Sector view: Energy

Imagine you have $100 to spend on fresh produce. Now halve it to $50. Would you still expect to buy the same quality and quantity of produce? Or would you accept both quality and quantity are likely to suffer? This battle between quality and price has hit the energy sector hard in the past two years, as crude oil prices dropped from more than $100 a barrel to less than $28 a barrel in early 2016.

As AXA Corporate Solutions’ head of marine cargo and hull, South Asia, Captain Sundeep Khera, explains: “For the past two years, the oil prices have crashed. This has had a huge ripple effect on our business and it also has an effect on the service industry surrounding the oil and gas sector.”

Khera says it isn’t just the value of the oil that has had an influence on insurers’ revenues. The value of the ships drops too, due to supply and demand imbalances. “At the peak of the oil prices, there was a lot of money in and around the shipping industry; a lot of financing tools available. But now many of those options are no longer available and many shipping companies have since gone bust, which has a direct impact on us as marine insurers.

“It is the same scenario as with cargo insurance when it comes to shipping the oil. All the oil which is going into the refineries used to go at $100 a barrel but it’s now going for $50 a barrel. That revenue has halved and it has a direct effect on our revenues as well,” he explains.

“IT’S A DOUBLE WHAMMY. NOT ONLY ARE INSURERS EARNING LESS, BUT THE VALUE OF CLAIMS RISES BECAUSE THE MAINTENANCE IS ALSO SUFFERING.”

AXA Corporate Solutions’ head of marine cargo and hull, South Asia Sundeep Khera

Another consequence of the oil price crash, which has had a direct hit on marine insurers, is maintenance of assets. Oil producers are receiving half as much revenue as they used to for the same amount of work, meaning that maintenance of the ships and rigs is affected. “If you have less money earned, then you’ll probably spend less on the maintenance of these ships. Consequently, the claims on these ships would also rise for insurers. It’s a double whammy, because not only are insurers earning less, but the value of claims rises because the maintenance is also suffering,” says Khera.

Alongside oil producers, shipping companies have been battling tough times, especially the ones that are directly connected to the oil and gas sector, says AXA Corporate Solutions’ head of cargo underwriting, South Asia & Pacific, Luca Ronsisvalle. “That’s a very challenging segment for us in cargo to work currently. We have to be very careful and very selective on which clients we are currently insuring.”

“IF PRICES RISE BACK UP TO $70 OR $80 A BARREL, THEN WE WILL DEFINITELY SEE MORE INVESTMENT IN OFFSHORE ACTIVITIES.”

AXA Corporate Solutions senior energy underwriter Satyendra

Khera says not only is the price of oil having an effect on the maintenance carried out on ships, but it is also having a ripple effect on the quality of staff who work on the ships. “They’re not getting the best in class, because they can’t pay the best wages. The risk of accidents on ships or human errors is rising, because they are not attracting the best and most qualified people.”

This has an effect on the whole industry, he adds, because accidents going up also means insurance claims are rising, which has a knock-on effect for premiums. “We have to be very careful on who we insure, what level of expertise are they hiring, in terms of their manning, and what is the grade of crew they have and the grade of ships they maintain. This has been an issue we have been monitoring for some time,” says Khera.

Ronsisvalle also weighs into the quality-of-crew debate. “We are seeing a spike in the number of claims due to negligence of crew on board this vessel, where they contaminate the product or they make mistakes; and mistakes in this end of the market unfortunately cost millions of dollars.”

OVER THE WORST
Optimism reigns, though, as Khera and Ronsisvalle both believe the industry has weathered the worst of the price storm. “The price of crude oil is on the rise. This is due to various reasons, namely geopolitical tensions, attacks on infrastructure which cause downstream outages but above all, in view of Opec’s firm stand on supply cuts. I believe most of the companies are used to the new price of oil, which is closer to $60 a barrel, so they have adjusted their expectations around that price.”

AXA Corporate Solutions’ national property manager, Damien Leembruggen, says: “From an Australian perspective, there has been a lot of investment in oil and gas, particularly liquefied natural gas (LNG), somewhere around $250bn worth of projects in the past decade. Most of these are now operating or near completion, but the drop in crude oil prices did put some pressure viability of those projects.”

Looking ahead to 2018, insurers are confident the market is improving and has stabilised in the past few months, compared with how it has performed for the past two years. “This is a really healthy sign for the oil and gas industry, not only because it helps so many of our clients when the market is stable, but it will also encourage oil companies – in particular shale gas producers in the US – to spend money on exploration activities, which brings in new business for us as insurers,” says Ronsisvalle.

AXA senior energy underwriter Satyendra Sharma says oil prices’ stabilisation is likely to have a knock-on effect for the oil and gas industry. He expects to see more offshore construction projects and movement of offshore rigs in deeper waters. These rigs have been laid up for an uncomfortably long time, he adds.

Onshore activities have been continuing in a more stable way for a longer period time than offshore, says Sharma. “This was down to local prices and refinery owners who were forced to expand or modify their plans to more high-value products. They have been forced to review their whole refining process so that their efficiency and output increases.”

At the same time, there has been pressure from governments globally for refiners to work towards producing cleaner fuel. Sharma says because of this pressure, downstream energy and offshore oil and gas markets have been continuously active. “Increasing crude prices will be a catalyst to a shift in the market but we still don’t know when this will hit sustainable levels for us. If prices rise back up to $70 or $80 a barrel, then we will definitely see more investment in offshore activities.”

AXA Corporate Solutions’ chief underwriting officer, Asia-Pacific P&C, Guillaume Parard, says concerns about a possible dip in maintenance levels could be a thing of the past if oil prices continue to stabilise.

“There have been some concerns across the market that the drop in barrel price will also mean cutting of maintenance costs. But now, we are more hopeful that maintenance will return to more sustainable levels.”

AXA’s energy and chemicals expert, Raymond Cai, adds: “With healthier margins, the asset value also increases. This means the premium pool is also increasing, which is very helpful from an underwriting point of view. It is also encouraging from a client point of view because they tend to buy more insurance with better coverage.”