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Valuation of Insurance Organizations

Update: Energy Insurance Market Conditions: 2020

Todd Fries | May 29, 2020

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As a result of energy prices collapsing, the energy industry's projections for 2020 changed dramatically, which will trickle down to other industries, including the insurance industry. The purpose of this article is to provide an update to our March 2020 article, reflect on the recent changes in the energy industry, and discuss the impact on demand for insurance offerings as a result of recent events.

The first quarter of 2020 was a challenging time for the energy sector, and this challenge does not appear to be dissipating anytime soon. Since our March 2020 article, which we authored in February 2020, much has changed. Shortly after our March 2020 article was published, energy prices collapsed as a result of the Saudi Arabia/Russia price war and the ongoing effects of the COVID-19 pandemic on worldwide energy demand. Even with an agreement in place resolving the Saudi Arabia/Russia price war, front month prices of oil in the United States turned negative for the first time in history on April 20, 2020.

Energy Prices

West Texas Intermediate (WTI) monthly average crude oil spot prices dropped substantially in the first quarter of 2020 from a high of approximately $63/bbl on January 6, 2020, to a low of approximately $14/bbl on March 30, 2020. 1 The second quarter of 2020 is not showing signs of improvement even with the April 12, 2020, agreement to limit production among OPEC and other energy exporters. On April 17, 2020, May WTI futures dropped below $2/bbl, and on April 20, 2020, for the first time in US history, front month oil prices were negative. 2

The price war, coupled with the COVID-19 pandemic, led to the perfect storm of an excess global supply of oil as a result of the suspension of previously agreed-upon production cuts by OPEC and other countries and a significantly lower global demand as a result of various lockdown and stay-at-home orders around the world. The April 2020 forecast by the Energy Information Administration (EIA) considers its near-term outlook as subject to heightened levels of uncertainty as COVID-19's market impacts are continuing to evolve but still predicts $30/bbl oil prices in the second half of 2020. 3

The International Energy Agency has more dire predictions than the EIA for 2020, with an expected drop in demand of approximately 20 percent due to the COVID-19 pandemic. 4 There is also concern that the agreement reached on April 12, 2020, to cut oil production in May and end the price war is too little to address the reduced demand levels around the world. 5

"WTI Price and Forecast for 2012–2025" highlights historical average monthly pricing between 2012 and March 2020, as well as the most recent Nymex forecasts available as of April 24, 2020.


WTI Price and Forecast for 2012-2025

Regarding natural gas, Henry Hub spot prices have decreased by approximately 25 percent from January 2020 levels to a monthly average of $1.74 per million British thermal units (MMBtu) in March 2020. 6 The March 2020 price level is the lowest average monthly price since March 2016. 7 Citing warmer-than-normal weather in the first quarter of 2020 and the slowing economy as a result of the COVID-19 pandemic, EIA expects residential and commercial consumption of natural gas in 2020 to be down compared to 2019 averages by 5.8 percent for residential and 7.1 percent for commercial. The EIA's April 2020 Short-Term Energy Outlook predicts that prices will begin to rise at the end of the second quarter of 2020 as US natural gas production declines and demand for natural gas used for power and generation increases. 8

Prior to the COVID-19 pandemic, the EIA anticipated Henry Hub spot prices to increase slightly to an average $2.33/MMBtu in 2020 and $2.54/MMBtu in 2021. 9 The EIA now anticipates Henry Hub spot prices to average $2.11/MMBtu in 2020 and $2.98/MMBtu in 2021, increasing in 2021 due to lower natural gas production compared to 2020 as a result of the energy industry adjusting production for reduced demand. 10 Not all commodity traders agree with the EIA though as, for example, NYMEX futures indicate prices between $2.00/MMBtu and $2.50/MMBtu in 2021.

"Henry Hub Price and Forecast for 2012–2025" highlights historical pricing between 2012 and March 2020, as well as the most recent Nymex forecasts available as of April 24, 2020.


Debt and Capital Expenditures

Large-scale development projects are one of the key drivers of demand for insurance coverage in the oil and gas industry. Directionally, these outlays tend to move with oil prices as companies delay or cancel projects during sustained declines. For an industry heavily loaded with debt, the recent downturn bodes poorly for prospects in the near-term and beyond. By way of example, the last downturn in 2016 led to approximately 70 of the 215 oil producer bankruptcies in North America between 2015 and April 1, 2020. 11 It is still too early to tell how many bankruptcies will occur in the energy industry as a result of recent events, but if the 2016 downturn is indicative of upcoming events, the outlook is grim.

While 2019 was considered in a light of cautious optimism due to a consistent debt level and a consistent debt-to-equity ratio for the industry, outlook revisions with lower revenues and higher debt-to-equity ratios in 2020 lead to a more pessimistic view of the industry. The following are some examples.

  • Oil companies are beginning to cut capital spending for 2020. For example, 2020 capital budgets for Texas development were slashed by $8 billion in recent weeks. 12
  • Over 1 million oil and gas jobs are likely to be cut in 2020, with contractors scaling down their workforce by at least 21 percent. Of this 21 percent, 13 percent is attributed to oil-price-driven cuts, and 8 percent is attributed to the slowdown of projects due to COVID-19. 13
  • Some analysts are expecting active horizontal rig counts in the United States to fall in the second quarter by 65 percent from 620 active wells as of mid-March 2020 to a bottom of approximately 200 active wells. 14
  • On a global scale, exploration and production firms are expected to cut capital expenditure amounts by up to $100 billion in 2020, down roughly 17 percent from the $546 billion spent in 2019. 15

While revenues decline due to reduced demand and lower prices, major debt is coming due. North American oil exploration and production companies have $86 billion in debt that will mature between 2020 and 2024, 16 while midstream companies face $123 billion in maturing debt during the same time frame. 17 With the industry experiencing reduced cash flows, there is concern that energy companies will not be able to remain current on their outstanding debt.

Impact on the Insurance Industry

With energy prices experiencing extreme fluctuations, including lows not seen in over 20 years and the continued economic uncertainty related to COVID-19, insurers will have premium income challenges for 2020 and likely beyond. Even if the current economic turmoil related to COVID-19 is resolved in the near term, the economic slowdown and associated record unemployment filings it has created will take time to resolve. 18 With exploration and production levels suffering under the wake of current circumstances, the outlook over upcoming years is negative.

Insurance Overcapacity

Like current conditions in the energy industry, the insurance industry is also experiencing a period of high supply during a time of slowing demand. As discussed in our March 2020 article, the upstream insurance market had significant overcapacity and showed no signs of significant underwriter withdrawals in the near term. 19 This trend continues today, but at a time with declining demand. Recent shocks in the energy markets and the ongoing effects of COVID-19 are expected to result in trauma to the energy industry that exceeds what was experienced in the 1985, 1999, and 2014 price crashes. 20

With capital and coverage in the upstream energy market being at an all-time high before recent events, the falling demand for insurance products will result in an even softer market than the one that existed at the beginning of 2020. 21 Until energy prices recover and increases in capital expenditures return, which may not take place for years, premiums and insurance demand will be under pressure, resulting in a continued soft market for the insurance industry.

Interest Rates Lower

Citing concerns regarding the COVID-19 pandemic and weakening economic signals, the Federal Open Market Committee (FOMC) lowered the target federal funds rate twice in March 2020, eventually landing on a target rate of between 0 and 0.25 percent. 22 These emergency rate decreases brought the target rate to levels not seen since the fallout from the 2008 financial crisis. 23

The decrease in rates adds another unfavorable variable for insurers as returns from invested premium will decline in line with the lower federal funds rate. An increase in the target rate will likely not occur soon until the COVID-19 pandemic is resolved and the US economy recovers. Due to the many uncertainties surrounding the pandemic, it is difficult to predict when rates will recover, but based on FOMC's approach to the 2008 financial crisis, an increase in rates is not likely to occur in 2020.


While energy prices showed signs of recovery in late 2019, with slight indications of cautious optimism, any hopes of a near-term uptick are now lost given the pervasive effects of both the COVID-19 pandemic and the direct and indirect effects caused by the Saudi Arabia and Russia dispute. Given the recent halt in oil and gas activity and the expectation of further shutdowns, industry players are hesitant to invest capital into operations and instead opt to remain focused on stability in times where finding sources has become a critical issue for many exploration companies.

The cuts in capital investment will result in lower demand for insurance products in an already oversaturated market. Lower investments by the energy industry, coupled with a continuing increase in overcapacity and low insurance premiums, have further softened the insurance market. Until the uncertainty surrounding the COVID-19 pandemic is resolved and the world economy recovers, insurers can expect lower capital investment by energy companies resulting in lower demand for insurance products.

Special thanks to coauthor Alex Walther, CPA/CFF, CFE, a senior vice president with the BVA Group. Mr. Walther's experience focuses on a wide range of valuation and financial forensic issues that arise in complex commercial disputes such as the preparation of valuations of onshore and offshore oil and gas interests in bankruptcy proceedings, contract disputes, and/or shareholder disputes.

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1 "Cushing, OK WTI Spot Price FOB," US Energy Information Administration, May 2020.
2 Ryan Dezember, "U.S. Oil Costs Less Than Zero after a Sharp Monday Selloff," Wall Street Journal, April 21, 2020.
3 "Short-Term Energy Outlook," US Energy Information Administration, April 2020.
4 Shadia Nasralla and Dmitry Zhdannikov, "UPDATE 1-IEA Says That Global Oil Demand Could Drop 20% as 3 Billion People in Lockdown," Reuters, March 26, 2020.
5 Jillian Ambrose, "Historic Oil Production Cuts 'Will Not Halt Slump in Demand," Guardian, April 13, 2020.
6 "Short-Term Energy Outlook," US Energy Information Administration, January 2020.
7 "Henry Hub Natural Gas Spot Price," US Energy Information Administration, May 2020.
8 "Short-Term Energy Outlook," US Energy Information Administration, April 2020.
9 "Short-Term Energy Outlook," US Energy Information Administration, January 2020.
10 "Short-Term Energy Outlook," US Energy Information Administration, April 2020.
11 Oil Patch Bankruptcy Monitor, Haynes and Boone, LLP, April 6, 2020.
12 Clifford Krauss and Matt Phillips, "American Oil Drillers Were Hanging on by a Thread. Then Came the Virus," New York Times, March 23, 2020.
16 Bill Holland, "Moody's: Oil, Gas Drillers Face a Daunting Debt Wall in Next 4 Years," S&P Global, February 20, 2020.
17 "North American Midstream Energy Companies Face $123 billion of Debt Maturities in 2020–24," Moody's Investor Service, Research Announcement, March 3, 2020.
18 Sarah Chaney and Eric Morath, "U.S. Jobless Claims Top 20 Million Since Start of Shutdowns," Wall Street Journal, updated April 16, 2020.
19 "Energy Market Review—Adjusting to Change," Willis Towers Watson, March 2019.
21 "Energy Market Review—Adjusting to Change"; "'Savage' Upstream Energy Conditions Threaten Capacity Exists, Warns Marsh JLT Specialty."
22 "Federal Reserve Press Release," Federal Open Market Committee, March 2, 2020; "Federal Reserve Press Release," Federal Open Market Committee, March 15, 2020.