Thursday, June 24, 2010

Who Will Insure Offshore Drilling? Probably Oil Companies

The consequences of the explosion on the Deepwater Horizon, and the fallout from it, aren't only related to BP (NYSE:BP) as the overall offshore drilling industry, will be affected, as a variety of interrelated events which haven't even been brought into the public eye are still out there waiting for their chance to be brought to the light.

At this time there is just too much to digest, and it'll have to be revealed incrementally, or it won't be absorbed or understood.

One of these is the insurance industry, whose rates would either be raised so high by insurance companies as to make it impossible for only the largest of companies to operate in the Gulf, eliminating competition and probably resulting in higher oil prices.

The other option would be for oil companies to insure themselves, which some are already doing.

As Moody's (NYSE:MCO) vice president senior credit officer, James Eck said, “What insurer is going to want to put out $1 billion worth of deepwater insurance and only get paid $5 to $10 million after this? They may as well write a few more hurricane-insurance contracts.”

In the early part of June, the cost of insurance policies covering oil rigs had already surged by 50 percent, and it's thought it'll rise by as much as 100 percent going forward.

Taking into account the entire global market, there isn't a large enough one to be able to insure drillers. At this time the annual premiums insurance companies collectively receive from the industry is $3 billion.

If the cap on liability is raised from $75 million to $10 billion, there is no insurance out their that could or would cover them. And this is just in the United States.

Premiums of course could be raised, but they would be so prohibitive as to make them irrelevant, as they couldn't be afforded to buy, and the insurance companies wouldn't survive if another catastrophic event were to happen.

That's why it's more than likely only several large oil companies could continue to drill in the Gulf by insuring themselves.

The only companies analysts see as being able to self-insure are BP, Exxon Mobil (NYSE:XOM) and Royal Dutch Shell (NYSE:RDS-A).

These three already insure themselves on a partial basis, and BP says it is less expensive in the current circumstance to pay as they go rather than to acquire policies outside of the company.

Self-insurance comes through wholly-owned units within the oil giants.

As you can see, this will cause a domino of events, which would force smaller drillers to leave the region, and an unknown amount of secondary events related to that which won't be known until it happens. From there it'll spread.

And that's just in this one area.

For insurance, there will be less of it for companies in the Gulf, and depending on the decisions on liability caps, it will drive out all but the very largest of oil companies.

Nothing after this will be the same in the Gulf of Mexico, and even in that regard regulations and responses around the world could change the industry even more.

How much all of this will be passed on to consumers in the form of higher prices is a ways off, but there is something that tells me we're not going to like it.

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