Oil Industry Woes Lead to Massive Changes in the Insurance Industry
July 21, 2021
A recent ruling by a federal judge dictates that oil companies must contribute to the roughly $7.2 billion in cleanup costs of decommissioning oil wells in the Gulf of Mexico. The ruling marks a significant turn in the bankruptcy case of Fieldwood Energy LLC, who are seeking to pass the buck on cleanup costs to prior owners of the oil wells. The implications of this ruling are massive, not just for oil producers, but for insurance companies as well. In this week’s blog article, we break down how the Fieldwood Energy LLC bankruptcy case impacts the insurance industry, and provide insurance agents with an overview of oil and gas bonds.
A Shift in Liability
A decades long problem in the oil industry is a lack of clear guidelines establishing who qualifies as the responsible party for retiring oil wells. So much so, that there are countless orphaned oil wells left unplugged because there is no definitive legal standard for establishing cleanup responsibility. Compounding the problem is the growing trend of smaller, over-leveraged drillers buying up aging wells for pennies on the dollar, depleting the waning oil supply, and then filing for bankruptcy when oil demand drops. But who ends up paying for the cleanup costs? In the end, it is most often the American taxpayer. Enter Fieldwood Energy LLC bankruptcy case. The case is so significant because it sets the precedent that previous well owners, and the insurance companies who issued them bonds, are also on the hook for cleanup costs.
Here’s how it happened: Big oil companies such as Exxon and BP, in an attempt to reduce their carbon emissions, sold off older assets in the Gulf of Mexico to smaller oil companies seeking to extract any remaining oil and turn a profit. Oftentimes these smaller oil companies do not have the capital to cover cleanup costs, and if a once in a generation worldwide economic depression occurs like it did in 2020, these smaller oil companies can’t continue to operate. Naturally, these companies file for bankruptcy to consolidate and offload their debts. However, in the case of Fieldwood Energy LLC, a federal judge has ruled that the previous well owners and their insurers are on the hook for cleanup costs. Why is this the case? Well, unlike on-shore wells, the Department of Interior can hold previous well owners liable for cleanup costs for all off-shore wells. The argument is basically as follows; You knowingly sold assets to a company who would be unable to cover all cleanup costs, therefore when that company fails you are required to reassume liability.
What Does This Mean for the Insurance Industry?
Simply put, insuring offshore oil producers just became far riskier. Insurance companies are not only liable for the time in which their customers own and operate oil wells, but also for when new companies assume ownership of the wells. Additionally, the Fleetwood Energy bankruptcy case sets the precedent that oil companies can simply transfer their profitble assets to newly formed entities, sheilding them from being used as collateral to pay for cleanup costs. Liberty Mutual, Hanover, and Travelers all filed objections to Fieldwood Energy LLC’s bankruptcy plan, arguing that they will be forced to bear the brunt of the cleanup costs for companies they never insured. Companies seeking to engage in offshore drilling are required to purchase a surety bond prior to conducting business. If surety companies vacate the market, which many have already threatened to do, then obtaining an oil and gas bond for offshore drilling could become extremely difficult, if not impossible, for oil companies.
What are Oil and Gas Bonds?
Oil and gas bonds are surety bonds that oil companies must purchase when applying for a drilling license or permit. Oil and gas bonds ensure that oil companies will follow all drilling regulations, and provide a financial guarantee that the oil company will perform the following actions:
- Comply with all relevant regulations when drilling, deepening, or re-drilling wells
- Properly dispose of all waste/pollutants
- Maintain the well and promptly conduct any necessary repairs
- Plug all retired wells and return the land to its original state
For example, if an oil company failed to adequately clean up a well and return the surrounding landscape to its original condition, then an oil and gas bond provides the funds needed to cover the cleanup costs. Oil and gas bonds provide the public with an efficient means of recovering the costs of returning land used for drilling to its original state. In the event of a bankruptcy or insolvency, it would be nearly impossible to hold companies responsible for ensuring the drilling site is returned to its previous condition without oil and gas bonds.
Oil and gas bonds are similar to reclamation bonds, which also ensure that companies who alter the environment (typically with mining activity) will return the land to its original state. That said, oil and gas bonds are specific to the oil and gas industry and cover additional liabilities, such as well maintenance, not present in reclamation bond requirements.
Unlike most insurance products, oil and gas bonds protect a third party (the general public) for acts that are violations of the law. When the surety company suffers a loss due to the oil company’s failure to properly maintain and clean up a well, the oil company must indemnify the surety company for any losses and sometimes court costs and other fees.
To learn more about oil and gas bonds, make sure to review our comprehensive guide located here.
Bearing the Brunt of the Costs
Insurance companies argue that the Fleetwood Energy LLC bankruptcy case sets a dangerous precedent. Oil companies, the insurance companies argue, can now simply file for bankruptcy after draining oil wells and transfer their profitable assets over to newly formed companies, leaving insurance companies responsible for the cleanup costs with no means of recuperating their losses.
Leaving the Market
It is entirely possible insurance companies such as Travelers, Liberty Mutual, and Hanover will honor their threat of abandoning the oil and gas market due to the precedent set in the Fleetwood Energy LLC bankruptcy case. After all, why would insurance companies voluntarily issue bonds with a high likelihood of claims and slim chances of recovering losses. This could lead to disaster for the oil industry, as surety bonds have historically acted as a prerequisite to starting drilling operations.
What does this mean for onshore drilling? Well, it sets the legal precedent that oil companies can file for bankruptcy if their investments sour and then simply transfer their profitable assets to new entites to shield themselves from being forced to sell said assets to pay for cleanup costs. Insurance companies are aware of this new precedent, and will likely impose far stringent underwriting requirements for onshore drilling oil and gas bonds. That being said, it is unlikely that insurance companies will be on the hook for cleanup costs for companies they didn’t insure for onshore wells, because unlike off-shore wells, the Department of Interior can’t hold previous well owners liable for cleanup costs on onshore wells.
It is still too early to tell what the full effects of the Fleetwood Energy LLC bankruptcy case will be for the insurance industry. What we do know is that obtaining an oil and gas bond will become much more difficult, with insurance companies who do choose to remain in the market likely to implement much more stringent underwriting requirements. Don’t be surprised if insurers start requiring oil and gas bonds for offshore wells to be fully collateralized prior to issuance, which would likely cause many smaller oil and gas companies to go out of business.
How Can an Insurance Agent Obtain an Oil and Gas Bond?
BondExchange makes obtaining an Oil and Gas bond easy. Simply login to your account and use our keyword search to find the “oil” bond in our database. Don’t have a login? Enroll now and let us help you satisfy your customers’ needs. Our friendly underwriting staff is available by phone (800) 438-1162, email or chat from 7:30 AM to 7:00 PM EST to assist you.
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