Where oil & gas contractors are left unprotected

Oil and Gas Production
The oil and gas industry presents a complex contractual “landscape” for all participating businesses, with long supply chains and, crucially from an insurance perspective, huge variations in the allocation of risk in relation to matters such as injury, property damage, pollution and financial loss.

Achieving a “standard” industry agreement has to date been an impossible task due to the sheer number of moving parts and companies involved in the process.  

Variables such as appetite for risk, differing regional practices, evolving legal developments, and straightforward corporate “jousting”,  as well as corporate “bullying” with large companies forcing terms on smaller players, seem insurmountable, leaving much of the industry without a clear view on who is responsible in the event that something goes wrong. 

“The well operator will have “operational” insurances that include cover for major infrastructure, revenue and costs, pollution, and other liability risks,” says Euan McKenzie, Account Executive - Risk Solutions, Aberdeen.

“For many the assumption has always been that for issues such as hydrocarbon pollution and damage to subsea pipelines and infrastructure, the operator buys insurance and that all contractors of every tier benefit from it, but the reality is that this was never a certainty and is less so now than ever,” McKenzie notes. 

Many subcontractors won’t see the original main contract the operator has signed, so even where the operator has agreed to accept responsibility for these major risks, the indemnity structure may have altered significantly as it “journeys” through the tiers, with either silence prevailing over these key issues, or the addition of obstacles blocking the benefit of any “master” policy or indemnity. 

The problem has existed in the sector for some time but has been exacerbated in recent years by catalyst events such as the Deepwater Horizon oil platform accident in the Gulf of Mexico in 2010, where arguments over blame have further tested the concepts of the traditional “Hold Harmless” or “Knock for Knock”, which establish that each party accepts responsibility for certain losses that may arise regardless of fault or responsibility on the part of the other. Likewise, the 2015 economic downturn made companies look for ways to reduce risk by pushing liabilities down the supply chain.

“In most cases, subcontractors have no protection at all in areas such as hydrocarbon pollution and damage to subsea pipelines and infrastructure because all of the standard insurance policies contain an absolute exclusion of these risks,” McKenzie explains.

In most cases, subcontractors have no protection at all in areas such as hydrocarbon pollution and damage to subsea pipelines and infrastructure because all of the standard insurance policies contain an absolute exclusion of these risks.

“As such, businesses providing products or services directly connected with exploration, production and decommissioning face huge and potentially devastating risks, particularly where there is no visible contractual protection, which is increasingly the case within the sector," he notes.    

The original CRINE (or LOGIC) “Mutual Hold Harmless” agreement required the operator to provide “ground up” protection for the supply chain as a whole against the “major risks” such as damage to the well, reservoir and associated infrastructure, hydrocarbon pollution, and any associated financial losses, such as loss of production, all of which was to be backed up by a robust energy insurance programme. 

However, this "ideal" arrangement is voluntary, restricted to the North Sea and always open to variation, or legal challenge by oil majors in the event of a major loss. Contracts often offer little if any overt protection for sub-contractors or, where they do, can impose “capped” levels of responsibility (which can run into seven figures), in areas where businesses have neither the financial ability, nor insurance cover necessary to bear such levels of risk.  

Additional issues can arise that further increase the uncertainty or lack of visibility of the exposure to risk for contractors:

  • Despite initiatives such as the Industry Mutual Hold Harmless (IMHH) agreement, a contractor may have no contractual relationship with third parties including “other contractors” on site, who may pose significant risks of loss/damage. 
  • There can be a high degree of “overlapping” of multiple contracts with different parties and varying levels of responsibility, both active and completed (indemnities often survive completion of the works indefinitely), which makes the relationships convoluted.  

The liability insurance available to the majority of the supply chain (even under specialist oil & gas policies) has always included these fundamental exclusions, based on a mistaken belief in the "industry standard," reinsurance restrictions and an aversion on the part of insurers to accept this levels of risk for relatively low level of premium.

With levels of uncertainty increasing, the insurance market has so far failed to respond to the realities of the risks that their policyholders face, McKenzie notes, but there are however, emerging solutions that can address some of these contractual liability issues in the energy sector.

For further information please contact:

Euan McKenzie
Account Executive - Risk Solutions, Aberdeen
Tel: +44 (0)1224 957802
E-mail: euan.mckenzie@uk.lockton.com

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