Consolidation. Increased business interruption exposures. Growing regulatory pressures. Continued global competition. These are some of the major challenges facing the energy marketplace and they have an impact on your business. But did you realize that they will also impact your insurance program? Because losses in the industry have increased nearly 200% in the past 10 years, energy insurance leaders plan to get back to the fundamentals of evaluating each individual risk on its own merits. That means your insurer’s risk control engineer will be spending a lot more time at your company.
But do not wait for the risk control engineer to arrive to start reducing your risk exposure. Take the time to review the principal causes of loss in the energy industry and compare them to how you operate. This will help you understand why losses are increasing and if your operations are at risk. It will also spark ideas that will help you avoid the mistakes that others have made. To get your planning started, listed below are some of the key risk and industry pitfalls are listed below.
Even though 2004 has been singled out as an unusually tough year for energy, with major losses from hurricanes in the offshore sector and 14 significant events in onshore operations, losses within the industry have actually been growing significantly for decades. Modern technology, such as computerized process controls, sophisticated alarm systems and better construction materials were supposed to result in safer plants. But that has not happened. Here is why.
Big Profits, Bigger Interruptions
In 2004, crude oil prices spiked well above $50 per barrel compared with typical prices of $20 to $30+ per barrel over the past 20 years. Concurrently, oil refinery margins have increased from $1 or $2 per barrel to levels of $8 or even $10 per barrel and natural gas prices rose along with oil. Lastly, while petrochemical plant margins have not increased as rapidly as those of oil and gas, they have also been trending upward over the last few years. The result: more expensive business interruption losses when an event occurs.
Increased Time Between Shutdowns
Recently, process plant operators have increased the periods between maintenance shutdowns, replacing them with inspections and minor routine maintenance. Refineries that operated in the past with three to four years between shutdowns now average five to six years. On one hand, this approach is beneficial. Plant operators can average out the cost of a turnaround period over a longer period of time and avoid profit loss that occurs during plant maintenance shutdown. However, there is a downside.
Potential problems, many of which can be only found during a regular shutdown, now go undetected. This greatly increases both the chance and the impact of a loss. Because problems have built up, the longer repair-and-replace downtime needed from even a medium-sized incident can now quickly erase the time and profit saved. Additionally, an overlooked side effect of less frequent shutdowns is that they are contagious. In order to remain competitive with the facility that reduces its maintenance schedule, neighboring facilities may try to implement a similar schedule and, to cut costs even more, leave out the inspection and maintenance. It is a cycle that only serves to increase the chance of an undetected problem.
Refineries today are operating well into old age—some even beyond their original design life. Many facilities were built in the 1960s and are now over 40 years old. In fact, the last new refinery in the United States was built in 1976 and no new construction is planned for the near future. This has two major repercussions. The first is that when an old refinery closes today nothing replaces it. As a result, the number of U.S. refineries has decreased roughly 50% since 1980 from more than 300 to 149 at the end of 2003. This dearth of resources means that there are fewer operations available to pick up production when a refinery unexpectedly shuts down—increasing both the frequency and severity of loss.
Secondly, consistent documentation shows that loss frequency increases exponentially once equipment has reached—and surpassed—the end of its design life. Making a bad situation worse, the technology and design in older plants is at a level far different then technology used today in new construction. Thus older plants, rife with failing equipment, are more likely to be congested, lack adequate structure fireproofing, automatic venting or isolation valves. They also tend to keep large inventories in intermediate storage and the construction of their control room is seldom blast-proof. All this means that in an explosion, older plants will suffer much more extensive damage.
Pushing Design Technology
Engineers today can design to a more exact final number, allowing operators to introduce more aggressive technology. However, older plants are not equipped to support the higher temperatures and pressures that increase the efficiency of process plants and their safety factors—the margin between the design criteria and the point of failure—get pushed dangerously close to the edge. Having a large safety factor means a safer design and less chance for failure. But operators constantly must make a choice between the business imperative of reducing cost while maintaining the increased safety demanded by the public. Compounding the problem is that based on today’s codes and standards, plant safety factors are already lower than in the past. Facility operations are starting out with an immediate handicap which, when stretched too far, increases the chance of loss when failure does occur.
Over the last few years, the oil, gas and petrochemical industry has increasingly lost experienced personnel from mergers, restructuring and retirement. Due to cost containment and automation, these people with the institutional knowledge necessary to operate the facilities under all conditions are not being replaced, leaving personnel operating complex facilities who may not have all of the time or training needed to deal with a crisis. Again, this lack of experience increases the potential for loss when normal operation processes fail.
Of course, some of the major causes of loss, like the price of oil and the age of your refinery, are beyond your control. However, there are steps you can take to proactively reduce your risk exposure. And the first step is to understand what the risk control engineers will look for—and why—when they examine your operations. Their consultation and review includes:
Technical review of risk. In order to help calculate insurance premiums, risk control engineers evaluate the following four areas of your operation to determine the risk quality of your facility: 1) Management: review of operations, maintenance, engineering, inspection, fire safety and security; 2) Procedures: examination of work permits, emergency plans, plant modification controls, emergency shutdown testing and engineering standards; 3) Plant: assessment of standards of design and construction, layout, process controls, plant condition and housekeeping; and 4) Protection Hardware: on-site inspection of process units, tankage, utilities, control room, jetty/truck/rail loading and fire fighting equipment.
You should keep in mind that because most losses come from personnel error, insurers give more weight to management and their procedures than to plant and protection hardware.
Assessment of inherent hazard. Risk control engineers will examine your operation to determine the potential for fires and explosions associated with the chemicals involved in the processing cycle. Of the two hazards, the severity of loss from unconfined vapor cloud explosions far outweighs the loss caused by fire as shown by the accidents at Flixborough in 1974, Phillips Pasadena in 1989 and as recently as last year at Santos Moomba in Australia and Sonatrach Skikda in Algeria. The root cause of many vapor cloud incidents is poor controls before, during and after construction or maintenance work, which are sometimes caused by outside contractors. You should pay attention to contractors and their safety procedures because even if they cause the problem, it’s your operation that shuts down and loses money.
Site surveys. Deficiencies in plant maintenance and plant inspection are a principal cause of major industry loss. Because of this, risk control engineers look at all aspects of a plant when conducting their technical review and will give detailed attention to your plant’s equipment and piping, metal thickness measurement and trending, construction materials verification, temporary repairs and machinery vibration analysis. Because risk control engineers understand your corporate culture of risk management and its application at each facility, their comments will help you understand both the potential exposure to time element losses at the facility they visit and the overall impact to the entire company.
Be proactive. By addressing these issues now, you make it easier for the risk control engineers to judge your risk management program operations based on its individual merits—not someone else’s.
Anthony Carroll is chief underwriting officer of global energy for Liberty International Underwriters. Michael Gosselin is the senior vice president of oil & gas
product lines, also for Liberty International Underwriters.