Tuesday, March 17, 2015 Houston, TX. 3:45 5:00 p.m. THROWING MONEY DOWN A HOLE: THE INS AND OUTS OF DOWNHOLE TOOL COVERAGE AND TOOL LOSS EXTRA EXPENSE

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1 Tuesday, March 17, 2015 Houston, TX 3:45 5:00 p.m. THROWING MONEY DOWN A HOLE: THE INS AND OUTS OF DOWNHOLE TOOL COVERAGE AND TOOL LOSS EXTRA EXPENSE Presented by Steven Patrick Pat Ashcraft President Towerstone Oil and gas operations present unique risks. The value of the equipment on site is substantial, including values in specialty drilling equipment below the surface of the well. An assembly becoming stuck in the well bore is just one example of losses that can occur. Specialty coverage for downhole tools that are lost or damaged while below the surface of the well is required to respond to the loss. This session will discuss downhole tool insurance (also called lost-in-hole insurance), including the types of tools that can be covered and eligible insureds. It will also review the extent of coverage and the critical exclusions that must be addressed. Copyright 2015 International Risk Management Institute, Inc. 1

2 Notes This file is set up for duplexed printing. Therefore, there are pages that are intentionally left blank. If you print this file, we suggest that you set your printer to duplex. 2

3 Steven Patrick Pat Ashcraft President Towerstone Pat Ashcraft has specialized in the placement of insurance for the energy industry since His extensive knowledge of the oil and gas exploration and production business has enabled Towerstone to become a premier broker for the energy industry. Mr. Ashcraft also has significant knowledge of mid-stream oil and gas field operations including natural gas pipeline and transmission operations, pipeline and plant compression operations, natural gas treating, and natural gas liquids production. Mr. Ashcraft has been a Lloyds of London Coverholder for well control and property risks since Mr. Ashcraft has served as a director of the IMA Financial Group, Inc., since

4 Notes This file is set up for duplexed printing. Therefore, there are pages that are intentionally left blank. If you print this file, we suggest that you set your printer to duplex. 4

5 Insurance and Subsurface Drilling Equipment INSURING THE BOTTOM HOLE ASSEMBLY Why California Hates Us 2 5

6 History of Wireline Tools 3 Downhole Logging Tools Well logging tools are designed to record the characteristics of the various rock formations present in the wellbore. 4 6

7 Downhole Logging Tools Conrad and Marcel Schlumberger, who founded Schlumberger Limited in 1926, are considered the inventors of electric well logging. On September 5, 1927, a crew working for Schlumberger lowered an electric tool down a well in Pechelbronn, Alsace, France, creating the first well log. In modern terms, the first log was a resistivity log. 5 Downhole Logging Tools Between 1931 and 1952, Schlumberger made several important discoveries and technological tool enhancements. In 1931: the spontaneous potential, allowing loggers to distinguish between permeable oil-bearing beds and impermeable non-producing beds In 1940: the spontaneous potential dipmeter allowed the calculation of the dip and direction of the dip of a geologic layer. 6 7

8 Downhole Logging Tools Resistivity logs: measure electrical resistance Image logs: used to identify the presence and direction of rock fractures, as well as understanding the dip and direction of the stratigraphy 7 Downhole Logging Tools Porosity logs: measure percentage of pore volume in a volume of rock Gamma logs: measure the natural radioactivity of the formation, useful for distinguishing between sands and shales 8 8

9 Downhole Logging Tools Density logs: measures the bulk density of a formation and can then be used to determine porosity Sonic logs: records formation lithology and rock texture but particularly porosity 9 Downhole Logging Tools Spectral noise logging: records noise generated by fluid or gas flow through the reservoir or leaks in downhole well components Noise logging tools have been used in well integrity analysis to identify casing holes. 10 9

10 Directional Drilling Tools Logging tools were originally designed to record rock properties in vertical wellbores using wire lines. Many modern oil and gas wells are drilled directionally. At first, loggers had to run their tools somehow attached to the drill pipe if the well was not vertical. Modern techniques now integrate logging instruments into the bottom hole assembly (BHA) inside specially designed drill collars

11 A Brief History of Directional Drilling 12 Rotary Drilling Expertise in the 1920s: What Could Possibly Go Wrong? 13 11

12 Directional Drilling The realization that vertically drilled oil wells were not necessarily vertical became apparent to the oil industry in the late 1920s. There were several lawsuits alleging that wells drilled from a rig on one property had crossed the lease boundary and were penetrating a reservoir on an adjacent property. Unintended directional drilling and the resulting legal actions fueled the development of small-diameter tools capable of surveying well drift during drilling. 14 Correcting Drift Avoiding unintentional directional drilling Measuring the inclination of a wellbore (its deviation from the vertical) is comparatively simple, requiring only a pendulum. Measuring the azimuth (direction with respect to the geographic grid in which the wellbore was running from the vertical) was more difficult. Sperry Corp. developed a directional survey tool under contract to Sun Oil (which was involved in a lawsuit as described above) A spin-off company, Sperry Sun, was formed, which continues to this day as part of Halliburton

13 Directional Drilling Unplanned directional drilling with rotary rigs led to understanding the configuration of drilling equipment downhole (BHA) that would be prone to drilling a crooked hole (i.e., initial accidental deviations from the vertical would be increased). Adjustments to the BHA design to correct drift also created counterexperience, giving early directional drillers principles of BHA design and drilling practices necessary for planned directional drilling operations

14 Directional Drilling Finds Purpose Disaster in 1933 at a giant Humble Oil field near Conroe, Texas 17 Directional Drilling Finds Purpose In January 1933, Standard Oil of Kansas s Madeley No. 1 near Conroe, Texas, blew in as a gusher and immediately erupted into flame. The runaway well cratered, completely swallowing nearby drilling rigs. All attempts to put out the fire with dynamite blasts and tons of dirt failed. The crater spread into a growing lake of burning oil, and the entire field was threatened

15 Directional Drilling Finds Purpose In an effort to choke off the unrestricted flow of oil into the crater, Humble Oil brought in H. (Harlan) John Eastman from Eastman Oil Well Survey Company of Long Beach, California. The growing dimensions of the oil-filled lake meant that the relief well would have to be spudded 400-feet distant and the borehole deviated deep underground to reach the crater s source. 19 Directional Drilling Finds Purpose H. John Eastman is recognized as the father of directional drilling and surveying in the United States. Eastman Whipstock, Inc., would become the world s largest directional company in

16 Directional Drilling Finds Purpose Drilling of the relief well began on November 12, At 1,400 feet, Eastman began his efforts to redirect the borehole. The Conroe Courier kept careful track of the relief well, reporting its progress. December 8: Killer Well Now Drilling At 2,760 Feet. December 29: Conroe Relief Hole Drilling Now At 4,870. On January 7, 1934, Eastman s directional drilling successfully reached its target. Four steam-powered pumps began forcing thousands of tons of water into the well under 1,400 psi pressure. After 2 days, the erupting oil flow was finally controlled. 21 Directional Drilling with Purpose Today, wells are drilled directionally for several purposes: Increasing the exposed section length through the reservoir Drilling into the reservoir where vertical access is difficult or not possible. Pad drilling, allowing more wellheads to be grouped together on one surface location can allow fewer rig moves, allow less surface area disturbance, and make it easier and cheaper to complete and produce the wells

17 Directional Drilling with Purpose Wells are drilled directionally for several purposes: Drilling along the underside of a reservoir-constraining fault allows multiple productive sands to be completed at the highest stratigraphic points. Drilling a relief well to relieve the pressure of a well producing without restraint (a blowout ) 23 Horizontal Drilling and Logging Tool Technology Today 24 17

18 The US Shale Revolution Horizontal drilling and hydraulic multi-stage fracturing technology pioneered in the Barnett Shale created the shale revolution in the United States

19 Horizontal Drilling Today 26 The US Shale Revolution Before the oil market collapse in 2014, according to the Baker Hughes report dated October 24, 2014, there were 1,927 rigs active in the United States on that date, and, of those, 1,566 (over 80%) were engaged in directional or horizontal drilling

20 Horizontal Drilling and Logging Tools Today, most unconventional oil and gas wells are drilled horizontally. Modern logging tools are designed to become part of the BHA and inserted into special drilling collars near the bit. Today s technology permits real-time capture of logging data (LWD) and drilling dynamics (MWD). MWD and LWD tools use mud pulse technology to transmit data from the tools on the bottom of the drill string to the processors at the surface. 28 Horizontal Drilling and Logging Tools In horizontal drilling operations, the BHA can include one or more of the following: Mud motors or rotary steerable systems Custom drill collars Bottom hole orientation subs Stabilizers Extra heavy and wired drill pipe Telemetry electronic, pulse, and repeater communication tools PWD and MWD tools LWD tools (gamma and acoustic logging tools measuring porosity, permeability, etc.) Magnetic ranging (to prevent intersection with other wellbores on multi-well pads) Jars, reamers, screens, etc

21 BHA Components 30 Combining horizontal drilling tools with logging while drilling tools and a host of measurement while drilling and pressure while drilling tools 31 21

22 Logging and Measurement Tools 32 Loaded into Drill Collars 33 22

23 BHA Values The tool values can range from $100,000 to more than $2 million, depending on the number and type of tools in the assembly. All of these tools make drilling more efficient, reducing drilling costs, maximizing oil and gas recovery on each well, and driving profits to operators. 34 Tool Loss and Extra Expense Losing a BHA is more costly to operators than the loss of the tools. It is one of the most costly unplanned drilling events that can occur for an operator

24 Tool Loss and Extra Expense Non-productive rig time (working pipe/jarring to free pipe, locating stuck point/severing or backing off pipe) Fishing pipe Cementing Setting a Whipstock and mill window in casing Cost of lost drill pipe Redrilling the lost section Cost of BHA components Other sidetrack complications 36 Tool Loss and Extra Expense Preventing extra expense resulting from stuck pipe and loss of tools aligns the operator and the downhole tool underwriter s interests. The technology available via MWD and LWD technology can reduce stuck pipe events and the loss of downhole tools

25 Causes of In-Hole Tool Loss It is often said that it is not a matter of if but when a tool will be lost. The mechanisms that cause stuck pipe events can be broken into three main categories: differential sticking (pressure transitions); hole cleaning; and mechanical/wellbore geometry-related issues. 38 Managing Risk As mentioned earlier, technology can improve the risk of downhole tool loss. Real-time MWD, LWD, and PWD tools can be used as early warning systems and allow drillers to adjust mud weights, casing points, and other drilling metrics to reduce the stuck pipe events

26 Managing Risk MWD/PWD sensors also detect weight and torque on bit, the level and duration of downhole shocks and vibration, and the bit stick/slip measurements indicating BHA whirl. The driller can then adjust weight and torque on bit, pick up the string and allow string torque to unwind, or adjust surface RPM, minimizing drill string fatigue, avoiding premature trips for failure, and again preventing stuck also making drilling more efficient. 40 Managing Risk Annular pressure while drilling (APWD) sensors provide real-time measurement of cuttings buildup, barite sag, lack of rotation, or poor hydraulics that lead to stuck pipe, allowing drillers to take remedial action. Near bit APWD sensors can also detect fluid losses or gains in real time (indicating kicks or loss of circulation issues) before they appear at the surface, creating better well control

27 Managing Risk Some operators have seen a dramatic reduction in the number of stuck pipe events with the use of rotary steering systems (RSS). These systems drill a smoother, less tortuous well path by eliminating spiraling boreholes and micro-doglegs (wellbore geometry issues) that are associated with mud motor slide drilling. RSS are also linked to better hole cleaning due to additional lifting capacity created by continuous rotation of the drill string. 42 Managing Risk Retrievable tools, sometime known as slim tools, can be retrieved and replaced using wireline through the drill string if the drill string becomes stuck. While these tools are small (about 2 in diameter) in order to fit through the drill string, their length may be 20 or more. However, retrieveable tools generally can not be retrieved if the drilling angle exceeds 30 degrees from vertical

28 Insuring Subsurface Tools and Drilling Equipment 44 Insurance for Downhole Tools There is a limited insurance market for damaged or lost subsurface tools. Primary downhole tool underwriters offer maximum limits of only $600,000. Operators are usually liable under directional drilling services contracts for loss of or damage to subsurface tools, regardless of fault. Most lost-in-hole coverage is sold through directional drilling contractor programs

29 Insurance for Downhole Tools Deductibles under contractor insurance sometimes are 50 60% of tool value. Not all tools in the BHA are insured, only those specifically scheduled. Fishing costs to recover stuck tools is not covered. Only the tools are covered and none of the extra expenses related to a stuck pipe event. 46 Responsibility for Loss of Downhole Tools Operators are contractually liable under directional drilling services contracts for loss of or damage to subsurface tools, regardless of fault

30 General Liability and Insurance for Downhole Tools Contractual assumption of risk without regard to fault or negligence General liability pays the insured s legal or contractual liability for damage to property of others. Is there coverage for lost-in-hole tools? Doubtful. An insured contract is defined as one where the insured assumes the liability of another for injury or damage to a third party, not for damage to the property of the other party to the contract. 48 General Liability and Insurance for Downhole Tools Contractual assumption of risk without regard to fault or negligence In the absence of the contract, would the insured have coverage for its negligence resulting in loss of tools? Yes. Subject to the care, control, custody (CCC) exclusion (generally modified by the UR&E endorsement). The modified CCC still excludes Property you own, rent, or occupy, including any costs or expenses incurred by you, or any other person, organization or entity, for repair, replacement, enhancement, restoration or maintenance of such property for any reason, including prevention of injury to a person or damage to another s property

31 General Liability and Insurance for Downhole Tools Contractual assumption of risk without regard to fault or negligence What if I did not rent the tools but hired the contractor who provided the tools? Then you are back to your own negligence and that of others (such as the drilling contractor) that you assumed under an insured contract. There is still no coverage for assumed sole or concurrent negligence of the tool owner or in the absence of negligence of the insured. 50 General Liability and Insurance for Downhole Tools Contractual assumption of risk without regard to fault or negligence: legal defenses The Texas oil field anti-indemnity statute makes assumptions of sole or concurrent negligence of others for property damage unenforceable in Texas. There is an exception for unilateral assumption of sole or concurrent negligence of others if supported by insurance but not exceeding $500,000 and the exception APPLIES ONLY TO BODILY INJURY TO INDEMNITORS EMPLOYEES. The anti-indemnity statute does not apply to property damage caused by radioactivity, pollution, reservoir, or underground damage, including the wellbore itself

32 Insurance for Downhole Tools Contractual assumption of risk without regard to fault or negligence: other insurance Well control policies with CCC endorsement provide limited downhole tool coverage resulting from loss of well control or following damage to surface equipment. Drilling rig property coverage generally covers the contractor s own drill pipe and only for certain named perils. Stuck pipe or tools of others are generally assumed by the operator. 52 Insurance for Downhole Tools Damage to property (CCC exclusion) Property damage to: (1) Property you own, rent, or occupy, including any costs or expenses incurred by you, or any other person, organization or entity, for repair, replacement, enhancement, restoration or maintenance of such property for any reason, including prevention of injury to a person or damage to another s property; (2) Premises you sell, give away or abandon, if the property damage arises out of any part of those premises; (3) Property loaned to you; (4) Personal property in the care, custody or control of the insured; (5) That particular part of real property on which you or any contractors or subcontractors working directly or indirectly on your behalf are performing operations, if the property damage arises out of those operations; or (6) That particular part of any property that must be restored, repaired or replaced because your work was incorrectly performed on it

33 Contractor Insurance for Downhole Tools Often, the directional drilling contractor will establish a replacement cost value of its equipment in its contract and offer a limited liability (lost-in-hole) option at an additional daily charge. If you do not take the contractor s lost-in-hole option, in the event the tool becomes stuck, it will bill you for the preset tool value. 54 Contractor Insurance for Downhole Tools If you pay the additional day rate and buy the contractor s lost-in-hole limitation, your liability is limited to the large deductible amount (50 60% of the tool value shown on the contractor s lost-in-hole program schedule). Tools that become stuck can be recovered but may be damaged during the recovery process. While the in-hole tool values are established and agreed in the event of total loss, partial losses within the lost-in-hole deductible can be difficult and contentious to adjust

34 Advantages of Specific Downhole Tool Insurance Rather than pay the contractor day rate for limited liability, it might be advantageous to buy downhole tool coverage from specialist downhole tool underwriters. They can structure coverage to mirror the contractor s lost-in-hole program limits and deductibles and offer competitive day rates, subject to underwriting. Alternately, they can provide a deductible buy-down under contractor lost-in-hole programs. They can also create individual policy deductibles and limits to match risk appetite and provide certainty and consistent coverage across multiple contractors. 56 Advantages of Specific Downhole Tool Insurance Rather than pay the contractor day rate for limited liability, it might be advantageous to buy downhole tool coverage from specialist downhole tool underwriters. They can differentiate risk based on the use of technology, continuity of equipment and crews, and repeatable well plans/bhas across a number of fields and contractors. While scheduled in-hole tools are insured on an agreed value for total loss (the owner or contractor s stipulated replacement cost), partial losses can be difficult to adjust. Inserting an insurance adjuster into the value discussion takes the insured out of this contentious arena and avoids confrontations with contractors over the amount of loss/liability

35 Selling In-Hole Tool Insurance Three potential clients: operators, tool rental companies, and directional drilling contractors 58 Selling In-Hole Tool Insurance to Contractors Contractors might want the coverage either for their own protection or to mitigate fault issues and credit risk if a tool is damaged or lost in hole. They can typically pass the cost and any deductible along to the operator, and in the event of a loss, they can turn the adjustment process over to an independent adjuster

36 Selling In-Hole Tool Insurance to Contractors Typically, the operator s risk management and insurance departments do not know that downhole tool insurance or the lost-in-hole limitation is being purchased. It is done at the operational level or well planning level by well planners and drilling supervisors based on their risk appetite for authority for expenditure (AFE) cost overruns. You need to get the well planning and drilling supervisors in the room to sell this. Insurance and risk managers will likely say, We can retain this exposure, but well planners often want more certainty in hitting expense budgets. They may even have bonuses riding on bringing in wells on budget. 60 Selling In-Hole Tool Insurance to Operators It is also easy for a well planner to justify $1,500 a day for lost-in-hole coverage on an $11 million AFE. If included in the AFE, the $10,000 or $20,000 cost of downhole tool insurance or lost-in-hole limitation barely moves the overall cost needle. So it s not a matter of getting the operator to buy the coverage (it is already buying for certain BHA values at the well planning and drilling supervisor level). You just have to demonstrate that there is a better and more efficient way of doing it. If an operator is buying lost-in-hole coverage, it can also use insurance as a deductible buy-down

37 Specialty Downhole Tool Insurance COMMON TERMS AND CONDITIONS All Risk of Physical Loss or Damage to: Scheduled Specialty Drilling Equipment either: Owned/used by the Assured or In the Assured s Care, Custody and Control While located below the rotary table 62 Specialty Downhole Tool Insurance COMMON EXCLUSIONS Equipment not scheduled or out of hole Infidelity or any dishonest acts Loss of hole or interruption of business Fishing costs Any fines, penalties, or punitive damages Wear and tear, inherent vice, latent defect, gradual depreciation or deterioration, corrosion, rust, dampness of atmosphere, freezing, or extremes of temperature Other insurance (such as well control) 63 37

38 Specialty Downhole Tool Insurance UNDERWRITING INFORMATION Well location Geological information and knowledge Formation pressures and mud program Pressure gradient Casing program Contractor s capabilities Operator s experience in the play Schedule of the BHA tools and values 64 38