1 Risk perception and management
The reasons for investing in natural resources are persuasive and numerous, as you have explored in previous sessions, but it is also a risky business. Effective planning to mitigate and manage risk is, therefore, a crucial part of any investment strategy. Risk is particularly pertinent for the oil sector because the stakes are so high. As the entire oil value chain is capital intensive it can take decades to achieve profitability, meaning that companies have to carefully weigh up the longer-term benefits of investing overseas. Risks can be categorised into three broad areas:
- Economic – susceptibility to volatile global markets, such as the price crash in 2015 that saw the price of a barrel dropping by half in just under a year; capital development costs can overrun; operational maintenance costs can be extremely high; supply and demand shocks.
- Political – the hosting government may try to renegotiate or change the terms of a deal, something which successive governments attempted in Nigeria; changes in policy and regulation, such as an increase in royalty payments or taxes, can adversely affect the ability to repatriate revenue flows; the level of political stability in a country can be a determining factor as to whether an investment is worthwhile.
- Environmental – infrastructure can be susceptible to extreme weather events and natural disasters such as offshore platforms being damaged by hurricanes, or onshore pipelines destroyed through mudslides and flash-flooding; operational hazards like pollution from oil spills; compliance with local environmental regulation and employee health and safety standards also factors into these assessments.
These are just some examples of potential risk, but what they highlight is that oil companies have to predict the likelihood, and plan to manage, many competing factors aside from the practical business of oil extraction. These risks are often not mutually exclusive but can overlap and combine to significantly increase the level of risk to an investment. As you will read in more detail shortly, in the case of Sudan, CNOCs were simultaneously having to contend with escalating civil conflict, international accusations of collusion in human rights violations and falling oil prices.