The Future of Risk: Energy

Firms entering into decommissioning need to closely consider operational and environmental requirements set out by the state, with significant variation depending on the territory. The North Sea, Australia and the Gulf of Mexico are perhaps the most mature markets, with decommissioning plans required by governments a relative formality. In less developed markets however, there is scope for more onerous demands. And in a number of jurisdictions, NGO pressure is a significant concern – with some lobbying for complete removal from the seabed, even when it may be more beneficial for the environment to leave particular infrastructure in situ.

A significant component of more mature regulatory regimes is the requirement that energy firms retain adequate funds on their books to cover decommissioning costs. With companies facing potentially significant future liabilities linked to decommissioning, they need to evidence there is sufficient security set aside to cover these costs. This tends to take the form of a guarantee or a capital allocation, which limits liquidity. Insurance options are available to reduce the impact of these capital constraints on financial performance and firms are increasingly turning to the insurance market to limit their financial obligations.

When considering future risk, firms must contend with political decisions that can affect their obligations when it comes to decommissioning redundant offshore assets. Decommissioning can be complex and costly, and financial projections are based on what the regulatory environment dictates at the time. If the political landscape changes, this could alter exposures and consequential cost significantly. A changing regulatory environment could also mean an increased financial obligation and a need to obtain more security.

If there is a deep and prolonged fall in oil prices due to COVID-19, this could negatively affect the economic value of assets and bring decommissioning activity - and cost - forward. Energy firms have already reduced activity, with some shutting down offshore assets, to avoid financial challenges. If assets are no longer profitable, decommissioning could be brought forward from 10 years to 5, or even sooner. The question is whether the industry can move at the speed required to meet the evolving obligations. When there is very little discretionary money on the budget, the onus will be on decommissioning specialists to provide commercially innovative solutions.

Firms are generally proactive in meeting the long and short-term challenges decommissioning poses. In terms of the impact on balance sheets, firms can’t avoid their financial obligations, but there may be scope to reduce it by collaborating closely with the relevant authorities and local jurisdictions. They should also utilise financial instruments to provide security and team-up with an experienced broker to maximise risk transfer opportunities.

There are insurance products for removal of wreck, physical damage, third party liability, and plug and abandonment (P&A) in the conventional energy market. There are also insurance solutions for off balance sheet surety provisions that can provide a way to meet those demands and these vary significantly dependant on jurisdiction, operator and timing.

There is also a huge amount of innovation currently underway to add value. The decommissioning market is relatively young, and - there is scope for considerable evolution in how things are currently done. P&A and decommissioning cost overruns are areas where Aon sees considerable opportunity for product innovation, which would help reduce the contingency placed in decommissioning budgets and free-up balance sheet capital.

The impact of COVID-19 is likely to be significant. Conditions may force firms to curtail their investments, resulting in the decommissioning of certain assets being brought forward.

Innovation in risk transfer will predominantly be focused on products like cost overrun, which would help to reduce balance sheet costs and increase liquidity during a particularly challenging period for the industry.

Emerging markets regulation linked to decommissioning will become more aligned with developed markets – with increased standardisation, consistent regulation and greater cost certainty for firms.

There will be significant technological advancements, including decommissioning hubs, more vessels capable of handling assets, and more competition as the decommissioning needs of the sector grow over the coming decade.

There is the potential for significant cost reductions relating to cement alternatives for P&A, which will help to deliver long-lasting seal solutions.

Decommissioning will be firmly part of the installation’s lifecycle - with all assets having clear plans for decommissioning from the offset – aiding long-term budgeting and projections.