Beware the LNG boom

The energy industry has been positioning itself to profit in an energy economy fuelled increasingly by liquefied natural gas (LNG). This 'dash for gas' is on behalf of an abundant, relatively clean hydrocarbon that many believe can close the worrying gap between energy supply and energy demand.

Industrialised countries such as the US, Japan and the UK are running out of their own domestic supplies of natural gas, and are looking abroad to meet rising demand. The emerging economic superpowers of India and China are also increasingly gas-dependent.

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, fed by the world's leading oil companies, is staggering. In early February this year, ExxonMobil and Total committed a combined $16.3bn to Qatar's North Field, the largest single gas deposit in the world. That project is expected to supply up to one-fifth of Britain's gas.

Then Shell announced a whole new LNG project called Qatargas-4 that will cost up to $7bn for shipping enough gas to Europe and North America each year in order to power 7 million homes; this is expected to start in 2010.

Underpinning the boom in demand for imported LNG is the technology to cool the gas into liquid so that it can be shipped on tankers, like oil.

The process also allows a producer such as Qatar to ship its gas to any market in the world, not just where the pipelines run.

Profile of the LNG (re)insurance market

A paper from Allianz claims that the majority of LNG plants have been built within the last 10 years, so in insurance terms, the market for LNG is relatively new. LNG production 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.

Additional risks arise from the larger-than-normal refrigeration units that are required to process the LNG. The study adds that 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 profile of the LNG (re)insurance market is very similar to that of the energy (re)insurance market as a whole. 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 (re)insurance is likely to remain with the established players who 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 remain so in the immediate future, as the main growth area for LNG plants is in the Middle East, most of which is reinsured through the London Market.

Is LNG an answer?

According to Steve Allum, Chairman of the Marine Global Practice Group at Aon, while LNG appears to provide an answer, the supply chain is complex and technical, involving the extraction and liquefaction of natural gas, shipment on special refrigerated tankers, and regasification at a coastal import terminal to allow delivery to the end users.

Steve adds that the growing efficiencies at all stages of this process are making it possible to extend the range of supply. This, together with higher total demand, is leading to the gradual formation of a globalised market. However, it would appear that the biggest challenge the insurers face is being able to understand the risks sufficiently to offer cover at the correct rate.

Mr Allum also identified the practice of engaging in long-term contracts, rather than spot trading, as a key area of exposure. With long-term fixed contracts, contingent exposures could be extremely large if the producing or receiving terminal should be out of action for any length of time.

As for the boom in LNG generating a corresponding growth in (re)insurance demand, the consensus is that 'yes, there is growth, but only at the margins'.

This is because the LNG market is dominated by large multinational refinery and petrochemical companies, and only a proportion of risks associated with LNG are labelled as LNG-specific risks. The remaining parts of the associated risks will reside within the appropriate multinationals' own insurance programme, which will be self-insured wherever possible.

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

By implication, therefore, unless (re)insurers are savvy, they will be writing the risks that the informed buyer does not want to retain, either because it is 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.