the top 10 risks for oil and gas

8/8/2019 The Top 10 Risks for Oil and Gas

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The Ernst & Young Business Risk Report 2010

The top 10 risks

for oil and gas


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About this reportThe Ernst & Young Business Risk Report 2010 has been structured to help todays busyexecutives nd the information they need as ef ciently as possible. We have summarizedour list of top risks with a tight focus on key issues and high-level developments. Togetherwith Oxford Analytica, we have also updated our popular Ernst & Young risk radar,providing an at-a-glance assessment of the top 10 industry risks and their relativeimportance in 2010.

In addition, readers can move directly to a more granular discussion of risks accordingto the following industry subsectors:

Upstream exploration and production (E&P) by integrated oil companies (IOCs),independents and national oil companies (NOCs)

Midstream gathering, eld processing, transportation and storage Downstream re ning and marketing

Oil eld services (OFS) including service companies and the supply chain

This information can support a variety of risk management initiatives designed tohelp companies:

Identify both upside and downside risks

Encourage new insights and out-of-the-box thinking

Prioritize issues to coordinate risk management at the enterprise level

Mitigate risks with a practical approach based on leading practices

Support strategic planning with a broad-based understanding of current industry issues

Sometimes thedifference between a risk and an opportunityis the right informationat the right time.


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1The Ernst & Young Business Risk Report 2010 The top 10 risks for oil and gas

Introduction 2

The Ernst & Young business risk radar 3

The top 10 risks for oil and gas 4

Below the radar 11

Key risks by subsector: 12

Upstream risks 13

Uncertain energy policy: the implications of the Gulf of Mexico spill for offshore drilling 15

Midstream risks 16

Downstream risks 17

Oil eld services risks 19

Contents


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The Ernst & Young Business Risk Report 2010 The top 10 risks for oil and gas2

Introduction

Last years underlying theme of managing risk in uncertain timesremains valid as the oil and gas industry is still recovering from thegreatest global economic shock in more than 75 years. While a moodof cautious optimism has emerged, economic uncertainty remains. Likethe aftershocks following a major earthquake, nancial jolts and marketworries will continue to impact a global economy recovering from theworst downturn since the Great Depression.

The global economy remains in a fragile state and additional stress is anticipated becauseof slow job growth, continued deleveraging and the struggle of riskier currencies. Theemerging Asian economies have been slowed by the global recession, and the developedeconomies the US and Europe in particular continue to struggle. Most analysts predicta dif cult and uneven road toward recovery, and a full return to economic strength is notexpected until 2011 or even later.

Oil and gas companies have not been impervious to the existing economic climate, whichhas been the backdrop for the risks noted in our report for this year, nearly all of which arelong-term in nature. However, their relative importance will uctuate each year based oncurrent economic and market conditions. In fact, the challenges to the industry that wereidenti ed in our previous reports are largely still in place. Uncertain energy policy is atthe top of the risk radar this year, not surprisingly, given that regulatory uncertainty has

been top-of-mind for many oil and gas companies during 2010. The Gulf of Mexico spill hasexacerbated this sentiment.

The oil and gas industry can expect a renewed and expanded regulatory focus on safetyand environmental risk preparedness and mitigation. The industry must remain evervigilant with respect to these and other risks it faces, and must re-examine them both froma current portfolio perspective and a future investment perspective. In light of corporatesocial responsibilities and the economic and regulatory pressures the industry is exposedto, it has become increasingly clear that managing these risks is vital, not only to short-term pro tability, but also to long-term sustainability for oil and gas companies.Accordingly, this report also outlines how we believe these risks can be mitigated throughimproved capital management, investments in technology, nancial and operationalprocesses and other strategies.

As you read the following pages, we hope that you will nd our report and shared insightsuseful, and that these will serve as a catalyst for the further development of your own riskidenti cation and mitigation strategies.


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The Ernst & Youngbusiness risk radar

The Ernst & Young risk radar is a simple device that allows us to present asnapshot of the top 10 business risks for a company or an industry.

The risks at the center of the radar are those that the analysts we interviewed thoughtwould pose the greatest challenge to the leading global companies in the oil and gasindustry in the year ahead.

The radar is divided into four sections: nancial, compliance, strategic and operations.Compliance threats originate in politics, law, regulation or corporate governance. Financialthreats stem from volatility in markets and the economy. Strategic threats are related tocustomers, competitors and investors. Lastly, operations threats impact the processes,systems, people and overall value chain of a business.

The top 10 risks for oil and gas

Risk weighting andrisk prioritizationWe interviewed commentators andacademics representing the oil and gasindustry, asking each interviewee toidentify the top business risks for 2010.We asked the panelists to focus on risksfor the leading global companies in theoil and gas industry. We also asked eachpanelist to provide commentary on whyeach risk was important, how each riskhad changed since last year, and whichof a companys value drivers might beimpacted by each risk. Based on theseinterviews, we drew up this list of risks,which we believe is comprehensive, forthe oil and gas industry.

Up from 2009

Down from 2009

New entry

Key to symbols


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The top 10 risksfor oil and gas

1 Uncertain energy policy

The general view is that this risk, ranked second last year, hasincreased. Uncertainties in the direction of energy policy have beenprolonged, partly by the vague outcome of the Copenhagenclimate conference in December 2009 and partly by the inability of

the US to adopt a clear energy policy. The Gulf of Mexico spill hasonly further complicated policy decisions across the globe.Uncertain energy policy hinders operators ability to plan, investand respond to supply and demand changes. Consequently, it canincrease the likelihood of future supply and demand crises bydelaying investment. Broadly speaking, the absence of clarityaround regulatory and legislative changes will undoubtedly impactthe industry in the future and create an uncertain framework forlong-term investments.

Steps companies can take to respondto this risk

Adopting an organized approach to educate and lobbypolitical leaders and the general public about the need for

a coherent and consistent energy policy. This is a long-termgoal to which companies should commit suf cientresources.

Understanding and anticipating the national energy policyof the country in which operations take place. This mayinclude making use of policy advisors on the ground, evenfor smaller companies.

Creating broad-based initiatives for compliance, includingnew reporting structures to implement compliance andother proactive measures to meet anticipated regulatorychanges. The relocation of sourcing or manufacturingoperations to countries or regions that offer lower

compliance costs is an option to consider.

The top 10Ranking from 2009 in brackets

1 Uncertain energy policy (2)

2 Access to reserves: political constraintsand competition for proven reserves (1)

3 Cost containment (4)

4 Worsening scal terms (5)

5 Climate and environmental concerns (7)

6 Price volatility (3)

7 Human capital de cit (6)

8 Supply shocks (9)

9 Overlapping service offerings for IOCs

and oil eld service companies (8)

10 New operational challenges, includingunfamiliar environments (new)


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2Access to reserves: politicalconstraints and competition forproven reserves

As in 2009, ensuring suf cient access to oil and gas reserves at areasonable cost will remain a signi cant challenge. The location ofmany of these reserves in dif cult environments where the E&Pcosts are high such as the Canadian oil sands, the Arctic or deepwater will increase the risk of making new investments.

Perhaps more importantly, oil and gas companies will face anumber of political factors that might limit or even prevent accessto these reserves. For example, in the US, a number of changes inregulations and tax laws could discourage industry growth bysubsidizing electric cars, renewables and other alternative fuels.In developing countries, political unrest or the nationalization ofresources might lead to disruptions in supply.

At the same time, competition for reserves will probably increasebetween IOCs and NOCs. In some cases, IOCs will face signi cantrisks from NOCs that have the backing of sovereign funds, local

government support and a greater proximity to emerging marketsin Asia.


Investing time and resources in fully understanding therisk environment in which operations are conducted; notwo operational environments are the same. To completelygrasp the political climate on the ground, a company mayconsider a local partner to take advantage of existing

opportunities. Improving access to reserves by increasing joint ventures

globally and re-evaluating the viability of currentoperations. Companies can also strengthen alliances andpartnerships with NOCs to help mitigate the risk of losingaccess to key reserves in the event of increased prices orpolitical disturbances.

Knowing the alternatives. Although oil will remainstrategically important for some time, companies shouldalready be looking to the future. Gas is likely to become amore signi cant commodity, as it is a cheaper alternativethan renewables. The current major problem with gas itslocation and complex transportation is likely to be resolvedas technology improves and new infrastructure is built.

3 Cost containment

Cost containment moved up one spot on the list this year, fromfourth to third. Controlling costs will help improve cash ow, and inthe current economic environment, this has become a key strategyfor many companies in order to sustain pro tability.

Regardless of the strategy, cost-containment measures always

carry a degree of risk related to return on investment (ROI), as wellas possible disruptions to operations, revenue streams, customerrelationships and vendor agreements. In 2009, many companiesfocused on cost controls to preserve margins during the downturn;as the economy improves, companies should look to sustain thosecost cuts. Going forward as the economy recovers, companies willneed to plan for increased risks as a result of project cost in ation.Moving forward, both operational and production costs will be onthe rise, especially given potential new mandates around safetyand the environment.


Tightening operational costs can help to manage this risk.This may involve streamlining processes, making moreeffective use of shared services, including IT services,improving business processes and trying to reduce costs all

the way through the supply chain. Ensuring that the management of cost-reduction programs

has accountability and bottom-up reporting. A companymust be able to communicate the strategy and theexecution plan. Companies are advised to align all costreduction initiatives with an execution strategy and adhereto it. Those companies that have already implemented costreduction initiatives should be continually reviewing thesuccess of these initiatives.

Increasing the focus on rigorous working capitalmanagement to raise liquidity levels, introducing newtechnology to enhance operational ef ciencies and

outsourcing non-revenue-generating services, such asaccounting and payroll management, are cost controlmeasures that should be evaluated.


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4 Worsening scal terms

This risk moved up one spot this year, from fth to fourth. Due tothe current economy, many developing countries now face a sharpdecline in income from their sovereign investments and taxregimes. As a result, oil and gas companies will continue to betargeted with increased tax rates and other scal measures. IOCsmight have to renegotiate their joint ventures with NOCs, agreeingto new models that favor the local country.

The risk of worsening scal and tax terms for the industry can alsobe found in developed countries. In uenced by both economic andpolitical factors, governments are considering or implementinghigher taxes, lower incentives for exploration, new royalty fees andother measures.


Having a thorough understanding of the local scalregimes, including tax laws in the country where operationstake place. In emerging markets, the way things aredone in practice can differ greatly from the published taxlaws. Working with a local advisor can help in overcoming

this challenge. Striking the right balance between managing worsening

scal terms and investing in new developmentopportunities, including scenario planning for scal risksagainst varying economic conditions.

Strengthening the tax supply chain management through aglobal approach that can include transfer pricing, businessrestructuring, partnering to gain foreign tax credits andother initiatives.

Having a good working relationship with local regulatorsand governments can be very helpful when terms begin tochange. Also, having international arbitration clauses inagreements can be useful.

Failure to be seen to be responding to climate change and oils perceivedrole as a driver of this change will have huge reputational risks.


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5 Climate and environmental concerns

Climate and environmental concerns moved up from seventh placeto fth. Although the debate continues over climate change andthe impact of carbon emissions on global warming, governmentshave already taken regulatory steps that directly affect the oil andgas industry.

In the European Union (EU), a number of environmental goals and

standards have been introduced, including a drive to reducecarbon dioxide (CO2) emissions at least 20% by 2020. The EU hasalso implemented measures, such as the Emission TradingScheme, to encourage the use of renewables over fossil-basedpower generation. China has implemented a number ofenvironmental regulations designed to curb greenhouse gas (GHG)emissions and increase the use of nuclear and renewable energy.Although many of these regulations are directed toward coalrather than oil and gas emissions, the sheer size of China and itsgrowing importance as a global player will affect the climatedebate for almost every industry in 2010 and beyond.

In the US, additional legislation that would affect oil and gas

companies is under consideration, including measures that wouldincrease safety and environmental compliance requirements, aswell as civil penalties and nes that would be levied for violationsof various environmental laws. Companies will have to continue tomonitor legislation to follow these and other proposed changes asthey develop.

For oil and gas companies, environmental issues have created notonly increased regulations but also dif culties in predicting howthese regulations will be implemented over time. Governmentregulatory policies are based on a number of competing goals,such as energy security, affordability and response to demand. Forexample, a sudden decline in the global economy might discourageadditional regulations or prompt governments to extendcompliance deadlines.

Aside from governmental scrutiny, companies are facing increasingpressure from shareholders to disclose risks related to environmentalconcerns. Following the spill in the Gulf of Mexico, some investorsare looking for full disclosure of the risks associated with offshoredrilling operations and the potential environmental impact, as wellas the prevention, response and governance measures companieshave in place to address those risks.

Looking ahead, the climate debate will continue to complicatethe strategic decision-making of oil and gas companies across

the industry.


Integrating climate and environmental concerns withthe core business model rather than treating it as aseparate issue. Climate and environmental concerns havebecome a core business risk and must be managed in aroutine manner.

Performing enterprise risk assessments to assess exposureacross segments and ensure mitigation and incidentresponse plans are in place.

Anticipating stricter regulations around carbon and makingthe appropriate amendments and investments now. Anopportunity exists for those who want to be leaders inlow-carbon energy.

Partnering with the NOCs in the country where operationstake place to better understand the local environmentalregulations.

Improving non- nancial reporting, including carbon

emissions data, and the environmental impact ofoperations. Companies can seek third-party veri cation oftheir climate change disclosures, including statements ofperformance and claims about the positive impacts ofproducts or services.


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6 Price volatility

The risk of price volatility, ranked as the third most importantstrategic risk last year, noticeably decreased in importance thisyear. The relationship between oil and natural gas prices haschanged dramatically.

Oil prices in 2010 have been relatively stable due to modestconsumption habits, and weak developed economies have eased

demand pressures. However, natural gas prices are currently lowby historical standards as a result of oversupply. There are stillsigni cant variations between regions in how gas prices are setand the level of government subsidy in some countries.A truly global gas market will not emerge until there is greater

exibility in gas supplies, increased transportation betweenregions and more gas-on-gas competition.

The global economic recovery is fragile and any setback coulddampen demand. Additionally, political or regulatory changes, aswell as geopolitical events, could alter prices almost instantly.While price volatility impacts companies differently, capital-intensive projects are the most vulnerable when oil and gas prices

go down. Falling prices will affect revenues and reduce companiescapacity to nance projects off their balance sheets. On the otherhand, re ners margins will continue to be squeezed by risingprices in crude oil.


Carefully re-evaluating all investment strategies, includingthe balance between oil and natural gas investments. Thisinvolves conducting scenario planning for investments anddivestments against low to moderate prices even if currentprices are high. It also involves having plenty of liquidity

before investing in a project as protection against anypotential volatility.

Engaging in econometric modeling to better understand oiland gas market developments. This is an often overlookedpractice outside of IOCs but potentially a very useful onethat companies can use to anticipate price volatility.

Applying prudent management techniques, includingcutting costs, evaluating the supply chain process andre-evaluating the capital plan and expectation of returns.

Companies can also consider hedging strategies formargins and costs, and tax management strategies toimprove cash ow.

7 Human capital de cit

Regardless of economic conditions, the availability of quali edpersonnel cannot be taken for granted. When the economyimproves, without suf cient growth in human resources theindustry will face project delays, canceled projects, lowerproductivity and higher operational costs. Many NOCs in particularare faced with severe shortages of experienced personnel as theyexpand their operations and enter new markets.

In developed countries, many senior engineers, managers andother professionals are now reaching retirement age, with noassurance that enough college graduates and younger workers willbe ready to take their place. Many universities in Europe and theUS report declines in the number of engineering and geosciencestudents. By contrast, schools in developing countries areproducing record numbers of graduates, but these youngprofessionals will still require years of training and experience tofully support the industrys needs in the 21st century.


To reduce duplication and inef ciency, companies mustmanage, de ne and coordinate HR processes on acentralized level to help HR professionals focus on

workforce challenges. Creating an inviting business culture to attract young

people for example, highlighting the technologicaladvances in the industry in order to create awareness thatthe industry is constantly developing, modernizing andevolving technologically.

Leveraging older workers knowledge. Be creative withretirement arrangements to retain intellectual capital.Consider slower, phased-in retirement arrangements and/or re-enlist retirees as part-time consultants.

Developing local and regional talent. This must beaccompanied by investment in culture and languagetraining to avoid issues with language barriers andmiscommunications as expatriate managers try to bridgethe cultural gap with their local workforce.

Oil prices have become more, rather than less, volatile in recent years andthere is no sign that this will change, despite proposed action by variousregulatory authorities to curb speculative trading in oil futures.


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8 Supply shocks

Ranked ninth in our 2009 risk report, supply shocks based ongeopolitical events will remain a signi cant risk for the oil and gasindustry. Major issues include chronic tensions in the Middle East;the threat of attacks on pipelines, re neries and harbor facilities;continued tensions between Russia and its former republics;political tensions in Nigeria; and the general unpredictability ofpolitical changes in Latin America.

At the very least, these risks can result in highly volatile prices thatmake strategic planning and investing more problematic.Companies could face even greater challenges from unexpectedgovernment interference, changes to joint ventures, the annulmentof contracts and civil unrest.


Investing in more stable markets, even if this means a lowerreturn, and making use of longer-term hedging tools suchas re-allocating capital to projects with longer-termstability.

Adopting a exible, shorter lead-time capital structurewould allow the generation of peak supply to help endurethe downturns.

Focusing on assets that allow production to be maximizedbetween supply shocks.

Restructuring agreements to ensure supply. Companiesshould carefully analyze the current strength andcapabilities of their supply chain and identify bottlenecksor weaknesses.

9Overlapping service offerings forIOCs and oil eld service companies

This risk remains low on the list this year, having ranked as eighthlast year. For some, depending on industry segment, this risk isseen as an industry evolution rather than a risk. There is a shiftingof focus away from IOCs toward NOCs in response to protectionistmeasures enacted by various countries to develop their ownresources. This shift in focus leaves IOCs and OFS companies tocompete for opportunities with NOCs. OFS companies areincreasingly taking on roles that were traditionally limited to IOCs.

At the same time, IOCs have overlapping competencies with OFScompanies, as they seek to partner with NOCs. This poses both arisk and an opportunity for IOCs and OFS companies as their rolesevolve in the global energy market.


For IOCs, taking advantage of the fact that they have astrategic advantage over OFS companies in the area ofprogram management, due to extensive experience.

For OFS companies, developing long-term strategies thatrecognize that price uctuations will affect them moreseverely than NOCs and IOCs.


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10New operational challenges,including unfamiliar environments

This risk was an emerging risk last year and is a new entrant to thetop ten. These challenges have grown signi cantly over the pastyear, due mainly to the increased focus on E&P in challengingenvironments, such as the Arctic region and deepwater areas. Inmany cases, this development is requiring a new generation of

technical and operational solutions, as well as special training andsupport for personnel in the eld. The costs and physical dangersinvolved in tapping these new reserves far exceed previous levels,adding to the risk of oil and gas companies. Furthermore,companies have no assurance that prices will continue to justifyheavy investments in these areas.

In addition, oil and gas companies must continue to adopt newtechnologies to mitigate the risk of losing their competitiveadvantage. This process includes a strategic commitment toresearch and development (R&D), ongoing investments to upgradeexisting facilities and the development of joint ventures withtechnology providers.


Continued heavy investments in new technologies,including those for unconventional oil and gas. IOCs havebeen at the forefront in developing new technologies forE&P and transportation. However, independent oil and gascompanies further developed technological advances that

unlocked the potential of unconventional natural gasresources. To remain competitive and gain access to newopportunities, this investment by oil and gas companiesmust continue.

Closely managed joint ventures (JVs) that can increasebusiness opportunities and mitigate risks among IOCs,subcontractors, NOCs and local governments. Companiesshould evaluate current and potential JVs for counterpartyand political risks in order to effectively establishsafeguards and manage exposures.

Strategic acquisitions in diverse geographies or challengingenvironments. These acquisitions can help companiesexpand their operations and give them access to trainedpersonnel and required R&D.

A dedicated focus on capital project management.Coordinating capital and project management activities inconnection with capital design and construction programsand projects will help identify and mitigate capital programrisks, thereby potentially improving project cost controlsand schedule performance.

The technical challenges of new operating environments, both above andbelow the surface, have been a feature of the oil industry since its veryearliest days. As oil and gas exploration moves into ever deeper watersand into the Arctic regions, these challenges will remain.


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Key risks by subsector

New to the report this year, we have taken our top 10 risks that apply tothe industry overall and identi ed the key risks of most importance tothe upstream, midstream, downstream and oil eld services subsectors.All the subsectors are interrelated and they rely on each other at variouspoints in the energy value chain; however, their business models arevery different. Thus, while each risk is important to the overall industry,each risk affects the subsectors in different ways. In addition, the riskrank varies among the subsectors, as each one has its own priorities. For

example, when prices on crude oil rise, the upstream subsector bene ts,while at the same time, re ners margins are squeezed.

Once again, we are de ning the subsectors as the following:

Upstream exploration and production (E&P) by integrated oil companies (IOCs),independents and national oil companies (NOCs)

Midstream gathering, eld processing, transportation and storage

Downstream re ning and marketing

Oil eld services (OFS) including service companies and the supply chain


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Upstream risks

Access to reserves: political constraints andcompetition for proven reserves

Risks involving access to reserves are based on both geographicaland geopolitical factors. As companies seek new reserves, they areexploring in more dif cult environments, often increasing the cost

involved, therefore raising the risk.In developing countries, political unrest or the nationalization ofresources might lead to disruptions in supply. Geopoliticaluncertainty creates another set of risks related to reserve access.In developing countries, IOCs must gain access and then be able tomaintain that access if they are to realize a pro t. Unfortunately,access does not always guarantee production for IOCs, especiallyin regions that have a history of resource nationalizations andsudden regime changes. Strong competition from NOCs alsoincreases the uncertainty that IOCs can maintain access toreserves, much less the pro tability of the project.

Upstream companies must also balance their oil to natural gasreserve ratio. Compared to oil, natural gas is considered to be arelatively clean fossil fuel. Russia, the Middle East, North America,Africa and other regions possess huge gas reserves enough tosatisfy world demand for the next century or longer, according tosome estimates. Additionally, natural gas is being viewed as abridge to a low-carbon future. The potential for natural gas is large,as it could become the major fuel for multiple end uses, such aselectricity, heating and transportation.

The growing importance of natural gas will lead to a shift ininvestment priorities by many oil and gas companies. Evencompanies now involved only in oil-related areas have increased

or most likely will increase their involvement in natural gas.

Upstream companies continue to operate in a dynamicenvironment and face signi cant unknowns that impact theirability to manage risks and make long-term investments. Beloware the key risks identi ed for upstream companies in order ofgreatest importance.

Uncertain energy policy

The absence of clarity around regulatory and legislative changescreates an uncertain framework for long-term investments, whichare essential for the long-term survival of upstream companies.Uncertainties in the direction of energy policy have been prolonged,partly by the vague outcome of the Copenhagen climate conferencein December 2009 and partly by the inability of the US to adopt aclear energy policy.

In the US, the Obama Administration is suggesting a number ofchanges in regulations and tax laws that could discourage industrygrowth. Many countries around the globe, most recently as a resultof the Gulf of Mexico spill, will also be reviewing their safetyregulations for offshore activities. In addition, increasing concernsaround the exploration and development of shale gas using hydraulicfracturing may give rise to additional regulatory requirements.

Increased regulations, inspection times and potential liabilitiesneed to be factored into global operations. The added regulationsare expected to drive up costs. In order to maintain margins andthe ability to absorb unsuccessful exploration costs, upstreamcompanies must continue to nd ways to reduce operational costs,while maintaining safety and environmental standards.


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Price volatility

Oil prices in 2010 have been relatively stable due to modestconsumption habits, and weak developed economies have easeddemand pressures. However, the global economic recovery isfragile and any setbacks could put downward pressure on prices.Falling prices will affect revenues and reduce companies capacitiesto nance projects off their balance sheets. Despite some modestgains, natural gas prices have remained at historically low levels.Low natural gas prices threaten the economic viability of manynatural gas elds.

Climate and environmental concerns

For oil and gas companies, environmental issues have created notonly increased regulations but also dif culties in predicting howthese regulations will be implemented over time. Governmentregulatory policies are based on a number of competing goals,such as energy security, affordability and response to demand.How each goal is weighted can change almost overnight. A suddendecline in the global economy, for example, might discourage

additional regulations or prompt governments to extendcompliance deadlines.

Currently in the US, there is considerable controversy surroundingthe environmental impact of oil and gas operations, including theuse of hydraulic fracturing technology for enhanced oil and naturalgas recovery. In the rest of the world, as in the US, environmentalsafety and health concerns have emerged and are being debated.This debate will continue to complicate the strategic decision-making of oil and gas companies across the industry.

Worsening scal terms

Worsening scal terms seem almost inevitable for the upstreamsubsector in 2010 and beyond. Many governments are seekingnew ways to increase revenues after watching revenues dropduring the recent recession. Large upstream companies provide ahighly visible tax target, and many companies are re-evaluatingtheir tax positions and developing new strategies to manage theirtax supply chain management.

New operational challenges, includingunfamiliar environments

Upstream companies that undertake E&P in extreme environments,such as the Arctic, often need to develop or invest in newtechnologies. The added costs and dif culties of building, operatingand maintaining infrastructures in these environments alsoincreases risk; if commodity prices fall below a certain threshold,once-viable elds become uneconomical to produce. As demandrises with limited reserves available, pursuing E&P in harsh orchallenging environments may be the only way to signi cantlyincrease reserves, and therefore future revenues.


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Uncertain energy policy: the implications of the Gulf of Mexico spill for offshore drilling

The recent spill in the Gulf of Mexicohas implications for the offshoreexploration and production industry thatgo well beyond the region, and thecleanup and liability debates seem likelyto run for some time.

Offshore oil and gas resources are animportant part of the energy mix andseem unlikely to be ignored or banned inthe longer term. In addition to existingoffshore elds, signi cant new reservesreside in deepwater and in frontier watersoff Brazil, Africa, Southeast Asia andOceania, as well as the Arctic andAntarctica. However, the industrys abilityto operate in a number of existing andnew areas is likely to be under threat untilcon dence in those operations is fully

restored. The root causes of theDeepwater Horizon incident need to befully understood and the appropriatemeasures need to be put in place toreduce the chances of a recurrence.

The industry needs to convince regulatorsand stakeholders that the lessons havebeen learned in terms of incidentresponse and that any future event couldbe resolved quickly, safely and withminimal leakage. For this to happen, thefollowing areas need to be addressed:

1. Risk assessment of currentoffshore operations

All offshore operators should completea full technical assessment of theircurrent offshore facilities. This will includelooking at all critical equipment in termsof type, age, service history and otherfactors.

In addition, an assessment of ongoingoperational procedures with regard to theregular testing and maintenance of thiscritical equipment should be undertaken.This assessment also should includeevaluating potential upgrades or

additional equipment that could bedeployed to reduce the risks in this area,even if such upgrades or equipment arenot necessarily required by regulation.Finally, a review of the contractualrelationships that exist between partnersand contractors should be undertaken toensure they support the highest levels ofsafe operation.

2. Risk assessment of future offshoreoperations

When organizations are consideringentering into new offshore ventures, anumber of areas in the investmentprocess seem likely to come underincreased scrutiny:

Technologically groundbreakingprojects need to address how to dealwith a catastrophic failure and whetherclear action plans and the supportingtechnological capabilities are in place.

There will be an increased focuson partner and contractor expertise

for the types of projects that areundertaken.

Partner and contractor nancialstrength, and their ability to fundcleanup and liability costs in aworst-case scenario, will bescrutinized.

The area being explored will need tobe considered in terms of its proximityto major population centers or areasof commercial or environmentalimportance.

3. Incident response

It is clear that there will be signi cantlessons coming out of this incident thatwill further the understanding of how bestto prevent a blow-out, and in the event ofa catastrophic failure, how to stop a

deepwater leak and manage the cleanup.But it is also clear that incident responsetechniques and technologies have not keptup as companies have expanded intodeepwater exploration, drilling andproduction.

The lessons learned should be sharedacross the industry and collaborativeefforts such as those undertaken byExxonMobil, Royal Dutch Shell,ConocoPhillips and Chevron in theformation of the non-pro t Marine WellContainment Co. should be applauded andencouraged. The plans for thedevelopment of a containment cap,specially designed subsea manifolds, and

exible riser pipes to link a damaged wellto the water surface are clearly responsiveto the need to have measures in place toaddress this type of incident in the future.Having available ships capable ofcapturing and storing oil and dedicatedcrews to ensure regular maintenance,inspection and readiness of equipment are

also key measures in addressing theindustrys ability to respond to anotherevent of this nature. However, existingcollaboration and support may need to goa step further by engaging regulators andother stakeholders in the process, thusproviding them further reassurance thatwhile deepwater exploration andproduction does in fact contain inherentrisks, these risks are manageable.


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Midstream risksCompanies in the midstream subsector include those focusedon the gathering, eld processing, transportation and storageof crude oil, petroleum products and natural gas. In general,midstream companies are less exposed to the risks of volatileenergy prices than their counterparts in the upstream ordownstream subsectors, as the majority of their operations aretypically performed on a fee-for-services basis. Below are

the key risks identi ed for midstream companies in orderof greatest importance.

Cost containment

Project costs continue to be an issue for midstream companies, inparticular, as they engage in planned infrastructure expansions. Asthe demand for natural gas increases and is projected to besatis ed by new sources of gas reserves, such as those found in theshale gas plays in the US, China and Eastern Europe, midstreamcompanies need to build additional pipeline infrastructure, includingnew extraction and gathering facilities. Midstream projects typically

carry higher investment risk because of the signi cant costsassociated with construction of the physical assets. Therefore,effective project management, including cost containment, iscritical to the success of the planned expansions. It is important formidstream companies to maintain a balance between managingcosts while sustaining and expanding activity levels. Continuousprocess improvements, including effective strategies aroundenterprise resource planning in order to strengthen the supplychain, will help to minimize costs in the long run. Reductions inoperational costs are key.

Managing the cost of capital associated with infrastructureexpansions is also critical. Companies will need to remain vigilant

with respect to nancing availability, security issues related to thephysical assets, regulatory intervention that could delay theconstruction period, and transit and cross-border risks, all of whichare factors that could have an impact on the project cost of capital.


Uncertainties around energy and regulatory policy pose substantialrisks for this segment of the industry. Government policies arebased on a number of competing goals, such as energy security,affordability and response to demand. How each of these goals isweighted can change almost overnight. Regulations typicallyimpose costs, some of which may not be recoverable in acompetitive environment.

Regulatory uncertainty may delay investment decisions, whilesome regulatory changes may cause some investments to becanceled, or cause some assets to be impaired. For example,regulatory uncertainty is affecting such proposed major midstreamprojects as the Alaska Natural Gas Pipeline, as well as the proposedexpansions of oil pipelines carrying Canadian oil sands to USre neries. Limits on deepwater drilling could remove the need foradditional pipeline infrastructure and possibly impair the existinginfrastructure. Similarly, limits to hydraulic fracturing could reduce

the access to new gas reserves and, thus, change the economicdynamics around potentially necessary new infrastructure for theprocessing and transportation of shale gas.


From an environmental perspective, carbon emission regulationswill also impact this segment. The ongoing debate over how carbonemissions will be regulated and reported has made it dif cult forcompanies to predict what the long-term outcome will be.Particularly important for midstream companies is to determine ifthe emissions at their facilities will be aggregated to one reportingnumber or if each facility will be considered independently. Inaddition, when expanding transportation infrastructure, midstreamcompanies need to address community concerns when building inenvironmentally sensitive areas.


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Downstream risksWith global re ning capacity expanding beyond demand needs,re ners will need to cut back throughput by eliminating old andinef cient plants. This could lead to additional costs forenvironmental remediation liabilities. Additionally, operatingsafely will remain a key concern for the re ning subsector.Below are the key risks identi ed for downstream companiesin order of greatest importance.


An energy policy that seeks to move away from oil, either foreconomic security or environmental reasons, would limit orreduce demand growth and constrain pro tability. In contrast,an energy policy that constrains domestic oil production wouldnotably affect the upstream and OFS subsectors, and mayonly increase dependence on imported oil. In either case, thelack of clarity around energy policy poses challenges fordownstream companies.


More speci cally, a strong energy policy with regard to climatechange, depending on how it is structured, could signi cantlyaffect re ners and marketers. The most recent cap-and-tradeproposals before the US Congress primarily target the powergeneration and utility segment of the energy industry, butalternate proposals, if adopted, could impose higher burdens onthe transportation fuels industry.

The EU, China and other countries are either currently assessingtheir carbon reduction potential or implementing policies tostimulate emission reductions. The oil re ning subsector will play apivotal role in the future as a continued reliable, resilient andsecure source of transport fuels and feedstocks for otherindustries. In doing this, re ners should consider the introductionof alternatives capable of being blended with or distributedalongside conventional fuels, which would keep options open onfuture diversi ed supply sources that are less carbon intensive.

To ful ll this role and to meet the changing patterns of demand aswell as future environmental requirements, re neries will likelyrequire substantial investments.


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Price volatility

Price volatility, as re ected in re ner and marketer margins, willimpact portfolio management and investment strategies. Pressureson re ners to maintain liquidity are driven by capacity exceedingdemand. New re nery construction and debottlenecking of existingre neries over the past decade has signi cantly increased globalcapacity beyond demand needs. Active portfolio management inthe downstream subsector has been a feature of the large,vertically integrated oil companies for many years, but must alsobe addressed by independent re ners. As strategic aims andmarket conditions change, so do the requirements of the portfolioneeded to achieve management and shareholder goals.

The biggest worry for independent re ners in 2010 has beenliquidity and cash ow; margins can affect not just theirpro tability but also their survival.

Access to consumers in new growth markets

If the global economy continues to recover and that recovery

is sustained, re ners will stand to bene t from a gradual butsteady increase in oil demand. Access to that growing demand,most prominently in Asia, will be critical for re ners, particularlyfor the integrated IOCs. However, the challenges of economicuncertainty will remain a critical part of risk management for thissubsector in 2010.

Aging oil and gas infrastructure

Aging re neries present risks from a safety, environmental andcompetitive standpoint. Older re neries have greater dif culty incomplying with environmental regulations. In addition, they oftencannot re ne the heavier crudes that are being used more todayas sweet crude reserves are depleted. Both factors increase theneed for new re nery construction or modernization.

Faced with excess capacity and aging infrastructure, re ners mightconsider whether to consolidate operations or shut down speci cre neries. In some cases, re nery shutdowns will be determined bythe local cost of compliance, as this cost can vary enormously fromcountry to country and even, such as in the US, from state to state.

Strategic investments to upgrade plants can help mitigate some ofthese risks, but the investments themselves can introduce otherrisks. Re ners, for example, can invest in new technology to runsour crude, but this investment can only be justi ed by marketsthat support speci c crack spread margins. The ability to runsigni cantly different crude slates might or might not turn out tobe the right investment for a particular re nery.

In 2010, new re neries will continue to be built, especially indeveloping countries such as China and India. However, a numberof construction projects will be delayed or canceled due to lowerdemand for gasoline, tight credit and general economicuncertainty. In contrast, additions to re ning capacity in the USand Europe have been con ned to expansions of existing re ningcapacity. In addition, many companies lack the capital to maintaintheir aging infrastructure. The result is a paradox an industrywith high capacity that is also experiencing growing problems withage, rust and decay.


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Oil eld services risksThe OFS subsector continues on its path of developing andcompeting on the latest technologies, while navigating its shiftingpartnerships with E&P companies. It faces risks equally aschallenging as those of the other subsectors. Below are the keyrisks identi ed for OFS companies in order of greatest importance.

New operational challenges, includingunfamiliar environments

The risk associated with new operational challenges, includingunfamiliar environments, is very signi cant for the OFS subsectorbecause a large portion of OFS companies are increasinglyoperating in challenging international locations. Tax regimes,business practices and the local sourcing of personnel ininternational locations can increase operational risks for OFScompanies. Complexity of the project, remote locations, newtechnology and environmental impacts will also add to theoperational challenges. Further, the alignment of interestsbetween operators and the OFS companies, as contractors,

has become essential.

Cost containment

Cost control at all levels of the supply chain is a key component ofproject execution. Good project execution is the key to deliveringmargins. As projects increase in complexity, they generally becomemore challenging and riskier to complete on time and on budgetwhile maintaining quality and safety.

Because manufacturing and engineering companies usually havea number of options in the sourcing of supplies, more OFScompanies are calculating the relative costs of compliance for theiroperations, in many cases offshoring production to developingcountries, where compliance costs as well as manufacturing andother costs can be lower. However, offshoring can also involvelocal content requirements for NOC contracts in regions such asSouth America and Africa. The enforcement of local content lawshas increased during the global recession, adding to risks for OFScompanies. Governments can levy nes, force contracts to berenegotiated and even shut down operations if OFS companies are

found to be in non-compliance with these laws.In addition, increasing regulations are likely to increase offshoredrilling costs due to more frequent inspections, certi cations andequipment redundancies. In particular, equipment manufacturersshould bene t from retro tting, redundancies and escalatedobsolescence. However, the overall demand for services andequipment could be reduced if the increased costs and reducedeconomics force operators to scale back spending. With higheroffshore costs, some spending may also be redirected to domesticand international onshore markets.


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Overlapping service offerings for IOCs andoil eld service companies

To address the risk associated with cost containment, some OFScompanies have consolidated units, divested assets or madestrategic acquisitions to strengthen their market position. SomeOFS companies have also taken on wider roles and builtcompetencies within areas that traditionally have been anintegrated part of an IOCs core business in order to deepen theirservice delivery to the market. This has led to some overlappingservices between IOCs and OFS companies. In order to furthercompete with IOCs, some OFS companies have developed jointventures with non-competing companies, although international

joint ventures carry legal, political and economic risks that must beproperly managed, both internally within the participatingcompanies and externally with NOCs and local governments. Asmargins for this subsector continue to be squeezed, many OFScompanies will pursue new ways to sustain pro tability and willneed to manage the risks within new operating models.

Worsening scal terms

Worsening scal terms is another concern for the OFS subsector.OFS companies, most of which are multinational in their operationsand business partnerships, are facing higher taxes and the growingdemands of complex tax supply chain management across multipletax regimes. Some OFS companies are relocating their headquartersto more tax-favorable countries. We expect this trend will continueas countries continually review their tax structures amid marketand currency uctuations.

Aging oil and gas infrastructure

In addition, ownership, maintenance and safety compliancecosts associated with maintaining infrastructure will continueto increase. Aging oil and gas infrastructure was identi ed thisyear as a below-the-radar risk but is still very relevant to thissubsector, where extensive aging infrastructure needs to bemaintained. Safety of the infrastructures and equipmentremains of great importance.


For a signi cant part of the OFS subsector that is taking on moreownership of the day-to-day operational activities across the valuechain, issues around health, safety and the environment have risenin importance. As activities move deeper and deeper offshore, inharsher environments and more remote locations, OFS companiesmust reassess and identify ways to reduce their risk and managethe environmental impact of their activities.


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the top 10 risks for oil and gas

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