Posted on April 27, 2015
The oil and gas industry remains the primary source of the world’s energy despite efforts to enhance the viability and acceptability of alternative sources. The growth potential for this industry is stable provided oil and gas risk analysis is deployed at strategic phases. The challenges faced by this sector span various aspects, including financial, strategic, operational, and regulatory compliance.
Financial Risks
Price volatility has been a major concern for the sector, but the urgency of this issue has been heightened with increasing costs of extraction and the frequency of political events that affect oil prices. For the most part, the industry favors extraction locations where the political system is stable since a change in leadership may lead to different regulations that directly affect operations.
Strategic Risks
While competition from alternative energy sources and new technologies remains limited, the oil and gas industry has to contend with fluctuations in demand. Politics may also add to strategic challenges. Access to reserves, risk of nationalization, and a shift in the regulatory climate can be costly for the industry.
Operational Risks
Oil and gas experts are involved in frequent testing to ensure that estimates of accessible reserves approximate actual values, but geological risk also includes challenges with extraction, cost containment issues, and ensuring safe conditions as drilling has moved to less hospitable environments.
Compliance Issues
Regulatory compliance has exacerbated operational and financial challenges. As safety regulations and environmental guidelines are tightened, the oil and gas sector is pressured to add substantial investments to ensure compliance.
Significant risks faced by the oil and gas industry coupled with massive investments involved to sustain operations have driven the need to deploy leading-edge methodologies to evaluate projects and measure risks. Mitigation strategies are most effective when oil and gas risk assessment involves an in-depth study of risks involved, including detailed determination and quantitative evaluation of risks involved to optimize investment returns.
DCF or Discounted Cash Flow, Sensitivity, and Scenario Analyses
The Discounted Cash Flow method compares the targeted rate of return or hurdle rate to the estimated net present value of the cash flow of the project. The DCF method is widely used in the industry as it provides a sound approach to accounting for the time value of financial investments, and it provides a clear baseline for critical decision-making. This method comes with a few inherent issues, including assumptions that cash flow is static, the discount rate sufficiently accounts for project risks, and inadequate assessment of risk mitigation efforts.
The application of sensitivity analysis and scenario analysis methodologies may address these shortcomings of the DCF method. Evaluating for uncertainty generates a range of values for the project’s metrics although the output may not adequately describe the range of possible outcomes for the project.
Quantitative Risk Analysis
Quantitative risk analysis takes each input and defines a set of characteristics to describe probability distributions. These metrics may include minimum and maximum values, expected values, standard deviations, and percentiles. Valuation models correlate the distributions to generate a relevant description of possible outcomes.
Quantitative oil and gas risk assessment provides for a broader and more in-depth accounting for uncertainties in project outcomes. The qualitative portion of the analysis identifies underlying factors that enhance risks. The ability to evaluate critical risk factors for oil and gas projects is crucial to optimizing outcomes and planning for effective and cost-efficient risk mitigation programs.
Substantial investments are required for gas and oil exploration and production projects. The attendant risks involved in this industry are considerable especially given increased regulation and vulnerability to political factors, which are among the wide-ranging factors affecting this sector.
Regardless of the size of the project or the outfit, operators may benefit from experts who specialize in petroleum economics consulting. Professionals with the experience and skill set to audit project risks, generate risk assessment surveys, and present mitigation strategies based on possible outcomes will certainly provide industry-relevant parameters for managing oil and gas projects.
