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Larger complexes, budget pressures and critical asset aging are driving loss and business interruption challenges in the oil and gas industry

03 November 2021 Allianz Global Corporate & Specialty

• New business interruption challenges could arise from an increasingly competitive environment for producers
• Small fires, machinery breakdown and unit shutdown/start-up incidents are contributing to larger losses than previously, due to increasing complexity and rising values
• Concerns have been raised that budget pressures may lead to reduced expenditures on maintenance and mechanical-integrity inspection programs, at the same time as a degradation of some protection features
• For companies to truly mitigate increasing business interruption risks, onsite surveys by risk engineers are essential

In recent years, pressures on oil prices have squeezed the oil and gas industry hard. An increasingly competitive environment has forced producers to seek cost-saving measures to drive optimization and profitability. The sum of these activities, however, may be new business interruption (BI) and contingent business interruption (CBI) challenges – whereby a company suffers a loss due to an event occurring at a customer’s or supplier’s location – especially if supply chain complexities are not fully understood and taken into consideration. Many companies’ supply chains are much more integrated and complicated, resulting in BI losses that impact multiple producers at once. The 2011 Thailand floods and their devastating, unforeseen impacts on the semiconductor industry was the first of a number of significant events that provide an excellent illustration of the impacts of supply chains, BI and CBI over the past decade.

Business interruption ranks as top risk for energy sector as exposures grow

BI, including supply chain disruption, was again voted the most important risk for companies in the Allianz Risk Barometer 2021, which surveyed a record 2,769 respondents from 92 countries and territories in order to identify the most important corporate risks they faced. It was also ranked, by some distance, as the top risk by those who worked in the oil and gas sector, where it accounted for more than half of all responses (see attached graphic). The trend for larger, more complex, BI losses – from major fires and natural catastrophes – continues unabated, with the cost of these claims rising, driven by the trend towards higher values and more concentrated supply chains. Exposures are growing in tandem as more volatile and severe weather brings the increased risk of damage and disruptions from storms, floods and wildfires.

In addition, smaller fires, machinery breakdown and unit shutdown/start-up incidents, and longer lead times for critical parts are also contributing to larger losses than seen in the past due to increasing complexity and rising BI values. Indeed, partial shutdowns of plants/units for relatively short periods of time now have the potential to cause the kind of financial losses previously expected from larger events/longer shut-downs.

Covid-19 could bring future problems

The Covid-19 pandemic created the largest oil and gas demand stress in history, which may well cause future problems as oil and gas companies curtail their spending on upstream operations, such as exploration, drilling and extraction. Producers cut their capital expenditures by a combined 34% in 2020 and will likely make additional cuts through 2021 – perhaps by another 20%, according to industry analyst, the Boston Consulting Group (BCG) (1). While investment has been reduced, however, suppliers have not followed suit. BCG suggests that industry investment will have to rise by about 25% annually over the next three years to avoid a crisis. (2)

One problem in the industry is that today’s refineries and petrochemical plants have enormous throughputs and plants of this size can introduce hazards and BI exposures that far surpass the available insurance policy limits. In recent years, several losses have resulted in claims in excess of $1bn to the insurance market and a significant component of these losses were driven by BI claims.

“Increased BI exposures are being driven by a number of factors. Companies are building larger plants and using bigger equipment with higher throughputs to capture economies of scale. We are seeing significant consolidation of industries and operations as companies strive to remain profitable. Some consolidation activities are predictable like the impact of renewables, green energy and retirement of old, less efficient plants. Other consolidation drivers, like the pandemic and its impact on demand and margins, are very difficult to predict,” says Steffen Halscheidt, Global Practice Group Leader for Oil & Gas at AGCS.

Loss recovery time grows, as do concerns over impact of budgetary pressures

Increased volatility is coming from a range of issues facing the industry. Certainly larger plants are introducing more technology and more complexity, so recovery after a loss can take more time. More integration of world-scale refineries with petrochemical operations creates greater interdependencies. Another problem area is increased incidences of starting, stopping and slowing down production operations due to fluctuations in demand. Simultaneous operations (SIMOPS), such as doing construction work at a plant that is running at full speed, introduces additional complexity – and risks. Although difficult to clearly quantify, budget pressures are leading to reduced expenditures on maintenance and mechanical integrity inspection programs, as well.

“One might also argue that small incidents can more easily morph into large incidents because there has been some degradation of protection features over the years as companies squeeze on design and insurers have less say about how plants are constructed,” says David Robertson, Global Head of Energy Risk Consulting at AGCS. For example, equipment spacing has been reduced in new plant designs, meaning a pump or tank fire could more easily spread to adjacent equipment because of reduced footprints.

“We have seen that new, more risk-based, mechanical integrity inspection programs tend to be less comprehensive,” says Robertson. “Process control technology has increased in complexity and is being used more often than more ‘tried and true’, inherently safer designs or safeguards, due to the drive for cost savings and operational efficiency.

“Fixed fire protection has decreased, in part from greater reliance on technology and partly because of budget pressures. Fire brigade/first responder expectations and funding have also gone down. All of these factors can potentially enable small losses to become large claims, especially with the high BI vertical exposure and limited opportunities to mitigate production losses.”

Consolidation and retrenchment of refinery operations and aging assets

Another area of concern is the consolidation and retrenchment of refinery operations. For example, in Asia-Pacific, reduced operations or shutdowns from reductions in demand and competition from more modern, lower cost and more efficient refineries in India, China and South Korea are driving increased concentrations of exposure. And expansion projects not only increase scale and complexity, but SIMOPS have been identified as contributing factors in a number of large energy losses. While this is going on, plants and equipment are getting older every day.

“How companies manage the aging process of both equipment and workforce is what counts. It is very dependent upon ownership, culture, management and, ultimately, budgets,” says Robertson. “Does management have the right people and processes in place, and are they allocating sufficient money for inspection, testing, maintenance, and equipment replacement? Are retiring employees being replaced by younger, less experienced people or even by machines?”

For companies to truly mitigate increasing BI risks, onsite surveys by qualified risk engineers remain essential. Insurers need to understand both the physical and BI exposures throughout the plant’s value chain in order to support risk management processes and mitigation.

“We are starting to see specialist BI pre-risk reports generated for the market,” says Tom Taberner, Global Product Leader for Energy at AGCS. “Also, we will continue to witness the delicate balance between capacity and volatility. Insurers are increasingly managing capacity deployment against volatility. BI waiting periods, volatility caps, and premium allocations are all in focus.”

[1] Boston Consulting Group, Oil And Gas Investment In the new Risk environment, December 10, 2020
[2] Boston Consulting Group, Oil And Gas Investment In the new Risk environment, December 10, 2020

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