Published on 06 July 2023

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Upstream Energy Market Update 2023

Published on 06 July 2023

As we move into the second half of 2023, the Upstream market continues to tussle with the challenges of underwriting profitably against a backdrop of a market with significant overcapacity; as this dynamic plays out we expect to see a softening of market conditions.

As we move into the second half of 2023, the Upstream market continues to tussle with the challenges of underwriting profitably against a backdrop of a market with significant overcapacity; as this dynamic plays out we expect to see a softening of market conditions.

In our previous update, we described the Upstream market as splitting into ‘sub-sectors’ (Onshore and Offshore) for the renewal process experienced by clients and this continues to be the case. The overcapacity and relative profitability in the Upstream market is being driven by fixed offshore assets, offshore drilling operations and the loss experience in this sector, which combined with several years of upward rate movement, has seen many syndicates look to increase their exposures to this business. In turn, this has created pressure on signings for accounts with this profile and underwriters face a real challenge in being asked to push rate on all accounts, whilst at the same time protecting their signed lines. The onshore sector includes accounts with Midstream, service contractors and onshore control of well exposures; all of these individual sub-sectors have the dual dynamic of loss activity mapped over less capacity and appetite. These factors have resulted in rate movements between 7.5-15% for onshore exposures versus flat to low single digit rate movements for their offshore cousins.

Conditions within the Construction sector differ from the above, with a more cautious and selective approach being taken by underwriters. In comparison to operational placements, there are relatively few recognised lead markets willing to provide terms, with various Environmental, Social and Governance (ESG) pressures precluding the involvement of some insurers on greenfield projects. As such, there is not the same oversupply of capacity and this has helped historic rating to be maintained. A recent Construction All Risks (CAR) loss in Turkey has quelled lead markets’ desire to sharpen their pencils.

Despite the withdrawal of the Munich Re Syndicate at the end of 2022 as a result of ESG, we have not seen other capacity follow suit. ESG continues to be a huge focus for insurers, but as all clients enter the transition, both the clients and market have become much better in managing their portfolio’s. Capacity will become constrained for those clients who are unable to demonstrate and engage with carriers on how they are bringing down their CO2 footprint, but the significant focus on this and investment going into ESG by the Upstream client base has meant both clients and in turn carriers are able to support and underwrite the Energy transition.

We believe Upstream will tip in to a buyer’s market in the second half of 2023, however this balance is only marginally tipping into the client’s favour. The same is not true for capacity risks which take up a small proportion of the overall Upstream client base. Underwriter’s are being conservative and reserving their capacity for buyers paying best rate, or have the highest quality operations.

The 1st January and 1st April Treaty renewals were not able to meaningfully harden the Upstream market and the impact of these Treaty renewals, although challenging, has resulted in many carriers retaining more losses and having their own margins squeezed as they have been largely unable to pass these costs onto clients. How each carrier purchases their reinsurance will directly impact the market conditions for the reinsurance renewal season and an emerging theme appears to be that many carriers have traded rate increases on their treaty renewals for bigger retentions. At the direct underwriting level, if more of each loss is retained by the direct market and as the market loss experience develops in 2023, this could impact their profitability. If all other dynamics remain equal and the market experiences a normal attritional loss year in 2023, the direct underwriting result will be worse as a result of this approach.

The challenge with profitability being squeezed in an environment with high interest rates is the same return can be made without the risk and capital will only be deployed if the return on capital rewards capital providers for doing so. If the overcapacity in the market has tipped the dynamic into a buyer’s market; loss activity and lack of return on capital could quickly reverse this into a seller’s market. We have seen this happen already in 2023 for clients who buy Natural Catastrophe cover in the Gulf of Mexico, where significant rate movement of between 30-50% have been seen and clients are having to retain more risk or buy available wind aggregate at the terms the market is willing to sell it at.