Oil and Gas

Oil firms' answer to global calamity: Insurance

The crisis in Ukraine has provided a reminder of an an old story: The world is a dangerous and unstable place—and some of the most volatile places on earth are oil-producing areas where oil companies are compelled to drill.

That stark backdrop means oil companies must insure against any number of adverse developments, all while prospecting for black gold in countries like Venezuela, Iraq and Nigeria. In a world where risks are mounting, threats are increasingly less conventional.

An ExxonMobil oil rig. BlackRock, the world's largest money manager, has recently cited its standing as one of the energy giant's biggest investors as it faces ESG pushback from Republican states including Texas.
Source: ExxonMobil

"While there's a lot going on in the U.S., the new exploration is all occurring in the most challenging countries and most high-hazard environments out there," said Chris Beck, president of Clements Worldwide, an insurance company that sells coverage to global energy companies.

"The reality of a lot of those countries is there a tremendous amount of economic instability and inequality," Beck said in an interview. Russia will continue to "re-establish its dominance in the region, and that will have a destabilizing impact on other countries" in Eastern Europe and central Asia, he said.

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While political uncertainty has been the order of the day in oil-producing countries, Beck said calamity can come from anywhere. Scenarios can include anything from a tanker hijacked off the coast of Africa, to a pipeline explosion in the perennially unstable Middle East, or even cyber terrorism.

Despite soaring domestic production that has sent U.S. oil reserves to their highest level in nearly 40 years, the U.S. is far from immune from instability abroad. International demand means major oil companies must explore in unsavory places.

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A recent report by Securing America's Future Energy and Roubini Global Economics underscores how vulnerable the U.S. is to supply disruptions abroad. The survey noted that rising domestic production has helped the world's largest economy become more secure, "but heavy oil use leaves the economy vulnerable to high and volatile oil prices."

The report added that outages in Iran, Iraq, Nigeria and Libya have driven global spare capacity down to 1.7 million barrels per day – a level that gives "a very limited amount of flexibility in the event of further outages."

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Beck echoed those findings, saying that domestic production alone was not enough to insulate big oil producers from unstable markets.

"It's not just the U.S.'s energy needs…it's the global need," Beck said. "Irrespective of relative energy needs in the US, there will be a significant ramp-up in other places. That requires [U.S. oil companies] to be in these hazardous environments."

That can cost a pretty penny. Beck said oil and gas companies can pay tens of millions for premiums to insure against a host of disasters, with prices determined by several factors. In hotspots like Libya and Iraq, pipeline security is a big issue, as are ransom and kidnappings, to name a few.

"It's not just about pricing, it's about risk management," Beck said, adding that Clements' strategy is to "develop processes and procedures to prevent there being a loss, as opposed to simply reimbursing them after a loss."

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The ability of oil companies to hedge against global risk is complex because the nature of those threats is diffuse and unpredictable. Beck, however, said they have one element in common.

"The roots of instability are all economic," he said. "It's that level of economic instability and insecurity that we have to pay close attention to now as we look at pricing of political violence coverage, and policies to protect operations in that developing part of the world."

--By CNBC's Javier E. David