The US shale boom remains in full force. As a result, profit margins for making ethylene and polyethylene plastics from natural gas liquids such asethane and propane have dramatically improved. This cost advantage has led companies manufacturing chemicals, plastics, fertilizer, diesel fuel an liquefied natural gas to consider $100 billion in projects through 2020 to take advantage of the economic feed stocks flowing from this boom. Developers of these petrochemical projects are undoubtedly well on their way to finalizing their EPC Contracts, and will ultimately turn to the other contracts necessary for these projects—including supply contracts, procurement contracts, energy contracts, and other utility contracts. Whether the project is the expansion of an existing facility or a greenfield project, contracts will either need to be amended to account for expanded operations or created for the first time.
Part of this process includes planning for the unexpected—such as a supply disruption or equipment malfunction at the facility itself or at the facility of a critical supplier—and how to structure these contract sand a company’s business interruption insurance to protect the bottom line when the unexpected occurs. Such insurance includes contingent business insurance, or CBI, which provides coverage for lost revenues when business is interrupted due to property damage that occurs away from the insured’s premises and disrupts the movement of goods or services from/to a supplier or customer (referred to as “dependent” or “contributory” properties). A recent court decision—issued in February 2014 by the U.S. Fourth Circuit Court of Appeals—highlights the importance of matching the insurance policy to the petrochemical plant’s actual operations.
Millennium owned and operated a plant that processed titanium dioxide in Western Australia. This plant’s primary energy source was natural gas received through Western Australia’s principal gas transmission pipeline. Millennium contracted with and purchased the natural gas from Alinta, a retail gas supplier, who in turn bought the gas from a number of natural gas producers, one of which was Apache.
In June 2008, an explosion occurred at Apache’s gas facility off the coast of Western Australia, causing its natural gas production to cease. The shutdown of gas production resulted in Millennium’s gas supply being curtailed, causing the plant to shutdown for several months.
Two days after the explosion, Millennium sought business interruption coverage under its two commercial coverage policies for its losses incurred when the titanium facility was closed. While both policies included CBI coverage, neither policy provided any coverage for “indirect” suppliers. Rather, the policies provided coverage only for “direct contribution or recipient property(ies).” After investigating Millennium’s claim, both insurers denied coverage on the basis that Apache was not a direct supplier to Millennium.
The coverage dispute proceeded in US federal court. Before the district court, Millennium won on the coverage issue and was awarded over $10 million. The appellate court, however, reversed and found no coverage for Millennium’s claim, reasoning that:
1. For Apache to be a direct contributing property, it must have supplied Millennium with materials necessary to operating Millennium’s business “without deviation or interruption” from an intermediary;
2. Because Millennium received its natural gas from Alinta and because Alinta exercised
the sole ability to control the amount of gas directed to Millennium and the rate at which Millennium would be charged, Apache could not be considered a “direct contributing party” of Millennium;
3. Apache did not own or operate the pipeline a tissue and relinquished legal title and physical control of the gas once it entered the pipeline and comingled with gas from other sources;
4. No direct physical or contractual relationship existed between Apache and Millennium; and
5. Millennium did not list the Apache facility as a “contributing property” on the schedules attached to the policies.
The Millennium case shows the importance of accessing whether the policy matches actual operations, and the current expansions and new projects provide an appropriate time to ensure that expectations will be met when the unexpected happen. Practical considerations when soliciting or renewing business interruption insurance include:
1. Understand the supply chain for necessary feeds and utilities and the risks to those supply chains
2. Consider whether the business requires coverage only for “direct suppliers/customers,” or should it also include “indirect suppliers/customers”
3. Make certain to list the “contributing properties” in the schedules to the policies—both to ensure coverage and because the amount of coverage for listed properties is often higher than for unlisted properties
4. Include a choice-of-law provision in the policy and that the selected jurisdiction’s law actually provides for the coverage sought. In these exciting times, it is natural to focus on the growing opportunities. But, some attention to potential risks and preparing for them will protect the bottom line and avoid dissatisfaction with unmet expectations.