UK: Macondo One Year On - Rules, Indemnities And Insurance

Last Updated: 27 June 2011
Article by Humphrey Douglas, Maurice Kenton and Wei Wu

Reactions to last year's Gulf of Mexico oil disaster continue to redefine regulatory, commercial, insurance and other arrangements in the shallow and deep water oil and gas industry, internationally.

Renewed attention was placed on the perceived inadequacy of international legislation in preventing or dealing with the effects of large-scale hydrocarbon disasters, with national regulators seeking to find local solutions and federal regulators seeking to impose in some instances, even extra territorial regulation of operations. In turn, operators, partners and the supply chain of contractors continue to better understand and negotiate the scope and scale of risks they are exposed to, with tertiary industries (including the insurance industry) reacting to regulatory and commercial attempts to reallocate risk.

Internationalisation of debate

Whilst the relevant arbitration provision in the Macondo joint operating agreement (JoA) may mean that certain disputes amongst joint venturers are held in private, the fact that the US Department of Justice is pursuing relevant parties in public (commencing February 2012), combined with the threat of visceral reputational damage, means that the world's regulators are perhaps more compelled to publicise their views and implement change promptly. The relative speed at which international regulators have moved, BP's recent published settlement with Mitsui and earlier fund contributions, are perhaps symptomatic and acknowledge negative perceptions of delayed settlements, given, for example, the 20 years or so over which the Exxon Valdez litigation took place.

Precedent for creeping US legislation

The fact that seemingly inadequate international legislation focused on oil spill, health and safety and environmental pollution from oil tankers (crossing national boundaries), rather than on static rigs, is something the US recognised following the Exxon Valdez sinking in 1989. The subsequent Oil Pollution Act 1990 (OPA) outlawed single-hulled tankers in the US and caused European regulators (concerned that outlawed single hulls would migrate from US to EU routes) to accelerate their planned phasing out of single-hulled tankers in European waters. Whilst rigs (even floating ones) are perhaps unlikely to migrate around the world in response to changing standards, there is clearly a precedent for greater US regulation to migrate abroad, and indeed maintaining, and being seen to maintain, best practice, remains in evidence over the past year. US amendment proposals following Macondo, including removal of the OPA $75 million liability limit, inclusion of non-pecuniary losses in the Death on the High Seas Act and Jones Act continue to be watched with interest in the US and internationally.

More immediate regulatory impact

In addition to the US drilling moratorium, the US National Commission's recommendations include goal-based regulation, building upon the implemented split of regulatory and HSE functions, further guidance under the existing system of notices to lessees or "NTLs" (in relation to spill response and containment resources for example), together with the new workplace and drilling safety rules.

Whilst the UK resisted EU calls for deep water drilling moratoria, by asserting that it is generally shallow water, post-Piper Alpha, goal-setting, duty-holder, and split regulatory regime was essentially "fit for purpose", Green Peace's recent judicial review of the Department of Energy and Climate Change's (DECC) grant of a deep water licence in November 2010, continues to focus coverage, despite recent North Sea tax rises stealing the limelight more recently still.

Whilst DECC and the Health and Safety Executive have issued additional guidance under the existing regulatory framework, Oil and Gas UK (the UK's oil and gas industry body) (OGUK) via its Oil Spill Response Advisory Group, rightly resisted some of the recent House of Commons Select Committee's (Select Committee) proposals (eg, prescribing two blind shear rams in blowout preventers) as being overly prescriptive, and which would perhaps fly in the face of the UK's goal-based (rather than box-ticking) scheme of regulation (eg, overreliance on two blind shear rams may in fact be insufficient).

However, OGUK, who modelled that not all UK spill (eg, deep water) damage may be covered by the recently increased Offshore Pollution Liability Association coverage limit of $250 million, are expected to take forward the Select Committee's insufficient cover allegation, by working towards industry guidance for additional insurance or other forms of: "financial responsibility". Indeed DECC issued a letter to operators in December 2010 now requiring confirmation of: "sufficient finance or insurance/indemnity provision" to cover the drilling of relief wells.

EU response

The European Commission's enthusiastic response, engagement and consultation documents have included proposals ranging from federal regulation of the oil and gas industry to even global regulation of EU-headquartered oil and gas companies. Whilst "respectful" resistance has characterised the response from UK quarters and certain other producing nations, the seemingly significant volume of management resources now devoted to EU initiatives post-Macondo, makes amendment to at least existing directives (such as the Habitats Directive) seem increasingly likely, eventually, even if EU consensus for root and branch regulation at an EU level remains more speculative.

Evolving contractual relationships

In the UK, potentially unlimited joint and several liability owed under licences, is typically contractually reallocated by co-venturers under a JoA, on a several basis to the extent of parties' respective equity interests.

An operator is usually appointed on a "no gain, no loss" basis whereby the operator should neither make additional profit nor take additional risk for acting as operator. The operator is typically not liable to other co-venturers except for: (i) "wilful misconduct"; and (ii) failure to place insurance. "Wilful misconduct" typically being defined as "an intentional or reckless disregard by senior managerial personnel of good oilfield practice", is difficult to prove.

The "no gain, no loss" principle has however come under renewed pressure following Macondo with the potential imposition of not only heavy civil liabilities, but also criminal liabilities under health and safety and environmental regulations. As criminal liability cannot be indemnified against (amongst other things for reasons of public policy), the burden will remain with operators.

Further, as BP has learned from its dealings with Anadarko and Mitsui (its co-venturers on the Macondo well), when potential liabilities are so large, contractual remedies are an imperfect risk transfer mechanism. By the end of May 2011, BP had recovered none of Anadarko's share and had settled Mitsui's share for less than 50 per cent of the sum claimed. Licensees facing unlimited liability to governments and third parties and that are unable to secure effective recourse against their co-venturers, may wish to insure the risk of their co-venturers' default.

We are also starting to see reallocation of certain risks under JoAs and beyond, more time spent negotiating indemnities and liabilities (particularly in relation to negligence and nuisance claims), and we expect that there will be even fewer instances of commercial arrangements being left undocumented.

Non-operators unable to negotiate effective limits on liability for blowouts and pollution, may also seek increased rights of oversight, albeit mindful of the liability implications of greater involvement with operations.

Such negotiations are also having a knock-on impact down the supply chain. Whilst operators traditionally indemnified drillers for blowouts and pollution, some, especially smaller North Sea entrants, may now argue the risk is unaffordable. Drillers conversely will argue that their need for indemnities has never been greater, with each well potentially being a "bet the company" event.

Implications for insurance

The insurance market has hardened with, for example, well control insurance costing more and with wider exclusions. That being said, with more effective blowout preventers (BOP) and other initiatives following Macondo, there is an argument to say that factually, such wells should now become less risky. Nevertheless, enhanced appreciation of the magnitude of the risks may enhance demand for higher limits and acceptance of higher premiums on renewal and possibly greater acceptance of functioning BOP warranty requirements.

In addition, contractual reallocation of liabilities both between co-venturers and between operators and contractors will present challenges when disclosing and assessing the insurable risks faced by individual industry participants.

Capacity for upstream insurance, however, remains robust with even a slight increase in 2011. Further, there are opportunities for insurance products to meet the demands of new challenges and new application to roles historically performed by other financial products. DECC and others recently put down a marker for the insurability of relief well provisioning but insurance or alternative risk transfer products could (with a fair regulatory wind) perhaps also find a role as alternative decommissioning security and expand into the roles historically performed by letters of credit and on demand guarantees in the North Sea and elsewhere. These are interesting times for the insurance industry and its potential role has never been greater.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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