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August 29th, 2008

Why Tropical Storms Raise Oil Prices

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Oil prices posted their highest weekly gain in nearly two months, raising two percent since Monday. The threat of Tropical Storm Gustav moving through the Gulf of Mexico by Sunday has many investors worried. The Gulf of Mexico is home to more than 5,000 offshore oil rigs that drill one-fifth of the US’s oil supply. Sunday will be the first true test for insurance companies who cover the offshore rigs since two devastating hurricanes, Rita and Katrina, caused nearly $50 billion in damage. The two storms compiled $8 billion in offshore-drilling claims to insurance companies; 113 platforms were destroyed, as well as 457 pipelines.

Gustav is not expected to reach the devastation of either of those two storms. According to the National Hurricane Center, as of 8a.m. this morning, Gustav has remained under the classification of a Tropical Storm. Insurers of offshore oil rigs are confident the lessons they learned from Rita and Katrina will pay off for them this hurricane season. Yet, if insurance companies are worried about covering their tail, it may not be the best scenario for oil drillers and consumers:

Insurers are trying to curtail their losses by putting limits for the first time on how much they’ll pay out for storm damage over the course of the entire hurricane season. They’re also repricing coverage based on studies of what kinds of oil- drilling equipment held up best when Katrina and Rita struck.

Insurers typically now limit coverage to $500 million in storm losses for all of a company’s offshore assets over the six-month season, said (Liberty Mutual vice president Christopher) Pluchino. Just one of the largest platforms can cost over $1 billion.

“It was estimated the premium in the Gulf of Mexico was $300 million a year” before Katrina and Rita hit, Costa said. “If you looked at the sum of those two losses to the industry versus the premium generated in the Gulf of Mexico, it was obvious that the formula was broken, that the exposures were a lot larger than anyone anticipated.”

Regardless of whether or not oil companies shell out extra funds for added insurance, any risk to the supply of our most popular commodity is due to raise prices down at the consumer level. Since the course of Mother Nature is out of consumers’ hands, this increase is just one of many that consumers have dealt throughout the history of offshore drilling.

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3 Responses to “Why Tropical Storms Raise Oil Prices”

  1. Rebecca Wilder Says: August 29th, 2008 at 12:18 pm

    I wonder what is going on with insurance stocks? If Gustav picks up (like it is expected to), wreaking havoc on homes and properties, insurance companies may have problems making the payments.

    In related events, the markets blew off the Russia/Georgia conflict, where Russia targeted (bombed) BP’s major pipeline that runs from Azerbaijan to the Mediterranean. Oil prices were essentially unchanged throughout the whole thing. Who knew that was less important than Gustav?

  2. Tim Manni Says: August 29th, 2008 at 3:47 pm

    I get it that every time our oil supply is threatened, prices tend to rise, hence hurricanes in the Gulf. But like you said, a foreign BP pipeline gets destroyed and prices hold steady. I assume that’s were speculation comes into play. My only guess is the hurricane has a much more direct effect on the US’s “personal,” domestic supply.

  3. Charles Hill Says: September 11th, 2008 at 3:55 pm

    Sarah Palin letter to Harry Reid on Energy Policy.
    Is she a “Energy Expert”?
    http://strategicthought-charles77.blogspot.com/2008/09/sarah-palin-letter-to-harry-reid-on.html

    Any comments??

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Tim Manni is the Managing Editor of HSH.com and the author of their daily blog, which concentrates on the latest developments in the mortgage and housing markets.

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