabilities that can produce from multiple sub-sea wells without relying on pipeline infrastructure.

Deepwater Disaster 2012

Depth and remoteness magnify risks

Such rapid advances bring opportunities but also risks. For the energy and insurance industries alike, understanding and mitigating those risks is paramount.
Exploration and production challenges aregenerally magnified, and the margins for error are reduced, with greater depth and remoteness.

Winds, waves, and currents

At the surface, powerful winds, waves, and currents are severe hazards. These hamper the ability of floating production units to maintain their position and stable connections to the sea floor, as witnessed during a North Sea storm in early 2011 that broke four of the ten mooring chains securing the Maersk Gryphon FPSO, forcing a lengthy shutdown. The overall loss to Maersk is thought to be in excess of US$1 billion, of which something in excess of US$ 900 million will be recoverable against its insurance policies. 

Much depends on the platform type and the mooring systems deployed. Advanced vessels use thrusters assisted by GPS-based dynamic positioning to keep on station while new, continuously taut deep water ropes have improved on conventional steel wire and chains.

Below the surface, extreme pressures and low water temperatures can form crystalline “hydrates” from natural gas and water that clog pipelines. Solutions range from heating with electric cables to removing the water from the gas using sub-sea installations.

Remote-controlled repairs

Cold water and high pressure may also affect equipment performance. And because all this equipment, including critical safety devices like pressure safety valves and blowout preventers, is deeper than human divers can go, it is more difficult and expensive to test, monitor, maintain, and repair. Oil companies must
rely on remote-controlled vehicles.

Within the well itself, the most fundamental challenge is managing the ‘pore pressure’ driving hydrocarbons up from rock formations into the well. The goal is to prevent an uncontrolled surge, which could lead to a blowout.

Drillers counterbalance upward pore pressure by pumping drilling fluid, or ‘mud’ down into the well bore. Too much mud weight, however, might fracture the surrounding formation, presenting another subsurface blowout risk, so drillers must continuously balance fracture gradient with pore pressure as they drill deeper. The greater the depth, the more delicate the balance, and the narrower the window of opportunity to drill safely. To stabilize sections of the well, drillers use steel pipes, or ‘liner strings’. Deep-water operations may require twice as many liner strings as shallow locations. “Seismic accuracy is a key issue,” says Pete Connors, Global Offshore Product Leader for AGCS. “If the engineers expect to encounter one substance and suddenly hit another, it could cause problems.”

Enormous assets at stake

As all this deployment of expensive hardware implies, deep-water operations demand huge economies of scale. This improves efficiency but also presents an other risk, says David Robertson, Global Head of Energy Risk Consulting at AGCS: accumulated exposure to “concentrated value” in enormous assets like FPSOs that run into the billions.

However, this has concentrated minds, says Robertson, leading to an impressive long-term claims record. Before Deepwater Horizon, an estimated 14,000 deepwater wells were drilled worldwide without any major oil spills, according to Lloyds research. And since then, industry and governments have made significant
efforts to further reduce risk.

Deepwater Disaster 2012

The insurance market remains receptive to deep water. “We are not shy of deep-water drilling and production. We cover all types of risks,” says Connors, who notes that underwriters are conducting more forensic analyses of oil companies’ risk management practices since 2010.

There are five key risk management layers to consider, explains Robertson: inherently safe platform design; redundant safety systems; proper testing and inspections; mechanical integrity; and management systems. “The more hazardous the operation, the more layers of protection required,” he says. “For deep-water, I would want the management program to be best in class, and the operations to be triple redundant.”

“It really comes down to knowing who is doing the work, whether they have the right people and equipment and the best safety and risk management practices,”
adds O’Neill. After all, the Macondo blowout, the presidential investigating panel concluded, was caused by “a failure of industry management.”

The limits are becomming higher

Despite their vigilance, insurers are not actually covering all these risks. The sheer expense of deepwater operations is beyond their capacity. An FPSO with associated mooring and sub-sea systems could be val ued up to US$5 billion. “The issue is that some of the limits are becoming so high,” says O’Neill.

The energy sector has adapted to these realities by combining the resources of the captive firms owned by oil companies, the industry-owned mutual Oil Insur ance Limited and commercial market players. Al though this takes premiums out of the market, O’Neill doesn’t see it as a threat. “It’s just a mature way of approaching these very major risks in an environment where I can’t see anything but the technology enve lope being pushed further. We will offer clients support to set up captives. We see it as opportunity.” He also foresees opportunities in some of the enormous offshore construction projects utilizing new technologies and in the “inevitable” future need for environmental protection insurances.

Standallone pollution coverage

Previously ‘seepage and pollution’ was combined with ‘control of well’ and ‘cost of re-drilling’ elements in Operators Extra Expense (OEE) packages under one lim it, usually up to about US$500 million. But post-Deepwater Horizon OEE combined limits look inadequate to cover anticipated economic damages from oil spills and so insurers are discussing how pollution coverage can become a standalone product with significantly increased limits.

“Our clients want more coverage,” says Paul O’Neill, and with Douglas Westwood forecasting US$232 billion to be spent on deep-water projects from 2012 to 2016, the market opportunity is clear. “We need to look at our existing products and ask whether we are providing what the client is looking for.” The age of easy energy is over, but the future promises rewards as well as risks.