"Please God, grant us one more oil boom and we promise not to p--- it away." Driving through various shale plays around the United States you will see this phrase on bumper stickers, billboards, and even tattooed on rig hands bellied up to the bar at their favorite watering hole.
The good news is that they might finally get their wish. The macro-economic view of the energy space is setting up for a sustained positive environment over the next five to ten years. It's important to understand what is happening at the macro level for us to see how this is going to affect insureds and insurance carriers down the line.
Demand is Increasing Quickly and Supply is Falling Short
Looking at overall demand, the world is currently seeing a significant shortage of energy resources. With the improving COVID-19 outlook worldwide, these issues look to only get worse. Coal, natural gas, and oil prices are soaring globally, primarily caused by countries decreasing their supplies during the pandemic and not replacing them in time to meet increasing demand.
Coal prices recently hit a two-year high due to demand in emerging economies in Asia that primarily rely on the fuel. We're also seeing increased natural gas pricing worldwide due to increased demand from economies emerging from the pandemic, as well as weather patterns. If we see a colder than average winter, look out.
We're also seeing the downside of the movement to renewables by many countries who are experiencing power issues due to the underperforming of these assets. When these forms of energy don't meet demand, traditional fossil fuel resources have to step in to make up for lost supply.
When it comes to oil, prior to the pandemic we saw world consumption of oil hover a little over 100M barrels per day (bpd). This number reduced to 80 million bpd during the pandemic and the EIA is predicting an annual average around 97M bpd in 2022 and beyond, getting back to pre-pandemic levels and higher.
Pandemic-Induced Supply Destruction and Focus on Profits Are Showing Effects
The results of severe supply destruction from the COVID-19 pandemic and a focus from production companies on sustained profitability are starting to show.
According to the EIA, the U.S. Crude Output peaked in Q1 2020 at 13.1 million bpd. Output bottomed out at 9.7 million bpd in Q1 2021 and has since risen to 11.1 million bpd. Overall, output is still down 15%. The large drop in U.S. output is driven by the austerity measures oil & gas companies were forced to enter into due to the pandemic.
The vast majority of oil wells in the U.S. that have come online over the last decade have come from a combination of horizontal drilling combined with hydraulic fracking. This process changed the U.S. oil and gas industry forever. Though these wells produce significant amounts of oil and natural gas when they initially come online, they will succumb to severe production declines very quickly. This means for U.S. producers to maintain output they need to continue to develop and bring new wells online—but this has not happened.
Outside of the pandemic, the other major reason for reduced investment in shale fields is due to investors demanding energy companies live within their means, pay down debt, focus on positive cash flows, and return equity to investors in lieu of focusing on growth and increasing market share.
One quick way for producers to increase their output while keeping costs down is through Drilled but Uncompleted Wells (DUCs). These are wells that have been identified, developed, and have gone through the drilling process, but haven't been completed and brought online. According to the EIA, the DUC count peaked in June of 2020 at 8,965 and as of Aug. 2021 had dropped an incredible 36% to 5,713. This isn't a sustainable path and additional capital will need to be dispensed, which we are seeing in the form of increased drilling activity.
Since the downturn in 2015 we saw the U.S. rig count peak at around 1,077 in Dec. 2018 and fall all the way to 250 in August of 2020. As of October 1, 2021, the Baker Hughes Rig Count has shown an increase of 278 rigs to a total of 528 operating throughout the United States. The rig count increase has been driven by private producers who have more flexibility with their budgets and aren't under investor pressures. OPEC also recently announced they aren't looking to increase output to drive down prices and won't look to increase supplies until they see sustained prices above $80.
What This Means for the Insurance Industry: Consistent Growth, But Challenges Persist
So what does this mean for our industry? Based on inflation combined with the supply and demand issues mentioned above, we are likely see sustained commodity prices for years to come. Here's why we will see increased activity in the energy space nationwide:
- DUCs being completed at a rapid rate has increased energy service companies in the fracking, sand and water logistics, roustabout, wireline, and well servicing industries. With drilling activity increasing, there will need to be a corresponding increase in these operations as well.
- With rig counts increasing, we will continue to see growth in the drilling, solids control, rig moving, pipe hauling, and site prep sectors increase as well.
- We should also continue to see increased activity in the well servicing space that works to improve output on existing wells.
- Look for revenues and wages to increase. Competition and a lack of a quality talent pool will see energy service companies charging more for their work due to increased wages.
- Keep in mind, we won't see the rates of growth like we did in previous booms. Energy production and energy service companies will continue to operate within their means and will continue to prioritize profitability and free cash flow in lieu of market share and growth. From an exposure perspective, we can expect to see larger payrolls, higher TIVs, increased fleet count, and higher revenue projections, but not at the levels seen in past booms.
Even with that growth, however, there are many hurdles for the industry that will have an impact on insurance programs and the carriers providing coverage and seeking profits:
- Hiring Issues - With the multiple downturns over the last decade, and the last one caused by the pandemic, many experienced workers were laid off and left the industry for good. The Federal Reserve Bank of Dallas recently published a survey that showed more than half of energy service companies had trouble hiring employees. 70% referenced a lack of qualified candidates and 17% who refused or failed a drug test.
In addition, a Wall Street Journal article recently highlighted the coming vaccine mandates for large companies and how it is going to further complicate hiring. For example, they referenced one energy service company who estimated less than 15% of their employees were vaccinated.
Look for underwriters to continue to focus on hiring practices. All submissions should have a completed supplemental discussing the company's policies or provide hiring guidelines. Preferred submissions will show the hiring and HR practices are working.
- Truck Driver Shortage - The oil and gas industry, known for paying increased wages for truck drivers, is still facing shortages like the rest of the economy. Truckers continue to be a significant part of the upstream supply chain hauling water, frac sand, hazardous materials and equipment.
Transportation and oil and gas underwriters are continuing to monitor CAB and SAFER scores for out-of-service rates for drivers, as well as reviewing MVRs during the underwriting process. A complete submission should include MVRs, fleet safety practices, and detailed information on what the company is doing to maintain or improve its CAB and SAFER Scores.
- Increasing Excess Requirements - During the downturn we saw many insureds reducing their umbrella capacity due to costs, as well as their customers reducing requirements. As the pricing environment improves, we also expect the need for increased excess limits to occur as well.
Whether at renewal or mid-term, the E&S marketplace can help with these placements. A good submission should include accords, loss runs, underlying quotes, binders, or policies, and a completed supplemental.
- The Rise in New Ventures and Existing Companies Re-entering the Industry - The O&G industry saw a significant number of business closures or coverage cancellations in 2020 and 2021 due to the downturn. In addition to this, we saw a significant amount of consolidation in the industry. With the improving pricing environment we're continuing to see increasing numbers of new ventures enter or re-enter into the industry that are lead by seasoned professionals. The E&S marketplace is meeting the needs of these companies and we are seeing week to week increased activity.
A quality new venture submission should include resumes from the owners and key staff, accords, a completed O&G supplemental, and previous loss runs if the insured was in business prior to cancellation.
- Large Audits - As policies from 2020 and early 2021 are set to expire, we saw many insureds provide very conservative revenue, power unit, and payroll projections due to so much uncertainty and lack of opportunities at the time. With recent submissions, we're seeing increased exposure projections that are likely to result in large audits. In order to secure renewals we are seeing carriers negotiate these audits or conduct mid-term adjustments. The key is to get in front of clients early to determine where their exposures are coming in at vs. the initial projections.
Sources:
https://www.dallasfed.org/research/surveys/des/2021/2103.aspx#tab-questions
https://www.wsj.com/articles/u-s-frackers-fear-vaccine-mandate-will-worsen-worker-crunch-11632994201