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Fri 1 Jun 2007 12:00 AM

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A game of risk

Risk manager, Marsh brought together the world’s national oil companies (NOCs) for a global risk-advisory meeting. Andrew George reflected on the event.

Large oil companies are part of a growing call for risk advice, according to Andrew George, Marsh's managing director of marine and energy practice. The company recently held a conference in Dubai to discuss risk space - a first for the industry.

According to findings published in Marsh's recent white paper, less than 10% of national oil company (NOC) leaders surveyed by the company strongly feel they have a full understanding of the risks they face - and how to manage them.

"What is clear is that over the past few years the NOCs have come into more power, as people judge companies on their reserves and reserve placements," said George.

They are fast becoming very sophisticated companies and their governments are acting like external shareholders who want them to up their game. This has been the shift in the last few years.

"Ninety percent of the world's reserves are held in the hands of these government and partial-government owned companies. This has caused a slight shift in power from the major independent companies of the 1970s, which became the powerhouses of the energy sector. They are still important, but the future lies in the NOCs, which hold the bulk of the reserves."

The paper, titled The Impact of Risk on National Oil Companies, also reveals a strong desire by NOC leaders to understand risk better and find more effective ways to share best practices. It outlines the major risks affecting the global landscape, including the ‘interconnected global community'. What happens in a remote corner of the world affects a company across the globe. This means disruptions in a supply chain can have consequences for companies in other countries and on other continents.

The report describes the risks linked to the need for efficiency. "With the advent of the digital age, global business has become ruthlessly efficient," it says. "But this means that even last minute disruptions can have disastrous effects. When operations, communications, or investments cannot take place instantly, they may cause severe problems."

It also highlights the current focus on short-term performance by investors. The report contends that today's environment is all about competition. Any indication of who is winning that competition, be it the release of quarterly results or the slightest fluctuation in stock price, has instant consequences. "These pressures are not going to go away," said the report. "But by bowing to them, business leaders risk forgoing long-term strategic planning - a dangerous proposition."

During the meeting, Marsh also cited other potential risks faced by NOCs, including the potential for a terrorist act to halt distribution, the effects of a major natural disaster on production and the potential vulnerability of supply chains - especially due to the threat of avian flu, as well as a variety of operational, strategic and financial risks.

Marsh wants to position itself to work within the industry. To do this it is developing risk ideas and addressing problems such as supply chain interruption and crisis management.

"There has always been a tendency for NOCs to treat risk relative to the demands of their shareholders," said George. "Some parts of the world are less regulated, with less of a framework. Now, this is largely not the case, as the companies that didn't need to share anything with anyone else in the past have become hugely powerful."

Statistics published by the BP Statistical Review show that Saudi Arabia has enough proven reserves to be able to produce hydrocarbons for the next 250 years, whereas the rest of the world is peaking at about 50 or 60 years. George contends the industry is reshaping and the power is now in the hands of the NOCs.

"These companies are realising that just having cheap insurance doesn't take risk off their balance sheet - they do need to look at their supply chain," he said. "They are fast becoming very sophisticated companies and their governments are acting like external shareholders who want them to up their game."

Marsh is spending more of its budget on consultancy than ever before, with increasing numbers of Middle Eastern oil companies looking to utilise these services.

"The key thing is risk measurement," said George. "We want to start from the beginning by looking at companies' balance sheets and establishing what their key performance indicators are. We want to stress how important it is to have enough mitigation and control techniques in place to allow their business to carry on and meet shareholder targets, should disaster strike. A lot of companies are realising that this is where they have to be.

"A key thing for NOCs is the valuation of their equipment. A steel jacket in the Persian Gulf, for example, which may have been bought for US $100 million, could cost up to US $400 million to replace. If you are hedging this risk, you have to insure it for the higher figure."

George said another big issue to come out of the conference was the need for talent in the industry, and the global problem of public sector employment strategies versus private sector employment strategies. "With the emergence of the NOCs, they have to be able to compete," he said. "The social structures and demands differ between countries, but what is fairly universal is that there is a shortage of engineers and other qualified people for oil and gas projects. At the risk level, management of these companies are now realising they have to address these issues."

George has observed a shift in NOC's approach to knowledge transfer, and contends how important it is for oil companies to move with the times.

"It is particularly relevant now, not just because of the power of those companies, but because in the past they haven't always shared information as freely as others," he said. "A lot of them are now finding that sharing some of their data with companies in other countries isn't necessarily a competitive disadvantage."

But George is willing to accept that knowledge transfer and cross-border investments remain potentially problematic for firms just starting to branch out of familiar territory.

"An NOC can operate within its own borders as it wants, possibly controlling the market, feed stock price, offtake, and it may own the whole value chain within that country," he explains.

"As you cross borders, however, you are acting independently and competing freely with the other companies in that country. In some of the developed economies, the NOCs are competing with the international oil companies (IOCs) for different projects.

"These companies may understand the transfer risk and regulatory framework in their own country, but when they cross borders, all of a sudden there is another set of rules they have to abide by. Cross border investment is new to a lot of the those companies, so they are looking to firms like ours to help them assess, measure and transfer their risk."

International stage

He explained how it would be more difficult for some companies to make the transition from the national to international stage, while some NOCs have been operating almost as IOCs for years.

"If you look at the footprint that companies like Petrobras, ENI and Statoil have, it is difficult to determine whether they are NOCs or IOCs," he said. "Some of these companies have 30-40% national ownership, but have been operating as independent oil companies. For companies like that, the transition would be less difficult. But for companies that have just stayed within their own borders, and are 100% government owned, there would be more of a challenge."

Marsh concluded its meeting by proposing a new strategic approach. In order to manage risk effectively and use it to create advantages, companies need to alter risk's place in the management system and the way in which it is considered and processed. Risk must be elevated to and incorporated into the highest levels of business strategy.

Risk transfer and insurance purchasing should be the last step in a long process of risk assessment, prioritisation and treatment. Instead of looking at risk as a necessary burden (i.e. simply the cost of insurance), companies need to incorporate it into their business strategy in the broader sense. The first two steps in the risk management process - assessment and prioritisation - are every bit as important as the last step - treatment. Without a disciplined review of a company's total risk, Marsh says, it is impossible to manage it effectively. In response to the findings in the report, Marsh has said it will sponsor and lead its second annual risk advisory conference for NOCs in February 2008.

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