Thought leadership

Introduction

East Africa has been regarded as the new frontier for oil and gas exploration and production. Commercially viable deposits of oil were discovered in Kenya and Uganda while Tanzania and Mozambique have discovered significant quantities of natural gas. Global energy demand and petrochemical applications of crude are projected to grow steadily to meet the needs of growing populations and industrialization. Commercial development of these resources therefore brings a promise of prosperity and economic growth to the growing economies of East Africa.

Oil and gas is a globally traded commodity. This makes the economies of countries that heavily rely on oil and gas revenues highly vulnerable to fluctuating global prices brought about by geopolitics and supply chain dynamics. The first two quarters of 2020 saw a sharp decline in demand for oil and gas, largely attributed to the COVID-19 pandemic. This coupled with a global oil glut caused oil prices to dip below $12 a barrel, not enough to break even for most producers in the world. This has since risen to just under $40 (WTI crude, 13 September 2020), still a far cry from the highs seen in 2008.

The transition to renewables has also increased pressure on oil and gas companies to revisit their long term strategies. The world economy is keen to break the nexus between economic growth and climate change attributed to burning fossil fuels. Cleaner forms of energy are required to facilitate the transition to a low carbon society and to meet the requirements of the Paris Agreement. This means renewable energy will progressively displace fossil fuels from the energy mix. This is inevitable.

It is because of these challenges and less than rosy future price forecasts that oil majors such as BP have written off assets worth more than $17 billion in the last financial year, amounts greater than the GDP of some Eastern African countries. This is because these oil and gas assets are no longer commercially viable with the new world realities.

Energy risk management is a specialized field in risk management with a particular focus on the commercial, technical and non-technical aspects of oil and gas industry operations and markets. To navigate the complexities of energy as a globally traded commodity, it is imperative that governments, policy makers, independent oil companies and other stakeholders in the oil and gas value chain understand and manage the various risks and opportunities present in the short, medium and long term.

Governments and policy makers

Governments, national oil companies and policy makers need to assess the long term viability of oil and gas as a reliable revenue source to fund public expenditure. Billions of dollars of planned investments are at stake. Projected revenue models should be compared with global economic growth models (that predictably indicate growing demand for energy) and the accelerated transition to renewables (that indicates reduced energy share for fossil fuels). This kind of horizon scanning is important and perhaps the only way to set a reliable price and demand outlook to facilitate decision making. Needless to say, East African countries must move with speed to address development bottlenecks and develop the newly discovered oil and gas reserves if they are to reap maximum economic benefit in the short and medium term.

Independent oil companies

Independent oil companies across the oil and gas value chain in East Africa should put in place an enterprise wide system of risk management that will facilitate identification, assessment and management of risks. Some of these risks include:

1.  Strategic risks – These refer to risks that could threaten the company’s operating model, commercial interests and future performance. Example of such risks include new competition, supply chain disruptions, product substitutes, unpredictable legal environments, impact of climate change and new production technologies.

2.  Financial and commercial risks – These are risks related to fluctuating commodity prices (market risk), capital cost overruns, liquidity risk, exchange rate risk and counterparty risk.

3.  Operational risks – These are risks related to the technical (exploration, production, infrastructure and transportation risks) as well as non-technical risks. Non-technical risks may include risks such as information security and talent attrition, but also include very important issues such as stakeholder management and acquiring a social license to operate, particularly in greenfield developments.

4.  Compliance risks – These risks exist in many forms and can relate to compliance with new and emerging regulations, local content, technical, legal and commercial frameworks, health and safety standards, policies, treaties and third party contract compliance.

A proper framework for assessment of the above risks provides valuable information for investment decisions, capital discipline, market development strategies, engagements with governments, third party contracting, risk financing mechanisms and setting of policies and procedures to manage operational risk.

Due to the complex nature of oil and gas operations and markets, risk management is seen as a critical business function aimed at creating a competitive advantage. Implementing an energy risk management system helps preserve shareholder value by facilitating active threat and opportunity management across the global oil and gas value chain. This applies to both governments and the private sector. There is little room for surprises.

Bernard Kiore, Director at Seven Levers LLP