(This article first appeared in Insurance Day)
By James McDonald, Head of Energy London Market & Europe Insurance at Sompo
Oil prices have spiked to an eight-year high this year, reaching as much as $128 a barrel. Following a slump in prices during the worst of the Covid-19 pandemic and resultant lockdowns, the conflict in Ukraine and the sanctions imposed against Russia, among other factors, have served to push up the oil price – and with it demand for insurance coverages for upstream risks, such as loss of production income (LOPI) cover.
After a period of a couple of years of modest, single-digit rate increases, set against a fairly stable claims picture, premiums for upstream risks are on the rise because of an increase in drilling activity, offshore construction activity and increases in the values insured.
But the picture is nuanced. Energy underwriters have seen a large chunk of premium, potentially about $100 million – around 5% of the global total – withdrawn from the market because of sanctions against Russian assets. The geopolitical situation means that many insurers are writing reduced lines or excluding certain coverages for some clients that have assets in Russia, for example.
The increased price of oil has had a knock-on effect, prompting some companies, particularly National Oil Companies (NOCs), to look for new oil development prospects. And this has sparked increased demand for insurance to cover the construction risks associated with these projects.
The hire of rigs for drilling is typically done on a day-rate basis, and as demand for offshore rigs ticks up then inevitably the cost of hire also increases. This leads to an increase in the daily value of the rigs, which are usually based on a function of the day rate, meaning that insurance premiums increase in tandem; increased activity and increased values means that there’s a greater pool of insurance premium to support these projects.
Again, the dynamics here are nuanced; the International Energy Agency last year stated that it believed part of the way to achieve net zero carbon emissions was to end the development of new oil and gas fields.
The Paris-based IEA, which was formed in the 1970s to secure the future of oil supplies, said in a report presented at the COP26 climate talks last year that it believed spending on new oil and gas projects must end – immediately.
There’s clearly both a moral and a business question to be addressed here. Developing new oil projects might have positive benefits in terms of prosperity for some under-developed areas, such as Guyana, which has untapped deep water oil prospects. We are also seeing increased interest in drilling in Brazil and fracking in the United States, among other areas. But set against the short-term potential for drilling for new oil, the energy sector, like all industry segments, has a firm and challenging goal of moving towards net zero emissions.
The energy industry finds itself in a period of transition and evolution. Most super-majors are well on the way to changing their business models to move away from a reliance on oil and gas exploration and towards new sustainable energy sources and new ways of producing and storing energy to reduce emissions. Given the IEA’s stance, coupled with the net zero ambition and the prevailing stakeholder sentiment that the transition needs to happen, it’s clear that there is not a large window of time in which new exploration projects will be acceptable.
As insurers, we have a clear duty to support clients who can demonstrate that they have credible transition plans. The Lloyd’s Market Association’s Joint Rig Committee has produced a transition questionnaire designed to serve as an outline for energy market underwriters collecting information about their clients’ progress towards the energy transition, greater sustainability and other Environmental, Social and Governance (ESG) goals.
At Sompo we are keen to work with energy clients that can illustrate they are on a clear path to transition. We recognise that this is a challenging period for energy clients and want to support those that can show they have a plan to achieve net zero and ESG goals that align with our own values. Our “One Sompo” approach, which means we include upstream energy, downstream energy, power and renewables in one unit, enables us to transition alongside our client base.
This is a period of change for the energy market. The pressure and the impetus to transition, combined with the delicate dynamics of the oil price and the geopolitical situation, mean that while underwriters have opportunities to write more premium volume, they must do so in a considered fashion.
Even when the Ukraine conflict is over, it’s likely that the oil price will remain high for some time, and that sanctions against Russia will remain in place for a period of time too. For energy clients this delicate situation, set against the backdrop of the drive towards net zero, means that their already complex risks are evolving all the time.
We want to maintain open and fruitful dialogue with our clients as we all navigate this new phase of the energy market together.