Landscape of risk is rapidly changing as energy sector searches further and deeper

The international energy market does not have a problem with demand as the global appetite for oil and gas continues to escalate despite the best efforts of interest groups and politicians to shift the focus to cleaner energies.

The problem the sector faces is rather one of supply and, more specifically, the cost and risks that must be taken to secure that supply.

Energy experts gathered in Dubai for Marsh’s National Oil Companies conference agreed that demand for fossil fuels will continue to rise, driven at a staggering rate largely by the fast-growing economies of China and India, over the next 40 years.

David Williams, President, Chairman and CEO of Noble Corporation, a leading offshore drilling contractor for the oil and gas industry, said that the current consumption of oil barrels per person, per year is about five based on a worldwide average, under two for India and China, 14 in Japan and about 23 in the U.S. By 2050, however, Chinese and Indian consumption will have rocketed up to over 15 barrels per person, per year, according to the oil industry veteran.

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“It is difficult to believe that the U.S. populous will adjust its lifestyle downward to match the rest of the world. It is much easier to believe that the rest of the world will continue to move their [lifestyle] upward,” said Mr. Williams.

“Energy is not the end, it is the means to an end, that is a better a lifestyle. It is difficult to see how non-petroleum sources of energy will be able to contribute meaningfully in the near-term,” he continued, casting doubt on the ability of alternative sources of energy to displace oil over this period.

According to Mr. Williams, for now, oil is still relatively available and accessible. He said that 79% (798 billion barrels) of offshore ‘proved and probable’ oil reserves lie under 0-400 feet of water and only 1% (5 billion barrels) lie in ‘ultra deep’ water.

The Middle East is by far the major holder of proved and probable reserves followed by Sub-Saharan Africa (Angola and Nigeria) and Latin America, mainly Mexico.

The deep water reserves are dominated by West Africa, Brazil, the Gulf of Mexico and the Asia pacific region. Brazil alone has almost half of the proved and probable oil reserves located in depths between 5,000 and 7,500 feet.

VIABILITY POINT

Mr. Williams reckons that the ‘break point’ for deepwater development is $50 to $60 per barrel to deliver a rate of return (excluding exploration costs) of 20%. This will continue to inspire the industry to maintain exploration and exploitation of new reserves to feed that fast-growing demand he said painting a relatively rosy picture.

But, according to Matthew Simmons, Chairman Emeritus of Simmons & Company International, the U.S. investment banking firm that specialises in the energy sector, the quality of the oil that is currently on tap is a problem.

“The world will never run out of oil or water but, high quality (sweet and light) oil and potable fresh water are becoming scarce,” he said during his speech that focused on the availability of traditional energy sources and potential alternatives based on new technologies.

Mr. Simmons pointed out that giant and old oil fields account for nearly two thirds of the world’s supply and have already passed their peak flows. Most of the remaining oil supply comes from small fields and so-called ‘junk crude’ that is harder to refine into finished oil, he explained.

“Creating motor gasoline, jet fuel and diesel will get increasingly costly and hard to grow,” said Mr. Simmons.

Alternative energy sources are one route but at the same time the application of new technology to find and exploit the better quality reserves in more remote places is a more immediate way in which this strategic risk is being tackled.

Mr. Williams said that his company had, for example, embarked upon a major upgrade and new-build programme to help push back the frontiers of exploration. Between 2005 and 2009 the total number of units operated by the company rose from 30 to just under 70 and the gross value rose from about $4.2bn up to $8.4bn. Moreover, the amount of capital dedicated to deepwater development rapidly outstripped that devoted to shallow water rising from about a quarter in 2001 to over three quarters last year, he said.

And the kit used to carry out this deepwater oil fishing is ever more sophisticated and expensive. For example, Noble has converted five bottom-founded submersible rigs capable of operating in 70 feet of water in the Gulf of Mexico into semisubmersible rigs that are capable of operating in 7,000 to 9,000 feet of water.

This year the company takes delivery of the Noble Paul Wolff rig that will drill offshore Brazil for Petrobas and sets a world record for water depth as it will drill at 8,616 feet of water. This impressive technological leap will, as any experienced underwriter will attest, inevitably raise the risk management bar and pose big new challenges for both risk and insurance managers.

To enable this technological change and attached investment the industry is also changing shape. NOCs are taking a much bigger role in exploration and development than in the past, partly because of the rising strategic stakes and funding needed.

The NOCs are also working much more in partnership with IOCs and other service providers to help take this technological leap and this in itself brings new risks that need to be managed and offloaded when possible.

The solution to this significant risk management challenge for most risk management experts would be to invest in risk management and adopt state-of-the-art enterprise risk management systems.

Jose M Carrera, Risk Manager with Petroleos Mexicanos, the Mexican NOC and tenth largest in the world, however, told delegates that this may look fine on paper but it is not that easy. He warned that the recent crises had proven that effective ERM is much more difficult to implement in practice.

“Processes may have been in place to identify, assess and manage risk but shortcomings became evident where these processes did not systematically refresh based on changing conditions,” he said.

“Many organisations have deployed risk management efforts to identify, assess and manage risks, using techniques such as value-at-risk, scenario analysis and stress testing as a basis for determining response strategies that align the firm’s objectives with risk appetite and tolerance. However, recent events revealed shortcomings in these efforts,” he continued.

NO TO ‘TICK BOXES’

The risk manager said that enterprise risk management systems are useful because they can provide ‘good order and visibility’ for risk management. But, he warned that ERM can also foster a ‘tick box’ mentality, that can hinder the ability to respond.

Mr. Carrera also said that traditional risk assessments that prioritise risks on the likelihood of occurrence and impact are often outpaced by the speed in which risks can move throughout an organisation. An ERM system should therefore include ‘risk velocity’ into the risk assessment and mitigation activities, he said.

And, Mr. Carrera warned fellow risk managers against over-reliance on models. “While quantitative models can be valuable in providing visibility to risk exposure they tend to oversimplify risks and override good judgement,” he said.

Risk managers should focus more on hard-to-quantify risks, reinstate ‘judgement’ in risk management decisions and ensure that their organisation has the right people in the right places to exercise that judgement on operational and strategic risks, he added.

Setting aside the political, macro-economic and social risks associated with this massive global industry it is clear that risk managers within the sector will have to be on top of their game to rise to the challenges set by executives such as Mr. Williams at Noble and the NOCs who remain determined to find and tap more oil wherever it lies.

And it will take a brave and confident risk manager to point out when the potential risk outweighs the potential benefits and try to potentially put a halt to projects that the board and exploration team are excited about and determined to make work.