Risk Allocation in Oil and Gas Industry

The realities facing the oil and gas industry have dramatically changed in the recent past since the industry has become more risky than before. The oil and gas industry is highly subjected to risks due to multi-jurisdictional operations that take place in the volatile global economy. In addition, the joint venture projects, the scope of the contracts have also complicated the business transactions in the oil and gas industry (Stenis, & Hogland, 2011). Apart from the environmental risks and the human capital, the legal fallout related to responsibility in undertaking the oil and gas operations has greatly threatened the entire business. In addition, the oil and gas industry have experience increased tax burden, geopolitical uncertainty, over regulation, and protectionist tendencies of some states.

In the context of oil and gas industry, risks are those situations that expose the operations of the oil and gas into unexpected danger. In this regard, there is a high potential of the investors in the oil and gas industry losing the value for their investment. In some instances, the risks that arise in the course of the oil and gas exploration has the potential of causing harm and even loss of life (Hinkelmann & Swidler, 2004). The bigger the risks, the higher the probability that the operations of the oil and gas investors are subjected to threat, damage, injury, liability, or the loss of the entire investment.

The oil and gas investment are subjected to several types of risks that threaten their operations and profitability. The risks faced by the oil and gas companies can be divided into upstream risks, mid-stream risks, and downstream risks. In the upstream, the oil and gas companies are constantly faced with political risks and uncertainty as political environment change with time. In most cases, the national governments become protectionist and this pose a great challenge to the oil and gas industry (Lajili & Zéghal, 2005). Due to constant changes in political leadership of the host countries, the oil and gas operators usually find themselves in unfamiliar environments with strange laws being enacted to unwelcoming political leaders. In the upstream, the oil and gas operators are constantly faced with health, safety, and environmental risks that derail their operations (Minassian & Jergeas, 2003). The oil and gas industries are also faced with financial risks in case of unfriendly economic environment with high cost of operations. In the recent past, there have been heightened climate change concerns with uncertain energy policy that make the future of their operations unknown.

In the mid-stream, the risks is not as high as in the upstream because it mainly involves transportation, processing, and storage of oil and gas products. In the mid-stream, oil and gas operations are subjected to health and safety risks that are related to transportation, processing, and storage of the oil and gas reserves (Chen et al, 2014). In the downstream, the risks in oil and gas operations are also reduced similar to the case in the mid-stream. The volatility in the oil prices is one of the greatest risks that oil and gas companies faces in the downstream since it has the potential of dictating the profit levels realized by such venture.

The heightened liability related health, safety, and environmental compliance pose a major risk to oil and gas companies. In this regard, the risks related to health, safety, and environmental compliance should be well distributed among the stakeholders so that the risk does not rest with the contractor alone (Cordner, 2011). An arrangement can be reached, such that the stakeholder’s share the profits are they are to share the risks as was in the case of British Colombia and Alberta-BC in Canada. Apart from environmental risks, the legal risks have heightened in the oil and gas industry, following a series of incidences that have resulted in costly litigation. In this regard, there has been a strong emphasis on the owner-operator sharing risk with contractors, suppliers, and field service companies to minimize the effect of such risks on one single entity. To solve such risks, agreements must evolve around the contract processes across the whole enterprise to seal all the possible legal loopholes that may prove costly in the end. In addition, the contractual agreements must be able to adapt to constantly changing business and economic environment so that they are in tandem with the daily realities of the business environment (Tayyebi, Chenani, & Kashkooli, 2014).

There are two types of indemnities mainly the simple and the mutual indemnities whereby, the indemnitor agrees to take responsibility of the indemnitee where loss is experienced in simple circumstances. This mainly occurs in the case of simple indemnity. However, on the side of mutual indemnity, all the parties are financially responsible for what happens to each other. The coverage of indemnity is depended on the negotiations made by involved parties. Peculiarities are catered for by mutual indemnity with good plans being set aside. This is because; principle is paid by the alternative contractual clauses, which avoids negligence and impractical practice in the oil and gas industry. Costs in gas and oil industry are being catered for through avoiding of insurance layers with high premiums whereby, this happens in the simplification of contractual negotiations. In mutual indemnity, one party is willing to save the other in danger time, even if it means through the use of the other party resources no matter the fault occurrence (Minassian & Jergeas, 2003). Simple indemnities for that matter can be said to be unilateral following that only one party is responsible for taking charge of the other needs while mutual indemnities is bilateral with all parties having to take charge of the needs and failures of one another. Jurisdictions are well set aside before the laws are implemented to ensure that they are well incorporated to avoid risk occurrence in the both industries (Mubin & Mannan, 2013).

The risk undertaking between the parties involved in the undertaking prove to have a big problem in the gas and oil industry. When mutual indemnity is present in a given company, the company is not in need of an insurance cover as the indemnity takes care of all matters happening to the company as a whole (Pongsiri, 2004). A lot of insurance cover leads to overlaps layers of insurance and high insurance premium leading to rise in cost and low returns on investment. Apart from cost reduction mutual indemnities aid in shortening the period of contractual negotiations and in the facilitation of administration of contracts availed to the company. There was the re-owning of institutions and associations as a result of the development of indemnity clauses in the oil and gas industry leading to the development model of contracts. Muhindo, Zhou & Mzuza, (2014) argue that indemnity tries to avoid wording problems in the interpretation and the enforcement of the oil and gas company laws. Problems in the wording of the contract can potentially result in litigation and losses to the parties in the oil and gas contracts. When dealing with the enforcing of clauses, any that is in conflict with the oil and the gas company is left aside. Through ensuring wordiness is avoided, risk has been reported to reduce in the gas and oil industry, mainly between the contractor and the operator. Indemnity mainly focuses on the public concerns mostly in the developing countries (Tayyebi, Chenani & Kashkooli, 2014). When a person is injured in a place of work, he ought to be compensated with immediate effect through the use of the right channels. The formal position is not left aside when compensation is an issue to the contractors (Muralidhar, 2010). The exclusion of liability for consequential damages is highly considered by indemnity.

The implementation of the right enterprise level contract management solution can also effectively be used to drive growth and to avoid the problems that come with a contract. A contract management solution will ensure that a company improves on their efficiency, increase their profitability, enhance their management, strengthen their strategic impact and to reduce the overall change (Cordner, 2011). In addition, a contract management solution will ensure that the oil and gas company delivers on their commitment and preserve their good reputation that would enable them to get more contracts.  Advanced contract management allows for rapid allocation for contract knowledge relevant to each other across the enterprise to help spread the possible risk. Contract management solution also ensures that contracts age appropriately by minimizing exposure to non-compliance risk with controls around archiving and dispositions (Pongsiri, 2004). Consistency and accuracy are also encouraged by shortening negotiation cycles with the aim of minimizing legal risks (Chen et al, 2014).

The availability of information technology capabilities in the gas and oil industries helps the company to curb the risk that may face the management. The way information is managed is changed by the capabilities of Information Communication and Technology for better distribution in the company. There are five capabilities used to encourage the use of energy insights into the two companies for their profitability ratios (Muralidhar, 2010). These capabilities are inclusive of the enterprise wide management that is applied with information and intelligence of the company to ensure that it is well used and incorporated effectively. Following the improved pressure and competition, these two companies have improvised a method of operations that encourage the maintenance of the current environment health and safety of all workers in the organizations (Pongsiri, 2004). IT is capable of managing the unstructured and structured information that is useful in planning and the maintenance of all the wells where oil is extracted from. The application of enterprise information security to all data systems and the company process at the knowledge of the people present in the both companies will aid to guarantee information security for the success of the two companies (Lajili, & Zéghal, 2005). Due to information security, tracking can be done from business to individual technologies, thus, the management is in a better position of identifying with the type of people it’s working with. The best way of mitigating risk will be by considering of developing approaches that a company and the host country uses in combination with technology that will be helpful to support its operations. Technology is useful in business analysis, the application of integration and in operation of the content management, leading to risk reduction at the end (Muralidhar, 2010). The development of business process is best in the identification of the organization’s workflow in making of good approvals towards the organization that will have reduced its risk rate. The companies ought to look at the areas of high vulnerability and focus on improvements that will enable them to move ahead. The regulatory pressure ought to be improved to be able to look for the required solutions of achieving g the company’s success by avoiding risks (Lajili & Zéghal, 2005).

The risk management policy in the oil and gas industry is not very effective since it has not managed to face out the major risks faced by oil and gas companies. However, the policy in the oil and gas industry has tried to streamline the legal hurdles that have negative consequences to the oil and gas operations (Cordner, 2011). The policy in the oil and gas industry tends to suffer from environmental policy that tends to promote green energy solutions and avoidance of greenhouse gases. Over the past few decades, there have been a lot of outcry and focus on the environmental degradation and this has a negative impact on the policies directed at improving the conditions of the oil and gas industry.

The risk management between IOC and the host country has changed in the recent past since the host states have included a stabilization clause to continue attracting foreign investment into the oil and gas industry (Chen et al, 2014).  Since there is a strong relationship between the stability and equity of investments, the stabilization clause strengthens the legal relationship between the foreign investors and the host states. In return, this reduces the risk involves and increases the level of investment in the oil and gas industry of the host state that has passed such a clause. The host country is thus expected to observe the legal mechanisms that are formulated in partnership with the IOC in order to reduce the risks in the oil and gas industry.

Indemnity clauses are one of the clauses that are aimed at reducing the risks in the oil and gas industry. There are two types of indemnities mainly the simple and the mutual indemnities whereby, the indemnitor agrees to take responsibility of the indemnitee where loss is experienced in simple circumstances (Muralidhar, 2010). However, on the side of mutual indemnity, all the parties are financially responsible for what happens to each other. The coverage of indemnity is depended on the negotiations made by involved parties. Peculiarities are catered for by mutual indemnity with good plans being set aside. Costs in gas and oil industry are being catered for through avoiding of insurance layers with high premiums whereby, this happens in the simplification of contractual negotiations. In mutual indemnity, one party is willing to save the other in danger time, even if it means through the use of the other party resources no matter the fault occurrence. Simple indemnities for that matter can be said to be unilateral following that only one party is responsible for taking charge of the other needs while mutual indemnities is bilateral with all parties having to take charge of the needs and failures of one another (Mubin & Mannan, 2013). So far, the indemnity clauses have been effective in reducing the risks in the oil and gas sector.

In conclusion, the energy industry is very complicated due to the scope and the nature of the activities that are multi-jurisdictional. Managing the risks in oil and gas agreements can be as risky as handling the operations altogether. When not properly handled, the risk involved in the oil and gas operations are so enormous that they result into big financial and reputational losses, which can even result in the end of the companies involved. Effective agreement in the oil and gas industry is end-to-end, integrated, and flexible enough to tackle the problems that may arise in the course of project execution. A contract management ensures that the life cycle of the project is proactively managed with the aim of ensuring that the interests of all the stakeholders are met. All the industry players also need to be involved in the formulation and planning of the oil and gas agreements to ensure that all are satisfied with the process and to reduce the chances of future litigation.

 

References

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