Protecting Our Pipelines

Oil has always been a booming business, but in the past decade that business has turned into a sonic boom in the Canadian marketplace. Alberta’s oil sands, an area roughly the size of the state of New York, now ranks second worldwide – behind only Saudi Arabia – for total proven oil reserves. The province has reserves of about 171-billion barrels, or about 13% of total global reserves. The vast majority of these, about 170-billion barrels, are found in the oil sands in northwest Alberta.

The development of these reserves is relatively new. The first geological survey of the sands occurred in 1875, but the first large-scale oil sands operations at Fort McMurray launched in 1967. It would be more than a decade before the second major project came on board in 1978, also in Fort McMurray. In 2000, production expanded into the remote areas of the oil sands. That’s when things really started to pick up. By 2010, the number of operators in this field had ballooned to 91, according to Alberta’s Department of Energy. And alongside the increasing number of participants came an increase in investment. In 1999, oil sands brought $2.4 billion of investment into Alberta. Ten years later, that figure grew to $13.5 billion. A record $20.7 billion was invested in 2008.In terms of the economic value of the oil sands, the stakes are high. And with high stakes come big risks. Extraction of bitumen in the area poses a huge exposure to environmental liability. The oil sands contribute about 5% of Canada’s greenhouse gas emissions, but they are also Canada’s fastest growing source, according to the Royal Society of Canada (RSC). Add to that the risk of a well blow-out, contamination of an area or a failure of a tailings pond, and the environmental liabilities stack up. In an industry undergoing such rapid growth, many view the technologies designed to aid mounting production requirements and lower the operations’ environmental impact as not only prohibitively expensive, but unproven. Thus, technological solutions to reduce exposure to liability pose a liability risk in and of themselves.

Mining and the extraction of natural resources has always been a contentious issue in the public realm. But recent events in other jurisdictions - the BP Gulf of Mexico oil spill, for example - have drawn the attention (and ire) of the public and garnered negative media attention, posing heightened reputational risk.  

Traditionally, the players in the field have been major, integrated, global oil production companies. But now the area is seeing an increase in smaller players in the market. Sources say keeping pace with the evolution of technology, the costs of production and keeping a lid on liabilities are even more challenging for risk managers of these smaller organizations, which have balance sheets a fraction of the size of their conglomerate counterparts.

As all of these different moving parts churn and twist, external drivers such as heightened regulatory requirements and stringent lender requirements are also driving change in how risk managers manage these risks.

Some of the ‘mega projects’ taking place in the oil sands have physical damage and business interruption  exposures exceeding $10 billion, says Joe Seeger, executive vice president and managing director of Willis Global Energy. “Some of the facilities make in excess of $10 million per day in revenue. If a plant like this were down for two years then it would be more than a $7 billion loss to the company. Right now the insurance market can provide about $1.5 billion in capacity, so the owners really take on a considerable amount of the risk.” he says. “At that point, the operators need to understand the risks really, really well because they’re taking on the bulk of it, even after they’ve taken on all of the insurance they can get.”

As a result, a new form of risk management has emerged in the sector. Organizations are putting competitive differences aside to share research and development discoveries and new technologies, all in the name of finding the right technology with the least amount of impact on the environment. Risk managers are looking further afield to other jurisdictions for indicators of what impending climate change regulations may bring. They’re also getting involved much earlier in the actual development of the projects, instead of waiting until it’s time to sit down with a broker at renewal time.  

The insurance market is also responding, sources say. As the number of operators has increased, so too has the number of insurance carriers. The result is increased competition, increased available capacity and more specialized environmental liability product offerings.

Back to the Way Things Were

When it comes to onshore oil risk, reclamation may be the most uncertain environmental liability exposure. In its report, Environmental and Health Impacts of Canada’s Oil Sands Industry, the Royal Society of Canada noted a clear definition or timeline of what reclaiming lands really means does not yet exist, nor does the cost of such an endeavour.

Alberta’s government requires that all developers restore oil sand mining sites to “at least the equivalent of their previous biological productivity.” This means “the region as a whole forms an ecosystem landscape at least as healthy and productive as that which existed before development,” says information from Alberta’s Energy Department.

In its report, the RSC found that while tailings pond operation and reclamation technologies are emerging, the rate of improvement has not prevented a growing inventory of these ponds. Tailings are the materials left over after the process of separating the valuable fraction from the non-economic portion (gangue) of an ore. To prevent tailings from being released directly into the environment, companies often create ponds at their facilities to dispose of them. Reclamation and management options for wet landscapes derived from tailings ponds have been researched but are not adequately demonstrated. The RSC report says operators are required to post financial security deposits, in the form of secure letters of credit, in case they declare bankruptcy or fall short of completely reclaiming an area, leaving the province - and ultimately the taxpayer - on the hook. But that financial backstop is estimated to fall 40% short of the required costs.

On Mar. 1, 2011, The Globe and Mail reported “leaked information” from the Alberta government indicating the province is about to release new financial security requirements. These would see smaller payments at the outset of production, with the payments increasing over the lifetime of the project. According to the Globe, new rules will force all mining companies to post security on plant sites to the tune of $30 million, or $60 million if the site has an upgrader. Larger operators, specifically Syncrude and Suncor, which have received a bit of a break in the amount they’ve had to post, will see increased requirements, bringing them on par with the other operators, the Globe added.

Kevin Doyle, managing director of Zurich’s Global Energy in Canada, says a general liability policy, or excess layers above that, would only cover pollution on a timed-element basis. “In other words, the pollution would have to occur or happen in a certain period and be reported in a certain period,” he said. “After that, there would generally be no coverage. From an insurance company perspective, we’re looking to provide coverage for a fortuitous event, something that is unintended and unexpected from the standpoint of the insured. So, if you’re into reclamation and clean-up, which you know is there but you have not gotten around to, there may not, in all cases, be a product that insurance companies can provide.”

In response to pressures of government and the public, oil sands operators have put aside competitive di fferences to share their respective ‘secret sauces,’ as it were, related to technologies around reducing environmental liability.

In December 2010, the Canadian Natural Resources, Imperial Oil, Shell Canada, Suncor Energy, Syncrude Canada Ltd, Teck Resources and Total E&P Canada announced they plan to work together to advance tailings pond management.

Each company pledged to share its existing tailings research and technology and to remove barriers from collaborating on future tailings research and development.

Experts agree the announcement was a hallmark step forward in the risk management field for the sector. “As companies put aside confidentiality issues to share research and development and best practices to speed up tail pond reclamation, I think we’re going to see a lot more of that type of collaboration,” said Sylvia Layton, head of Risk Engineering, Energy and Marine, at Zurich North America. “What needs to happen now, those findings from research and development need to be escalated up into an organization’s enterprise risk management framework.”

Environmental Exposures and Policies

As Alberta’s oil producers band together to tackle the reclamation risks, the issue of greenhouse gas emissions seems to be a moving target. The oil sands accounted for 31.4% of Alberta’s greenhouse gas emissions by the industrial sector in 2008. One year earlier, the province passed the Specified Gas Emitters Regulation requiring all facilities emitting more than 100,000 tones of carbon dioxide per year to reduce emissions intensity by 12% from 2003-05 levels. The province’s Climate Change Strategy outlined further reduction goals in 2009. Last year, oil sands operators were to have reduced CO2 emissions per barrel by 45%, Alberta Energy says. More regulation in this area is expected.

“Environmental regulations are going to be changing around the world,” says Layton. “An event can occur in one part of the world that has nothing to do with your local operation, and yet it can change regulations throughout your geographical region and impact you directly. Anything an organization can do to understand its exposures more holistically and to understand the total cost of risk – and, if it decides to retain the risk, anything it can do to be sure it can afford to retain it - is basically what an organization is going to have to do more and more.”

Historically, the biggest insurance spend to cover environmental liabilities in the oil sands has been the sudden and accidental coverage under the CGL policy. Sudden and accidental coverage would respond to an event in which, for example, an explosion or spill caused damage to a third-party property. However, in the oil sands business, the remote geographic location of the industry means this insurance is not necessarily the best fit to cover this kind of risk, since third-party properties are typically not at risk of damage.

David Mew of Marsh Canada’s energy practice makes this exact point. From a liability perspective, most of these locations are very, very remote, he says. “They have very little else around them, aside from muskeg and forests. You can have an incident there and it’s not necessarily going to affect a city like Fort McMurray. From a third-party liability perspective, that risk is quite remote.”

And so if sudden and accidental insurance coverage isn’t a sensible option for transferring a company’s risk, what other options are available?

Kate Dodge, vice president and leader of Aon Reed Stenhouse’s Environmental Practice, says clients in the onshore oil sector are re-evaluating how they manage their environmental risk based on external drivers. These external drivers include:

• changes to the regulatory frame-work (the strictness of remediation standards, for example, in addtion to forthcoming climate change regulation);
• a higher level of director and officer accountability, both in terms of financial reporting and disclosures as well as operational and compliance issues;
• tighter lender requirement; and
• “unprecedented” shifts in contractual liability.

Traditionally, environmental coverage has been narrow in scope, with few carriers and high prices. But Joe Restoule, a consulant with Aegis Insurance Services, points to an increase in the number of carriers in the sector, offering a broader spectrum of environmental liability products and a new capability to layer capacity. Dodge adds the increased availability of dedicated insurance has allowed clients to consider new risk transfer options beyond the often expensive and narrow sudden and accidental coverage.

“And that’s where we look at dedicated environmental liability products,” Dodge says. “These coverages may include fixed site liability policies, environmental impairment liability, pollution legal liability and cleanup cost cap programs.”

Mew notes the uptake on dedicated environmental liability products has been slow, suggesting risk managers are retaining those exposures on their books. He thinks risk managers may be hoping that by investing in new technologies, they will minimize their environmental liabilities and create efficiencies to meet production demands.

Liabilities and New Environmental Technologies

But the use of new or unproven technologies can open a whole new can of liabilities. “Operators who are trying to do well in respect of minimizing pollution liability and emissions through new forms like carbon capture synchronization are really concerned about future liabilities, because it’s new technology,” says Restoule. “What happens if [the new technology] turns out to have long-term negative effects? You’ve invested all of this money into research and development, and into the project, and then you get stuck with a huge liability in the end. Although there is a lot of money being spent on research and development, there is no 100% guarantee that the reward will be greater than the risk they took.”

Derek Robinson, vice president of Aon’s Energy Practice, agrees. As new projects come onstream, insurance companies begin looking at the different emerging technologies as a potential issue. That can sometimes create constraints of available insurance capacity. “As technologies emerge, it requires a greater need or level of understanding and knowledge by the underwriters in order for them to establish a comfort level in underwriting that risk,” Robinson says.  

Jerry McAloon, senior vice president and account manager of Aon’s Energy Practice and Global Large Accounts, believes it’s up to the risk manager to help convey that information to the underwriter or broker. “The risk manager has to understand exactly what the technology is and understand how the underwriter is going to respond to it. A classic tactic brokers use when confronted with a project that underwriters perceive to be a new technology is to make the case that it’s not new technology, it’s a new application of proven technology, if it is in fact a truthful statement. So, you’d better have a good story, and you better be able to communicate it well to [underwriters], because we’re also seeing more and more underwriters with an engineering background.”

Robinson says the key is for risk managers to work with internal engineers and engineers from the brokerage firm to put together a very comprehensive package. Arranging a meeting between the underwriter, broker and the risk manager and the project’s engineering team well in advance gives the underwriter the opportunity to ask any questions then and there. “So later, when a broker sits down to negotiate terms, we’ve already addressed all of those concerns.”

Funding Formula

The same approach should apply when dealing with lenders to fund these projects, McAloon adds. Lenders have always had loan requirements in place. But one consequence of the economic recession has been a tightening of these requirements, placing lenders in the driver’s seat when it comes to influencing the purchasing patterns of risk managers. Adding to the complexity is the increasing involvement of international financiers, who may have requirements with which a Canadian risk manager is not familiar. “There has always been pressure on risk managers to comply with requirements of the loan agreement,” McAloon says. “There have been examples of cases in which the risk managers were not consulted until after the loan agreements were concluded. The risk managers then found themselves trying to comply with requirements that were very difficult, if not impossible - and possibly very expensive - to comply with.”

Also, lenders will likely require risk managers to buy insurance that perhaps hasn’t been purchased in the past. “Smaller companies have smaller balance sheets,” says McAloon. “That means either they or their lenders are going to say: ‘Here’s a risk that we can’t afford to eat, so we’re going to have to transfer it to the market.'” One example of this might be business interruption (referred to as delay in start-up insurance in construction).

A risk manager should want to make a presentation to underwriters on any new and emerging technologies being used in the project. The lender requirements should also be a part of that presentation package, McAloon says. “Have a slide in the presentation that says, ‘This is the type of insurance we’re required to have. I know we haven’t required it in the past, but here’s the reason why we require it now,'” McAloon adds.

Talking ‘Bout My Reputation

In spite of their economic benefits, mining operations have never ranked high in public opinion polls when it comes to their handling of environmental risk. In today’s environment, operators in Alberta’s oil sands are increasingly facing public pressure to mitigate the risk of environmental damage. Seeger points to a 2009 protest in which Greenpeace activists occupied an operation in the tar sands. In another example, following the BP oil spill in the Gulf of Mexico, Corporate Ethics International launched a mass media campaign in the United States called ‘Rethink Alberta.’ In the campaign, Alberta’s oil sands were compared to the BP spill, and tourism to the area was discouraged. The campaign worked. It motivated high-profile Hollywood director James Cameron to take a much-publicized tour of the oil sands “to see for himself.”

Canada West Foundation released a report in July 2010, entitled Blackened Reputation: A Year of Coverage of Alberta’s Oil Sands. Prompted by media reports in 2009 of the death of 1,600 ducks on a Syncrude tailings pond, the report examined media coverage over the course of a year. In the report, researchers found 71% of coverage about the environmental effects of the oil sands were negative. The economic stories, on the other hand, were for the most part positive (61%). Alas for the industry, the environmental stories outnumbered economic stories by a margin of nearly 2-1.

The RSC report examined claims that the Alberta’s oil sands were the world’s “most environmentally destructive project on earth.” The claim is not accurate, the panel decided. “Despite the lack of evidence to support this particular view, it has gained considerable traction with the media and it now pervades the Internet,” the report says. “This depiction is clearly aided by photographs of ugly surface-mine landscapes, but the claims of global supremacy for oil sands environmental impacts do not accord with any credible quantitative evidence of environmental damage.”

“I think the Canadian oil sands used to fly under the radar,” says Seeger. “With the rise in commodity prices, and the need to search the globe for more resources, it’s definitely on the radar screen now.”

Mew suggests this negative public perception could translate into certain U.S. buyers boycotting Alberta’s oil sands’ products. “Only so much of it can be refined and upgraded in Canada, because there is only so much capacity at the refineries to deal with that type of crude. So they may have to find another market for their product, which could mean shipping it out West by pipelining it through the Rockies and then tankering it out to China.”

Layton says recent oil industry losses around the world have tarnished the image of the industry as a whole, highlighting the need for government and industry to keep pace with changing environmental and technological exposures. “In January [2011], the U.S. National Commission released a report that calls for a more formalized, proactive, risk-based performance approach to risk assessment and risk management,” she says. “Regulators will expect industry to look further afield – globally if necessary – to see what their peers are doing with regard to best practices.. That’s very different from the local prescriptive approach that currently exists.”

Seeger suggests some industry leaders are taking steps towards promoting a more positive image by allowing their leadership teams “to take on educational roles and show the benefits of the industry and how they can responsibly go after those barrels [of oil], and have those barrels provide a benefit to society.”

Once an insular marketplace, with only a handful of participants, the oil marketplace has now arguably grown into the largest driving force behind Alberta’s – and to an extent, Canada’s – economy. With this growth come new responsibilities and pressures. Risk managers, as a result, will need to be on their toes and ready for them. “You have a lot of changing parts that are going to be happening in the midterm,” Layton says. “Risk managers are going to have to understand these exposures, understand the operational issues and their impact on strategic goals. As well, they cannot just look at these issues locally, but expand [their focus] globally,” Layton says.