The devastation hurricanes Katrina and Rita caused to Gulf of Mexico energy operations is well documented. Losses to the offshore oil and gas industry from Katrina alone are estimated at about $5 billion. This includes Oil Insurance Ltd. (OIL), commercial insurance market, and assured retention losses. In contrast, energy insurers took in about $800 million in premiums on Gulf risks in all of 2005. The hurricane losses represent a watershed event for the energy industry-and for carriers that insure and reinsure energy risks. As companies seek to renew insurance coverage for exploration and production risks, they are finding an insurance market transformed, with the treatment of Gulf windstorm risk akin to that of earthquake risk in major exposed areas. Along with the magnitude of the losses themselves, three major forces are driving this new perception. First is the reality that more harsh weather is ahead. Since 1995, there has been a marked increase in the number and intensity of North Atlantic hurricanes. Climate experts point to that year as the onset of a period of heightened hurricane activity that is expected to last decades. Indeed, in 2004 and 2005, eight U.S. landfalling hurricanes caused insured losses to Gulf oil and gas assets. Second, current design and mooring standards for mobile offshore drilling units (MODUs) were not set with this high storm frequency and severity cycle in mind. MODU standards in the Gulf at the time of Katrina and Rita were primarily intended to support safe evacuation of personnel, not to withstand major windstorms. Hence, when Katrina's Category 5-force winds blew through, MODU moorings in its path struggled to remain in place. Some didn't have a chance. Many were not equipped to withstand even a strong Category 2 storm. In addition, the last multi-decadal period of high hurricane activity occurred during the latter half of the 20th century and ended at the beginning of the 1970s. This was before large fleets of drilling rigs and multi-million-dollar deepwater installations became common in the Gulf. At that time, values were a fraction of what they are today. Third, not only were insurers hit hard by the recent storms but reinsurers were as well. Consequently, while reinsurance capacity for E&P risks used to be virtually unlimited, with essentially no strings attached, insurers now confront a hardened reinsurance market. Sub-limits on windstorm risk are standard on reinsurance contracts, similar to those used for earthquake risk in exposed areas. Restrictions on limits from natural perils have become common on reinsurance contracts. Insurers are managing catastrophe accumulations more intensely than ever. Hence, while Gulf E&P operators once found insurance capacity plentiful, they must now compete with their peers for quality capacity-capacity from experienced, financially stable underwriters- and this is in more limited supply. Insurance prices are rising. Contract limits, terms and conditions are constricting. Coverage enhancements are being curbed. The tightening of coverage for "making wells safe" is an example. Exclusions or limitations are cropping up in new areas, such as OIL drop-downs. With these drop-downs no longer available, assureds are expected to retain more risk. The commercial market will no longer lower its attachment point if OIL limits are exhausted. Other coverages, such as business interruption, are now only available on new, more restrictive industry forms. Ninety-day business-interruption waiting periods, for example, are commonplace. Coverages, such as contingent business interruption, are not generally offered. When they are, prices are often not attractive to purchasers. Risk-management reality Many companies with Gulf of Mexico operations are responding to the new post-Katrina reality by stepping up catastrophe risk management, and investing heavily in managing windstorm exposure-and creating new industry best practices in the process. Among the tactics being deployed are mechanical upgrades and the decisive avoidance of seasonal hurricane risk. Risk avoidance. Among the wisest strategies is to simply "get out of Dodge" when windstorms are coming. Moving jack-up rigs out of the Gulf during the hurricane season can dramatically mitigate a company's exposure-and will no doubt win points from a company's insurance underwriters. Mechanical upgrades. The recent catastrophes underscored the need to protect property as well as people against the elements. They have driven companies to undertake substantial mechanical changes to MODUs, bringing them up to a standard that can withstand a Category 4 or 5 storm. One drilling contractor is upgrading its semisubmersibles in this manner. Its goal is to increase the number of moorings and create mooring lines strong enough to weather a Category 5 storm. The company is not only enhancing its existing mooring systems but also adding new, higher-strength systems designed to withstand greater than a 1-in-100-year hurricane. The company has completed dynamic analysis on the design to ensure that applicable American Petroleum Institute (API) safety standards are met. It has also tested the new structure using a model that simulates wind speeds of 157.5 miles per hour, which is equivalent to a Category 5 storm. Of course, this is no cheap or quick fix, but rather a major investment in long-term risk management. The company estimates that it will cost about $20 million to fix and retrofit its semisubmersibles, with 60 days of lost productivity at $200,000 per day. This company is among the lucky ones. The equipment it needs is on order and shipyard space is booked so that changes can be made quickly. Other contractors will find that backlogs on supplies and shipyard space have quickly grown to 18 months and beyond in Katrina's aftermath. Platforms pose the greatest risk-management quandary. One company that had 12 older platforms in Main Pass lease blocks in the Mississippi Delta lost the full dozen. Newer facilities suffered as well. According to the Minerals Management Service (MMS), nearly one-fifth of the 113 platforms known to be destroyed by Katrina and Rita were less than 10 years old-and built to new, higher standards. This fact has led MMS to sponsor a research initiative to help improve industry standards for platform structures and deck height. Insurance renewals So how is an energy company to approach insurance renewals? Knowing that the ability to manage Gulf exposure will be under the microscope, provide as much information as possible to differentiate a risk and give underwriters the highest level of comfort possible in deploying capacity to the risk. Start early. Underwriters will be looking for large amounts of detail on E&P exposures. Values submitted must be thorough, up-to-date and accurate. Underwriters will require plenty of time to consider a risk and will likely be zeroing in on three areas: • The company's investment in catastrophe risk management. This includes both strategies to avoid the risk where possible and to undertake mechanical changes to mitigate risk. • The company's risk profile. This should be illustrated in detail. Include the latest information on asset location, age, design, function and depth as well as the number of producing and drilling wells. Information and analysis from available modeling tools should be submitted as well. • The company's willingness to share the risk. Expect to assume higher retentions going forward. Energy companies can benefit from looking to their insurer for help in managing catastrophe risk. This approach can help the insurer-insured relationship to thrive through open communication, sharing information and sharing risk. It is a challenging time for energy operations and insurers. On the bright side, the major investments E&P companies presently make to manage catastrophic windstorm risk may pay off for many years to come. Moreover, the energy insurance industry overall remains robust. There are experienced energy insurers out there that are committed to riding out these catastrophic storms with their insureds, who are also committed to improving the risk. When the wind starts blowing in the future, a strong business relationship with one of these insurers could turn out to be a great asset. Mel Causer, CPCU, is senior vice president, exploration and production, for Zurich Global Energy in the Houston office.

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