$1 Billion Absolute Liability in Oil & Gas

$1 Billion Absolute Liabilityin Oil & Gas: What does it mean for insurers?

September 2015    |    By Indrani Nadarajah

On February 26, 2015, the Energy Safety and Security Act (formerly Bill C-22) was granted royal assent. This far-reaching act, which comes into force in February 2016, affects Canada’s offshore oil and gas operations. The Act also enacted the Nuclear Liability and Compensation Act, and repealed the Nuclear Liability Act.

Of particular interest to the insurance industry is that the new legislation raises the absolute liability for companies operating in the Atlantic offshore from $30 million to $1 billion and in the Arctic from $40 million to $1 billion. Liability for fault will remain unlimited. It also progressively raises the liability for nuclear plant operators from the current $75 million to $1 billion.

The Energy and Safety Security Act is also supported by the Federal Pipeline Safety Act, which was granted royal assent on June 18, 2015 and will come into force 12 months after that date. The Pipeline Safety Act includes amendments to the National Energy Board Act and the Canada Oil and Gas Operations Act. The new sections of the National Energy Board Act reinforce the polluter pays principle. This liability is joint and several, which means that the harmed parties can fully recover from any party who is at fault.

Hefty new penalties for contraventions to environmental laws have also been introduced. The fines, which can be levied by the National Energy Board, Canadian Nuclear Safety Commission and Canada’s offshore boards, range from $25,000 to a maximum of $100,000 per day.

Absolute liability

Canadian pipelining has a long history, dating back to 1853, when a 25-kilometre cast-iron pipe moved natural gas to Trois-Rivières, QC, to light the streets. Today, there is an estimated 825,000 kilometres of pipelines in Canada, and most provinces have significant pipeline infrastructure. The oil and gas sector is a vital component on Canada’s economy. It directly employs approximately 190,000 people and generated almost 7.5% of Canada’s GDP in 2013.

As far as pipelines are concerned, absolute liability means an operator is liable for any cleanup costs and compensation from an oil spill, up to $1 billion, regardless of whether it is at fault. Companies would now also be required to maintain a cleanup cash reserve of at least $100 million to ensure they have the financial resources to respond to incidents and remedy damage without delay.

Current operators of major pipelines in Canada will be able to meet the financial test, government officials have said. The $1 billion threshold could consist of cash on hand, bonds, lines of credit, liability insurance and other financial assets, including third-party guarantees.

Pipelines in Canada are regulated based on jurisdiction. The National Energy Board regulates pipelines that cross inter-provincial or international boundaries. This includes 73,000 kilometres of inter-provincial and international pipelines within Canada. It oversees 101 pipeline companies in total.

Companies that construct and operate pipelines will also be required to maintain financial resources necessary to pay the amount of their without-fault liability exposure. However, pipeline companies may be allowed to participate in a “pooled fund” to cover their exposure. The limitations period for claims against pipeline companies has also been extended from two years to three years after damages are suffered. There is an ultimate six-year limitation period from the date of a release for a claim to be commenced, regardless of when the damages are suffered.

Pipeline accidents increasing

Not everyone is impressed with the new limits. The Canadian Environmental Law Association says that $1 billion absolute liability is too low. Critics point to the fact that Norway and Greenland have instituted unlimited absolute liability on their pipelines.

The 73,000 kilometers of oil and natural gas pipelines regulated by the National Energy Board transport about $103 billion of hydrocarbons each year. However, pipeline infrastructure is ageing with a significant portion of oil and gas infrastructure fast approaching its functional end of life. Approximately 30% of the pipelines in Alberta are greater than 25 years old, while 5% are greater than 50 years old.

The number of pipeline safety incidents is on the rise in Canada and, of all the provinces and territories, British Columbia had the highest number of reported in the past decade, according to a report by CBC News.

National Energy Board data showed that 279 incidents involving federally-regulated pipelines were reported in B.C. between 2000 and late 2012. The data also suggests that, nationwide, the rate of overall incidents has doubled in the past decade.

By 2011, safety-related incidents, which covered everything from accidental fires to spills, rose from one to two for every 1,000 kilometres of federally-regulated pipeline. That reflects an increase from 45 total incidents in 2000 to 142 in 201, the CBC noted.

The incidents include small leaks, large oil spills, gas ruptures, equipment failures, worker injuries and deaths. The dataset does not include incidents along smaller pipelines monitored by provinces, CBC said.

$1 Billion not enough, say some

Some commentators have also claimed that the new regulations seemed very closely timed to the cabinet decision on the Northern Gateway pipeline, and is an attempt to boost B.C. support for the pipeline, said Nathan Lemphers, former senior policy analyst at the Pembina Institute. The 1,200-kilometre line would transport Alberta's oil sands bitumen across B.C. to Kitimat for export to Asia. The pipeline was approved on June 17, 2014, with 209 conditions.

An outspoken critic on the insufficient liability levied on pipeline companies, former Insurance Corp of B.C. chief executive Robyn Allan, says Canadian and especially B.C. taxpayers aren’t adequately protected if Enbridge’s proposed Northern Gateway pipeline suffers the same kind of catastrophic failure that resulted in a US$1.2 billion cleanup cost after an Enbridge oil spill in Michigan in 2010. The rupture along its Line 6B pipeline poured around 843,000 of bitumen from Alberta's oil sands into the Kalamazoo River over 17 hours, and is the largest onland oil spill in U.S. history.

On top of the $1.2 billion mopping-up bill, this year, Enbridge Energy settled with Michigan over the inland oil spill. The company will restore or create more than 300 acres of wetlands, as well as fund a dam removal and improve access to boating and fishing on the Kalamazoo River.

Oil price fallout

Regardless of the critical voices, oil companies are not turning the same kind of profits they were 18 months ago. Indeed, the new legislation comes into force in an environment of severe industry cost cutting and oil prices that are 50% lower than the peak over a year ago as the Organization of Petroleum Exporting Countries has been pumping well above its 30 million barrels of oil a day quota for over a year now.

In fact, oil is expected to hover around the US$50 mark for the foreseeable future, writes Goldman Sachs. This could have a major impact on development of Canada’s oilsands, which make up 90% of the country’s oil reserves. “Oilsands producers need US$100 a barrel oil to build a new mining project, US$60 oil to build a new Steam Assisted Gravity Drainage project and US$40 to expand an existing SAGD project.”

Oil and gas companies are slashing budgets, including risk management budgets. Willis reports that there are anecdotal accounts of a handful of the largest buyers of upstream insurance now cutting back their programs and electing to buy significantly reduced programs. Lower oil prices are also reducing the opportunities for insurers to expect premium income growth, as losses in this sector are the lowest for a decade, Willis writes in its April 2015 edition of the Natural Resources Market Review.

Insurance implications

The onus on underwriters is to be more stringent in assessing risk. As Stephen Stewart, managing director and chief agent for Ironshore Insurance Ltd.'s Canada branch says, "The proposed absolute liability requirement will mean that underwriters will have to be even more diligent than they already are in assessing the risk management practices, mitigation plans, processes and corporate culture around pipeline integrity, control and leak detection and overall operational excellence of pipeline operators."

Stewart was quoted in a September 2014 Canadian Underwriter article on absolute liability.

Kevin Doyle, head of energy for Canada, Zurich Global Corporate in North America, who was quoted in the same article, said: "Many pipeline operators already have the insurance limits, financial strength and specific reserve funds dedicated to respond to a major incident that would adequately cover the $1 billion in financial capacity required by the legislation.

“However, some operators, if subject to the legislation, may have to up their game from a risk management perspective for underwriters to feel comfortable putting up the significant third-party liability limits that would be required to help meet the proposed legislative financial requirement," Doyle warned.

The ability to manage risk depends strongly on companies detecting oil leaks quickly, something that is not always achieved, despite the significant technological advances in this area. As B.C.’s Allen points out, it took Enbridge 17 hours to react to the Michigan oil spill. In Alberta, Nexen admitted that one of its pipelines there could have been seeping oil for two weeks in June/July this year, before it was spotted by a contractor who was not looking for a leak. About 16,000 square metres were affected.

It is not all doom and gloom for oil companies as far as purchasing cover is concerned. The insurance market is awash with capacity as soft interest rates, uncertain stock markets and stagnating economies continue to take their toll on investment returns. Willis calculated that the total “theoretical capacity” in the upstream oil and gas market at the beginning of this year was US$7 billion. Not surprising, market conditions continue to be soft.

Large oil and gas companies with significant operational risks sometimes establish captives to contain costs.

BP’s Gulf of Mexico oil spill, which began on April 20, 2010, turned the spotlight on captive insurers in the oil and gas industries. BP operates a profitable captive, Jupiter Insurance, which insures the company's international oil and gas assets from a base in Guernsey, the offshore UK tax haven. The company could claim $700 million (its maximum payout for any one event) for the oil spill.

Nexen established a captive in 2001, which is domiciled in Barbados. The captive absorbs a large portion of deductible claims. In the past, this has included claims relating to equipment losses, including assets damaged by hurricanes. Nexen has also dramatically increased its deductibles over the last 10 years, up to 400%, the company said.
Currently, the claims that are still handled by commercial insurers are business interruption, property, well control and pollution insurance.

Nuclear liability

The Energy Safety and Security Act also enacted the Nuclear Liability and Compensation Act.

Canada’s nuclear industry generates well over $5 billion in electricity annually and accounts for approximately $1 billion a year in uranium exports. According to the World Nuclear Association, about 15% of Canada's electricity comes from nuclear power, with 19 reactors mostly in Ontario. According to the Canadian Energy Research Institute, Canada’s nuclear reactors contribute C$6.6 billion per year to GDP, create C$1.5 billion in government revenue and generate some $1.2 billion in exports. The nuclear power industry employs 21,000 directly, 10,000 indirectly as contractors.

There have been eight nuclear incidents in Canada, with the first in 1952, and the most recent, in 2002. However, no claim has ever been filed under the Nuclear Liability Act.

Operators must now have adequate operating and insurance coverage to meet the new limits as liability coverage will progressively increase from $650 million (in the first year after the Act comes into force), to $1 billion, in year 3.

The limitation period has also been raised from 10 years to 30 years. The new Bill integrates the current nuclear liability regime with the Atomic Energy Agency’s Convention on Supplementary Compensation For Nuclear Damage, which Canada signed in December 2013.

The Act is the government’s sixth attempt to bolster Canada’s forty year old regime of civil liability for nuclear incidents. The current regime, which was adopted in 1976, is outdated, especially with respect to the $75 million liability cap. In fact, the $1 billion liability limit has been proposed since the 1990s. Others have noted that the liability cap is also inadequate, pointing out that the US has an approximate US$12.6 billion liability.

Nuclear operators can also cover up to 50% of their liability by satisfactory financial security other than traditional insurance.

Nuclear insurance pools

According to the World Nuclear Association website, Western-designed nuclear installations are a sought-after business for insurers because of their high engineering and risk management standards. Apart from Three Mile Island, the claim experience has been very good. Chernobyl was not insured. Experts say that Chernobyl’s design would not have been an acceptable risk at the time as the plant did not have a containment structure, so that incident had no impact on premium rates for Western plants.

The structure of insurance of nuclear installations operates differently. Insurance (direct damage and third party civil liability insurance) is placed with . These are set up by the nuclear industry itself.

The national nuclear insurance pool approach was particularly developed in the UK in 1956 to harness insurance capacity.. Other national pools that followed were modeled on the UK pool – now known as Nuclear Risk Insurers Limited, and based in London.

In 1958, 67 Canadian insurers committed C$13.5 million in capacity to the Canadian nuclear insurance pool (Nuclear Insurance Association of Canada, or NIAC) to cover property and liability for nuclear risks.

Today, 19 Canadian insurers and reinsurers are members of NIAC. The main reason for NIAC's decreased capacity over the years is due to consolidation in Canadian property and casualty insurance industry.

NIAC provides 92% of the current C$75 million, third-party liability insurance limit the Nuclear Liability Act requires. However, when the new limit of C$650 million becomes effective, NIAC's percentage share will drop to 10% (foreign capacity provided through the British and United States nuclear pools is used to supplement the Canadian capacity, as required). The NIAC also announced in June that international nuclear pools will now have access to Canada’s own domestic pool through a cooperative agreement arranged by the UK’s Nuclear Risk Insurers (NRI). The arrangement grants access to other insurance pools overseas “to increase capacity in order to meet Bill C-22’s $650 million and rising liability limit for nuclear operators.”

Safeguarding Canada's Seas and Skies Act (formerly Bill C-3)

Part 4 of the Safeguarding Canada's Seas and Skies Act, which was granted Royal Assent on December 9, 2014, implements the provisions of the International Convention on Liability and Compensation for Damage in Connection with the Carriage of Hazardous and Noxious Substances by Sea, also known as the HNS Convention.

The HNS Convention provides a regime of liability and compensation for pollution damage from ships, including:

  • damages caused by hazardous and noxious substances carried by the vessels,
  • risks of fire and explosion, including loss of life or personal injury;
  • loss of or damage to property outside the ship;
  • economic losses resulting from contamination (e.g. losses in fishing and tourism);
  • loss or contamination of the environment;
  • the costs of preventive measures (e.g. clean-up) and further loss or damage caused by them;
  • costs of reasonable measures of reinstatement of the environment.

The changes to the Marine Liability Act would fill a gap in the currently liability regime for ships and to ensure that Canadians and the environment are protected from the risks of transporting hazardous and noxious substances, Transport Minister Lisa Raitt said.

The current regime does not require ship owners to carry insurance for their liability in relation to a spill of hazardous or noxious substances. Should damages exceed the shipowner’s insurance coverage, the convention would provide access to an international fund that would pay compensation for pollution damage caused by such spills. The cap is set at $400 million. The international fund, once established, would be paid into by cargo owners.

Marine insurance: Abundant capital, stagnant rates

The premium volume for marine insurance in 2014 was US$32.6 billion, reports the International Union of Marine Insurance, but the association notes that the trend towards increasingly costly marine losses is continuing, beginning with the Costa Concordia sinking in 2012, which has so far cost the insurance industry US$2 billion.
The insured losses from a series of explosions at a chemical warehouse in Tianjin on August 12 this year could exceed US$1.5 billion for the Chinese insurance industry. According to IUMI, the Tianjin incident could be the largest cargo claim ever.

The sector could be affected by the economic slowdown in emerging economies and China, the fragile Eurozone recovery, as well as cost containment measures by off shore oil companies. However, IUMI noted that the marine market still has abundant capital which will translate into further pressure on rates, affecting premium growth and company profits.

In a September 2014 presentation, Isabelle Therrien, Vice President of the Canadian Board of Marine Underwriters, noted that hull has been running at a technical loss for 18 years. Cargo was not much better – even though the upswing in trade was continuing, cargo premium was stagnant. Referring to hull, she emphasized, “All risk aspects must be considered.

ADVANTAGE Monthly trends papers

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The CIP Society represents more than 18,000 graduates of the Insurance Institute’s Fellowship (FCIP) and Chartered Insurance Professional (CIP) programs. As the professionals’ division of the Insurance Institute of Canada, the Society’s mission is to advance the education, experience, ethics and excellence of our members. The Society provides a number of programs that promote the CIP and FCIP designations, continuous professional development, professional ethics, mentoring, national leaderships awards, and research on the issues impacting the p&c insurance industry in Canada.