Potential softening in 2012 for ‘stable but fragile’ energy market reports Willis

According to Willis’ Energy Market Review, the energy market remains ‘stable but fragile’ having escaped relatively unscathed from 2011’s record natural catastrophe losses, but suffering its worst ever year in terms of non-windstorm-related losses. With an absence of catastrophic losses last year, theoretical underwriting capacity for energy risk is at an all time high, up 10% across the upstream and downstream markets, according to Willis figures. Despite this average, rates for buyers have been flat at best, bucking the natural trend of supply and demand. Willis admit that this discrepancy is hard to explain but argue that both macro and micro economic factors are, in part, the cause.hideWhile the insurance industry as a whole suffered catastrophe losses of $105bn in 2011, according to Munich Re figures, the energy market suffered losses totalling just over $1bn. This compares to an energy market loss of some $18bn in 2005, the previous record year for nat cat losses. The energy market, however, posted record combined insured and uninsured non-windstorm-related losses of nearly $9bn last year, said Willis. Losses in the upstream sector were dominated by events at two Floating Production and Storage Offshore (FPSO) facilities and two further significant losses in Nigeria. At a briefing on its latest review, Robin Somerville, Global Communications Director at Willis Global Energy, explained that the loss pattern in the upstream sector was dominated by a high number of incidents costing between $100m and $200m. “This is particularly relevant as many upstream insurers’ reinsurance programmes tend to respond in excess of the $100m mark, which suggests that several of these losses have had to be absorbed directly with little or no recovery from reinsurance programmes,” he said. Losses from the Elgin platform, which leaked back in March, could still be ‘very large’ but the potential for an Armageddon style total loss seems to have been averted, he continued. Canadian Natural Resources’ Horizon oil sands upgrader loss and the Japanese Tohoku earthquake and tsunami dominated the 2011 downstream energy loss record. At $710m, the Canadian incident produced the largest loss in terms of physical damage and ‘very significant’ business interruption losses of $600m. The Japanese catastrophe resulted in three losses of over $150m. “Given the deductible discipline the market has maintained over the last ten years it may be that a significant proportion of these losses have been avoided by the market,” explained Mr Somerville. Despite these losses capacity continues to grow for energy risks. Upstream levels are now nearing the $5bn mark and the downstream total, at least in the international market, continues to increase year on year, Willis figures show. “In practical terms we can now say that for the most attractive business requiring the maximum capacity programme, limits of something like $4bn for operating business and $3.6bn for offshore construction business are now achievable at a realistic price,” said Mr Somerville. There is now as much officially stated capacity in the downstream international arena as there was at the height of the ‘great soft market’ of 1997 to 2001, he added. However, the reinsurance market capacity to protect this portfolio is nowhere near as robust and competitively priced as it was 12 years ago, Willis pointed out. There is a growing differential between capacity in the North America and international markets. The main reason for this is the growth of regional insurance markets in key areas such as the Middle East, Eastern Europe, the Asia Pacific and Latin America, Willis explained. Neither the upstream or downstream markets saw any meaningful withdrawal of capacity in 2011. Despite this seemingly rosy picture the correlation between capacity and rates in the energy market has weakened markedly in recent years, with a significant increase in overall capacity failing to lead to a further decline in rates. Modest rating increases were the norm on upstream business at recent renewals, while the downstream market remains effectively flat, albeit with average rates at their lowest ebb for a number of years, said Willis. The broker made clear that underwriters are deploying this capital selectively and showing greater differentiation in favour of the most attractive business. Insurance buyers must follow best practice and be fully prepared, and able, to show they are on top of their risks to get the best deals. “Conditions in the energy insurance market are stable but fragile. Capacity is at a record level but insurers are deploying it selectively due to past claims volatility,” said Alistair Rivers, Chief Executive Officer, Willis Global Energy. “Insurers are differentiating even further between the risks they truly value and those they don’t due to the recent losses or lack of underwriting information. It is vital that buyers provide as much information as possible and differentiate their risk profiles to secure optimum terms and conditions from underwriters. “The offshore market direction remains in the balance as insurers wait for the full picture to emerge on the Elgin platform situation. However, if Elgin is resolved satisfactorily, there is ample opportunity for those buyers that can continue to differentiate themselves from their peer group to obtain much more preferential terms,” he continued. Presenting the market review, Mr Somerville gave further encouragement to buyers. “If we are being optimistic from a buyer’s standpoint there is the possibility of softer market conditions later in 2012. If current loss record improves, the situation at Elgin resolves itself and we have another loss free year in the Gulf of Mexico we can see insurers needing to provide a return on the capital they are deploying and competing more aggressively for business,” he said. Based on a charted comparison of stated market capacity versus average rating levels Willis believes the overall upstream market cycle is more restricted post 9/11. Even if the market were to soften again later this year, the new market floor is likely to be much higher than before the attacks on the twin towers, the broker argues. The downstream market has also shown a weakening of the correlation between capacity and rates. “If anything the market is differentiating even further between those risks that it truly values and those that have either been more impacted by recent losses, or which do not offer an attractive risk profile or sufficient underwriting information to generate their interest,” said Mr Somerville. The anomaly of increased capacity not leading to decreased rates is not easily explained, the broker admitted. But it did offer some conclusions. “Although there is more stated capital it has been deployed more selectively and, as we have said often before, this is an intelligent market that understands the risk it pursues. Also capacity remains very much in the hands of the same select group of leaders as during the last five years or so. This is enough in itself to restrict competitive pressures,” explained Willis. The broker also pointed out that much of the increased capacity, especially in the downstream sector, is from regional markets that have the ability to write business on a global basis but rarely do so. And loss records are sufficiently alarming to offset, for now, the effects of increased capacity, it added.

Potential softening in 2012 for ‘stable but fragile’ energy market reports Willis

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