Oil Rig Activity in 2015 - What’s Your Exposure Now?
According to Forbes, the collapse in oil prices has claimed over 200,000 jobs worldwide, affecting both large and small firms in the oil industry. Mark Schultz, the President of the Canadian Association of Oilwell Drilling Contractors, shared that the Canadian drilling sector shaved over 28,000 jobs since 2014. In Texas alone, exploration and production companies shed over 60,000 jobs according to Karr Ingham, petroleum economist for the Texas Alliance of Energy Producers.
The ripple effect of falling oil prices is being felt in all stages of exploration and production. The drilling and well servicing sector has experienced a steady decline in rig utilization rates, number of wells drilled, and employment levels - all key indicators of market strength. In Canada, 2015 represented the lowest rig utilization rates since 1983 and a 58% decline in the total number of wells drilled. The same thing has occurred in the U.S. where the total active rig count in 2015 decreased by 61.5%, equating to a drop of 1,113 rigs.
This environment has driven many smaller companies in the oil industry to consider bankruptcy, with others looking to survive by merging. The environment is also forcing some firms to sell equipment at discounted pricing. Other companies are searching for opportunities outside of North America and are shipping assets to locations where operating margins are better. We know of one insured that relocated its assets to another country for an entirely different purpose - to drill water wells. Finally, other drilling companies are deciding to store their equipment and wait for the market to turn. In the U.S. shale sector, many newly drilled wells have been capped and companies will wait to frack or produce when oil prices have normalized.
As the oil commodity market stays soft, with rigs and equipment parked more than they are operational, the framework of property exposure shifts. Instead of spending days, weeks or sometimes months over the well, equipment is being stacked in storage yards and maintenance shops for lengthy periods. As other companies move equipment to different regions of the world, they are likely to encounter unfamiliar regulations and political risk.
From an underwriting standpoint, these operational changes create different exposures. One of the major changes for property underwriters is the significant amount of equipment accumulating in storage yards and facilities. In 2015 one insured reported an exposure of $150,000,000 in idle equipment at a single location. This change represented more than a 50% increase from the previous year. Clearly, a single catastrophic event could have huge implications for all parties involved. The insured may not have adequate coverage, or perhaps the insurer may not be prepared to take such a significant loss in a single event.
In terms of catastrophes impacting the oil and gas sector, 2015 was an extremely active year for forest fires as they raged across much of Western Canada - a region heavily committed to the oil and gas sector. In the U.S. 12 fatal tornadoes touched down in 2015, half of these taking place in Texas. We are aware of two operational rigs that were hit by tornado in 2015. Assuming an average rig value is between $5 million and $10 million, it is crucial for underwriters to know an insured’s maximum expected accumulations so an appropriate (re)insurance limit may be offered.
Experienced drilling and fracking companies follow a “mothballing” checklist to prepare their equipment for storage during an idle period - something an underwriter may want to know. Storage will help preserve equipment but also signals to an underwriter the need to look at the level of risk management that the organization displays. Equipment that is not properly maintained while idle is more likely to show signs of corrosion and may lead to problems when the equipment is brought back into service. Even with the market downturn, many companies should remain focused on safety, training and equipment maintenance. Employing a simple risk management strategy, such as properly maintaining equipment during storage, will ultimately allow a company to save money on equipment repairs and insurance premiums.
Some tips for property underwriters include:
- Request up-to-date estimates of a firm’s equipment storage plan. This will be critical in establishing your PML and MFL scenarios.
- When contemplating loss scenarios, factor in possible CAT exposure to your storage locations.
- Inquire about fencing/security measures to mitigate the chances of theft, mischief and arson.
- Review the insured’s Emergency Response Plan to weather events and forest fires.
Major oil and gas players have made significant changes to their operations in reaction to the shifting economic landscape.
- However, these new property exposures are cyclical; as the oil and gas market regain momentum, these issues will become less prevalent. For now forecasts are suggesting that current conditions will continue in 2016. For underwriters, the key is gathering the appropriate information to help provide the right solution for both your client and for your organization.