April 20, 2020

Insurance can mitigate the rising risks of decommissioning

The introduction of new standardised contract wordings goes a long way towards providing the clarity required by underwriters in evaluating the risks of decommissioning oil fields.

Global spend on decommissioning is reportedly estimated by Wood Mackenzie to be USD85bn[1] during the next decade.  Decommissioning on this scale will undoubtedly give rise to multi-million dollar losses, often with no means of recouping these losses following the end of a field's producing life.  The current slump in the oil price will further increase the need for operators to keep their decommissioning costs to an absolute minimum, passing on any unforeseen costs to insurers wherever possible. 

Anyone underwriting the risks associated with a decommissioning project needs to understand the typical risk allocation between the operator and contractors. The introduction in 2019 of a standard form BIMCO contract (DISMANTLECON) followed the 2018 LOGIC conditions. These standardised contract wordings, which are likely to form the basis for most decommissioning contracts, go a long way towards providing the essential clarity required by underwriters in evaluating risk.

Why the push for standardised contract wordings now?

Whilst offshore decommissioning has been happening for decades, it has been ad hoc and its scale is now being ramped up.  Oil & Gas UK estimated in its 2019 Decommissioning Insight report[2] that, in the UK North Sea alone (representing one third of global expenditure), there will be around 12 platforms removed per year and 150 wells abandoned per year over the next decade.  Approximately twice as many wells are now being abandoned each year and this ratio is only likely to increase following the decreased demand and surplus in supply during 2020 so far, which will lead to an inevitable decrease in capital expenditure.

Although insurers often underwrite construction risks without seeing the underlying contracts for the project, decommissioning is different for several reasons.  Firstly, the contractual regime for offshore construction is relatively well settled and underwriters are familiar with the usual contractual arrangements.  Secondly, offshore CAR policies (usually written on WELCAR 2001 wording) tend to cover all parties to the construction venture.  To a large extent, therefore, the allocation of risk between the parties does not really matter. 

In contrast, the lack of uniformity in decommissioning project insurance, where operators and contractors may be separately insured, means that the allocation of risk between those parties is important for assessing exposures.

Understanding DISMANTLECON

The specialist marine contract wording publisher, BIMCO, describes DISMANTLECON as "the first global standard contract designed for the dismantling and removal of offshore structures in the energy sector".  The contract is intended to be used for a wide variety of structures (pipelines, topsides etc.) but not for the plugging & abandonment (P&A) of wells, nor for the onshore disposal aspect of decommissioning where responsibility remains with the operator. 

The wording covers some key areas, most notably liabilities and indemnities. Here, the clauses reflect a standard offshore knock-for-knock arrangement, where the contractor is responsible for: its own property and personnel; third party damage or injury caused by contractor negligence; and pollution caused by contractor property or equipment. The operator is responsible for its equivalent liabilities and its own property and personnel, including the facility which is being decommissioned and any other operator property at the decommissioning site.

Debris and wreck removal is another key element of the wording which specifies that the contractor is responsible for removal of wreck/debris costs arising out of its negligence in carrying out the decommissioning operation up to an agreed limit (USD250,000 is the default), above which the operator will be responsible.  This aspect of DISMANTLECON is important because the removal of debris can lead to significant decommissioning project cost overruns, particularly given that the aim is to remove all trace of offshore assets from the seabed.  Dispensation to leave any dropped items on the seabed is therefore unlikely to be granted. 

In terms of choice of law and jurisdiction, the dispute resolution provisions default to the sophisticated legal systems of English, US or Singaporean law and specify an arbitration forum rather than court. 

DISMANTLECON also specifies the agreed insurance requirements. The operator is required to be named as a co-insured on the contractor's insurance policies and vice versa.  This requirement envisages that there may not be an all-encompassing "Decommissioning All Risks" (“DAR”) policy in place, as there is no standard version of such cover currently available in the market.  Perhaps as a result of this, DISMANTLECON specifies the types of cover which must be taken out. Specifically, it requires that a contractor must procure hull & machinery cover for the vessels, protection & indemnity cover with a minimum limit of USD10m and general third-party liability cover with the same limit. An operator must procure third party liability cover with a USD10m limit and pollution liability cover with a minimum limit of USD100m. 

These requirements reflect the view that decommissioning is predominantly a liability exposure.  They do not include a requirement to take out cover that would respond to losses caused by a delay to the project, or an increase in the cost of the project as a result of a removal operation going wrong and an alternative engineering solution being required.

What are the differences under LOGIC?

The LOGIC conditions for decommissioning, published in 2018 for use in the UK North Sea, has key terms which are broadly similar to those of DISMANTLECON but the LOGIC contract goes further in terms of insurance requirements by requiring the operator to obtain DAR insurance or providing the contractor with an indemnity in lieu.

Given the predicted scale of decommissioning projects over the next decade, and the risks and costs incurred in undertaking this work, insurance will no doubt play an increasingly important role for operators and contractors. For underwriters exploring insurance solutions to offer to their clients for this wave of complex decommissioning risks, the clarity provided by DISMANTLECON and LOGIC are very welcome and should help to bring some standardisation to the contract terms for future decommissioning projects.

[1] Referenced in https://oilandgasuk.co.uk/wp-content/uploads/2019/11/OGUK-Decommissioning-Insight-2019.pdf

[2] Oil & Gas UK Decommissioning Insight report[2] https://oilandgasuk.co.uk/wp-content/uploads/2019/11/OGUK-Decommissioning-Insight-2019.pdf

This article was first published in Insurance Day.