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Securing oil and gas supplies

As the global demand for oil and gas grows, energy companies will be forced to take increasing risks to try to secure future supply. Not only will energy companies need to explore new, untapped areas and search for fields at greater depths, but they will also be under increasing pressure to forge joint ventures with national oil companies, as well as better relations with the governments that own them, as they assume greater control over the extraction of their mineral wealth.

The next few years will be tough for the oil and gas sector, especially as companies will need to invest more funds to finance increased risks that insurers will likely be unwilling – or incapable – of wholly underwriting. The world’s energy markets have been greatly impacted by the global economic crisis and increased price volatility, and financial markets are still nervous about the pace of economic recovery and the status of the energy industry, particularly as the margin between supply and demand becomes dangerously thin.

Presently, oil supplies are just managing to meet demand – but the pressure is on to find new reserves fast. The International Energy Agency (IEA), which acts as a policy adviser to its 28 member countries, has recently increased its global oil demand forecast for 2010 to 87.32 million barrels per day – up from the 2009 figure of 84.9 million barrels per day. The figure is expected to reach 88.51 million barrels per day in 2011. By 2030, the IEA estimates that global demand for oil will reach 105 million barrels per day – an increase of over 20 percent on current demand. Current supply is around 92 million barrels per day.

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The industry is facing a growing demand

Even oil-producing countries are finding that they need to import greater volumes of oil to meet industrial and consumer needs. For example, China, a significant glob - al growth engine, increased its demand in January 2010 by 28 percent and today buys as much as 8 million barrels per day, or more than the combined daily production of Kuwait, Venezuela and Norway.

Six Saudi Arabias

Dr. Fatih Birol, the IEA’s chief economist, has said that the world would need to find the equivalent of four times the crude oil reserves now held by Saudi Arabia – the world’s largest oil producing country – to maintain current production plus six Saudi Arabias if it is to keep up with the expected increase in demand between now and 2030. As a result, exploration and production (E&P) investment, which dropped to $400 billion in 2009, is forecast to rise to $447 billion in 2010 – an increase of 12 percent.


Accountants Ernst & Young’s (E&Y) Business Risk Report 2010, titled “The Top 10 Risks for Oil and Gas”, says that access to reserves at a reasonable cost is a key problem for oil and gas companies. It points out that the location of many of these reserves are in difficult environments where the E&P costs are high — such as the Canadian oil sands, the Arctic or deep water — and so will increase the risk of making new investments.

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Oil companies will be forced to search for oil in riskier areas

A vast number of offshore projects are coming on line and many more are being developed. Australia is seeing record breaking projects on the North West shelf, for example, with the vast Gorgon liquefied natural gas (LNG) project with reserves estimated at 1.1 trillion cubic meters of natural gas (see article on the Pluto gas field p. 20). Other projects are reaching fruition off the West African coast and in Venezuela and Canada. The targets are ambitious, as they often are in this industry: Iraq currently plans to expand production to as much as 12 million barrels per day over the next six to seven years. Shale gas projects are also coming to the fore: as the technology matures, projects are looking increasingly economically viable, although distribution remains a problem, particularly in newly tapped areas. However, such obstacles are being overcome, and major projects such as Nord Stream and the Russia-China pipeline will enable the development of a more efficient distribution network from source to customer.

The Oil Companies (OCs)

Paul O’Neill, head of energy underwriting at Allianz Global Corporate & Specialty (AGCS), says that without doubt the energy environment represents a challenging future in which both quality energy companies and insurance partners will recognize opportunities, though the volatility of oil prices makes the economics of planning projects for the long term unpredictable and difficult.

O’Neill also points out that the influence and strategic importance in their relationship with national oil companies (NOCs) is rapidly changing. NOCs, such as Petrobras in Brazil and China’s Sinopec, are now intent on controlling their own reserves, relying on the oil majors for their industry expertise and as equity partners, rather than needing them to carry out the bulk of the work. And their influence should not be underesti mated – NOCs now control nearly four-fifth’s of the world’s oil and gas reserves, compared to just six percent controlled by independent oil companies (IOCs). O’Neill believes that IOCs will be under increasing pressure to explore for oil and gas reserves in riskier areas and in deeper waters, and that they will need to use the latest technical innovations to secure fields as NOCs concentrate on exploiting their own national reserves. He also points out that the process will be an expensive one: IOCs will need to spend billions of dollars on E&P investment, while NOCs have the back - ing of sovereign funds, local government support and a greater proximity to emerging markets.


In the past few years, governments in emerging markets have showered billions of dollars worth of investments on their own oil companies. The growing desire to secure supply has seen Petrobras put together the largest ever share offering of over $67 billion. This will be used to fund a capital expenditure program of $224 billion, with the aim of developing the company’s significant offshore reserves. Chinese NOCs such as Sinopec and the China National Offshore Oil Corporation (CNOOC) have been taking stakes in projects from Africa to Canada.

O’Neill believes that the rise of NOCs poses several challenges for the industry and for insurers, at least in the short-term. For example, he says: “Insurers need to make sure that NOCs provide quality information about the projects they are involved in, the inherent risks that have been identified, and the controls that have been put in place to mitigate them. This has not always been the case in the past, which has made it more difficult for insurers to price premiums and assess whether they could provide adequate coverage.”

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Covering the risks: oil refinery

“The insurance industry has to help create a culture of openness with NOCs so that they understand how we price premiums. We need to encourage a greater exchange in quality information as this will help both parties,” he says.

Securing skills

Another global problem is that presently oil companies – both national and independent – do not have enough skilled and experienced people in place to actually carry out operational and project work. “Oil companies are not attracting enough young people with experience to meet the needs of the industry,” says O’Neill. “The workforce needs to be constantly replen ished so that oil companies do not suffer a skills short age, particularly as global demand for oil is pushing them to look for reserves in riskier areas at greater depths.” O’Neill adds: “While this is a short-term problem, there is currently a higher risk of an accident or spill occurring as human error is still one of the main causes of losses, which means that insurance premiums become more expensive and the scale of potential liabilities also increases.”

Political risks also come to the fore. In developing countries, political unrest or the nationalization of resources might lead to disruptions in supply. As governments have realized the benefits of securing their own oil supplies, some have taken “authoritarian” steps to ensure that they remain in control. For example, in 2006 Russia forced oil giant Shell to cede its majority control in the Sakhalin 2 project to Gazprom, majority- owned by the Russian government, slicing its stake in half down to 27,5 percent.


In May 2007 the Venezuelan government nationalized the country’s Orinoco Oil Belt reserves so that the state had at least 60 percent stakes in all oil projects. State participation in the Orinoco River Belt has since increased from 39 percent to 78 percent. Six major companies were asked to hand over proportions of their stakes, and Chevron, Total, BP PLC and Statoil negotiated deals with Venezuela to continue on as minority partners. But ExxonMobil and ConocoPhillips rejected the terms, prompting Venezuela to nationalize Exxon’s 42 percent stake of the Cerro Negro project. Exxon went to the International Centre for Settlement of Investment Disputes (ICSID), a World Bank institution that arbitrates investment disputes between member countries and individual investors, demanding that projected profits be included so that the total compensation was $5 billion, rather than the $750 million on offer. However, in June 2010 the ICSID Tribunal concluded it had no jurisdiction to act.

“Increased direct government involvement in oil and gas projects has always been on the risk register for insurers and IOCs,” says O’Neill. “However, the industry and insurers need to work more closely with NOCs and their governments so that best practices are followed, technical innovation and expertise is maintained, and risks are properly identified and managed,” he says.

O’Neill believes that insurers need to make a greater effort to help oil companies understand that they plan to be involved in the industry for the long-term. “If insurers are going to promote greater openness to encourage better information sharing, then it is important that clients understand that we are committed to the industry for the long-term. This means that insurers need to invest in better training and recruitment so that underwriters have a better understanding of the oil and gas sector and the risks that it faces,” he says.

 

http://www.iea.org

WWW.AGCS.ALLIANZ.COM/SERVICES/ENERGY/

  1. David Robertson on the rising demand of oil & gas supplies:

    Global demand for energy continues to grow at an astonishing rate.  Traditional oil producing regions are seeing significant declines in production as fields are depleted and oilfield infrastructure ages and deteriorates.  Political clouds continue to accumulate over large oil and gas producing areas like the Middle East, North Africa and Venezuela.  Advances in oil and gas production technologies like shale oil and gas, oil sands, deep water and forays into offshore opportunities above the Arctic Circle (Barents Sea, Beaufort Sea) are opening new frontiers for oil and gas production that will help satisfy the increasing demand for energy.

    The technical innovations that are opening these new oil and gas production opportunities present a number of new exposures but it is not just the new technologies that concern Allianz. The high prices commanded by crude oil and gas have made so many projects economically feasible that the resources required to produce new sources of oil and gas are in short supply. Engineering design talent, onshore and offshore production equipment, experienced oilfield operators and even basic materials like steel are in short supply. Increases in the scale of production operations, concentrations of values and financial interdependencies further increase the complexity of the Energy underwriting equation.

    These changes in the Energy industry translate into a very different set of risks and challenges for both underwriting and loss control. Finding risk solutions to mitigate these new challenges is the task we face as we work to make this business profitable for AGCS.

    /assets/Thumbnails/Thumbnails%20for%20Experts%20and%20Contacts/DavidRobertson_106x70.jpg David Robertson

    David joined Allianz in 2000 as an Energy engineer in Burbank, California, after a long career in risk engineering and corporate research on fire retardants, smoke inhibitors, plastics and oil, gas and chemical loss prevention. He currently leads the Energy risk consulting team and works in the Burbank office.