CATASTROPHIC EVENT MODELING—2: Industry exposure and value at risk to storms in the Gulf of Mexico

Dec. 10, 2007
Offshore energy insurers have traditionally been defined by their willingness to take risk without relying on technical analysis to model or quantify their exposure.

Offshore energy insurers have traditionally been defined by their willingness to take risk without relying on technical analysis to model or quantify their exposure.

The 2005 hurricane season in the Gulf of Mexico changed this perspective, and underwriters are now attempting to control their exposure to contingent losses through policy sublimits, exclusionary wording, and other restrictions on coverage.

In the second part of this two-part article, we quantify the losses to property damage in the gulf for historic weather events using the patented RMS Offshore Platform Model.1

Value at Risk measures indicate that the financial exposure of platform and rig assets in the gulf is on the order of $60-70 billion. Probabilistic scenarios from storm simulations indicate a 100-year loss estimated at $5.7 billion and a 250-year loss estimated at $7.5 billion for physical damage to platforms and rigs not including business interruption and operator extra expense losses.

Catastrophic modeling

The purpose of catastrophe modeling is to anticipate the likelihood and severity of potential future events so that companies can prepare for their financial impact.

Physical damage, business interruption, and contingent business interruption losses depend on both subjective and objective inputs related to natural and man-made conditions. Probabilistic modeling allows the frequency and severity of potential hurricane losses to be quantified so that rational pricing and risk decisions can be made.

Design codes

Hurricanes have played a significant role in the design evolution of offshore structures, since the most significant learning and subsequent changes to standards has come from the performance of facilities during hurricanes.2

In the early years of offshore development, structural integrity was largely the responsibility of the designers, who worked to a variety of standards drawn from coastal and onshore engineering experience. Structural engineers followed deterministic construction practices and dealt with uncertainty not by quantifying it but by incorporating explicit factors of safety in design procedures.3-6

Safety factors/design margins were used to account for unknowns known to exist, as well as those that are unknown, including construction loads and stresses, changes in loading assumptions, and uncertainties in environmental loads.7

Probabilistic methods in design and analysis began to be applied in the late 1960s.

The American Petroleum Institute’s (API) Subcommittee 2, Offshore Structures, is responsible for recommended practice and specifications that govern the design, construction, and installation of offshore platforms.

The subcommittee unofficially began after Hurricane Hilda in 1964, and by 1969 the first API Recommended Practice 2A (API RP 2A) was issued.8 In 1980, in the 9th edition of API RP 2A, environmental parameters and minimum deck height requirements for a 100-year storm, were defined.

In 1992, Hurricane Andrew triggered a need to review and upgrade design guidelines. Data from post-Andrew performance evaluations and insights from the Minerals Management Service (MMS) offshore inspection program prompted updates in the 20th edition of API RP 2A, including major revisions to the methodology of calculating design loads using the 100-year wind and wave criteria. The 21st edition of the API RP 2A uses consequence based design.9

The MMS will generally accept the risk of losing a structure where there is no threat to life or the environment. Owners may be willing to accept the risk on less important structures such as caissons and well protectors, but monetary considerations usually dictate increased capacity for structures with a high production rate, facilities that serve as a transportation or processing hub, and deepwater structures.

From an economic perspective, for a given probability of an extreme weather event, the investment required to avoid damage must exceed some fraction of the cost to repair the damage plus the expected business interruption cost. Trade-offs thus exist that attempt to balance the potential costs of damage and disruption due to a catastrophic weather event against the benefits of a more robust but expensive design.

Rig and structure inventory

The inventory of rig and structure assets in the GOM is constantly in flux, but for our purposes, we fix the time frame and assume the assets exhibit pseudosteady state behavior, balanced roughly between structure removal and installation, and rig entry and exit.

Rigs

Offshore drilling rigs are classified into two categories: mobile offshore drilling units (MODUs) and fixed units. Fixed units, also known as platform rigs, are drilling units that are placed on a platform. MODUs are further classified as bottom-supported (shallow-water) and floating (deepwater) rigs.

As of December 2006, there were 145 MODUs in the Gulf of Mexico, with 120 of the rigs contracted for service (83 jack ups and 37 semisubmersibles and drillships). A total of 55 platform rigs was available, with 28 in service.

In bottom-supported units, the rig is in contact with the seafloor during drilling, while a floating rig floats over the site while it drills, held in position by anchors or equipped with thrusters so that it can be dynamically positioned. Bottom-supported units include jackups, tenders, submersibles, and barges. Floating units include semisubmersibles and drillships.

Shallow-water structures

The basic size and function of an offshore structure result from the requirements of the development plan.

Caissons, well protectors, and fixed platforms are widely used throughout the shallow-water basins of the world. Caissons and well protectors protect the well bore from damage, while fixed platforms host the drilling rig and treatment facilities.

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In the Gulf of Mexico are about 4,000 structures in less than 1,000 ft of water, but over time, the inventory of assets continually changes as fields deplete and structures are decommissioned and new fields are discovered and new infrastructure installed (Table 1).

Deepwater structures

Fixed platforms have a water depth limit of about 1,500 ft. Beyond this threshold, subsea completions and floating production systems are employed.

The objective of a deepwater structure is the same as a fixed platform, namely, to provide a safe, cost-effective, and stable workspace for operations. Deepwater structures are significantly heavier and more expensive than their fixed platform counterparts because of the environmental conditions and design requirements.

In a subsea completion, the valves and equipment used to control fluid flow are placed on the seafloor and are tied back to a fixed or floating facility.

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Floating production, storage, and offloading vessels are the most popular deepwater development strategy worldwide, but in the gulf, spars, tension leg platforms (TLPs), and semisubmersibles have been the preferred development option because of the extensive pipeline network. The inventory of deepwater structures and subsea completions in the gulf is summarized in Table 2.

Replacement costs

The replacement cost of a platform or rig is defined as the cost today to replace the asset with new property of comparable material and quality used at the same location for the same purpose. Replacement costs vary over time with the price of labor and materials and as a function of technology, inflation, location, and other factors.

Following underwriting practices, structure and contents (topsides) coverage are merged into a single property damage coverage. Structure type is specified, and for fixed structures, classified in terms of construction class. MMS and various commercial vendors maintain databases that describe the physical characteristics such as the age, type, location, and water depth of platforms, and the location, size, throughput, and capacity for pipelines. Commercial sources provide data on the location and specifications of offshore rigs.

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The replacement costs for shallow-water structures are calculated based on typical expenses for each of the major components. Characteristics useful in the development of platform replacement cost include structure function (drilling, production), age, construction class (caisson, well protector, fixed platform), equipment inventory, production type (oil, gas, condensate), and production capacity. For the handful of deepwater facilities that exist in the gulf, reference to trade journal publications and company web sites were sufficient to estimate replacement cost.

The replacement costs for drilling rigs is based on data collected from Rigzone; ODS-Petrodata, Jefferies & Co., company web sites, and trade publications provided supplemental information. Due to the wide variability in the cost estimates reported, we found it useful to construct generalized rig replacement cost functions.

Value at Risk

The value of gulf structures and rigs at the end of 2006 is estimated to range between $60 billion and $70 billion.

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The value of gulf assets is estimated by construction class (Table 3), water depth (Table 4), and geographic region (Fig. 1). As rigs move into and out of the gulf, and as platforms are removed and new structures are installed, the total exposed value will change over time. Subsea completions and pipelines are not covered in the value assessment, and the development cost of a field, including the cost to drill and complete wells—which may range from 25% to 50% or more, of the total development expenditures—is not included.

We assume all structures and rigs are insured to their replacement value, whether active or idle. About 30% of the current inventory of GOM structures are idle,10 and although idle structures are not expected to be insured to their full replacement cost, we did not discount this in our analysis.

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Caissons and well protectors are the most prolific infrastructure in the GOM, but because they are minor structures without production facilities or drilling equipment, they only contribute about 7% of the total Value at Risk (VaR). Fixed platforms contribute nearly 50% of total property value, with deepwater structures (TLPs, spars, compliant towers) contributing 24% (Table 3). MODUs are estimated to comprise about 20% of the total VaR (jack ups 7%, semisubmersibles 10%, drillships 4%).

Across the water depth categories 0-200 ft, 201-1,000 ft, 1,000+ ft, structure exposure is roughly uniform (Table 4). Drilling rig exposure is concentrated in the deep water, where the most expensive and sophisticated rigs operate.

About half of the total exposure in the gulf is concentrated in six geographic regions, in Green Canyon 15%, Mississippi Canyon 11%, Garden Banks 5%, Eugene Island South 5%, Viosca Knoll 4%, and Eugene Island 4% (Fig. 1).

Physical damage

High wind speed, high wave height, and landslides are the main weather-related threats to offshore infrastructure (Fig. 2). Failure of primary structural components such as main braces, jacket legs, deck legs, and piles often leads to listing or capsized units. Deck inundation increases the horizontal load and overturning moment, resulting in the potential failure of structural members and collapse. Bottom-current loading or foundation failure may also lead to failure because of soil instability and mud slide conditions. Moorings on mobile offshore drilling units may fail, setting units adrift.

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Vulnerability assessment is an estimate of losses due to physical damage, business interruption, and contingent business interruption. Physical damage is generally easier to model than business interruption and contingent business interruption, since the losses are localized, and vulnerability curves can be constructed based on historical data and physical models.

Historic storm events can be used to estimate the risk posed to an individual structure, a portfolio of platforms, regional assets, or the entire gulf inventory. For the current gulf inventory of structures and rigs, we examine the impact of historical storm events, leading to the ground-up loss estimates shown in Table 5.

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Losses portray what-if scenario results based on the current offshore inventory and exposure levels and will be different from the actual losses for these events. Hurricane Andrew would be expected to cause structure and contents damage of $2.3 billion if it were to occur today; Hurricane Camille would cause $1.6 billion in property damage.

Offshore exposure

It may be interesting to speculate on what the loss today would be from another Hurricane Camille or Andrew, but since these events have a near-zero probability of occurrence, the more interesting question involves the expected losses from potential future events.

The annual exceedance probability curve, defined as the annual probability of losing more than a particular amount, is a common way to convey loss information and to derive estimates of average and extreme loss.

Annual average loss (AAL) in the gulf for return periods of 100 and 250 years are estimated using the RMS Offshore Platform Model at $5.7 billion ($4.2 billion for structures, $1.8 billion for rigs) and $7.5 billion ($5.5 billion for structures, $2.3 billion for rigs), respectively.

References

  1. “Offshore Platform Model Methodology,” RiskLink 6.0, RMS, Newark, Calif., 2006.
  2. Wisch, D.J., “Observations of hurricane impacts on deepwater facilities,” Offshore Technology Conference, OTC 18414, Houston, 2006.
  3. Cox, J.W., “Standards and regulations. Planning and Design of Fixed Offshore Platforms,” McClelland, B., and Reifel, M.D., eds., Van Nostrand Reinhold Co., New York, 1986, pp. 46-58.
  4. Gerwick, B.C., “Construction of Marine and Offshore Structures,” 2nd Edition, CRC Press, Boca Raton, Fla., 2000.
  5. Graff, W.J., “Introduction to Offshore Structures,” Gulf Publishing Co., Houston, 1981.
  6. Mather, A., “Offshore Engineering: An Introduction,” 2nd Edition, Witherby & Co. Ltd., London, 2000.
  7. Wisch, D.J., “Adequate margins,” Offshore Technology Conference, OTC 18333, Houston, 2006.
  8. API RP 2A, “Planning, Design, and Constructing Fixed Offshore Platforms,” American Petroleum Institute, Dallas, 2000.
  9. Ward, E.G., Lee, G.C., Hall, R.A., Turner, W., Botelho, D., and Dyrrkopp, F., “Consequence-based criteria for the Gulf of Mexico: philosophy and results,” Proc. of the 2000 Offshore Technology Conference OTC 11885, Houston, 2001.
  10. Kaiser, M.J., and Mesyanzhinov, D.V., “A note on idle oil and gas platforms (idle iron) in the Gulf of Mexico,” Ocean Development & International Law, Vol. 35, 2004, pp. 365-377.

The authors

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Mark J. Kaiser ([email protected]) is professor and director, research and development, at the Center for Energy Studies at Louisiana State University. His primary research interests are related to policy issues, modeling, and econometric studies in the energy industry. Before joining LSU in 2001, he held appointments at Auburn University, American University of Armenia, and Wichita State University. He has a PhD in industrial engineering and operations research from Purdue University.

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Allan G. Pulsipher is executive director and Marathon Oil Co. professor at the Center for Energy Studies at LSU. Before joining LSU in 1980, he was chief economist for the Congressional Monitored Retrievable Storage Review Commission, chief economist at the Tennessee Valley Authority, a program officer with the Ford Foundation’s division of resources and the environment, and on the faculties of Southern Illinois University and Texas A&M University. He has a PhD in economics from Tulane University.

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Ajay Singhal is vice-president of model development at RMS and has over 10 years of experience in catastrophe risk assessment for natural and man-made catastrophes. He has a B. Tech. from IIT Madras, an MS from Rice University, and a PhD in civil engineering from Stanford University.

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Tom Foster is a technical analyst in the Americas Model Management Team. He supports the product marketing and business development activities for RMS’ Americas climate hazard peril models. He has an MS in geology from the University of Michigan at Ann Arbor and a BS in meteorology from Pennsylvania State University.

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Rajkiran Vojjala is a catastrophe risk modeler in the man-made catastrophe and large commercial risk practice group. He has played a major role in the development of the RMS offshore platform model. He has a BE in structural engineering from Visvesvarya National Institute of Technology and an MS in civil engineering from Stanford University.