Emerging risks for E&P firms

Written by Rajiv Puri | Updated: Nov 1 2010, 17:59pm hrs
The global economy still remains in a fragile state and additional stress is anticipated because of lower demand, continued deleveraging and currency fluctuations. The oil and & gas industry is still recovering from the global events of last year, though a mood of cautious optimism has emerged.

Ernst & Young in its recent annual oil & gas business risk report highlighted top risks as perceived by C-suite executives, academics and industry decision makers. The report is positioned to assist the industry in developing risk management initiatives, prioritise issues, develop mitigation strategies and support strategic planning.

From the Indian context, national oil companies and private players are looking at growth outside the Indian shores and investing or planning to invest heavily in international assets. Uncertainty in the emerging policy and regulatory framework is very critical to the investment decisions planned by these companies. Post-Gulf of Mexico incident, there is uncertainty on how the energy and policy framework will evolve.

The view is that additional legislation are under consideration, including enhanced focus on safety and environmental compliance requirements with heavy penalties in case of any violation. With the likely introduction of stringent environmental compliance requirements, the costs are expected to increase, having a negative impact on return on investment.

For example, in the European Union, several environmental standards have been introduced, including a drive to reduce carbon dioxide emissions at least 20% by 2020. China has implemented various environmental regulations designed to curb greenhouse gas emissions.

Such measures will raise both operating cost and business continuity risk. The changes in regulatory and compliance laws will have an adverse impact on the investment decision. This is a critical aspect; when companies look for new reserves, many of which are in difficult environment, that will increase the risk of investment. Even to attract large investments into the country, which government intends to seek through future NELP rounds, the policy and regulatory framework needs to be clear and consistent as policy uncertainty is a hindrance in attracting long term-large investments in the sector.

Also, companies are vulnerable to oil price volatility. The global economic recovery is fragile and any setback could dampen demand. Additionally, political or regulatory changes, as well as geopolitical events, could have an immediate effect on oil prices. In India, there is a view that the issue of gas pricing is still not fully resolved. Besides, the new tax code has clauses that will affect capital-intensive projects.

Another key issue worrying industry captains is the shortage of quality manpower across the value chain of oil & gas industry. This is a serious challenge and industry will face project delays, lower productivity and higher operational costs. In India, oil & gas is not the first choice for young professionals. The academia and institutions have to work closely with the industry to have industry focus programmes and prepare talent for the industry.

With companies looking at challenging locations and alternative sources like shale gas, there is a need for new technical and operational solutions. This is an emerging risk. As cost involved in tapping these new reserves far exceed previous levels, companies will have to evaluate their investment decisions to mitigate this risk effectively.

Given the volatile environment, environmental concerns and cost pressures, oil & gas companies will have to focus on developing innovative strategies to mitigate therisks effectively.

(Rajiv Puri is associate director-oil & gas practice, Ernst & Young. The views are personal)