How NOCs Can Redefine The Future For The Middle East
By Mark Robson
Mr Robson is a Dubai-based Partner in Oliver Wyman’s Global Risk and Trading practice. He has over 20 years experience consulting in a wide variety of industries spanning energy, chemicals, technology and manufacturing. He specializes in turnaround projects, enterprise risk management, strategic planning, capital budgeting, large project value optimization, corporate portfolio design, financial hedging, as well as purchasing/selling contract design performance management.
National oil companies (NOCs) in the Middle East are under pressure. New oil and natural gas discoveries, rising demands for jobs for the region’s youth, and massive infrastructure programs are changing their competitive landscape. Consider: Saudi Aramco recently committed to two projects that will require $230bn with Sinopec and Dow Chemical. Meanwhile, the UAE and Saudi Arabia are embarking on nuclear programs that will require them to train hundreds of nuclear technicians for up to seven years to operate the facilities planned.
It is not unusual for successful companies to be challenged to manage risk when making critical decisions regarding new investments, existing projects, and operations. But for NOCs, the stakes are much higher. Their actions can potentially change the futures of their countries. Done properly, they could lead the way to a more energy efficient future. Handled badly, the result could be more difficulties in continuing to support social and other government programs.
To continue funding their governments’ visionary strategies in a shifting environment, NOCs must embrace risk management to create value within their organizations and to maximize their commercial potential. Doing so will be critical for NOCs to navigate through the next era of global hydrocarbon exploration and production.
Pulling this off will not be easy. Most of the critical variables that NOCs consider in their strategic planning process have become more unpredictable. The pace and scale of events introducing uncertainty into earnings are increasing. Risks such as volatile commodity prices have become more important, and supply chains have become more complex. Add to this the recent instability of sovereign nations, Arab Spring events, and Iranian threats and it is easy to understand the importance of developing an astute recognition of risks – as well as the opportunities that they may present.
States are increasingly interested in taking risks into account when making critical decisions or allocating capital to realize more value from NOCs’ projects. Their concerns are justified. NOCs make long term investments. If they miscalculate the risks involved in a project, there can be serious and enduring consequences. Sometimes an NOC’s corporate objectives can also be in conflict with those of the state.
Most NOCs realize this. But far too often the underlying risk management process has no real connection to the organization’s strategic or financial management. Instead, it’s a costly, resource-intensive, compliance-driven, bottom-up evaluation exercise that often results in lists containing hundreds of risks. The process is designed to be comprehensive rather than to focus on the key interconnected risks and opportunities that will deliver both immediate and lasting benefits. For example, an NOC can free-up funds for other projects by better managing the risks inherent in infrastructure projects so that they can be completed on-time, on-budget, and on-spec.
As a result, many NOCs have inconsistent or insufficient approaches to link risk management to their most important strategic decisions. Financial planning and capital decisions often remain disconnected from risk management. Multiple projects are pursued with little understanding of how risk flows through an NOC’s entire portfolio. At the same time, overly optimistic assumptions catch management teams by surprise and put strains on their organizations’ available cash flow. This has been particularly evident in many of the region’s real estate projects that have recently been placed on hold.
By applying best practice risk management methodologies and tools, NOCs have the opportunity to increase the value that they create for their countries and to reduce the volatility in their financial performance. With an incisive understanding of the risks they face, NOCs can avoid catastrophic errors and instead capitalize on new opportunities to contribute to their governments’ GDPs.
Oliver Wyman recommends that NOCs undertake a four-step program to create a more dynamic financial planning process, underpinned by risk management: This entails defining their organization’s appetite for risk, prioritizing risks, aggregating risks, and then linking risks to strategic decision-making.
As a first step, NOCs should develop a clear risk appetite statement and conduct a top-down, strategic examination of the drivers and core material risks across their organization – such as the price of oil, the availability of talent, and the rapidly expanding portfolios of projects.
Next, executives must agree on the most important risks to their entire organization. Typically, 10-15 risks account for roughly 80% of a company’s total risk exposure. Yet organizations often waste a lot of time and effort developing risk maps and risk registers filled with risks that have limited meaningful impact.
Key risks must then be aggregated and quantified to determine how they will likely impact financial projections. This enables executives to understand the potential impact of various management actions such as making new investments, managing the spend rate on existing investments, or taking actions to mitigate the risks more clearly. Management teams can then refine their plans rather than be forced to fix a big problem once it has already occurred.
Finally, NOC executives must consider these risks in evaluating critical strategic decisions. Whether an organization is deciding if it should expand into a new country, move into downstream refining and marketing, or diversify into renewables, it’s important to quantify the key risks involved in each initiative and to determine how often they may, or may not, be aligned with the company’s overall appetite for risk. Based on that information, it becomes very clear what needs to materialize for an NOC’s strategy to work.
If NOCs improve these risk governance practices, the potential rewards are substantial. A management team can optimize a company’s returns because it will be able to quickly, easily, and accurately evaluate the impact on financial statements of different scenarios involving multiple risks.
More important, NOCs will be able to play an even more important role in bringing about a brighter future for the countries that they serve.
© Copyright MEES 2012.