Contract Risk Management: A High Priority in the Upstream Oil Industry

Posted: 07/05/2010

Uncertain economic conditions and increasingly risky operating environments have made contract risk management a high priority for the upstream oil and gas industry.

With investment in the sector dropping, it is essential that upstream oil and gas industry firms entering into contracts cushion themselves properly against potential risks, particularly as the BP oil spill has added to the uncertainty within the global market.

Figures from Deutsche Bank suggest that the Deepwater Horizon spill could increase the cost of exploration and development by as much as 10 percent, to around $25 (£16.51) per barrel.

The investment bank pushed its long-term price of oil up by $5 to $10.

Issues such as extra equipment, more expensive insurance, increased numbers of inspections and changes in investment will have an effect on the upstream oil and gas industry, according to experts.

RCM Director Christopher Wheaton told MarketWatch: "There's no doubt we'll see increased regulation with time. You'll see more complexity in equipments and certification."

Liability within the Upstream Oil and Gas Industry

Liability is another key concern within the field of contract risk management for the upstream oil and gas industry which the BP incident has pushed into sharper focus.

Transocean, which owned the submersible drilling rig involved in the Deepwater Horizon disaster, has been taking steps to reduce its liability in the wake of the incident.

Initial arguments involved who was responsible for the cleanup and now the discussion has turned towards responsibility for paying out liability claims.

Steps have been taken by the United States House of Representatives to prevent Transocean reducing its liability by passing a bill which invalidates three previous laws.

The bill repeals the Limitation on Liability Act, which meant that vessel owners were only responsible for the value of the platform after the accident as long as it could be proved that they did not act negligently. It is under this old law that Transocean attempted to cap its liability.

According to the Associated Press, the changes in the law were welcomed by all sides as a way to ensure that those involved in the oil spill were not able to limit the damages paid out.

High-Risk Areas

As the wars in Iraq and Afghanistan begin to die down, the potential of their large reserves is being realised by the upstream oil and gas industry.

Royal Dutch Shell recently signed a deal with Iraq to undertake a $17 billion joint venture project to develop natural gas resources in the south of the country.

The joint venture, which in itself presents challenges for contract risk management, is being undertaken with the Basra Gas Company, Shell and Mitsubishi Corp, which will hold stakes of 51 percent, 44 percent and 5 percent respectively.

However, the risk presented in Iraq means that few United States upstream oil and gas industry companies are choosing to invest in the region and China is taking the lead.

Ruba Husari, an oil analyst in Baghdad who runs the Iraq Oil Forum, told the Washington Post: "[United States firms] made a mistake and overestimated the risk. I think they did not realise on the spot that it was the biggest window of opportunity, and they missed out."

According to the United States Bureau of Economic, Energy and Business Affairs: "Iraq's oil licensing rounds in 2009 may have been the world's largest ever and were widely regarded as open, equitable, transparent, competitive, and free from corruption."

The department warned that overall investors can expect "significant security costs; cumbersome and confusing procedures for business visas or new business registration; long payment delays on some Iraqi government contracts; and sometimes unreliable, non-transparent dispute resolution mechanisms."

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Posted: 07/05/2010

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