E&P Risk Analysis: Expecting the Unexpected

E&P Risk Analysis: Expecting the Unexpected

By Mahinaz El Baz

Exploration and production (E&P) of hydrocarbons is a high-risk venture. Geological processes are dynamic and uncertain with respect to structure, reservoir seal, and hydrocarbon charge. Economic evaluations of E&P activities contain uncertainties related to costs, probability of finding and producing economically viable reservoirs, global oil prices, and supply and demand dynamics.

Even after reaching the development and production stage, engineering parameters and concepts include a high level of uncertainty in relation to their critical variables—such as infrastructure, production schedule, quality of oil, operational costs, and reservoir characteristics. These uncertainties originate from geological processes along with economic and engineering concepts and involve high-risk decision scenarios with no guarantee of the discovery and development of hydrocarbons.

Experts argue that “future trends in oil resource availability depend largely on the balance between the outcome of the cost-increasing effects of depletion and the cost-reducing effects of the new technology. Based upon that scenario new forms of reservoirs exploitation and managing will appear where the contributions of risk and decisions models are one of important ingredients. This trend can be seen in the last two decades,” noted Suslick and Schiozer in their study on Petroleum E&P for the Journal of Petroleum Science and Engineering.

Current E&P strategies are driven, in part, by international oil companies’ (IOCs) aim to rapidly evolve new technologies. New technological advances have allowed the further exploration of “well-established basins as well as new frontier zones such as ultra-deep waters. Those technology-driven international hydrocarbon exploration and production strategies combined with new and unique strategic elements where risk analysis and decision models represent important components of a series of investment decisions,” write Sulick and Schiozer.

Risks Facing E&P Activities

Oil and gas companies face many types of risks, ranging from volatile commodity prices—which are more linked to global socioeconomic factors than supply and demand—to increased quality, health, safety, and environmental (QHSE) pressures resulting from major accidents that negatively impacted the environment, the industry’s image, and its social lease, according and IDC Energy Report on reducing risk in oil and gas operations. In addition, there are fundamental uncertainties and risks in normal E&P activities related to asset damage, business interruption, pollution, injuries, and damage to properties. Risks can be classified as risks of non-compliance and cost overruns, according to the IDC report. As the level of information increases, many uncertainties and risks are mitigated and consequently the importance of the uncertainties related to the recovery factor increases.

On the other hand, some experts divide risks facing E&P into geological, political, economic and financial, environmental, and cyber security risks. Geological risk involves the prediction by geologists based on historical data, statistics, and analogues of other similar basins and work with comparable geological characteristics of the probability of hydrocarbons. The estimate could prove either correct or incorrect, stated Donwa et al. in a paper on risk assessment in the oil and gas sector published in the Journal of Business Administration and Management Sciences Research.

Politics is another factor that creates risk as it impacts hydrocarbon industry regulation. “In our current time, [the political risk] factor is become more important and the international investment company must take it into account before they make a decision to invest: Would my company survive, if I lose the investment in this country? This question must be answered,” Dr. Kenanah Shereih, Researcher in Petroleum Economics, said. IOCs are mainly covered by a range of regulations that limit where, when, and how extraction is done. This interpretation of laws and regulations differ from one country to another. Thus, companies tend to prefer countries with stable political systems and a history of granting and enforcing long-term leases, according to Tamara Joy Somers’s thesis on Political Risk in the Oil and Gas Industry in Emerging Markets, 2014. Experts argue that political risk can be obvious, such as in developing countries with a history of sudden nationalizations or in nations that adjust foreign ownership rules to guarantee that domestic corporations gain an advantage. On the other hand, a political change is not necessarily a bad thing, as political changes can improve the business climate, such as when China opened for economic reform and foreign trade and began to generate steady investment growth. Political risk analysis can therefore contribute to identifying and capitalizing on unexploited opportunities, stated Donwa et al.

In addition, economic factors play an important role in the performance of E&P activities. Macroeconomic factors include economic growth, inflation, employment, interest rates, and business sentiment. Any change in one or more of these factors can constitute an E&P risk. The price of oil and gas is another primary factor in deciding whether a reserve is economically feasible or not. Basically, the higher the geological barriers to extraction, the more price risk a given project faces. As unconventional extraction techniques cost more than a vertical drill down to a deposit.

Furthermore, supply and demand fluctuations are a very real risk for the industry players. Operations take a lot of investment and time to get going. The uneven nature of production is part of what makes the price of oil and gas volatile. Other economic factors play into this, as financial crises and macroeconomic factors can dry up capital or otherwise affect the industry independently of the usual price risks.

Environmental risk is another serious risk facing the upstream industry in general and E&P activities in specific. It can be considered as the most serious due to the interaction of consequences and the probability of an event. The risk is related to environmental issues and refers to both the hazardous outcome and the probability of its occurrence as a consequence of man’s activities in the environment, explained M. A. Ayoade in a paper on environmental risk and the decommissioning of offshore oil platforms in Nigeria. “Environmental risks include blowouts, fires and explosions, spills, unintentional discharges, pipeline strikes and failures, and platform strikes and failures,” Dismukes and Christopher wrote in a paper on diversifying risk in the energy industry.

New Types of Risk

Rapidly improving technology in the hydrocarbon industry creates a new type of information-technology (IT) related risk. Cyber security threats targeting sector companies are real risks facing E&P activities. Concerns were originally raised about the security of process systems with the revelation that the highly sophisticated Stuxnet virus was capable of invading process control systems and potentially disrupting processes of systems on drill rigs. For instance, the cyber-attacks on Saudi Aramco and RasGas in 2012 were a huge shock for many oil and gas companies in the Middle East and North Africa (MENA) region. The Saudi company was the victim of a significant cyber-attack. The company announced that 30,000 of its workstations had been infected by a virus, according to IDC Energy. Qatar’s RasGas was hit by a similar attack, resulting in the company going offline for a few days.

A group of hackers—who called themselves the Cutting Sword of Justice—claimed responsibility for the attack on Saudi Aramco. They allegedly infected the organization’s systems by replicating malicious software for political reasons. Some IT analysts credit a virus called Shamoon for both attacks. “Both Saudi Aramco and RasGas managed to limit the damage and the attacks did not affect extraction or processing. Such a bold attack, however, had important repercussions on the IT strategies of oil and gas organizations operating in the Middle East, demanding new projects on risk assessments, new IT security policies, and the adoption of additional security solutions,” according to a paper prepared by Roberta Bigliana for IDC Energy Insights

Although technology creates new types of risk, it provides solutions to mitigate this risk as well. IT “capabilities such as mobility, cloud and Big Data/analytics offer opportunities to transform the way information is managed, used, and distributed across the company, according to Bigliana. She goes on to say that ‘[h]aving timely, updated, and contextualized information is a prerequisite to be able to make sound decisions and operate effectively and efficiently on assets, reducing the possibilities of mistakes and ultimately mitigating risks. The same goes for data integration.”


Risk Assessment Methods

Risk assessment is “the process used to identify hazards in the workplace and assess the likelihood that these hazards will cause harm to employees and others,” according to trade union congress. It is a crucial part of risk analysis and management as it entails the overall process of risk identification, analysis, and evaluation. In the oil and gas industry characterize with a lot of working equipment and complicated technologies, and high risk working environment, major E&P players must assess the level of risk associated with their investment and infrastructure in order to provide a mitigating measure. Risk assessment is carried out to identify these risks and to develop remedies to mitigate them.

Risk can be assessed either qualitatively or quantitatively. “Qualitative risk assessment is the process of prioritizing the risks by assessing the probability of occurrence and impact while quantitative risk analysis is the process of numerically analyzing the effect of the identified risks on the investment objectives,” stated Donwa et al.  Some experts argue that there is no single method of risk assessment that covers all types of oil and gas investment risk or workplaces risk. Different risk analysts employ different methods. Every method, however, involves decisions being made on how acceptable a risk is. This decision is based on the value that they place on the safety of their investment and health of their workers, Donwa et al. argue. “The most common approaches used in the industry are EMV & Monte Carlo simulation […] these methods lead to a very similar result and all methods are built based on a deterministic economics model. Therefore, only by using a clearly defined robust deterministic economic model, including all relevant cost and revenue variables, their mathematical treatment, and functional correlations, the E&P risk could be better addressed. The process [to] address the E&P risk must be a continuous process along the cycle life of the petroleum project in order to support the preparation of strategies and the decision-making process,” Shereih noted.

Other experts think that there are better approaches to address E&P risk. “I prefer the top down approach in both cases, new entry or new project. This means performing regional risk analysis on the status of politics, [the] financial situation [of] the government, and [the] infrastructure existing in the region—followed by economic modeling exercises and scenarios development then merging or integrating the previous steps to come up with a full risk analysis. [Yet] it varies from [one] company to another based on size and risk appetite,” explained an industry expert in risk analysis who requested anonymity.

Egypt: What Experts Think?

Egypt, like other oil and gas producing countries, faces different types of E&P risk. “Risk can vary from [one] company to another based on the business model; domestic or export market; area of operations, and also project phase. However, there are common risks for everyone: for example guarantees of payment, ease of getting permits from authorities for drilling purposes especially in the Western Desert and Sinai, [as well as] depleting reserves in major oil and gas field around Egypt. I believe these are the main uncontrollable risks IOCs are exposed to in Egypt. Other risks can be controlled through close monitoring and negotiation with the government which is showing flexibility to meet IOCs’ demands on many occasions.… It is very simple to overcome these challenges through better alignment, coordination, and communication between host authorities,” explained the expert.

In addition, Stephen Fullerton, Research Associate at Wood Mackenzie, thinks that “the main risk for E&P companies in Egypt is still non-payment of receivables. Although this has improved in recent years, companies still view this as a major risk. A lesser risk would be infrastructure bottlenecks, especially available processing capacity in the Western Desert. Outside of Egypt the main risk will be slowing demand driving down oil prices globally in the near term.” E&P activities involve a number of operational risks, including explosions, fires, and the release of hydrocarbons into the air, water or soil—resulting in serious harm to the environment or multiple deaths or serious injuries.

When asked about the best methods and approaches to address E&P risk in Egypt, experts stressed the importance of companies’ risk assessments. “Companies need to stick to realistic criteria when sanctioning projects and make sure they break-even at lower prices,” noted Fullerton. Tackling an HSE angle, Mohamed Maghraby, a HSE Professional, stated that “operational facilities which have the potential of a major accident due to the storage, handling, or processing of hazardous or toxic materials are classed as major-hazard facilities. Safe operation of all major-hazard facilities is demonstrated through the safety case developed specifically for the unique operations and situation. The safety case is the means of ensuring and demonstrating that suitable and sufficient measures are in place to prevent a major accident or environmental event and to reduce the effects of these events should they occur.”

Despite the conventional methods to mitigate E&P risk in Egypt, technology is a potential unconventional approach. “New technologies and software have always been a good aid to E&P companies in managing upstream related HSE risks,” noted Maghraby. Technology can help in “accessing remote areas especially in the Western Desert, and reaching out ultra-deep waters in the Red Sea and West Mediterranean. [Moreover, it helps in] optimizing depleting reserves and utilizing every single barrel we can produce  GOS [Gulf of Suez], WD, East Mediterranean. [Technology enables companies] to convert the non-economic discovered reserves to economic prospects and further explore the shale gas prospects in [the] WD with no major effect on the environment,” stated an industry expert in risk analysis.

Furthermore, experts stress on the importance of flexible modeling. “In the current environment due diligence is key. Properly appraising a resource and having a good geological and commercial model prior to sanctioning a project will go a long way to making sure the project is a success. This may mean that an extra appraisal well or more seismic is needed but should prevent any nasty surprises when the field comes on-stream,” noted Fullerton.

E&P is considered a capital-intensive business. Its activities have recorded success in dealing with the uncertainty associated with its operations over the years. Although the cost of these processes has fallen and success rates have increased considerably due to improved technology, the average rate of return is still low. Thus, experts argue that greater utilization of risk analysis is necessary to ensure that IOCs receive a good return on their investments.

Dr. Mahinaz El-Baz 318 Posts

Mahinaz El Baz received her PhD degree in International Economics from Helwan University in 2022. She has +10 years of experience in journalism and economic analysis. She received the "Best Economic Article Award" in 2016 from CFA Society Egypt.


Welcome! Login in to your account

Remember me Lost your password?

Don't have account. Register

Lost Password