Managing frontier risks

December 3, 2013

Strategic decision-making in the boardroom is vital for those operating on the new frontiers, a new report says. Elaine Maslin reports.

“A single event can transform the fortunes of an entire industry,” warns a recent report on frontier hydrocarbon exploration.

An oil spill on the scale of the Deepwater Horizon disaster, for example, would likely result in the imposition of another moratorium on drilling on the Outer Continental Shelf, or worse, it continues.

The report is by Marsh Risk Management Research, part of the Marsh & McLennan Companies, which provides risk management and insurance.

It warns that the danger of a “low-likelihood- but-catastrophic disaster” rises as demand pushes energy exploration into frontier areas such as deepwater, the Arctic regions and the Middle East. Shale gas exploration was also cited as a “frontier area.”

Simultaneously, the requirement for more sophisticated risk management strategies becomes vital. Each frontier also poses its own set of risks.

Marsh identified both deep water and the Arctic regions as two areas pertinent to the offshore oil and gas industry that are new frontiers, or areas with previously untapped reserves due to reasons from high capital requirements or environmental concerns.

Deepwater Drilling

According to Marsh, within a decade, 40% of the world’s oil is expected to come from deep water, defined as water depths greater than 1500m.

It notes that deepwater reserves are only available to nation states with offshore sovereignty. To date, it says that 60% of deepwater drilling has been in the US Gulf of Mexico, citing SubseaIQ.

Although drilling technology has advanced, deepwater drilling is still too expensive to all but the largest companies. Just 13 companies produce 84% of worldwide deepwater capital expenditure in the next four years in three dominant regions, Latin America, Africa and North America, according to Infield Systems data, cited by Marsh.

One of the main costs are day rates, for suitable drilling units, which have significantly increased over the last decade, as availability has decreased and local jurisdictions limit the age of rigs allowed to drill in their territories, Marsh says.

The risks to companies from deepwater E&P activities has remained similar over the past decade, however, Marsh says. The main risks are: a well blowout; environmental liability; first-of-a-kind (FOAK) technology; availability of sub-sea expertise and equipment; supply chain disruption; regulatory compliance; environmental tax; and oil/gas price volatility.

Meanwhile, the perception of risk has increased, US regulations have become more stringent, and the contractual landscape has changed, due to the Deepwater Horizon oil spill in 2010.

“Drilling contractors have organizational preservation as a main driver to ensure high standards of operational and process safety,” the report said. “Another incident on the scale of Deepwater Horizon would likely change the contractual regime forever, pushing some liability back onto the contractor, prohibiting all but the largest contractors from operating.”

To manage the risk, Marsh advises:

1. Develop an approach to identify and evaluate risk exposure, from a top-down perspective (such as scenario analysis) that aims to assess risk and interdependencies across the whole organization. This approach should complement a bottom-up approach to risk management.

2. Evaluate risks derived from working with third parties and explicitly seek reassurance as to the efficacy of partners’ approaches to risk management.

3. Establish risk exposures derived from the supply chain by mapping supply chain dependencies.

4. Build crisis management and recovery plans in conjunction with third parties to improve response planning and resilience to an incident.

Arctic Extraction

Estimates suggest that the Arctic region currently has 136.6 billion boe, according to Infield Systems data. A US Geological Survey report from 2008, estimates a further 346 billion boe remain undiscovered.

Risks in the region are the climate and its isolated geography. Ice, storms, engineering, and electrical communication complications, as well as high costs, are all challenges. Only 22 of 174 fields discovered have produced hydrocarbons, with an average lag time of 13 years, says Marsh, citing Infield. Just 38 new fields are expected to come into production between 2012 and 2018.

“Arctic exploration has the problem that 85% of the estimated reserves are natural gas (the majority of which is expected to be in the Russian segment),” says the report, amid a market currently favoring oil.

Further complicating drilling operations in the Artic are the extreme riskmitigation requirements, such as having a standby rig to drill relief wells in the event of a blowout.

“Reputational damage from a blowout in the Arctic would likely be irreparable,” says Marsh, with a moratorium on drilling inevitable.

Despite these risks and costs, an estimated US$20 trillion will be spent in the region between 2011-2035, led by companies from Norway, Russia, Canada, and the US, according to the International Energy Agency World Energy Outlook 2011.

If Arctic ice continues to retreat and engineering competence is advanced through technological improvements, exploration of Arctic reserves will more likely become less expensive. To manage the risks, Marsh suggests:

1. Introduce an enterprise-wide approach to risk management to view and evaluate the risks of a field development. This approach allows an integrated and holistic view of likely risk exposures and opportunities and helps to avoid assessing exposures in narrow silos.

2. Apply quantitative risk analysis (QRA) techniques to identified risk exposures to add a degree of rigor and robustness to otherwise subjective assessments of impact and likelihood. QRA can determine likely risk impacts at varying degrees of confidence and help evaluate the effectiveness of mitigation measures in controlling those exposures.

“Firmly embedding strategic decisionmaking in the boardroom is a benefit for all organizations, but for those operating on the new frontiers of energy exploration, it is vital,” concludes Marsh. OE

Image Caption: Managing Risk: ENI norge has an oil spill response solution for the Goliat Oil Field.  Last year, the firm,  carried out the first scale excercise of Goliat's oil spill contingency operations. Image Credit: ENI