“Top business risks in the oil and gas industry” by Aldrin M. Cerrado (November 29, 2010)

SUITS THE C-SUITE By Aldrin M. Cerrado
Business World (11/29/2010)

Given the challenges facing the oil and gas industry today, there is greater need for effective risk management and controls. After the recent global financial crisis and the Gulf of Mexico oil spill, financial challenges, regulatory pressure and long-term risks pose significant threats. Recent local events have also drawn public scrutiny.

Integrated oil companies (IOCs) and national oil companies (NOCs) should consider investing in high-level risk scenario management and planning. Sometimes, the difference between a risk and an opportunity is having the right information at the right time.

The Ernst & Young top 10 risks for oil and gas report offers insights into the risks facing the oil and gas sector. It cautions companies to expect renewed, expanded and more stringent regulatory conditions with regards to safety and environmental risk preparedness. The following risks are relevant to the Philippine oil and gas industry.

Uncertain energy policy

The top challenge is the uncertainty of sudden changes in regulation. This is exacerbated by the vague outcome of the Copenhagen climate conference in December 2009, the inability of the US to form a clear energy policy and the devastation caused by the Gulf of Mexico oil spill.

To respond, global companies should consider working with local advisors to better understand the energy policies of various countries. The industry, as a whole, should also create broad-based compliance initiatives and reporting structures. By taking the lead in regulation, the sector can show political leaders and the general public that it earnestly wishes to build coherent and consistent national and global energy policies.

Access to reserves

Sufficient access to oil and gas reserves remains a significant question. Considering that many reserves are located in difficult and dangerous environments, companies need to anticipate that high exploration and production costs will increase the risks of new investments.

Cost containment

Many companies used stricter cost control as a means of improving cash flow during the crisis. While this remains a necessary strategy, it is also potentially disruptive to returns on investment (RoI), operations, revenue and business relationships. In a recovering economy, there is increased likelihood of project cost inflation and cost-intensive new safety and environmental regulations.

Worsening fiscal terms

Post-crisis, many countries face a sharp decline in income from sovereign investments and tax regimes. To compensate, governments may levy increased tax rates, cut incentives for exploration or apply new royalty fees and other measures. Companies should consider engaging a local advisor as well as having international arbitration clauses in their agreements.

Climate and environmental concerns

Governments are taking more steps to ensure that companies reduce their carbon impact, with some even implementing measures that support renewable energy over fossil fuels. In addition, companies face mounting pressure from stakeholders to provide full disclosure of environmental risks, and the prevention, response and governance measures they have in place.

Supply shocks

Increasing geopolitical tensions can affect supply. Some examples include chronic tensions in the Middle East, Russia, Nigeria and Latin America. These tie back to the worries on access to reserves and pricing volatility. In a market that is already facing static demand, ensuring availability becomes even more imperative.

Overlapping service offerings

Focus is shifting away from IOCs to NOCs in response to protectionist measures in various countries. Since IOCs have overlapping competencies with oilfield service OFS companies, they are forced to compete on the same playing field as their roles evolve.

Recent global and local ecological incidents involving oil and gas companies have made some of these risks into real issues, such as regulatory policies, environmental concerns and access to supply.

The question now arises: Do we have adequate policies in place to regulate or mitigate these kinds of incidents?

Companies need to face the risk of increasing public pressure to ensure that facilities and aging pipelines are safe, which can be a very capital-intensive endeavor. If a similar incident were to occur at some offshore drilling sites, would the industry have an adequate response?

All stakeholders and anyone affected by the industry will want to be reassured that the potential for a recurrence on an ecological incident has been minimized and that it could be contained and cleaned up within a short period of time.

To help offset these risks, the industry needs to look at increasing transparency and accountability. It needs to take public opinion into greater account and work to rebuild the confidence of the general public. They should also aim to increase capital reserves to deal with the possibility of needing to replace or rehabilitate existing facilities.

Government may also consider partnering with global players. It should not only to come up with constructive regulations on dealing with potential accidents, but also to increase the industry technology level, which can help prevent or reduce the impact of future incidents.

More so than almost any other industry, the very real threat posed by ecological disasters has far-reaching and widespread repercussions. It goes beyond just the oil and gas industry: it will require full commitment from government leaders, companies and even the public to jointly address and manage these risks.

(As of publication, Aldrin M. Cerrado is an Assurance Partner of SGV & Co.)

This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.