2009 Rims Energy Session V3

April 21, 20099:00 am – 11:30 am

IND 910Energy ResourcesOil & Gas Industry

Welcome to RIMS 2009 Annual Conference & Exhibition

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Here’s to a greener meeting! To support RIMS Green Initiative, there are no printed handouts. Visit www.RIMS.org/Handouts to download available handouts. Printing on Demand stations are available in Lobby A of the Orange County Convention Center, as well as in RIMS cyber stations located in booths #431 and #1759 in the Exhibit Hall.

April 21, 20099:00 am – 11:30 am

IND 910Energy ResourcesOil & Gas Industry

• Upstream & Downstream Insurance Market Overview

• Construction Risk Issues

• Ergonomic Loss Control

• Risk Manager’s Roundtable

• Lloyd’s – State of the Market

• War & Terrorism Update

• OIL – Mutual Insurance

• Offshore Construction Insurance Update

RIMS Oil & Gas Industry Session History

1. Anti‐Indemnity Statutes – Risk Allocation in Oilfield Contracts

2. Owner Controlled Insurance Program – A cost effective alternative?

3. Rating Agencies 101 – A Primer

4. Drilling Contract Issues

5. “Roundtable” Discussion of Current Issues

2009 RIMS Oil & Gas Industry Session

0

CoordinatorGabriel Lugo Taylor Risk Consulting

Speakers William W. PughLiskow & Lewis

Steve DavisMcGriff, Siebels & Williams

Mohammed AshabSignal Administration

William W. PughAttorney at LawLiskow & Lewis

Anti-Indemnity Statutes

Risk Allocation in Oilfield Contracts –Maximizing Indemnity and Insurance

Protection

• Must have valid “magic language” to obtain indemnity for one’s own negligence

• Indemnity (and “magic language”) must be broad enough to extend to all intended beneficiaries

• Anticipate and address possible restrictions on indemnity

• Be aware of any issues relating to the scope of the indemnity

Basic Indemnity Issues

• Include sole or concurrent negligence of indemnified Group

• Include reference to strict liability, unseaworthiness, and pre‐existing conditions

• Consider whether to address gross negligence and/or punitive damages

• Include "release" and "defend" and a specific reference to attorney's fees

• Be aware of “conspicuousness” requirements

“Magic Language” –Reference to Negligence Should Be As

Clear and As Broad As Possible

• Beware Lanasse v. Travelers Ins. Co.– include “loading and unloading of cargo” ‐ Gaspard

v. Offshore Crane and Equipment

– include “ingress and egress”

• Be sure that insurance provisions address Lanasse issues as well

Vessel Operations Present Special Issues

• Drilling contractor will want indemnity for Company’s people and property and people and property of Company’s other contractors

• With broad reciprocal indemnity, Company will owe indemnity to drilling contractor every time there is an accident involving anyone other than the drilling contractor

Drilling Contract is Often the Key –Anticipating the Broad Reciprocal

• Narrow – each party responsible for its own employees and property (simple; doesn’t require reliance on what’s in other contracts)

• Broad reciprocal – includes contractors and subcontractors (creates extensive potential liability for Company; without a “pass‐through” provision, there may be no back‐up indemnity)

• Variations – modified reciprocal; fault‐based reciprocal, hybrid

Effect of Different “Reciprocal”Indemnity Provisions

• Indemnity scheme in drilling contract (and other major contracts) affects all underlying contracts (with common workplace)

• Company must have “pass‐through” provisions in its underlying contracts (to pass indemnity from other contractors to the drilling contractor)

• Indemnity without a pass‐through provision won’t solve the problem

• Be aware of enforceability issues

Broad Reciprocal in Drilling Contracts Necessitates a “Pass-Through” Provision

Operator Contractor

OtherContractors Subcontractors

Mud Log Wireline Vessel Casing Helicopter

Operator Drilling

Subs, if any

Drilling

Wireline

Helicopter

Casing

Mud Log

Vessel

Operator

Drilling

Wireline

Helicopter

Casing

Mud Log

Vessel

Operator

• Indemnity obligation from contractor X generally will not cover Company’s contractual liability to others (such as drilling contractor)

• If indemnity received by Company does not extend (or pass‐through) to those Company owes, Company’s stuck with the liability

• For every instance in which Company owes a broad reciprocal indemnity, but the underlying contract has no pass‐through provision, Company has no recourse

What Happens Without a Pass-Through Provision

Foreman v. Exxon - Contractual Situation

ExxonExxon(Indemnity)

EmployeeEmployee

Caterer Vessel(Charter)

OffshoreOffshore WirelineContractor

(Inde

mni

ty)

Diamond MDiamond M

Foreman v. Exxon - Contractual Situation

ExxonExxon(10%)(10%)

(Indemnity)

EmployeeEmployee

Caterer Vessel(Charter)

OffshoreOffshore(35%)(35%)

WirelineContractor

Diamond MDiamond M(55%)(55%)

(Inde

mni

ty)

Foreman v. Exxon - ResultExxon Exxon

(15%)(15%)(10%)(10%)

(Indemnity)

EmployeeEmployee

Caterer Vessel(Charter)

OffshoreOffshore(35%)(35%)

WirelineContractor

(Inde

mni

ty)

Diamond Diamond M M

(85%)(85%)(55%)(55%)

Foreman v. Exxon - ResultOffshoreOffshore(15%)(15%)(10%)(10%)

(Indemnity)

EmployeeEmployee

Caterer Vessel(Charter)

OffshoreOffshore(35%)(35%)

WirelineContractor

(Inde

mnity)

ExxonExxon(85%)(85%)(55%)(55%)

Wireline

Vessel –M/V Work Horse

DrillingContractor

Roughneck

OperatorBlowoutSupplier

Wireline

Vessel –M/V Work Horse

DrillingContractor

Roughneck

Operator

Wireline

Vessel –M/V Work Horse

DrillingContractor

Roughneck

Operator

DiamondDrilling

Mud Log

Helicopter

Casing

OffshoreCasing

Vessel

Exxon

COMPANY CONTRACTOR

OTHER CONTRACTORS SUBCONTRACTOR

Company

Drilling Wireline Vessel Casing Helicopter

Mud LoggingContractor

Subs, if any

Drilling

Wireline

Helicopter

Casing

Mud Logging

Vessel

Company

16 2/3 %

16 2/3 %

16 2/3 %

16 2/3 %

16 2/3 %

16 2/3 %

Drilling

Wireline

Helicopter

Casing

Mud Logging

Vessel

Company

• Indemnity obligation from contractor X generally will not cover Company’s contractual liability to others (such as drilling contractor)

• If indemnity received by Company does not extend (or pass‐through) to those Company owes, Company’s stuck with the liability

• For every instance in which Company owes a broad reciprocal indemnity, but the underlying contract has no pass‐through provision, Company has no recourse

What Happens Without a Pass-Through Provision

Diamond M(55%)

Caterer Vessel(Charter)

Offshore(35%)

WirelineContractor

Exxon(10%)

(Indemnity)

(Inde

mnity)

Employee

Foreman v. Exxon - Contractual Situation

Exxon (84.6%)Diamond M

(55%)

Caterer Vessel(Charter)

Offshore(35%)

WirelineContractor

Offshore(15.4%)

Exxon (10%)

(Indemnity)

(Inde

mnity)

Employee

Foreman v. Exxon - Result

Wireline

Vessel –M/V Work Horse

RowatanDrilling

Roughneck

Big OilBlowoutSupplier

Wireline

Vessel –M/V Work Horse

RowatanDrilling

Roughneck

Big Oil

Wireline

Vessel –M/V Work Horse

RowatanDrilling

Roughneck

Big Oil

• Waiver of subrogation

• Additional insured

• Coverage should be primary, at least for risks assumed

– see Hodgen v. Forest Oil Corp.

• Insurance requirements should dovetail with indemnity provisions

• Extend all protection to “Company Group”

• Consider using your own insurance certificate form

Basic Insurance Protections

• State that minimum limits are not a limitation or restriction on indemnity

• Comply with Texas insurance requirements if applicable

• Include critical maritime insurance extensions– Lanasse endorsement– limitation of liability endorsement

• Be aware of benefits of Getty and Marcel

Specific Insurance Pitfalls

• Texas ‐ Getty and Oryx

• Louisiana ‐ consider application of Marcel

• LHWCA ‐ insurance protection is enforceable even if indemnity is invalid under § 905(b)

Depending on Applicable Law, Insurance May Provide More Protection Than

Indemnity

• Applicable law will be critical

• Multiple laws may be potentially applicable

• Type of contract may determine risk and enforceability

• Protection available in existing contracts determines flexibility

Interplay of Indemnity, Insurance, and Applicable Law

• Maritime law ‐ indemnity and insurance generally fully enforceable

– drilling contract for jack‐up is maritime

– be aware of § 905(b) of LHWCA

• Texas, Louisiana, New Mexico, and Wyoming law –significant restrictions

Effect of Applicable Law

• Restricts indemnity and insurance• LOIA only applies to contracts relating to a well

– different analysis depending on whether onshore or offshore

• Applies to personal injury/death, not property damage• No insurance exception unless company pays contractor’s

insurance premium under Marcel v. Placid Oil Co.• Compare Amoco Prod. Co. v. Lexington and Rogers v. Samedan

Louisiana Oilfield Indemnity Act (“LOIA”)

• Applies where work is an integral part of the Company’s business or essential to Company’s ability to generate its goods or services

• Statutory employer relationship must be recognized in the contract

• Provides Company with tort immunity in return for secondary obligation to pay worker’s compensation (and Company is entitled to indemnity)

Louisiana Statutory Employer Protection

• Applies to property damage and personal injury/death

• Exceptions for indemnity supported by insurance– unilateral indemnity ($500,000)

– mutual indemnity (up to amount of insurance obtained “for the benefit of the other party as indemnitee”) – no longer required to specify equal amounts)

• Act does not apply to insurance that does not directly support the indemnity – Getty & Oryx cases

Texas Anti-Indemnity Act

• New Mexico anti‐indemnity act same scope as Texas (property and personal injury/death)

• Different as respects exceptions– no unilateral or mutual indemnity exceptions

– no effective insurance exception

New Mexico Law

• Wyoming anti‐indemnity act is similar to Texas in basic scope (property damage & personal injury/death)

• No unilateral or mutual exceptions such as Texas• Provides “shall not affect the validity of any insurance

contract” but True Oil case may negate insurance• Cases have been relatively restrictive in applying Act

insofar as requiring a relation to drilling

Wyoming

• Indemnities generally fully enforceable– except § 905(b) of LHWCA (no indemnity for a

“vessel” from employer of a longshoreman), but insurance is enforceable and there is an exception under § 905(c) for reciprocal indemnity on OCS

• Insurance protection is enforceable– but beware Lanasse

Maritime Law Restrictions

• Contract for vessel (including drilling contract on jack‐up) is maritime

• Contracts for services on a vessel may or may not be maritime

– casing contract on jack‐up rig – maritime

– wireline contract – may be non‐maritime (even on jack‐up)

Determining Applicable Law

• OCSLA applies law of adjacent state if maritime law is not applicable on its own– contracts for work on fixed platforms are governed by

state law

– TLP and a SPAR are not considered to be vessels, so OCSLA is applicable, as on a platform

• OCSLA is considered a mandatory choice of law provision; reverse is not true

Determining Applicable Law(cont’d)

• Choice of law clause generally upheld if reasonable connection unless application of chosen law would violate public policy

• Anti‐indemnity statutes are based on public policy, and choice of law clause will not be enforced contrary to anti‐indemnity statute (subject to some possible exceptions)

• Reverse is not true ‐ if Louisiana law is chosen, LOIA will apply even if provisions would have been enforceable

Choice of Law Issues

• Include pass through provision

• Avoid broad “magic” language– “floating” – IADC contracts

– sound location provision

• Beware of assuming liability for damage to the drilling rig

• Wreck removal can be important

Drilling Contracts

• Beware of broad consequential damage provisions• Commercial and other provisions may be dangerous

– uncapped exposure for paying day rate during repairs

– uncapped exposure for paying standby rate– liability for contractors hired by drilling contractor

Drilling Contracts(cont’d)

• Building block for risk allocation program

• Get a pass through provision – start a company policy

• Anticipate other contracts and potential hurdles

• Think through choice of indemnity structure

• Consider approach to consequential damages

• Learn when MSAs should not be used

MSAs

• Biggest issue may be allocation of liability for loss or damage to the work

• Insurance too expensive to be the answer every time

• Offshore policy form (WELCAR) has significant pitfalls– provides various sublimits– additional insured coverage is restricted

Construction Contracts

• WELCAR sets condition precedent– Requires QA/QC requirements in contract– Makes additional insured coverage and waiver of

subrogation dependent on compliance– Puts Company in a very precarious position

• May request amendments but have to ask• Warranty protection now even more important and

default provisions may be critical• Still need pass through provision

Construction Contracts(cont’d)

• Still need pass through provision • Vessel will try for a broad reciprocal indemnity

– creates significant risk, particularly in conjunction with MSA carve out for transportation and/or drilling contract carve out for damage to drilling rig

– consider matching carve out• Maritime endorsements are critical• Dovetailing of insurance is essential – 905(b)

Master Time Charters

• Historically largely fault‐ based; now seeking reciprocal

• Fault‐based more accurate from a risk standpoint, but won’t fit with drilling contract or other broad reciprocal indemnities

• Ideal would be to graft the two together and still require pass through protection

Flight Service Agreements

• Consider the big picture and the need for all contracts to fit together

• Understand basic rules of indemnity and insurance• Anticipate the drilling contract obligations and design a

risk allocation program accordingly• Understand the need for pass‐through protection and the

impact of different reciprocal risk allocation provisions• Company’s ability to agree to any broad reciprocal

depends on its underlying contracts

Conclusion

• Different contracts have different drivers• Company policy can help negotiations – consider setting

definition of Company Group and refusing to vary• Work arounds can be found for special situations – but

options may depend on understanding existing and future contracts

• Include your broker and let your insurance be a safety net and a possible solution

Conclusion(cont’d)

Owner Controlled Insurance Programs

An Effective Alternative?

Steve Davis

Senior Vice President

McGriff, Seibels & Williams, Inc.

ADVANTAGES• Provides broadened uniform coverages among participants

• Reduces ultimate cost by “bulk purchasing” of insurance and elimination of contractor overheads

• Ensures substantial limits

• Promotes safety by utilization of site safety programs. Safety dividends are returned to the owner and/or contractors

• Facilitates use of disadvantaged businesses

• Allows for pre‐negotiated and pre‐planned Medical Care Paths which provides prompt treatment of injured employees at an agreed rate

• May be the only alternative to contractor exclusions:i.e.. residential projects

Why Do A Wrap?

COVERAGES

Coverages typically offered in a wrap‐up program may include:

• Workers’ Compensation and Employers Liability

• Commercial General Liability

• Umbrella / Excess Liability

• Builders’ Risk

• Professional (OPPI/CPPI) Liability

• Environment or Pollution Liability

What Coverages Are Included In An OCIP?

• Worker’s Compensation and Employers’ Liability

• Commercial General Liability

• Umbrella / Excess Liability

• Builder’s Risk

• Professional

• Environmental / Pollution Liability

Owner• Worker’s Compensation and

Employers’ Liability – Offsite

• Commercial General Liability –Offsite

• Umbrella / Excess Liability –Offsite

• Automobile Liability –Certificated

• Contractor’s Equipment –Certificated

• Vendors & Suppliers –Certificated

Contractor

Are Contractors Still Required ToProvide Some Coverages?

• Term of Project – Markets are responding to longer-term projects; i.e. P3s

• State Workers’ Compensation Rates – states with high rates (e.g. Florida) would support smaller projects

• Type of Work Performed – high rate classification (Concrete, Steel) generate a greater pool of insurance costs for savings

• Project Labor Content – projects that are comprised of a large percentage of equipment installation may not generate savings necessary

• Number of Contractors – a project with fewer contractors may generate greater savings and less administrationthan average

When Should A Project Be ConsideredFor An OCIP?

The Secret to Project Success

• The selection of the project or project (s)– State

– Legal climate

– Size and Scope

– Lump Sum versus Negotiated

– Maximize time before project term

• Formal Feasibility Analysis– Cost Models

– Best Practice Loss Rate

– Economics

The Secret to Project Success

• Project Financing – Lead Lender

– Credit Ratings

• Response time on critical issues

• Claims Management & Protocols

• Integration of Builder’s Risk– Professional

The Secret to Project Success

• Contractor Selection– Cooperation / support

– Safety Management

– Loss Rates

– Best Practices

• Insurance / Service Specifications– Coverage & Terms

– Administration

– Limits

– Underwriter knowledge

The Secret to Project Success

• Systems, enrollments, data collections & reporting– Larger the project more sensitive to IT

– Longer the project more sensitive to IT

– Over $500 million

– Can make up mistakes with manual operations

• Letter of credit management & close out options

Rating Agencies 101:A Primer

Mohammed Ashab

Vice President

Signal Administration, Inc.

• Standard & Poor’s Ratings Services (“S&P”)

• Moody’s Investors Service (“Moody’s”)

• A.M. Best Company (“A.M. Best”)

• Fitch Ratings (“Fitch”)

Who Are The Major Rating Agencies?

• “… opinion on the general creditworthiness of an obligor, or the creditworthiness of an obligor with respect to a particular debtsecurity or other financial obligation.”

• Globally consistent against a standard scale

• Measure of default

• Applied to entities and securities

• Assigned in local and foreign currencies

What Is A Rating?

• A recommendation to buy or sell investments

• A way to define good or bad companies

• An audit

What Is NOT A Rating?

• Ratings are forward looking

– Medium term time horizon 3‐5 years

• Stability objective

– Ratings should not necessarily reflect market volatility

• Risk measured is probability of default

– Not trading loss or loss given default

• Financial strength ratings (FSR) measures ability of insurers to pay policyholders according to policy and contract terms

Rating Fundamentals

Rating MeaningAAA Extremely Strong

AA Very Strong

A Strong

BBB Good

BB Marginal

B Weak

CC Extremely Weak

R Regulatory Action

N.R. Not Rated

Sample S&P Rating Definitions

InvestmentGrade

Non- InvestmentGrade

• Notching (“+” or “‐”): Relative standing within major rating categories

• Outlook: Potential direction of rating over intermediate to long‐term

– “Positive”: Rating may be raised

– “Negative”: Rating may be lowered

– “Stable”: Rating is not likely to change

– “Developing”: Rating may be raised or lowered

– “N.M.”: Not meaningful

• CreditWatch: Highlights potential direction of a rating

– Positive

– Negative

– Developing

Some Rating Terminology

• Insurer sends written request for an interactive rating

– Rating agency sends agreement letter outlining terms, fees, etc.

– Insurer signs and returns letter listing primary contact

• Primary analyst assigned and coordinates through primary contact:

– Date of management meeting (usually full day)

– Format / structure of meeting(s)

– Complying with information request list

• Conduct management meeting:

– Company: Senior executives (e.g., CFO, etc.)

– S&P: At least 2 analysts plus any other specialized analysts

S&P Rating Process

• Actions taken at conclusion of management meeting:

– Primary analyst conducts detailed analysis (public and nonpublic data)

– Primary analyst presents analysis at rating committee (generally 3 weeks after management meeting)

• Rating committee:

– Consists of an odd number of experienced analysts (1 person, 1 vote)

– 8 different rating criteria scored to derive rating

– Analyzed within context of “peer group” if exists

• Rating decision:

– Communicated to company by analyst

– Key rating factors driving rating plus future expectations

S&P Rating Process

• Management & Corporate Strategy

• Competitive Position

• Operational Performance

• Capitalization

• Investments

• Liquidity

• Financial Flexibility

• Enterprise Risk Management

S&P Rating Criteria

• Assessment of “human element”

• Most subjective rating criteria

• Involves evaluating:

– Strategic positioning

– Operational effectiveness

– Financial risk tolerance

– Organization structure, management breadth and experience

• Includes Accounting & Financial Reporting analysis

Management & Corporate Strategy

• Substantially subjective assessment

• Identify sources of sustainable competitive advantage

– Allow insurer to compete more effectively vs. peers

– Improve ability to write more business or earn higher margins

• Often a precursor to satisfactory operating performance

• Involves evaluating:

– Distribution

– Market Advantages / Market Share

– Product Diversification

– Geographic Diversification

Competitive Position

• Earnings is a function of corporate strategy and competitive position

• Key driver of earnings = Profit margin on operating revenues

• Return on Revenue (ROR) vs. Return on Equity (ROE)

– ROR captures both sources of earnings (i.e., underwriting, investment)

– Evaluate earnings before tax and capital gains

– ROE can be distorted by capital structure (i.e., leverage)

• Underwriting performance important to overall operating performance

– Loss ratios, expense ratios, combined ratio, premium growth

• Competitive advantages lead to increased margins

Operating Performance

• Measured by S&P’s capital model

• Covers losses from disparate risks in excess of expected losses

– BBB: 97.2%– A: 99.4%– AA: 99.7%– AAA: 99.9%

• Risk variables stressed (e.g., assets, reserves, pricing, credit, etc.)

• Total Adjusted Capital (TAC) vs. Required capital for targeted rating

• Other important factors in assessing capital adequacy

– Reserve adequacy

– Ability to generate capital through earnings

– Potential calls on capital (i.e., parent, affiliate, subsidiary)

– Capital support (i.e., parent, affiliate, subsidiary)

Capitalization

• Assess insurer’s asset allocation strategy

– Bonds, mortgages, common stock, etc.

– Higher risk assets have higher expected returns

• Assess diversification of investment portfolio

– Review unusual concentrations (e.g., asset type, industry sector, company)

– Review existing correlations (e.g., real estate)

• Assess asset credit quality

• Interest rate risk (not a big concern for P&C companies)

Investments

• Operating cash flows

– Cash flow from underwriting

– Cash inflows (i.e., premiums) to cash outflow (i.e., losses, expenses)

• Investment portfolio

– Absolute level vs. ratio to total invested assets

– Key considerations (e.g., public vs. private, short‐term vs. long‐term, MBS (percent, duration, type), equity (percent, type, quality))

• External sources (e.g., bank credit lines, CP programs)

• Significant catastrophe exposure

Liquidity

• Capital Requirements: Factors that may result in an exceptionally large need for long‐term capital or short‐term liquidity

• Capital Sources: Ability to access an unusually large amount of short‐term and long‐term capital

– Multiple types of capital markets (e.g., long‐term public debt, CP market, etc.)

• Reinsurance

– Reinsurance leverage (e.g., NPW vs. GWP, net reserves vs. gross reserves)

– Credit quality of reinsurers

– Review Schedule F

Financial Flexibility

• Separate rating category since October 2005

• Analyze across 5 key areas:

– Risk Culture

– Risk Controls

– Emerging Risk Management

– Risk Models

– Strategic Risk Management

• Evaluated in one of 4 buckets:

– Weak

– Adequate

– Strong

– Excellent

Enterprise Risk Management

• Natural extension of sound risk management

• Increasingly important part of sound risk management

– Establish risk‐aware culture

– Use of sophisticated tools to manage (measure) risk correlations

• Foundation of any risk management framework:

– Credit Risk (e.g., counterparty credit risk)

– Market Risk (e.g., interest rate risk, investment risk)

– Underwriting Risk (e.g., pricing, reserves)

– Operational Risk (e.g., fraud, data security)

– Strategic Risk (e.g., adverse business decisions)

• What’s New: “E” in ERM

A.M. Best On ERM

• Widely recognized overseas in areas other than insurance

• Mostly rates medium to large public companies

• Income statement focus (i.e., earnings)

• ERM formal rating category; published in press releases

S&P• Highly regarded for U.S. insurance

ratings

• Rates small to large companies (public and private)

• Balance sheet focus (i.e., capital adequacy)

• ERM becoming more important and noted in press releases

A.M. Best

S&P vs. A.M. Best

• Slow to react in issuing downgrades

• Relationships with company management

• Creation of “death spiral”

• Barriers to entry

• Judgment errors in rating structured products

Criticisms of Rating Agencies

• Credit Rating Agency Reform Act of 2006

– Passed by Congress (Fall 2006)

– SEC authorized to supervise rating agencies (i.e., NRSROs)

– Promote accountability, transparency and competition

• Implementation of the Act (effective June 2007) by SEC

– Conducted 10 mo. extensive investigation of 3 rating agencies

– Adopted several rulemakings and proposals to promote Act’s objectives

In The Spotlight: Rating Agencies

• Purpose: To examine oversight of credit rating agencies

• Participants include industry leaders: investors, rating agencies, financial services associations, gov’t agencies and academics

• 4 panels formed to discuss:

– Perspective of current NRSROs: What went wrong and what corrective steps is the industry taking?

– Competition Issues: What are current barriers to entering the credit rating agency industry?

– Users’ perspectives of credit ratings

– Approaches to improve rating agency oversight

SEC Roundtable (April 15, 2009)

Thank You!

William W. PughAttorney at LawLiskow & Lewis

Drilling Contract Issues:A Contractor’s Perspective

Drilling Contracts - Indemnity

• Beware of “floating” magic language– Paragraph 501/IADC Offshore Daywork– Preamble and Subparagraph 14.13 of IADC

Onshore Daywork– Preamble and Subparagraph 19.19 of IADC

Onshore Footage– Preamble and Subparagraph 18.17 of IADC

Onshore Turnkey

501. Contractor’s Standard of Performance

Contractor shall carry out all operations hereunder on a daywork basis. For purposes hereof the term “daywork basis” means Contractor shall furnish equipment, labor, and perform services as herein provided, for a specified sum per day under the direction and supervision of Operator (inclusive of any employee, agent, consultant or subcontractor engaged by Operator to direct drilling operations). When operating on a daywork basis, Contractor shall be fully paid at the applicable rates of payment and assumes only the obligations and liabilities stated herein.

501. Contractor’s Standard of Performance (cont’d)

Except for such obligations and liabilities specifically assumed by Contractor, Operator shall be solely responsible and assumes liability for all consequences of operations by both parties while on a daywork basis, including results and all other risks or liabilities incurred in or incident to such operations, notwithstanding any breach of representation or warranty, either expressed or implied, or the negligence or fault of Contractor, its employees, subcontractors, consultants, agents or servants, including sole, concurrent or gross negligence, either active or passive, latent defects or unseaworthiness of any vessel or vessels, including the Drilling Unit, (whether or not preexisting) and any liability based on any theory of tort, breach of contract, breach of duty (whether statutory, contractual or otherwise), regulatory or statutory liability, or strict liability, including defect or ruin of premises, either latent or patent.

503. Compliance with Operator’s Instructions

Contractor shall comply with all instructions of Operator consistent with the provisions of this Contract, including, without limitation, drilling, well control and safety instructions. Suchinstructions shall, if Contractor so requires, be confirmed in writing by the authorized representative of Operator. However, Operator shall not issue any instructions which would be inconsistent with Contractor’s rules, policies or procedurespertaining to the safety of its personnel, equipment or the Drilling Unit, or require Contractor to exceed the rated capacities of Contractor’s Items or the minimum or maximum water depths or maximum well depth set forth in Appendix A.

601. Equipment and Personnel

. . . When, at Operator’s request and with Contractor’s agreement, the Contractor furnishes or subcontracts for certain items which Operator is required herein to provide, for purposes of this Contract said items or services shall be deemed to be Operator furnished items or services. Any subcontractors so hired shall be deemed to be Operator’s contractor, and Operator shall not be relieved of any of its liabilities in connection therewith. For furnishing said items and services, Operator shall reimburse Contractor its entire cost plus a handling charge as specified in Appendix A.

605. Drilling Site and Access

Notwithstanding any other provision of this Contract, should there be any obstructions, impediments, faulty bottom conditions or hazards to operations at or within the area of the drilling location, including the anchor pattern, and these obstructions, impediments, faulty bottom conditions or hazards to operations damage Contractor’s Items, or Contractor’s Items damage these obstructions or impediments, or if seabed conditions prove unsatisfactory to properly support or moor the Drilling Unit during operations hereunder, Operator will be responsible for and hold harmless and indemnify Contractor for all resulting damage, including payment of the Standby Rate during required repairs, but Operator will receive credit for any physical damage insurance proceeds received by Contractor as a result of any damage to the Drilling Unit. All expenses associated with improvements to the seabed and repositioning of the Drilling Unit at the drilling location under this Paragraph 605 shall be for Operator’s account.

901. Equipment and Property

(a) Except as specifically provided herein to the contrary, Contractor shall at all times be responsible for and hold harmless and indemnify Operator from and against damage to or loss of Contractor’s property, Contractor’s Items, and the property, equipment, material and services of Contractor’s Affiliated Companies, partnerships, and limited liability companies, and its and all of their co‐owners, partners, co‐venturers, joint owners, and its contractors and subcontractors of any tier and the officers, directors, employees, agents, assigns, representatives, managers, consultants, insurers and subrogees of each of the foregoing. Except to the extent that the proceeds from Contractor’s insurance as made available to Contractor do not compensate Contractor therefore,

901. Equipment and Property

(a)(4) Operator shall be responsible for and hold harmless and indemnify Contractor for damage to or loss of the Drilling Unit caused by Operator furnished helicopters, tugs, supply or service vessels.

905. Pollution and Contamination

Notwithstanding anything to the contrary contained herein, the responsibility for pollution or contamination shall be as follows:(a) Contractor shall be responsible for and hold harmless and indemnify Operator for control and removal of pollution or contamination which originates above the surface of the water from spills of fuels, lubricants, motor oils, normal water base drilling fluid and attendant cuttings, pipe dope, paints, solvents, ballast, bilge and garbage wholly in Contractor’s possession and control and directly associated with Contractor’s equipment and facilities. For purposes hereof the term “normal water base drilling fluid” means drilling fluid which does not exceed toxicity limits specified for offshore discharges by the environmental protection entity having jurisdiction over the Operating Area.

905. Pollution and Contamination

(b) Operator shall be responsible for and hold harmless and indemnify Contractor against all claims. demands, and causes of action of every kind and character (including control and removal of the pollutant involved) arising directly or indirectly from all pollution or contamination (including radioactive contamination), other than that described in Paragraph 905(a) above, which may occur as a result of operations hereunder, including, but not limited to, that which may result from fire, blowout, cratering, seepage or any other uncontrolled flow of oil, gas, water or other substance. as well as the use of or disposition of radioactive sources, lost circulation and fish recovery materials and fluids, oil emulsion, oil base or chemically treated drilling fluids and attendant cuttings, and drilling fluids other than “normal water base drilling fluid” defined in Paragraph 905(a) above.

906. Debris Removal and Cost of Control

Operator shall be responsible for and hold harmless and indemnify Contractor for the cost of removal of debris (including Contractor’s Items) to the extent that proceeds from Contractor’s insurance as made available to Contractor do not compensate Contractor therefor. Operator shall be responsible for and hold harmless and indemnify Contractor for the cost of regaining control of any wild well.

909. Consequential DamagesSubject to and without affecting the provisions of this Contractregarding the payment of rights and obligations of the parties or the risk of loss, release and indemnity rights and obligations of the parties, each party shall at all times be responsible for and hold harmless and indemnify the other party from and against its own special, indirect, or consequential damages, and the parties agree that special, indirect or consequential damages shall be deemed to include, without limitation, the following: loss of profit or revenue; costs and expenses resulting from business interruptions; loss or delay in production; loss of or damage to the leasehold; loss of or delay in drilling or operating rights; cost of or loss of use of property, equipment, materials and services, including without limitation those provided by contractors or subcontractors of every tier or by third parties.

909. Consequential Damages (cont’d)

Operator shall at all times be responsible for and hold harmless and indemnify Contractor from and against all claims, demands and causes of action of every kind and character in connection with such special, indirect or consequential damages suffered by Operator’s co‐owners, co‐venturers, co‐lessees, farmors, farmees, partners and joint owners.

911. Indemnity Obligations

a) The parties intend and agree that the phrase “be responsible for and hold harmless and indemnify” in Paragraphs 605, 606, 805 and 901 through 910 hereof means that the indemnifying party shall release, indemnify, hold harmless and defend (including payment of reasonable attorney’s fees and costs of litigation) the indemnified party from and against any and all claims, demands, causes of action damages, judgments and awards of any kind or character, without limit and without regard to the cause or causes thereof, including preexisting conditions, whether such conditions be patent or latent, the unseaworthiness of any vessel or vessels. breach of representation or warranty (express or implied), strict liability, tort, breach of contract, regulatory or statutory liability or the negligence of any person or persons, including that of the indemnified party, whether such negligence be sole joint or concurrent, active, passive or gross, or any other theory of legal liability.

911. Indemnity Obligations

(b) An indemnifying party’s obligations contained in this Contract shall extend to the indemnified party and its Affiliated Companies and the officers, directors, employees, agents, owners, shareholders and insurers of each and to actions against the Drilling Unit, its legal and beneficial owners, whether in rem or in personam.(c) The terms and provisions of Paragraphs 605, 606, 805 and 901 through 910 shall have no application to claims or causes ofaction asserted against Operator or Contractor which arise solely by reason of any agreement of indemnity with a person or entity not a party hereto. Nothing contained herein shall confer any rights upon any third party beneficiary.

1003. Subrogation

For liabilities assumed hereunder by Contractor, its insurance shall be endorsed to provide that the underwriters waive their right of subrogation against Operator, its Affiliated Companiesand their co‐owners, co‐venturers, co‐lessees, farmors, farmees, and joint owners and the officers, directors, stockholders, partners, managers, representatives, employees, consultants, agents, servants and insurers of each. Operator will, as well, cause its insurer to waive subrogation against Contractor and Contractor’s Affiliated Companies and their co‐owners, and the officers, directors, stockholders, partners, managers, representatives, employees, consultants, agents, servants and insurers of each for liabilities it assumes.

1004. Additional Insured

Contractor shall name Operator as additionalinsured, where permitted, under its policies of insurance, but only with respect to and to the extent of the liabilities specifically assumed by Contractor under this Contract. Operator shall name Contractor as additional insured, where permitted, under its policies of insurance, but only with respect to and to the extent of the liabilities specifically assumed by Operator under this Contract.

1005. Primary

Appendix EVI. Marine Insurance

1. Hull and Machinery Insurance (including collision liability) shall be provided for the Drilling Unit owned or chartered by Contractor and utilized in the performance of this Contract in an amount equal to the declared value of the Drilling Unit, subject to a deductible determined by Contractor.

2. Protection and Indemnity Insurance or equivalent comprehensive general liability insurance, with watercraft exclusion deleted, shall be provided with a combined single limit of U.S. $_______________ per occurrence or the value of the Drilling Unit, whichever is greater.

Interplay Between Drilling Contract, MSA and Vessel Charter

• Assume broad reciprocal in the drilling contract

• Operator will owe indemnity to the Drilling Contractor each time there is an accident involving anyone other than a member of the Drilling Contractor Group

• Be careful of carve out for damage caused by a vessel

Wireline

Vessel –M/V Work Horse

RowatanDrilling

Roughneck

Big Oil

Damage to Rig by Vessel

Broad Reciprocal in Any Contract Necessitates a “Pass Through”

Provision

• Company must have “pass‐through” provision in other contracts ‐ MSA, Vessel Charters, and Flight Service Agreements

• Always be aware of enforceability issues– Maritime Law might govern the Drilling Contract – if so,

indemnities are generally enforceable– State Law might govern the MSA; if so, the indemnity

provisions might be void based on LOIA or TOAIA

Follow Up Issues

• Get MSAs and other contracts in place

• Make sure they fit with Drilling Contract – Charter indemnity may depend on drilling

contract carve out (901(a)(4))

– If using broad reciprocal in charter, exclude liability for damage to rig up to amount of carve out

Follow Up Issues (cont’d)

• Consider Marcel provision if possible LOIA – consider how to handle Marcel issues in your

standard MSA

– if not done generally, may want to consider Marcel provision for specific vendors

• Get Risk Management Dept and broker involved in reviewing the Drilling Contract and related contracts

Onshore IADC Contracts

• Preamble – same as 501 of Offshore Daywork, but no “magic language”

• Indemnity provision (¶ 14.13, 19.19, or 18.17 in different contracts) adds “magic language”– “all releases, indemnity obligations, and liabilities assumed

by such parties under terms of this Contract, including, without limitation, Subparagraphs [force majeure, sound location, etc. and indemnity provisions] be without limit [notwithstanding breach of warranty or sole or gross negligence, or other liability of Contractor or its subs]”

Selected Commercial Terms

• Be sure that Repair Rate provision reflects parties’ intent– Operator should be sure it goes to zero at some

point– length of time is negotiable

• Be sure there is a time limit on the force majeure rate and on the standby rate (particularly if it can be triggered without fault of Operator)

Conclusion

• Drilling contracts are high risk

• IADC contracts are tricky and can have unanticipated consequences

• Critically important to understand drilling contract issues and relationship with other contracts

Open Discussion