The Intelligent Quarterly from the publishers of The Insurance Insider

Spring 2012

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With oil from the Deepwater Horizon rig escaping at a rate of some 5,000 barrels a day as IQ went to press, it is hardly surprising that the disaster has continued to dominate international media headlines.

Depending on the flow rate - and some industry observers have criticised BP's estimate as too conservative - this could go down as the worst environmental disaster ever in US territory, surpassing the amount of oil released into Alaska's Prince William Sound by the Exxon Valdez tragedy in 1989.

For the energy markets, though, the explosion and blow-out in many ways came at the best time possible - in the run up to the official start of the US hurricane season on 1 June, with several key renewal discussions underway.

Indeed, the timing has proved to be particularly galling for many oil companies with operations in the Gulf of Mexico (GoM) that would ordinarily have expected to have completed their renewal by the time the accident occurred on 22 April.

This year, faced with a soft market and in the understandable expectation that windstorm rates would only continue to come down, many companies opted to temporarily extend their cover and sought to negotiate their annual renewal a month later than normal.

Given the swathe of comments coming from the offshore market about a hardening in rates in the aftermath of Deepwater, this decision is now costing companies dear.

Yet one should not get carried away by the prospect of rate hardening for the energy market. Of course an upturn in rates is welcome, but any additional premium achieved this year is almost certain to be paltry given the scale of the disaster, whose cost to the (re)insurance industry appears to be creeping up as each day goes by. And remember that total GoM premium income last year was only $1bn.

So there are the property claims, which have been relatively easy to quantify. Drilling contractor Transocean's physical damage insurance programme, led by O'Farrell Syndicate 1036 at Lloyd's, provided overall cover of $945mn, including sub-limits for sue and labour and control of wreck.

Yet it is the casualty side of claims that looks likely to be horrific. Transocean had purchased liability cover in the market of $950mn excess of $50mn. Ordinarily it would be sitting relatively comfortably, according to energy market experts, as the standard position under industry drilling contracts is that pollution from the leaking well is the responsibility of the operating group unless the drilling contractor is found to have been grossly negligent.

But this is no standard disaster, as the scale of the environmental tragedy set to hit the GoM has turned into a real political hot potato for the Democrats.

The feeling on the ground is that the Obama administration will be out to prove negligence in as many nooks and crannies as it can.

And that include Click to enlarge s the sub contractors with Halliburton, which cemented the rig wall, and Cameron, the manufacturer of the blowout preventer, both touted as targets for recrimination.

In a curious way the industry should at least be thankful for BP, which could yet rue its decision not to purchase cover in the commercial market and instead rely on its $700mn per event limit captive Jupiter.

Again, in normal circumstances even BP's liability position would have been reasonably quantifiable, as the US Oil Pollution Act effectively limits the liability of responsible parties for an oil slick to only $75mn for the cost of removal.

Yet once again the legal landscape is shifting, with the Obama administration working on legislation to lift and extend the current cap to a possible limit of $10bn. Will it be retrospective? All bets are off where Deepwater is concerned.

The most serious consequence in the long term, however, looks likely to be the impact it has on future GoM drilling operations.

Prior to the disaster President Obama had lifted the long-standing moratorium on drilling in parts of the eastern GoM - an area believed to contain as much as 3.5bn barrels of oil and 17 trillion cubic feet of gas.

The offshore energy (re)insurance market had been eyeing this prospect with relish - now it will have to curb its enthusiasm.