Editor’s Note: Beginning next week, The Energy Letter’s production schedule will change; the ezine will now delivered to your inbox every Monday.

Even with the constant media coverage and live video feeds oil slick spreading across the Gulf of Mexico, the magnitude of the Macondo disaster is astounding. According to estimates from the Insurance Information Institute, the BP (NYSE: BP) oil spill has eclipsed the IXTOC-1 debacle (see Macondo and $100 Oil) as the biggest oil spill in North American history.

Elliott H. Gue covered the liability issues of the well owners and associated services firms in The Energy Strategist shortly after news of the disaster struck and has continued to analyze the latest market-moving developments and their implications in each subsequent issue, identifying the energy patch’s likely winners and losers along the way.

But in today’s complex and interconnected world a disaster of this size has meaningful implications for a wide range of satellite industries and businesses. This week’s installment of The Energy Letter will focus on the insurance and reinsurance markets.

Here’s a quick summary of what promises to be a hornet’s nest of profitability for the current and next generation of legal eagles.  

Liability: A Thorny Issue

At this point, it’s abundantly clear that BP, as the well’s operator, will shoulder much of the burden for cleaning up the spill and paying claims to individuals and businesses impacted by the blowout at its Macondo Well.

As of this writing, BP has spent $3.95 billion on clean-up and containment and paid out $207 million on more than 33,000 claims. The UK energy giant has also established a $20 billion escrow fund to pay out legitimate damage claims. Regulatory fines and a criminal investigation likewise loom on the horizon.

Naturally, BP and the other companies involved are jockeying to reduce their financial exposure, pointing figures at one another and seeking to shift as much of the onus as possible to the insurance industry.

BP CEO Tony Hayward has made it abundantly clear that the company wasn’t solely responsible for the disaster and has filed suit to extend rig owner Transocean’s (NYSE: RIG) liability to the pollution streaming from the well itself, attempting to extract additional money from the firm’s insurers.

Meanwhile, Anadarko Petroleum Corp (NYSE: APC), a 25 percent stakeholder in the joint venture, has asserted the opposite, publicly suggesting that BP’s gross negligence should make it solely liable for the spill.

Given the complexity of assigning liability, this drama should have a long run. And a host of individual lawsuits from businesses, environmentalists and individuals should also muddy the waters for the producers, services and equipment firms involved.

Insured Returns?

What are the implications of the oil spill for the insurance and reinsurance industries? Although the spill will challenge the 1988 Piper Alpha tragedy as the most costly property-damage case in the hydrocarbon patch, losses won’t submarine insurers and reinsurers; the industry boasts ample capital levels and loss exposure is spread across a wide range of operators.

For one, BP has opted for self-insurance since the mid-1990s; its captive insurance unit, Jupiter Insurance, has $6 billion in capital but its coverage is limited to $700 million for physical damage and business interruption–the firm isn’t on the hook for clean-up costs. This is bad news for BP and its shareholders but spared insurers and reinsurers loads of pain.

Going forward, energy insurers should enjoy higher premiums as operators seek to bulk up coverage, and models price in substantial risks. A widely cited research report from Moody’s indicated that premiums for property coverage were up 15 to 25 percent on shallow-water rigs and 50 percent on deepwater rigs, while many in the industry regard the BP spill as a game-changing event.

That being said, capacity in the energy-insurance space was at a 10-year high at the end of the first quarter; insurers have flocked to the space now that higher oil prices have given producers the confidence to begin investing in new projects. And last year this niche proved quite profitable in the US, as hurricane season was relatively tame.

But higher capacity tends to heighten competition and depress rates; questions remain about the long-term sustainability of this increase in premiums. In fact, prior to the BP oil spill, premiums had declined 15 percent from a year ago.

Investors seeking to profit from higher premiums on offshore operations might consider UK outfit Lancashire Holdings (LSE: LRE), a niche insurer that offers leverage to the energy space, boasts a conservative investment portfolio and has a history of sound underwriting. In its second-quarter investor report, management noted that its exposure to the deepwater spill was limited to only a month’s worth of earnings.

Going forward, an active hurricane season in the Gulf of Mexico could drive insurers from the space, a development that would increase premiums further. Legislation under consideration in Congress would increase producers’ potential exposure to spill-related damages from $75 million to $10 billion; if such a proposal were to pass, only large self-insured players–the BPs of the world–could afford to drill in the deepwater Gulf of Mexico.

A Profitable Discussion

One of Editor Elliott H. Gue’s favorite features on The Energy Strategist’s newly designed website is a live chat function that enables him to interact directly with subscribers to address their questions about energy markets and specific stocks. The last session lasted two hours and attracted almost 200 attendees. The next chat is scheduled for Wednesday, July 28 and will focus on second-quarter earnings. Don’t miss out–sign up for a free trial of The Energy Strategist.