# It's a gas

Liquefied natural gas is a booming sector. Jeremy Golden explains the opportunities and risks for insurers in the market

Liquefied natural gas is fast emerging as one of the most dynamic sectors of the global energy business. Industrialised countries, such as the US, Japan and the UK, are running out of their own domestic supplies of natural gas and looking abroad to meet rising demand.

Environmental concerns are also driving the market. Natural gas is the cleanest burning of all the fossil fuels, making gas-fired power plants easier to site near to energy-hungry cities. Improvements in combined cycle gas turbine power generators have also led to increasing levels of thermal efficiency, reducing both fuel consumption and emissions.

Qatar, Iran, Australia, Indonesia and Brunei are - and will continue to be - the world's principal locations of LNG plants, with Qatar and Iran dominating new developments. There is also increasing expansion of LNG supply from North Africa.

The scale of new investment in LNG, being led by the world's leading oil companies, is staggering. In February this year, Exxon Mobil and Total committed a combined $16.3bn (£8.9bn) to Qatar's North Field, the largest single gas deposit in the world - a project that is expected to supply up to one-fifth of the UK's gas. Shell then announced a whole new LNG project, called Qatargas-4, that will cost up to$7bn to ship enough gas to Europe and the US each year to power seven million homes, starting in 2010.

Opportunities and risks

Underpinning the boom in demand for imported LNG is the technology to cool the gas into a liquid so that it can be shipped on tankers. The process also allows a producer such as Qatar to ship its gas to any market in the world, not just where pipelines run.

So what opportunities and risks does this LNG boom present for energy underwriters? According to David Way, managing director of Heath Lambert's natural resources group: "To go from extracting the natural gas from a source country, such as Indonesia or Qatar, to delivering it to the end-user, say in the UK, is a complicated process requiring the participation of multiple entities.

"The LNG supply chain starts with exploration and production; then comes the onshore plant in the source country for liquefaction facilities; followed by hull and cargo cover for shipping; and then onshore cover for the terminal and re-gasification plant."

Mr Way explains: "Each of these has its own distinct insurance needs and insurance market, including the construction element, as many new facilities are being built around the world."

LNG processing is an expensive business, requiring large capital expenditure.

Each LNG processing facility can be worth \$500m, and there can be up to six processing facilities on any one site.

Consequently, LNG insurance is likely to remain with the established specialist insurers that are able to offer sufficient capacity. This type of insurance is generally sourced through specialist energy brokers, rather than property brokers.

The London market has already established itself as the main carrier of LNG risks and built up world leading expertise in terms of covers and exposures. This is likely to the case for at least the immediate future, as the main growth area for LNG plants is in the Middle East, where most risks are insured through the London market.

Claire McDonald, head of energy portfolio, and John Duckworth, energy risk engineer at Allianz Global Risks UK, outline the specific underwriting challenges, market potential and associated production risks of LNG as follows: "An expanding market offers insurers opportunities for increased business from both existing and new clients. These opportunities are not restricted to just the energy insurers. As more gas fields are discovered and existing plants expanded, more processing trains are built offering opportunities to construction insurers."

According to AGR, production of LNG typically involves a complex mix of property, business interruption, engineering and construction risks.

"Vapour cloud explosion potential at LNG liquefaction plants primarily arises from the large inventories of refrigerants such as propane and multi-component refrigerant (a mixture of propane, ethane and methane).

"Additional risks arise from the larger-than-normal refrigeration units that are required to process the LNG. Machinery breakdown of these refrigeration units can lead to over-heating and a rise in pressure within the system, increasing the risk of explosion."

The explosion at Algeria's Skikda LNG complex in January last year, which destroyed half of the capacity at the coastal complex, was a vivid illustration of the potential dangers in LNG production. However, Steve Allum, chairman of the marine global practice group at Aon, says that the industry on the whole has an excellent safety record.

"The biggest challenge that insurers face is being able to understand the risks sufficiently to offer cover at the correct rate, although catastrophic events can be envisaged with LNG as with most hydrocarbons. The key, therefore, will be in assessing the risks accurately enough to provide a balance now - without having to resort to knee-jerk rises should a major event occur in the near term. If there was ever a case for using the techniques of quantified risk assessment in the underwriting process, this is it."

Marginal growth

He adds that with gas reserves increasingly located greater distances from markets, transport costs become significant, typically representing 60% to 75% of delivered cost. "Therefore, the associated transport risks also increase, including terrorism, supply disruption, political interference and high operating costs."

As for whether the boom in LNG is generating a corresponding growth in insurance demand, the consensus is that growth exists, but "only at the margins". Many of the developments lie with the oil majors that will self-insure wherever possible.

You only have to look at the risk assessment capabilities of these majors to know that they have the ability to understand the risks and, consequently, will be taking informed decisions as to whether risk transfer to the insurance markets is cost-effective.

By implication, insurers need to be equally savvy, as they will be writing the risks that the informed buyer does not want to retain - either because those risks are too unpredictable or because it is cost-effective to transfer.

In short, the LNG insurance market could be exceptionally volatile, with good profits in some years and huge losses in others. This will particularly be the case where deductibles are high, or there is selective risk transfer.

The LNG industry is generally safe but, as shown by the Algerian event, when something does go wrong, particularly at a terminal, it can cause major loss of life, property damage, and business interruption. As the industrialised world becomes ever more dependent on LNG, energy suppliers and their brokers and insurers will have much on which to ponder.Clause must consider causation.