Petro United: Managing Geo-Political and Regulatory Risks

Executive Summary

University- Indian Institute of Management, Indore

Team Members:

Abhishek Pai

Keerthan G

K. Pradeep Rajagopal

Geo-political risk and Regulatory risk framework

We have developed a scorecard to assess the opportunity for fresh investment and continuance of

operations in a particular country. The parameters on which a country would be rated are:-

1) Potential Oil Reserves in that country. Countries with over 100 bbl reserves would assigned

score of 10, 10-100 bbl assigned score of 7, 1-10 bbl would be assigned a score of 5 and <1

bbl would be assigned a score of 3

2) Geo Political risk associated with that country:- This will be due to regime changes, internal

political turmoil, hydrocarbon endowment factors, Government’s ability to attract foreign

investment, political & Legal environment for pursuing Business in that country. Each

country would then be banded as having High, Medium and Low Geo-Political Risk. The

scores for High, Medium and Low risks would be 2, 5 and 10 respectively.

The oil reserves and the Geo Political risks for the MENA countries have been tabulated below:-

Country Reserves(bbl)(Wt 0.4)

Geo-Political

Risk(0.3)

Score

Saudi Arabia 265.4

7

Iran 151.2

4.6

Iraq 143.1

5.5

United Arab

Emirates 136.7

7

Kuwait 101.5

7

Libya 47

3.4

Qatar 25.41

5.8

Algeria 13.42

5.8

Azerbaijan 7

5

Sudan 6.8

5

Oman 4.978

2.6

Egypt 4.4

2.6

Yemen 3.3

3.5

Syria 2.5

2.6

Tunisia 0.425

1.8

Turkey 0.3

4.2

Bahrain 0.125

1.8

Georgia 0.035

4.2

Israel 0.002

2.7

Morocco 0.00075

4.2

Jordan 0.0001

1.8

Palestine 0

0

Lebanon 0

0

Western Sahara 0

0

Somalia 0

0

Armenia 0

0

Cyprus 0

0

Djibouti 0

0

Red signifies high Geo Political Risk. The factors contributing to High Geo Political Risk are internal

turmoil, Regime Changes, Coup or a Government being overthrown, Armed Conflicts, Dictatorial

Government, Hegemony etc.

Factors contributing to medium Political Risk (Amber) would be partial regime changes, Minor

agitations against Government, Coalition Governments where minority parties are against exploitation

of Oil resources etc.

Green Signifies relatively stable Government, Favourable Conditions for doing Business and few

conflicts or uprisings.

It is to be noted that the Geo Political Scenario in a sensitive region like MENA can change very

quickly. It is therefore recommended to take stock of the situation once every 3 months and update the

risk profile of the country.

For the purpose of simplicity, we have divided the potential oil reserves into 4 bands and the risk

profile of countries into three categories. The scorecard allows for increase or decrease in the number

of bands considered.

The Geo-Political risk transition to high, medium or low can be measured by putting it in the

following Framework.

Libya for example, is undergoing a transition. Even though it is shown as high risk in the analysis,

once the newly elected government puts a constituent assembly in place for the democracy of Libya, it

is likely to turn to green. However, reports coming out of Libya suggest a military coup headed by Al-

Rahel threatening to capture eastern Libya where most of the oil fields rest. Similarly Yemen, Egypt

and Tunisia are moving towards red from their previously green status in terms of Geo-Political risk.

Some of the mitigation techniques against the political and geo-political risks can be:-

1) To protect against "creeping nationalization" under which a host government by legislation or

regulation may unilaterally change the terms and conditions of a petroleum agreement to the detriment of the oil company, companies should negotiate stabilization or equilibrium clauses

in their agreements. Such clauses provide that if the fiscal or economic benefits of the

agreement are adversely affected by unilateral legislation or regulation of the government, the

parties shall adjust the fiscal and contractual benefits of the agreement to give the companies

the same benefits of the agreement in the absence of the unilateral action by the government. 2) To protect against the risk of unilateral change, a company should provide that its agreement

with the government or state company must be promulgated as the law of the country by

appropriate and effective legislation or decree.

3) To protect against the risk of currency controls, a company should provide that there be no restrictions with respect to currency and financial transactions. The company should provide

that it may freely export and import funds resulting from operations in the country. The

company should also have the right to convert payments and cash flow into convertible currencies at market rates and should not be compelled to keep funds in local currencies.

4) To protect against the risk of partiality in a local tribunal, the company should provide for

international arbitration in the event of a dispute or disagreement with the government under their agreement. The arbitration provision should be "self-executing" so that the conduct of

either party will not frustrate the arbitration process. Self-executing arbitration mechanisms

can be provided by institutional arbitration - the AAA (American Arbitration Association),

ICC (International Chamber of Commerce), the World Bank's ICSID (International Center for the Settlement of Investment Disputes) and others. To provide for impartiality, the place of

arbitration and the arbitrators should be of a neutral country. The decision of the arbitrators

should be final and be given full effect by a court of appropriate jurisdiction. 5) With respect to the risk of the applicable law being only the law of the host country, a

company should provide for international law, regulations, traditions and customs applicable

to international oil and gas ventures between a company and a government to also be applicable.

6) With respect to exploration and production licenses from a host country, a company must take

special care that there are no boundary disputes between adjoining or adjacent countries.

7) In the event a company is interested in drilling rights in areas where there are boundary disputes, the company should not assume the political risk of accepting a license until the

countries involved resolve their differences themselves in direct negotiations or resolve them

at the International Court of Justice or other tribunal before a company undertakes a drilling and seismic program. Otherwise, the political risks in drilling in disputed territory are too

high to accept.

8) A company in its dealing with domestic political issues must exercise not just a common

degree of due diligence but a high, even an extraordinary, degree of due diligence in dealing with political risks. Due diligence to lessen political risks would require an in-depth

knowledge of the host country's laws, culture, traditions, religion and history, particularly in

relation to the international oil and gas industry in its conduct of oil and gas operations in the country. Sensitivity to a country's historical influences would be important for an oil

company.

9) One of the rules of international exploration seems to be that the most prospective oil and gas reserves are in countries of high political risk. One must be careful not to invest too heavily in

a single country or region with high political risk. The political risks may be too great. A

company should diversify its exploration efforts - consistent with its strategic planning - to

provide against inordinate concentration in a particular country or region.

There is no absolute certainty that risk mitigation strategies will be effective. They must be reviewed

constantly and adjusted to meet changing circumstances. It is inevitable that there will be changes in

international risk scenarios and careful attention to such changes will result in maximum ability for

effective response.

Regulatory Risks: - Regulatory Risks can be classified into Financial Regulations, environmental and

political regulations.

a. Financial regulations like Dodd-Frank, restrictions imposed due to Euro zone crisis, exchange

rate and futures trading and compliance related regulations are likely to impact all MENA

countries in the same way.

b. Environmental regulations are those related to emissions, oil spills, shale gas exploration and

shift towards renewable sources.

c. Social and political regulations cover those related to labour working standards, wage related

regulations, UK anti-Bribery law, GOP Energy Bill and any regulations imposed by the host

country where Petro United is operating in.

The framework for capturing regulations related risks has been described below:-

We have plotted the regulations in a 2X2 matrix. The matrix used is a slightly modified version of one

used by the Australian Tax office in its operating strategy. The dimensions of the matrix are

Likelihood of Event occurring and Consequence of non-compliance. Then each regulation is plotted

on the graph based on the parameters. The mitigation strategy for each regulation is based on the

quadrant in which it is located and is given in the box in each quadrant. Also, it should be noted that

the consequence should not be measured purely in monetary terms but should also include other

qualitative factors as well.

The details of how to make the framework operational and how to deal with specific Financial,

Environment and Socio-Political Regulations will be provided once more details on specific

challenges faced by Petro United are provided.

Appendix/References

Standard and Poor Ratings have been factored while determining band for Geo-Political risk.

A supplement on political risk mitigation strategies to the IPAA International Primer by

Alfred Boulas.

Gartner, Forrester, Data Monitor and IDC reports to get data on Oil Reserves and various

Regulatory Risks.