FEBRUARY 2012

AN EVOLVING RISK LANDSCAPE

THE ENERGY INDUSTRY

CONTENT
1 3 6 9 12 14 16 18 21 24 OVERVIEW PARADIGM SHIFT IN INTERNATIONAL OIL COMPANIES IOCs , NATIONAL OIL COMPANIES NOCs AND INTERNATIONAL NATIONAL OIL COMPANIES INOCs RELATIONSHIPS INCREASINGLY CHALLENGING RESERVES REGULATORY ENVIRONMENT RESTRICTED AVAILABILITY OF CAPITAL ASSET AGEING AND DECOMMISSIONING SKILLS SHORTAGES GEO POLITICAL TENSIONS LENGTHENED SUPPLY CHAINS CONCLUSIONS

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THE ENERGY INDUSTRY: AN EVOLVING RISK LANDSCAPE

OVERVIEW
Throughout the last decade risk landscapes have evolved, often dynamically, such that today, the risks faced by many enterprises have proliferated and are larger and more inextricably linked than ever before. Relief is not at hand: according to the World Economic Forums Global Risks 2012 report, macro risks will become increasingly complex and interrelated over the next 50 years, as constellations of risk overtake singular risk silos in representing serious threats to global prosperity and security. The purpose of this paper is to consider the evolution of energy risks in the context of the global macro-risk picture; to anticipate evolving high-level energy risk trends that should perhaps loom large on the radar screens of industry risk managers; and, to offer insights on potential risk mitigation and treatment techniques. Never before has the function of energy risk management been more challenging, nor offer those that do it well such significant competitive advantage over those that are merely adequate. Energy sector risk managers need to ensure they have addressed key issues in this new reality of risk: Risk magnitude has grown such that traditional risk transfer capacity may be found wanting unless complemented by new or evolved solutions. The size of an insurance recovery is only half the story: experience has demonstrated that when losses threaten balance sheets, the rapidity of cash injections via insurance indemnities is of critical importance. Risks have an increasing habit of compounding the ability of a singular incident to ignite innumerable and perhaps unforeseen consequences which, in turn, may emit their own shockwaves. These after-shocks may have far greater impacts than the original occurrence. Risk compounding presents myriad challenges to risk managers: it is both difficult to model the consequences and easy to lose control of event management, stabilisation and recovery. Regulatory and organisational insularity undermines the pursuit of insightful risk management. Effective risk management should recognise the merits of competition but also the value of collaboration. Our own research has shown that energy companies are good at internally cascading the lessons of their own experience but poor at learning from the mistakes or insights of others. The Black Swan moment. Risk managers should assume that their company will suffer a major loss regardless of the preventative measures in place, and that it may bear little similarity to those appearing on the corporate Risk Register. This insight drives a very much more expansive risk perspective and one that is an essential guarantor of corporate survival. Corporate success or survival may depend more on postevent agility and a culture of adaptability than pre-event prescriptive, embedded procedure. Process and regulation are essential for the conduct of business and may even exert positive cultural influences from a risk management perspective. Yet far-sighted risk managers increasingly look to crisis management, disaster planning and business recovery as the critical competitive differentiators. Many actively engage in internal dialogues to align various stakeholders, for example with boards, human resource departments and health and safety functions. Risks may be identified and exposures modelled, but organisations that are capable of quick-witted problemsolving and decisive remedial action perhaps at multiple customer and media interfaces mark themselves out as being elite. We hope this paper will provoke some consideration of how well prepared your organisation is to deal with these pressing risk issues.

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THE ENERGY INDUSTRY: AN EVOLVING RISK LANDSCAPE

1. PARADIGM SHIFT IN IOC, NOC AND INOC RELATIONSHIPS

During the last decade, the continued growth of developing petro-economies on the world stage, fuelled by advances in technology, increasing national selfdetermination and local/global energy demand, has caused a shift in the energy industry business paradigm.
Previously, NOCs or sovereign governments had provided access to hydrocarbon reserves, whilst relying on IOCs to provide technical skills, project management expertise and access to markets. This dynamic is changing as NOCs develop their own capabilities in these areas. None of the five leading IOCs feature in the top ten of any league table of oil companies measured by size of reserves (see table). This reality is having a profound effect on investment curves, and the increasing economic dominance of the NOC block is amply illustrated in the figure below.

FIGURE 1: DATA SHOWING CAPITAL EXPENDITURE FOR THE VARIOUS CLASS OF OIL COMPANY.

RANK 1 2 3 4 5 6 7 8 9 10

COMPANY Saudi Aramco National Iranian Oil Company Qatar General Petroleum Corp Iraq National Oil Company Petroleos de Venezuela Abu Dhabi National Oil Company Kuwait Petroleum Corp Nigerian National Petroleum Corp NOC Libya Sonatrach In addition to a growing number of global geo-political trends, the rise in prominence of NOCs has significant implications that are already impacting IOC business models and growth strategies. And although the business risk to IOC performance is clear, the increasing fluidity in the business dynamic produces a diverse array of risks that affect both IOCs and NOCs.

TABLE 1: TOP 10 OIL AND GAS COMPANIES BASED ON KNOWN RESERVES.1

http://www.petroleum-engineering.net/top-10-oil-companies-based-on-oil-reserves/

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Some of the implications of the shifts are: Traditional Joint Venture and Production Sharing agreements are being supplanted by dollar-per-barrel tariffs, often triggered or enhanced by built-in production level targets. At the same time, host states will naturally seek to impose levies on IOCs in the form of taxation and royalties, whilst their NOC instruments of energy strategy may change the balance of risk transfer to the IOC and seek to moderate investor rewards. These arrangements may produce a complex risk/reward environment, which can be dangerous for IOCs and NOCs alike if there is insufficient alignment of interest. NOCs may have different drivers to IOC. NOCs may be subject to OPEC quotas, international relations of the host government and expectations for their local populations whereas IOCs may well have rather different stakeholder priorities such as shareholders, investors, public relations and downstream customers. Host nations may seek to exercise control over projects through a requirement for IOCs to partner with NOCs, and through their NOCs may become shareholders in companies that participate in the oil and gas value chain. This can lead to a number of challenges to both parties including: Increased risk to national / strategic / operational objectives due to additional complexity of operating with non-aligned partners. Potential divergence on operating standards may expose one party to a higher hazard / operational loss exposure. It may become more difficult to protect intellectual property. Increased investment requirement for exploration activities due to more demanding contract terms. Sovereign states that are perceived to lack political stability risk a contraction of inward foreign investment, leading to curtailment of project activity and stunted industry development. By the same token, foreign investors may risk asset expropriation and an attendant failed investment. This is not just a developing country issue as, established democracies are increasingly viewed as having the potential for fiscal volatility and unpredictable political dynamics.

There is an increasing trend for NOCs to become International NOCs (INOCs) as they search for investment opportunities beyond their own national borders. This exposes them to political or country risks that are comparable to those experienced by IOCs.

RISK MANAGEMENT STRATEGIES

Undertaking political risk assessments before embarking on new investments, perhaps in new geographies, enables organisations to consider the stability of political and fiscal environments, the robustness of the legal framework and the potential consequences from plausible change. Depending on the nature of the threat, risk management may range from the lobbying of ministers regarding the legal framework and fiscal policy to contingency planning for staff repatriation from territories that have become hostile. Political risk, in all its guises, should be the subject of robust analysis and pre and post-loss mitigation: preparedness allows organisations to respond to incidents in a measured and controlled manner. Developed project risk management processes allows for both transparent risk allocation between partners and enables considered provisioning for risk events. This in turn reduces volatility for the balance sheet, and allows for pragmatic mitigation should risk events materialise. Supply chain risk assessment that evaluates risks derived from third parties (suppliers, joint ventures, investors, contractors et al) is a valuable technique for understanding dependencies and sources of risk. Stronger contract negotiation and management through: Contract risk due diligence and allocation Joint venture management guidelines Concentrated budget allocation with tighter due diligence process to steer exploration activities. Affinity Partnering. In the coming years, the most successful joint ventures will likely be those that emphasise an affinity of interest and recognise the value that each partner may bring. For example, some partners may offer technological expertise that is complemented by the political influence of another. Choosing ones partners is now much more than a simple act of capital capture.

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2. INCREASINGLY CHALLENGING RESERVES

In 2010, global primary energy consumption grew by 5.6%, the largest increase (in percentage terms) since 2 1973 . Oil remains the worlds leading fuel, at around a third of global energy consumption3 and in order to meet this perpetual demand for energy, oil and gas companies are pursuing more complex resources to meet energy consumption.
Recoverable resources are estimated to be nearly 5.5 trillion barrels (current proven reserves of oil are 1.47 trillion barrels4 ) and current oil prices justify the increased exploration and production (E&P) cost. This is particularly true for costs associated with exploiting new reserves whether in the Arctic, ultra-deepwater or in marginal oil fields using alternative drilling techniques and enhanced oil recovery. E&P costs are predicted to increase by over 10% in 2012 compared to 20115 as oil and gas companies exploit new reserves notably including offshore Brazil, the Caspian sea, Greenland and Canadian oil sands. Some of the issues facing the oil industry as a result of this push into new areas of operation are as follows: There are higher risks associated with extracting hydrocarbons from harsher, remoter environments. The Arctic for example is characterised by extreme cold, varying forms, and amounts of sea ice, seasonal darkness, high winds and extended periods of heavy fog and week-long storms that approach hurricane strength6. This environment places increased demands on the performance, safety and operability of equipment and technologies. Deepwater drilling and production has associated challenges with equipment suitability and performance. These risks are compounded when also dealing with high pressure and/or high temperature wells, which often they are. There are unknown risks of using new extraction methods and innovative technologies in new environments. The risks associated with first of a kind technology are difficult to fully assess, by virtue of the lack of data upon which to base an assessment. For example, the use of fracking to increase shale gas production requires both investment in research and development with uncertain returns as well as the higher risk associated with the implementation of new technologies. Equally, new technologies and processes present opportunities to reduce unit costs of producing oil and gas. Harsher, remoter environments such as deepwater and the Arctic are not conducive to dealing with situations where problems are encountered. Catastrophe liabilities for drilling contractors and operators are increased in environments where containment of leakage is complex and difficult. Furthermore, in environments that are deemed ecologically sensitive and/or pristine, the consequences of environmental impact are likely to be far-reaching. Reputational risk is heightened for companies operating in environments that are regarded with significant interest. Some frontier areas, for example, the Arctic, can be especially sensitive and both political and social reaction to any catastrophe is likely to create lasting reputational damage to both contractors and operators. Control of this risk is in the mutual interests of all companies engaged in drilling and production activities another event comparable to the Deepwater Horizon current could change the landscape for the whole industry. From recent catastrophe events (for example, the earthquake and tsunami in Japan, flooding in Thailand and Australia, earthquakes in New Zealand, and Deepwater Horizon in the Gulf of Mexico), it is clear that climate and weather patterns are changing. So while extractions of hydrocarbons in new frontiers pose challenges, heightened natural catastrophe hazards will also complicate extraction in well known, developed and tested areas.

THE ENERGY INDUSTRY: AN EVOLVING RISK LANDSCAPE

RISK MANAGEMENT STRATEGIES

An enterprise risk management (ERM) approach to risk exposures allows an organisation to view and evaluate risks of a field development. This allows an integrated and holistic view of likely risk exposures and opportunities, and helps to avoid assessing exposures in narrow silos. In particular scenario analysis can be an effective tool for evaluating new and emerging risks. Developed and exercised business continuity and crisis management plans are effective at planning contingency measures in the event of an incident. Tried and tested plans are critical for ensuring events are not left to spiral out of control and could protect an organisations reputation if a crisis is deemed to have been handled successfully. Applying quantitative risk analysis can help an organisation understand the exposures in any project. Analysis can determine likely risk impacts at varying degrees of confidence and help evaluate the effectiveness of mitigation measures in controlling those exposures. Whilst the aggregation of risks in some of the frontier (both geographic and technological) developments presents new levels of overall risk many of the component issues have historically been encountered and managed. A crucial issue though is to be aware of the existence of those component risks and put in place plans to manage them so as to reduce the overall risk level. The recent Marsh publication 100 Largest Losses suggests that the industry does not always learn as well as it could from past mistakes especially those made by others, those made in different parts of the world and those made some years ago. Deeply embedding the learning from past losses is a key first step in any risk management strategy before addressing the more complex risk combinations.

2 3 4 5 6

BP Statistical Review of World Energy June 2011. Ibid IEA, World Energy Outlook 2011 Energy E&P spending to reach record high, Reuters News 5 December 2011, Global 2012 E&P Spending Outlook Drilling in Extreme Environments: Challenges and implications for the energy insurance industry, Lloyds 2011

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THE ENERGY INDUSTRY: AN EVOLVING RISK LANDSCAPE

3. REGULATORY ENVIRONMENT
The regulatory environment is a key driver in investment economics of oil and gas companies. Key risks arise from changes to legal regimes determined by sovereign states; instability in national tax regimes; and uncertainty in the domestic rule of law or in international regulations designed to address climate change.
Some of the issues which impact an oil company are: The ability to demonstrate good corporate governance is a requirement for companies domiciled in many jurisdictions. The Foreign Corrupt Practices Act in the US and the recently enacted Bribery Act in the UK are two examples of the stringent requirements imposed upon enterprises with severe penalties for those that transgress. The extent of this type of legislation means that international companies operating in many different countries may well find themselves subject to the requirements of those laws merely by having a presence of some form or other in say the US or the UK. This can then present serious challenges to projects in countries where the local expectations can mean the inward investor faces demands at odds with corporate governance requirements. This risk can be particularly difficult to manage when it does not become apparent until after agreements have been signed and finance and resources committed. Fiscal regimes determine the structure of contractual agreement between host state and operator, whether a production sharing agreement (PSA), a concession or a hybrid structure. Contract terms are often amended in favour of the host state and affect the project economics for oil and gas companies. Unstable tax regimes also increase the uncertainty in future cash flows and potentially make ventures unattractive to the extent that companies are forced to close down operations. Changes to taxation rules, registration requirements, exchange control provisions, types and duration of licenses, relinquishment and surrender requirements / rights all contribute to determine the profitability of potential projects. For example, in the UK the government has cited debt levels and the current macro-economic environment for increasing the supplementary tax rate of North Sea oil producing companies from 20% to 32%.This tax increase is blamed for recent drilling figures for the third quarter of 2011 which show a fall in the number of exploration and appraisal wells started offshore to 12, compared with 21 in the equivalent period in 2010; and a reduction in the number of development wells drilled offshore to 22, compared with 30 in the corresponding period a year earlier7. The industry remains vulnerable to often sudden regulatory responses to major incidents. For example, reviews are continuing into offshore exploration and operational requirements in the Gulf of Mexico following the Deepwater Horizon incident. The Piper Alpha incident of 1988 also generated many changes in North Sea Operations. Onshore in Europe, the Seveso Directive, following an incident in Italy in the 1970s, has had a similarly lasting impact.

http://www.decc.gov.uk/en/content/cms/statistics/energy_stats/source/oil/oil.aspx

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Increasingly stringent climate change regulations are anticipated as governments seek to meet emission reduction targets. Legislation and industry guidance on greenhouse gas (GHG) emissions and renewable energy sources could significantly impact business operations for energy companies. An example is the variation and likely flux in biofuel blending rates: as governments aim to meet renewable targets the use of biofuels is being encouraged. However, with current overcapacity, it is expected that blending limits will increase in some countries (for example, Brazil, Argentina, Colombia) in order to absorb the excess capacity8. This in turn will impact the project economics and profitability of biofuels as an alternative energy source, currently being explored by some oil majors. Recent losses have driven shifts in regulatory and public opinion, especially in relation to the issues of pollution and other liabilities. In the event of a catastrophic incident, regulatory priorities will be aimed at both protecting the public and ensuring wider confidence in the regulatory process.

RISK MANAGEMENT STRATEGIES

Foreseeing changes to regulatory regimes can be aided through scenario assessment and quantitative analysis on plausible changes to fiscal and environmental legislation. Such an approach can be useful in modelling likely impacts from changes to pricing and costs. Review and assessment of green / white paper system (where applicable) allows organisations to maintain awareness of impending and emerging legislation. Participation in industry bodies and engagement with climate change / regulatory panels can help ensure realistic and phase changes. Being prepared to react to an incident which does not directly affect a companys own operations can be critical to future profitability. Some circumstances may require plans to protect hard won reputations after a competitor has caused an adverse impact on the whole industry. In another global business sector, the recent cruise ship incident in Italy has led the cruise industry to remind the public of its historic safety record. Additional regulatory control may well be a consequence of such incidents. Being prepared to keep an open dialogue with government should be part of a companys preparation planning and pre preposition.

Global Biofuels Outlook 2011 2020, http://www.globalbiofuelscenter.com/MiscellaneousContent.aspx?ContentId=19

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4. RESTRICTED AVAILABILITY OF CAPITAL

Oil and gas projects are among the most capital intensive and as such oil and gas companies are required to work closely with banks to secure financing.
Over the past ten years, worldwide costs of developing production capacity have doubled, largely due to increases in the cost of materials, personnel, equipment and services. In 2011, upstream oil and gas investment was forecast to hit US$550 billion 9% up on capital spending in 2010, and almost 10% higher than the previous peak in 20089. However, in the current environment longterm financing is increasingly difficult to procure with contracted markets and more stringent terms. Capital markets are wary of taking investment decisions in conditions of economic and regulatory, tax and legal uncertainty. Significant commodity volatility also adds to uncertainty around projecting financing requirements accurately. There is also limited market capacity to purchase exposure indemnification and this is viewed negatively by financing organisations. As a consequence, internal parent guarantees may be increasingly required by lending organisations, limiting balance sheet leverage and the transfer of risk. In short, lack of liquidity coupled with significant payback uncertainties (caused not least by product pricing volatility) is making it very difficult to secure finance for many projects. In particular there is a lack of appetite to lend to the smaller entrepreneurs who are often the ones at the forefront to break the mould with technological advances.

RISK MANAGEMENT STRATEGIES

Risk tolerance analysis allows an organisation to establish financial limits and thresholds that determine the level of volatility its balance sheet can withstand. By establishing the acceptable amount of financial impairment that can be retained without a material impact on the business, it is possible to review investment decisions to determine if there is sufficient financial buffer to take into account potential risks. Project financing scenario / what-if analysis allows plausible outcomes to be tested against an organisations risk tolerance and can help inform investment decisions. Long-term risk adjusted partnership arrangements can be negotiated with investors that take into account longevity and performance of investments and repayments. A tiered and gated decision-making approach to investments provides appropriate thresholds for approving decisions and stage gates ensure that risks are considered throughout the life cycle of a project. Securing project insurance is usually a key step in obtaining any project finance. The complexity of many projects though means that, in the absence of information to the contrary, insurers often assume worst case and load premiums and impose restrictive conditions. An essential early step is to have a full risk engineering review carried out of the proposed design and project management plan. Due to the progressive nature of projects this review needs updating on a regular basis to ensure the insurance is still matched to the needs of the project.

IEA, Global Outlook 2011

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5. ASSET AGEING AND DECOMMISSIONING

As reserves are depleted in the North Sea and Gulf of Mexico an increasing number of assets are reaching the decommissioning phase. Out of a total of 630 platform installations in the North Sea, it is expected that 284 installations, subsea structures and pipelines may be ready to be decommissioned over the next decade.10
Over the last five years forecast decommissioning costs have more than doubled due to cost inflation but also more accurate assessments of the scope of work and experience from current decommissioning projects.11 This poses a significant cost to oil and gas companies where historically there may have been no requirement to provision for decommissioned assets. Costs associated with decommissioning are difficult to accurately forecast for a number of reasons: It is difficult to anticipate when it becomes uneconomic to keep a well open due to volatility in oil prices and changes to tax regimes and environmental legislation Technological advances improve production methods, making previously uneconomic fields profitable The track record of removing installations is not extensive, many of the technological challenges may have yet to be encountered and so cost estimating can be difficult There may be alternative uses for structures such as for gas storage or carbon sequestration Changes to accounting legislation are impacting on contingent provisioning versus on-balance sheet reserving.12 Many of the majors have sold their interest in fields which are coming off plateau production in order to free up capital for larger, newer projects. This has meant many assets are now operated by companies without the experience or resources of the majors, and with a dwindling revenue stream to fund ongoing asset integrity and maintenance.

RISK MANAGEMENT STRATEGIES

Effective project risk management allows cost and schedule analysis to ensure completion to time and budget. Factoring in decommissioning costs into the project life cycle allows for provisioning and balancesheet smoothing.

FIGURE 2: DECOMMISSIONING COSTS FROM 2005 TO 2010.

10 11 12

http://www.oilandgasuk.co.uk/cmsfiles/modules/publications/pdfs/OP049.pdf, Oil and Gas UK, 2010 Decommissioning Insight Ibid IAS 37, http://ec.europa.eu/internal_market/accounting/docs/consolidated/ias37_en.pdf

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6. SKILLS SHORTAGES
Resourcing particularly of technical skills is a key challenge facing the industry. This has been well documented and the oil and gas industry is in general having to deal with resource shortages.
In a 2010 survey at Marshs National Oil Companies conference (see graphic below) recruitment and retention of qualified workforce was the second highest concern of respondents. There are two facets to this issue: In developed economies there is a reduced pool of technical graduates / experienced personnel In emerging oil and gas hubs there is limited experience in the local talent pool. As such there is a demographic move from some of the more established geographies to new developed economies offering greater rewards. The dearth of skilled expertise has been attributed to the following reasons: Cutbacks of the oil industry graduate programmes in the1990s An ageing workforce in developed economies and IOCs An increased but sometimes unmet demand for technical skilled resource, in line with the industrys push to extract resource from increasingly remote and harsh environments for example there is understood to be a serious lack of sub-sea expertise throughout the industry This risk is pervasive to all projects and operations and reduces the capacity to exploit opportunities. Resources are also a key differentiator in determining competitiveness, particularly in delivering on the technical challenges moving forward.

RISK MANAGEMENT STRATEGIES

Measures to address the challenge of resourcing stem principally from how organisations manage their human capital. Talent management and development programmes; competitive remuneration; and links with universities and other academic institutions should aim to attract and retain the skilled resource. In a global marketplace, skills inevitably move, but with those skills come cultural differences. It is imperative that organisations understand those cultural differences and the impact they can have on a risk profile and then manage the risks accordingly. Due to the skills shortages and an ageing workforce, inevitably this gap will eventually be filled by younger and less experienced people. With that comes the huge attendant risk arriving from loss of corporate memory. Industry accident statistics suggest that unless learnings from losses have been deeply embedded in procedures and standardsand many are not then mistakes get repeated after 10 years or so when people who suffered the original misfortune have moved to new positions or new companies. The insurance sector is well positioned to ensure some of these losses are understood by the new generation through Learning from Losses seminars a regular feature now of Marsh underwriting surveys.

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7. GEO POLITICAL TENSIONS

The continued demand for energy sources, the location of resources and the political uncertainty in those regions is arguably the largest macro risk facing oil and gas companies.
This is reflected in a 2010 survey at Marshs National Oil Companies conference (see graphic below), which indicates that availability of oil and gas resources is considered the largest risk to the industry. Whilst the industry indeed presses ahead into more remote and challenging environments, much of the increased demand for oil will need to be met by Middle Eastern and African countries. Indeed the International Energy Agency forecasts that 90% of the growth in petroleum supply will come from this region in the next 20 years13. Of course this region has seen unprecedented political upheaval in the last 12 months with more still likely.

FIGURE 3: RESULTS FROM 2010 MARSH NOC CONFERENCE SURVEY.

13

The Importance of the Middle East and North Africa in Providing Energy, R. Takieddine, Al Arabiya News

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Given that an investment has already been made, the instability and uncertainty directly impacts on the ability of oil and gas companies to continue operations from a variety of perspectives: Political risk impacts on the ability to continue operations from a safety and security of personnel and assets protection perspective. Regime unpredictability increases the credit risk of key suppliers and customers in the region. Country risk impacts on future opportunities as regime instability adds a risk premium to investment assessments and makes it more difficult to secure project financing. Downstream activities in the value chain are dependent upon a predictable upstream supply of oil and gas interruption to supply is heightened when downstream activities are dependent on crude from politically volatile countries. Recent events in North Africa, Russia, Venezuela, Nigeria and Iran all serve to re-emphasise the potential impact on existing operations.

At the most basic level, having a well defined (and tested) contingency / crisis management plan that can be executed in the event of a political risk incident, should provide a degree of assurance regarding resiliency. Key Risk Indicators (KRI) can provide businesses with metrics for assessing emerging risks and allow for the measurement of waxing and waning exposures. Leading KRIs can, for example, allow alert levels to be raised to the board regarding operations in a specific territory (or region) and if aligned to a risk management framework, provide important foresight in changes to business conditions. There are a variety of qualitative and quantitative techniques for identifying and evaluating risk exposures and these should be applied judiciously and appropriately to understanding the risks associated with expanding into, and maintaining a presence in, certain jurisdictions. A country risk assessment exercise should address external and internal variables with detail sufficient to provide assurance on the risk / reward profile associated with doing business in a certain territory. This should include other emerging risk issues such as the rule of law, human rights and business ethics. At the more complex end of the risk management spectrum government lobbying (both local and international) can influence to an extent the likelihood and impact of any political or emerging economy risk.

RISK MANAGEMENT STRATEGIES

Effective risk management is not solely about reducing the negative consequences of risk, it is also about taking opportunities for innovation and growth. The challenge remains how to deal with complex macro risks of this nature.

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8. LENGTHENED SUPPLY CHAINS

There are a limited number of oil and gas companies with operations throughout the hydrocarbon value chain. A consequence of outsourcing by these companies is the presence of multiple organisations throughout the value chain. For the oil majors outsourced drilling, maintenance, design, project management, IT and financing is not uncommon. As a result, interdependence is intrinsic throughout the value chain and this places huge pressure on ensuring that multiple third party relationships are effective and efficient. A corollary of this inherent interdependence is the presence of highly complex and geographically extensive supply chains. Well publicised supply chain shocks from the earthquake and tsunami in Japan and the ash cloud from Iceland highlight the vulnerability of complex supply chains and the risks derived from dependence on multiple parties. Notable consequences include: Difficulty with responding to incidents, such as containing a well blow-out, due to the requirement for multiple organisations (drilling contractor, servicing company, equipment provider, well operator etc) to work together efficiently. This risk is compounded when an incident occurs in a remote location and logistics associated with obtaining equipment and spare parts are formidable. There is an increased risk of insufficient oversight in safety and operational procedures and processes, particularly when offshore activities are controlled by onshore centres. Conversely there is a risk of inefficiency due to duplication of overlapping processes that are imposed by multiple parties. The presence of multiple parties increases the risk of an event setting off a series of unintended and unplanned correlated incidents. A platform of fire may occur due to a technical fault, which in turn may trigger supply chain, environmental, political, contract and reputational risk impacts. The compounding of risk events is extremely difficult to anticipate, and is more likely to occur with multiple parties involved. The presence of multiple parties reduces well owners ability to control budgets, especially during times of volatility.

RISK MANAGEMENT STRATEGIES

An ERM framework allows an organisation to assess risk exposures from a top-down and bottom-up perspective. An approach that is embedded should provide management with relevant and complete risk data to inform decision-making. When dealing with third parties, ERM can have application in evaluating the dependence between organisations and allows for the prioritisation of mitigation against identified risk exposures. The key advantage to managing risk through the application of ERM compared to traditional risk management is that risk exposures are evaluated regardless of organisational barriers. This is important as corporate silos create artificial boundaries in identifying risk exposures and inhibit comprehensive assessment of risk impacts. Under the umbrella of ERM, proactive supply chain risk management can help prepare an organisation for anticipating consequences to supplier interruptions. Nonetheless there are of course many risks outside the control of an organisation (for example natural catastrophe) and embedded contingency plans for crisis management, disaster recovery and business continuity are prudent measures for dealing with unforeseen issues. Organisations are far more resilient to major shocks if they have clear lines of communication and if employees across the organisation are empowered to take decisions. Organisations should also seek assurance over suppliers risk management processes and contingency plans. A tactical measure is to maintain an exception log showing all deviations from standard operating practices / standard terms and conditions, stating why such deviations were required.

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It is useful to regard ERM as an approach that evolves and becomes increasingly sophisticated with continuous improvement. In this way expertise in risk assessment builds and develops over time, allowing an organisation to sustain progress in its risk management capabilities. The table below is a maturity model developed by Marsh that allows organisations to develop their risk capabilities in a pragmatic and measured way. On the y-axis are six criteria necessary to develop leading practice ERM, with five maturity levels on the x-axis.

FIGURE 4: ERM MATURITY MODEL BY MARSH.

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CONCLUSIONS
A BETTER WAY TO TREAT RISK
It can be seen from the examples above that risk issues are extremely diverse in nature and potential impact, even before we consider ripple effects. Silos of risk (e.g. a new refinery, an exploration well) may be easily given to description and evaluation, especially if the parameters of analysis are informed by accessible data (such as an investment or replacement value) or data that can be readily modelled (such as an Estimated Maximum Loss). Tellingly, our ability to articulate the nature of risk and plan for wider consequences may break down when we try to envisage knock-on effects. It seems that the further away from the initial event we go, in time and effect, the more abstract our conceptualisation of risk must become, making it very much more difficult to model impacts and devise response plans. In part, this is because of the way that many companies manage risk, and in fact we all too often see corporate risk management structures that mirror perceived silos of risk (e.g. treasury risk, operating risk, legal risk, hazard risk) thus exacerbating the silo effect. We believe that the future of enlightened risk management lies in an increasingly holistic approach, so that above the silo level, risks are assessed for wider, more company-wide impacts. This approach is often called ERM, which although regarded as best practice, has in some respects struggled for necessary recognition and adoption. An effective ERM process helps to illuminate and model the wider risk impacts emanating from a single event or indeed a cluster of events. In such a dynamic environment, large and complex enterprises will always struggle to identify all risk permutations. Therefore, successful ERM extends also to arming a company with the ability to mount superb responses in the face of unforeseen risk impacts. It is this very excellence in the face of the unpredicted that helps mark such companies out as elite organisations.

THE EVOLVING ROLE OF THE RISK MANAGER

Our conclusions about the necessity of ERM leads us to consider what risk managers can do to help overcome the limitations of the silo risk approach seen in many energy companies, large and small. The adoption of ERM within any given company will to some extent reflect the organisational structure and culture of that company. The aspirational risk manager (or whoever is performing that role, perhaps in addition to other responsibilities) will seek increasingly to broaden the influence of his or her office across the business, migrating from a pure insurance function towards areas such as procurement, supply chain, human resources and acquisitions and divestments, risk governance, crisis management and business continuity planning. Evidently, all of these areas are either beset with risks or are tasked with mitigating the effects of risk. By bringing into each of these areas a profound knowledge of the company risk appetite and broad risk management expertise, the risk manager can help optimise the company relationship with risk and, thereby, the success of the enterprise. The paper entitled Creating Values Under Pressure: Why National Oil Companies need risk management in a shifting environment, by our sister company Oliver Wyman, presents some very clear specifics on how he sees an NOC risk manager should go about this process.

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THE ENERGY INDUSTRY: AN EVOLVING RISK LANDSCAPE

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AUTHORS AND CONTRIBUTORS

DANIELLE ANDERSON Marsh Risk Consulting danielle.anderson@marsh.com WILLIAM BRUCE Marsh Risk Consulting william.bruce@marsh.com EDDIE MCLAUGHLIN Marsh Risk Consulting edward.m.mclaughlin@marsh.com DOUGLAS URE Marsh Risk Consulting douglas.ure@marsh.com SIMON BOXALL Marsh Energy Practice simon.boxall@marsh.com ANDREW GEORGE Marsh Energy Practice andrew.x.george@marsh.com ROBERT ROBINSON Marsh Energy Practice robert.robinson@marsh.com JAY SYRETT Marsh Energy Practice jay.syrett@marsh.com

The information contained herein is based on sources we believe reliable and should be understood to be general risk management and insurance information only. The information is not intended to be taken as advice with respect to any individual situation and cannot be relied upon as such. Statements concerning legal, tax or accounting matters should be understood to be general observations based solely on our experience as insurance brokers and risk consultants and should not be relied upon as legal, tax or accounting advice, which we are not authorised to provide. In the United Kingdom, Marsh Ltd. is authorised and regulated by the Financial Services Authority for insurance mediation activities only. Copyright 2012 Marsh Ltd All rights reserved