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The Culprits of Oil Spill Disasters

It is mid-January 1991; the oil valves and pipelines have discreetly been spilling into the Arabian Gulf. In May that year, an alleged estimate of ten million barrels of oil and over eighty sunken wrecked ships polluted the area.

Until this day, the gulf incident remains to be the worst oil spill in history.

Although many lost fleets reside in the seabed of oceans, the shipping and energy industries pose a daily threat to our blue planet.

 The below statistics and figures summarized from the International Tanker Owners Pollution Federation Limited’s database show the frequency and amount of oil tanker spills over time.

Source: International Tanker Owners Pollution Federation

We can infer from the numbers above, that one incident can leave substantial damages behind, and that the diminished frequency of oil spills demonstrates better vessel management.

The economic distress and damaged ecosystem at the time of such losses occupy breaking news headlines.

However, it is just as important to reflect on the extent of cover that insurance can provide, and the compromised efforts of policyholders in understanding their insurance policy.

The courts of England have played a significant role in the advancement of insurance, cover, policy, and wording. Once claim disputes reach the courts, and are appealed in front of a judge, the final judgements or rulings, which are referred upon as precedent cases, create new statutory requirements. Accordingly, these statues become law and thus affect profoundly insurance requirements. In response, insurance companies create or amend their insurance programs as required.

Unsurprisingly, the development of insurance liability policies (in terms of cover and reasonably foreseen events) lags behind until this very day. Insurance policies remain uncertain, and are only a mere promise to diminish the costs of abrupt oil outbreaks.

The Deep Water Horizon case shows how costly improper contract interpretation and the uncertainty of insurance policies and can be.
The catastrophic British Petroleum (BP) oil spill in 2010, which had leaked 4.2 billion barrels of oil, received substantial consideration for their operating misconduct and compensation fund for victims.

Initial reports estimated the total amount that BP and its drilling contractor Transocean should pay for the ill-fated rig to be around $750 million (as per property casualty newsletter Feb 13, 2015)1. However, industry experts estimated that the ultimate cost could rise up to $50 billion.
To meet liabilities, BP turned to Transocean’s insurance policy (which named BP as co-insured) for compensation for the extensive sub-surface oil pollution. This evolved into a series of court cases; are BP entitled to claim from Transocean’s policy2? Transocean’s insurance policy covered the rig for a $50 million primary layer from Ranger Insurance and an excess layer up to $700 million dollars from Lloyds3 amongst other insurers. However, the final ruling at

the Texas Supreme Court denied BP’s entitlement; the standard contractual risk allocation in the oil and gas industry holds the principal (being BP) legally responsible for any liabilities incurred by their subcontractor (being Transocean) specifically for sub-surface pollution.

Simply put, BP did not exercise enough due diligence in understanding their insurance policy. It is also worth noting that contracting partners should never interdependently rely on each other’s insurance contracts.

As for BP’s own insurance, they are self-insured through their own insurance company Jupiter Ltd (with an underwriting limit of $700 million)4. Evidently, a good percentage of the overall costs of Deepwater’s deadly spill will probably pay out from BP’s net profit over the years. BP had already paid $20.8 million to federal and state governments along with $175 million to investors, and this was just the beginning. Alleged reports on July 2016 have declared that the total cost of Deepwater Horizon is now close to $62 billion5. Such disastrous events could wipe out years of profits and leave alpha firms bankrupt if the cover reflected in the insurance policy does not match.

Insurance contracts and their wordings by nature lead to different interpretations. A single word or change in punctuation can completely alter the reader’s understanding.

In Transocean’s insurance policy, BP is simply named as co-assured with no monetary cap or clear extent of cover. Moreover, some of the conditions of cover may not apply for either BP or Transocean due to international acts or conventions. The insurance policy itself will not refer to exemptions, allocations of responsibility, or define acts.

Another distinguished oil spill case was the accident of marine vessel Exon Valdez. In which Exon hit a reef off Alaska6. The accident leaked 11 million barrels of oil (approximately 20% of the supertanker’s cargo). The Exon incident raised government awareness, and inspired the signing of the Oil Pollution Act (US) in 1990 (which is still the most important act for oil spills)7. This act dictated the responsibilities of the owners of vessels or other facilities relative to oil leakage. This act continuously influences other aspects in insurance policies as well; wherein its impact on business interruption insurance sets an example. In brief, business interruption policies cover the insured for loss of income, of ceased operations, in the event of a disaster.  The Oil pollution act has specifically demanded that there be a connection between damage to property/natural resources and “pure” economic loss.

This is a problem for claimers because it is difficult to establish a direct connection between pollution incurred and the firm’s operations. Debatably, the subsequent economic loss from a spill will be the cost of their liabilities; however, this does not serve as a direct loss and the claim stands refuted.

It is with no doubt that,

the most plausible solution for oil spills from ship-source (ie: travelling vessels and energy offshore vessels) is P&I - in short for Protection and Indemnity.

The P&I’s capacity to cover such enormous claims relies on a shared pool of funds between members. However, government agencies conduct the actual cleanup operations while closely involving the clubs. The limit of cover for clean-up costs and compensation for contamination damage is USD one billion8 any one event; should the costs go higher than this limit, the clubs will liaise with International Oil Pollution Compensation Fund for third party damage only9.
Operational oil and gas facilities have a different insurance solution, whereby “Lloyds” leads the market. QBE is one of the leading insurers, and offers a USD 150 million capacity for oil and gas liability. However, the structure of the policy and pricing have been undergoing changes ever since the BP incident; there has been an increased demand for insurance at double the limits and more stringent regulatory requirements. In response, Lancashire, a lead reinsurer in the energy sector, has raised their levels of premium by 10-30%10.

Lloyds has always been the number one market for oil and gas insurance. However, Lebanon has taken up great interest in creating insurance capacity to cover the forthcoming drilling works in the region. This prevailed in the Annual 31st GAIF conference held in Beirut, Lebanon (in May 2016) whereby discussions of the future of the oil and gas industry for Arab insurers grasped the attention of the international attendants. Mr. Wissam Zahabi, chair of the Lebanese Petroleum Administration, had the liberty of presenting the legal and regulatory structure of the oil sector in Lebanon, which has taken on a promising route for a much more developed track. Engagements were already underway before the GAIF conference, whereby

Mr. Max Zaccar, current president of the Association des Compagnies d’Assurances au Liban (ACAL), has declared that the idea of an insurance pool managed by ACAL members is under discussion with the Lebanese Petroleum Administration

and the Ministry of Energy & Water in an exclusive interview in January 201611. It has been a busy year for the Lebanese Petroleum Administration with several conferences internationally and locally12.

To close, it is just as interesting to compare the average net retention of insurance companies in Lebanon to the $ one billion limit that P&I insurers offer globally.

However, practically Lebanese local insurance companies cover up to $ two million dollars on average under their net retention. As a result, the coverage gap is substantial.

So how will the local insurers contribute to the pool? And to what extent? What capacity will the future pool offer? Where will the funds come from? According to ACAL, in 2015 USD 1.52 billion worth of premium was written across all insurance lines in Lebanon.

A simple comparison shows that this can barely help cover a single oil spill policy of which the minimum adopted insurance limit is USD 1 billion of coverage.

This all leaves us with much anticipation for the challenges to secure coverage and the unfolding accomplishments in 2017.

The presence of oil and gas deposits in the Lebanese territorial waters did not just make headlines; documentation of this has been present for more than fifteen years now.

In 2010, the US Geological survey noted that there are around 1.7 billion barrels of recoverable oil and 122 trillion cubic feet of recoverable gas in the Levant Basin area13.

Until present, there are no wells in Lebanon’s waters. In light of all this excitement, we think how disastrous it would be if we face any oil fiascos that could happen anywhere in the world. However, such occurrences depend on the conduct of the contractor employed and their safety culture. The accomplishments and failures of chief oil contracting firms can serve as Lebanon’s stepping-stone in understanding the insurance requirements of offshore/drilling works.

Insurance goes hand in hand with risk management. This takes us back to the BP case, were Professor Nancy Leveson14, with over 30 years of experience in safety engineering, is on board the Baker Panel investigation of the BP safety culture.

Leveson has highlighted some major shortfalls; if counter actioned, can serve as sound recommendations for future works. It is imperative that the leaders in oil companies provide incentives for updating safety control technology in their firms. To achieve this, the oil offshore industry needs to acknowledge that there is a clear relationship between safety, profits, and future visibility. Leveson also stressed that there are no clear industry standards and that guidelines are weak. The workers on BP’s platform had minimal training, and at present, there are no required certifications for the workers on site.

Many professionals such as Leveson have valuable recommendations for the actual works; nevertheless, insurance companies also contribute to safer operations. The insurer “Travelers” for instance provide their customers with an emergency response plan for different explosion or defect scenarios; however, “Travelers” do not warrant or guarantee accuracy and do not hold themselves responsible15.

In this turmoil, the whole world seems to be more concerned with the continuity of the supply of oil. The US Energy Information Administration (US EIA) has declared that we will have sufficient oil up until 204016. At the same time, BP boldly states “Nobody knows or can know how much oil exists under the earth's surface or how much it will be possible to produce in the future17.” However, pollution-free substitutes are on the rise. Renewable forms of energy such as biofuels and solar energy could be the future. Still,

research and testing to date is modest, and considerable roadblocks lie ahead of us; it would take decades to replace oil.

However, these new forms of energy provide new opportunities for investment, research, and innovative insurance programs. In this light, we can say that the future is not something to be predicted, but something to be achieved.


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