The oil and gas landscape continues to change. Demand is migrating to the East, supply is becoming concentrated in the hands of the few, new technology is a near prerequisite to

Risks are a part of the business, but proper management can result in profitable projects. (Graphic courtesy of Ernst & Young)
production and exploration and production costs are rising rapidly. In recent years, agendas of state-owned gatekeepers controlling access to natural resources have also transformed. Combined with changing fiscal and regulatory regimes in several countries, there has been a profound impact on many industry participants.

These developments have resulted in new relationships, as players try to secure their futures. The traditional partnership drivers remain, including access to reserves, markets, technology, capital or new value chains, project management know-how and delivery capability. However, companies are increasingly selective when it comes to prospective partners. A partnership is, after all, an inherently risky endeavor.

Partnership risk
Numerous risk factors can adversely impact partnerships and must be fully considered when entering a partnership and during the lifecycle of the arrangement. At the top of the list are the potential impact on the reputation of the national oil company (NOC) and its partners and the potential for financial loss in connection with the arrangement.

Perceptions of reputation and value can differ greatly depending on the strategies and objectives of individual partners. Reputation for a state-controlled NOC with limited external reporting requirements, for example, may mean something quite different from that of a publicly traded, SEC-governed prospective partner.

Similarly, the concept of value between an organization mandated to aid national economic development initiatives and one seeking operational efficiency and return on investment can, and often do, differ markedly.

If not adequately addressed, differing views of the world could erode the benefits of a partnership over time. The risks include:
• Organizational: Inadequate planning, ineffective integration and mobilization, inappropriate management control and decision-making and ineffective disputes resolution process.
• Cultural: Insufficient understanding between partnering organizations of local business practices and the cultural norms and expectations of other partners.
• Operational: Impact on value and investments due to operating inefficiencies and delays, commitments not being met, lack of appropriate resource (both human and technological) and reputational risks such as safety non-compliance.
• Financial: Financial reporting and controls, corporate governance, exposure to litigation, and tax claims and issues in realizing cash and return-on-investment.
All of these risks can fundamentally impact the success of the partnership and have the potential to detrimentally affect the partner companies if not managed properly.

Market risk
Aside from the risks listed above, there are further issues that are part of exploring for and developing hydrocarbons. One emerging consideration is market risk in focus countries, including changes in fiscal and regulatory regimes. Recent examples of modifications to hydrocarbons laws in Algeria, Bolivia, Kazakhstan, Russia and Venezuela have brought into focus risks that could impact returns on foreign investments. A key question in the area of market risk is, will governments in other provinces make similar changes?

Bolivia example
Bolivia has the second largest natural gas reserves in South America (behind Venezuela), and the country has historically depended heavily on foreign investment. Nonetheless, as part of President Evo Morales’ oil and gas nationalization, international energy companies were required last year to hand a larger share of revenues generated in Bolivia and majority control of Bolivian assets to the state.

President Morales has since announced plans to visit Iran and Russia in an attempt to attract investment in Bolivia’s natural gas industry. This campaign may also include visits to Libya, Angola, and Qatar. The tour has been highlighted as an opportunity to seek “strategic partnerships between Yacimientos Petroliferos Fiscales Bolivianos (YPFB) and the state petroleum companies of these gas-producing nations,” according to the government news service. A decree by Morales in May 2007 gave YPFB the power to sign contracts with fellow state petroleum companies, including Gazprom and the National Iranian Gas Co., as long as Bolivia retains a majority share in any new project.

Venezuela example
Since President Hugo Chavez came to power in 1998, the fiscal and regulatory regimes governing the oil and gas sector in Venezuela have been substantially modified. The changes are part of a strategic policy intended to re-affirm the nation’s sovereignty over its petroleum resources and bring about a re-nationalization of the oil sector.

Following the general strike of 2002 and 2003, which severely constrained the country’s oil production capacity, the government moved to re-establish control over Petroleos de Venezuela (PdVSA). As part of the tightening of state control, responsibility for oil policy was transferred to the Ministry of Energy and Petroleum. New legislation was also implemented to provide a revised framework for foreign investment and participation in the oil sector.

The Hydrocarbons Law of 2001 allows foreign companies to take stakes of up to 100% in downstream projects. However, their participation in oil exploration and production is restricted due to a mandate allowing PdVSA to have at least 60% control in all projects. For foreign ventures already operating in the oil sector, the law has necessitated the migration of existing operating service agreements to new “mixed companies” in order to accommodate the minimum shareholding in each enterprise by PdVSA.

The road ahead
It remains to be seen whether the shift in the risk/reward balance in some of the major oil and gas producing regions around the world will deter further foreign investment or jeopardize production growth targets. For many international oil companies (IOCs), the only route available to access reserves is to partner with resource-holding NOCs in provinces where the prevailing investment environment is dynamic and likely to continue to be so. In many cases, this means being prepared to accept a smaller portion of the revenue than they have traditionally enjoyed and to address market risks that could create further financial uncertainty.

Ultimately, however, reserve holders must secure a market for their product. And reserve seekers require security of energy supply. Technology, capital, manpower, and project management know-how are all key elements for success, and no single country or company holds all the required cards. Cooperation and partnership will continue as a result.
Geopolitical agendas and the energy industry will always be inextricably linked. Effectively navigating an increasingly political marketplace is becoming a critical business activity for today’s international oil and gas players.

Fiscal and regulatory policy uncertainty in emerging markets undoubtedly increases risk for foreign investors. With this challenge in mind, a detailed understanding of target markets, including current and potential fiscal regime structures, as well as a well-developed risk management process, can help manage financial exposure. In some cases, legal recourse options may exist should a worst-case scenario be realized. And, as always, careful and deliberate tax structuring can often help manage downside risk for foreign investors.