Risk impacts on the economic

performance of oil and gas

projects in Nigeria

Olusegun Omole, T.A. Borisade and

Ahmad Muhammad

Abstract

Despite the risks and uncertainties associated with investment in

the petroleum industry. Nigeria remains attractive to foreign inves-
tors, due (partly) to the high rate of return on investment, the pres-
ence of a prodigious hydrocarbon base and the existence of a relia-
ble legal framework for the protection of such investment. This study
attempts to identify the key elements of risks and uncertainties in
the Nigerian oil and gas industry and their associated impacts on
the economic performance of capital projects, using data obtained
from experts in the industry. The study reveals that the reservoir
area, the hydrocarbon formation thickness, the porosity, the produc-
tion drive mechanism and, hence, the recovery factor are the most
significant uncertainty factors in oil exploitation. The major econ-
omic uncertainties identified include the crude oil price and joint
venture cash calls (the latter is currently on the decline, due to the
improved Government commitment to its cash call obligations).

December 2004 ©2004 Oi-gantanon of the Petroleum Exporting Coiintrie.s 247

 The authors are all from the Department of Petroleum Engineering at
University of Ibadan, Ibadati. Nigeria. Olusegun Omole is Petroleum
Technology Development Fund Chair in Petroleum Engineering, at the
University.

248 ©2004 Oi-ganization ofthe Petroleum Exporting Countries OPEC Review

 ARGUABLY, the greatest challenge currently facing the Nigerian oil
/ I and gas industry is the need to inerease the nation's overall produe-
^ -M^ tivity and reserve base.' It is in recognition of these potentials that the
Federal Government, through the state-owned Nigerian National Petroleum
Corporation, introduced the now well-known Memorandum of Understand-
ing (MOU) on ineentives for encouraging investment in exploration and de-
velopment activity and enhancing crude oil exports. The MOU was signed in
1986 and modified in 1992 to include a "reserves addition bonus" that was
later expunged from it. This was done in an effort to protect operators in the
industry, in addition to encouraging capital investment and rewarding suc-
eess in diseovering new reserves. So far, the Govemment has demonstrated its
ability to make periodic amendments to the existing fiseal regimes, ineentives
and eontractual agreements, in order to provide a more favourable investment
climate.
Massive capital outlays, volatile oil priees, cash call problems and traditional
geological and technical uncertainties are the factors that may accelerate or impede ef-
forts to increase the nation's productivity and reserve base. Potitieal and environmen-
tal uneerlaintics have been on the increase in the last two decades. A properly planned
measure for mitigating negative environmental impacts of impending projects should
contain realistic community development projects and welfare initiatives that will
avert unfriendly attacks and civil strife from host communities. These and many other
geopolitical issues have become prime concems for investors. Therefore, in making
investment decisions, present and potential investors in the Nigerian oil and gas in-
dustry are expected to consider the above-mentioned concems.
The terms "uncertainty" and "risk" are used almost interchangeably in c\cry day
discussion. Although there is no consensus among authors as to a general definition of
"risk*" and "uncertainty", the tcmis are, in fact, different in implication, with respect
to the outcome of some future events.
For the pui^posc of this study, the term "uncertainty" will be used to characterise
the fact that the eventual outcome of a decision or event is not precisely known.-^ The
degree of uncertainty will be described by the probability of its occurrence. Uncer-
tainty can also be defined as the degree to which a chance event will occur. The con-
cept of uncertainty implies that the range of possible outcomes can be detemiined and
that the probability of each outcome occurring can be estimated.
Uncertainties may be either subjective or objective.
Ohjeciive uncertainties are those that can be accurately calculated ahead of time.
as in the case of flipping a coin. They are unlikely to change, as there is usually a gen-
eral agreement as to the probability ofthe outcome.
Subjective uncertainties, on the other hand, are always open to reassessment on
the basis of new infomiation, further study or recognising the opinions of other ob-
servers.
There are three major types of uncertainty associated with the exploration and
production of oil and gas reserves:-

December 2004 ©2004 Organization ofthe Petroleum Exporting Countries 249

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250 ©2004 Oigiinization ofthe Petroleum Exporting Coimtrie.s OPEC Review

 1. Uncertainty of occurrence
2. Uncertainty of magnitude
3. Uncertainty of production rate

During the exploration phase, uncertainty of occurrence is of major concem

and will probably dominate exploration evaluations, such as volume (reserves), while
value (technieal costs) and rate become the dominant uncertainties during the produc-
tion phase. These uncertainties will remain throughout the entire production life of a
project. Uncertainty is generally used as a continuous probability model, where the
result can vary between a selected maximum and minimum.
The term "risk" has been defined- "* as the probability of incurring economic
failure or loss. That is. the possibility that some variable events will negatively affect
the returns from a project.^ Vose'defined risk as a potential event with a negative im-
pact and a probability of occurrence of less than 50 per eetit. If the probability of oc-
currence of a negative impact is less than 50 per cent, its "opportunity" is often con-
sidered. Murtha,' however, detlned "risk" in a more general sense as "the potential
,t,'rt//w or /owf.v associated with a particular outcome of a chance event".
The recognition that a certain venture is risky involves a judgment, because what
one individual considers risky may not be so appraised by another person. High-risk
ventures' are those with the chance of a large loss, even if the probability of such an oc-
currence is small. It is, therefore, possible for a project to be highly unceiiain. but have a
low risk, if both the odds ofthe various outcomes and the magnitude ofthe rewards and
penalties that are involved are small, when they do occur.' The most serious risks in a
business are those resulting from events that cannot be controlled or predietcd.
There are four fundamental methods of coping with risk and uncertainty. These
include:'

1. Diversification
2. Reduction of exposure
3. Avoidance
4. Insurance

Diversification, as in the case of geological risks, means participating in the

drilling often wells, instead of putting all one's resotirces in a single prospect. This
reduces exposure, by taking less interest in a greater number of ventures.

Types of risk
Figure 1 depicts a business model for risks in an oil and gas development
project. It divides risk into fotir categories: environmental, technical, economic and
political (management).

Technical risk
Teclinica! risk'' relates to whether the hydrocarbon volumes estimated by the ge-
ologist and engineers exist in the ground and whether the reserves and recovery rates

December 2004 ©2004 Organizalion of ihc Pe/roleutn Exporting Countries 251

will bc as projected by the engineers. Technical uncertainty., almost always, is a func-
tion of how long the property has produced, its maturity and the quality of the data
from which the reserves" estimates were calctilated.
Following the discovery of oil and/or gas, there are uncertainties associated with
the ultimate volumes to be recovered. The reason for these uncertainties is the lack
of complete knowledge ofthe parameters used in the calculation ofthe volume ofthe
hydroearbon in place. However, as more wells are drilled and more data acquired, the
amount of uncertainty is reduced.

Political risk
Political risk' involves the uncertainty arising from possible ehanges in the poli-
cies of regulatory bodies and the degree to which such changes may affeet the project
cost and revenue. When evaluating petroleum investment, a multinational company
has to assess the economic impaet of political risk elements on project profitability.-
ln assessing and evaluating the impaet ofthe political environment, major decisions
in intemational business are often made subjectively and superficially. While regu-
lar politica! changes' will certainly affect operations, it is generally predictable and
likely to affect only the magnitude of retums. Irregular discontinuous change, on the
other hand, is by its nature very difficult to prediet and often affects both the magni-
tude of expected retums and the risks associated with them. This may be in the form
of constraints on operations, such as local ownership regulations, restrietions on re-
mittance, exchange controls and expropriation. Regulatory considerations can be sub-
divided into fiscal and non-fiscal aspects. Fiscal considerations include ehanges in
the levels of local and national taxation, exchange controls and limitations on the im-
port and export of foreign and local currencies, and changes in the levels of custom
duties on imported equipment and supplies. Non-fiseal considerations inelude possi-
ble interruptions by regulatory bodies over environmental matters, disagreement over
the hiring and firing of local personnel, issues on ownership restructuring or outright
nationalisation. Political risk is not a homogenous phenomenon, but rather it is
industry-, firm- or even projeet-speeific. Because of its inherent subjectivity, geopo-
litical risk is diffieult to quantify.

Economic risk
This refers to the risk that produet prices, operating costs, equipment costs
(CAPEX), inflation and market conditions will be in reasonable agreement with the
assumptions used in the economic analysis ofthe project at the planning stage.^ Eco-
nomic risk covers a very broad range of potential situations.- For instanee, the prin-
cipal economic risk associated with an infrastrueture project may be confined to the
possibility of CAPEX overrun, and timing of completion. In the ease of a depleting
asset, such as mining or petroleum production, the operating costs, inflation, interest
rates, product priees. demand over the optimal investment decisions and the frame-
work ofthe opportunities are the major economie factors.

252 ©2004 Oi-ganization of lhe Peti-olciim E.\porling Countries OPEC Review

Environmental risk
An emerging phenomenon in the petroleum industry is that the needs to en-
sure the safety of life, the health of personnel, the reduetion of environmental pol-
lution and the safeguarding of investments have become veritable indices of good
business practice. Environmental risk factors are not easily quantifiable,^ because the
impaet ofan activity on the environment is usually not known exactly early in the life
of a projeet. Beeause ofthe time taken for a polluted system to recover fully, in ad-
dition to the general lack of statistical data, the best estimate ofthe risk level is usu-
ally obtained by means of analogy with similar systems. Some eompanies use a risk-
based hazard-identifieation technique' at the start of projeets to ensure that the actual
and potential environmental impacts are identified at the conceptual stage. With a
hazard-identifieation approach, impacts are identified in a systematic manner through
a brainstonning session involving a multidiseiplinary team consisting of experts from
engineering, environmental, legal and other relevant departments. During sueh meet-
ings, the sources of impacts are identified and methods for their prevention, control
and mitigation are diseussed.
Perceived threats to national resources and environmental quality'* posed by
petroleum exploration and exploitation often lead to the demand by the public for
better management and accountability in the decision-making process. A structured
approach toward environmental assessment ensures an understanding ofthe local en-
vironment and ecosystems and the identification ofthe ehanee and uncertainty events.
which impart value.
Strategic and health risks are other identifiable risk types that may affeet the
economic perfomiance of oil and gas projects. Strategic risk analysis eorrelates a
company's capabilities with the quality of possible ventures. The company's inter-
nal strengths and weaknesses are matched against extemal opportunities and threats
(SWOT analysis). The degree ofthe strategie risk is proportional to the mismatch be-
tween the SWOT elements.^ The strategic risk is. to a great extent, an element of po-
litical risk. Health risk eould result from human exposure to crude oil or natural gas.
Health risk is. in most eases, a component of environmental risk."*

Risk analysis
Though relatively new in the petroleum industiy. finaneial analysts have long
used the theory of risk analysis to account for uncertainty in capital investment ven-
tures.'' Waelstrom e! aP'^ applied the teehnique of quantitative risk analysis to several
petroleum industry engineering problems. Using the Monte Carlo simulation teeh-
nique, they demonstrated how uncertainty in reservoir parameters can be handled in
the estimation of recoverable reserves.
Murtha"^" '' and others- ''•'' '^ have also demonstrated how the techniques eould
be used and their importanee in problems involving decision-making, Hatndhi" dis-
eussed the impact of uncertain oil priees on eapital investment and gave some recom-
mendations on how best to handle the challenges arising from optimising competitive
resources. The major constraints are: reduetion in investments, environmental issues
and policies, and workforee optimisation. Caldwell"" diseussed the concept of risk anal-
December 2004 ©2004 Orgamzalioii of lhe Petrokntm Exporting Countries 253
ysis in its simplest fonn. using a two-outcome detemiinistic model, and examined how
historical drilling statistics can be manipulated to provide benchmarks that would assist
the analysts in the determination of aeeeptable ranges ofa success probability.
Garb'' focused on risk categories associated with the acquisition and operation
of producing properties, and presented methods for using risk estimates in the evalu-
ation ofa producing property. The maturity ofthe technical data, the location and the
life ofthe property were taken into account. Mustafaoghu'' presented a procedure that
utilises the discounted cash flow theory and the concept of expected present worth
under uneertain timings, to arrive at an expropriation risk-adjusted present worth in
decision-making. A similar work by Coven"* was based on financial indices to meas-
ure the effect of uncertainties on the financial outcome of proposed hydrocarbon ex-
ploration ventures.
Proehl''' indicated that methods that are used to assess political risk follow a ge-
neric analysis pattern. It begins on ihe subjective, observational unconstrained ends of
the spectra and tends towards the quantitative, expert-gencrated/approved. systema-
tiscd ends ofthe spectra. He further stated that, in any process whieh attempts to re-
duee qualitative subjective data to quantitative conclusions, six weaknesses would be
addressed, namely; utility, conservative bias, faking, lack of foresight, herd behaviour
and credibility/evidenee. By applying an approach to decision-making, which foeuses
on the aehievement of the key goals required at every decision point and systemati-
cally followed up. a firm ean greatly increase its ability to succeed in the business en-
vironment ofthe future.
Brewer-" suggested ways to improve political risk assessment, with regard to
foreign direct investment, since they are conceptually constrained. He suggested that
the current widely used approaches to political risk assessment are deficient in three
ways; narrow in foeus, emphasis is made mostly on expropriation, exchange control
and Govemment instability in developing countries; infonnation collection and the
analytical method are too mechanistic and formalised; and the integration of politieal
risk assessment into capita! budget analysis is too simplistic. He suggested methods
of improving political risk assessment by more systematic specification. According to
Kobrin.-' the most important means by which conflict affects the economic perform-
ance of firms is not through direet threats, such as eivil strife, kidnappings or even
the deterioration of social and eeonomie infrastructure, but rather through potential
changes in Government polieies. If used eorrectly, risk-analysis can have a great ef-
fect on improving the safety and economy of any operation, especially where sever-
al technical systems and activities are managed by the interaction of men and proce-
dures. Shapiro" highlighted the need for a formal assessment of politieal risks. This.
aecording to him., involves: recognising ofthe existence of political risk and its con-
sequences, developing policies in advance to cope with political risk, and, in the event
of expropriation, developing ways to maximise eompensation. The evaluation of in-
temational petroleum investment requires the assessment ofthe eeonomie impact of
politiea! risk elements.
Micallef-' believes that political risk assessment is often limited to an exereise in
political forecasting. He suggested three interrelated approaches of assessing political

254 ©2004 Ot-ganization of the Petroleum Exporiing Countries OPFX" Review

risk: identify those elements of political risk associated with foreign direct investment,
and develop an intelligence system to monitor and evaluate changing eonditions of po-
litical risks in a host country; allow a finn to deal with changing conditions of political
risk by integrating the politieal risk assessment with the finn's strategic planning; and
devise strategies to protect the finn from political risk, especially expropriation.
Rummel and Heenan"^ stated that a mixture of subjective and objective methods
dominate eorporate attempts to analyze a nation's political climate. These are divided
into four categories: grand tours, old hands, the Delphi technique and the quantitative
method. The grand tours method involves on-site inspection by executives or hired
consultants in the region for preliminary market research. The old hands method de-
pends on the judgement and advice from experts, such as educators, diplomats, jour-
nalists and businessmen from the country of interest. The Delphi teehnique allows
for brainstonning by decision-makers to identify, select and rank factors jeopardising
analysis of an investment, in order to resolve such issues. And the quantitative melhod
employs the use of mathematical and statistical techniques to analyze politica! is-
sues and to confirm intuitive impressions based on subjective approaches. By doing
so. a consolidation of knowledge is aehieved and the future trend can be predicted.
Risks sometimes are worth taking. If correctly used, risk analysis can be used to
improve the safety and the economies of auy operation in which several teehnical sys-
tems and activities are managed by the interaction of humans and procedures.-' The
willingness to take risks, however, depends upon the odds and the stakes involved.
Despite the odds, the investment elimate in the Nigerian oil and gas industry remains
attractive to foreign investors. This is due in part to the high rate of return on invest-
ment (Nigeria has one ofthe lowest oil production costs in the world), the presence
ofa prodigious hydrocarbon base and the existence ofa reliable legal framework that
protects such investments.-'' Hence, there is a great need to adequately identify and
quantify the associated risks and their ctTects on existing and potential investments.

Description of study
This study was limited to the identification of major categories of risk that have
a signifieant impact on the eeonomie performance of oil and gas projects in Nigeria
and the level of impaet. The Delphi teehnique for quantitative risk assessment was
employed. Furthermore, using empirical analysis of historical data, a verification of
the findings obtained from the risk assessment process was carried out to test the sig-
nificance ofthe four major identified risk elements.

Methodology
The study applied the Delphi teehnique to obtain the most reliable consensus
and variability of opinion ofa group of experts on the impact of risks on the eeonom-
ie performance of oil and gas projeets in the Niger Delta. First, it evaluated experts"
aggregate opinion on risks, as they affect the economic perfonnance of oil and gas
projects in Nigeria. Seeondly, it evaluated each ofthe risk elements and ranked them
according to their degree of influence on the economic performance ofthe projects.
And thirdly, it applied weighted eriteria. using the eompanies' erude oil production as

Deeember 2004 ©2004 Oi-ganization of the Petroleum Exporting Countries 255

a factor on the degree of influence of these risk elements. The study involved a series
of intensive intenogations of experts in the oil industry (through questionnaires), in-
terspersed with a control feedback.
Interaction among the experts was aecomplished by collating their respons-
es, along with their answers to the questions. Such a mode of controlled interaction
among experts was a deliberate attempt to avoid the disadvantages associated with the
conventional use of experts' round table discussion or direet eonfrontation of oppos-
ing views. Such procedures are more conducive to independent thoughts and allow for
a more gradual fomiulation of considered opinion.

Variable modelling
Detennining the impact of risk on the economic performance of oil and gas
projeets is a eomplex procedure that involves many variables. It is incorrect to assume
that integrating all the variables will produee a unique answer. Speeifically. variables
under technical risk — such as the area extent of hydrocarbons, the porosity of fonna-
tions. the net pay thickness, water saturation, the production mechanism, the recovery
rate and the production rate — are estimated reasonably, either by analogy or from
experienee. Similarly, estimates are made for specific economic risks concerning the
domestic and foreign interest rates, the cnide oil price, the inflation rate, costs and the
depreeiation of local or intemational currencies.
In modelling the effect of risk on the economic performanee of oil and gas
projects, each element (variable) in the model eorresponds to the real world. The use
of eomputer software enables a range of variables to be combined and their infiuenee
on the overall result to be aseertained.

Assessment procedure
The identified risk items were arrived at by consulting available literature'' -' in
the areas of interest, and supplements were made when an expeit felt that an impor-
tant factor had been excluded. The assessment procedure required the expert to con-
sider eaeh factor listed in the questionnaire and judge the extent to which each risk
item infiuenced the economic performance of oil and gas projects in their firm. This
approaeh allowed the professionals, such as explorationists. financial analysts and pe-
troleum engineers, to apply their skills directly in a way totally consistent with their
training. The impact of certain identified factors was evaluated against the economic
performance of eaeh firm.
The risk faetors were grouped under the following headings: technical risk, eco-
nomic risk, environmental risk and political risk.

1. Technical risk
a) Area extent of hydrocarbons (HC)
b) Porosity of formation
c) Net pay thickness of hydrocarbon zone
d) Water saturation
e) Production mechanism

256 ©2004 Organization ofthe Petroleum Exporting Countries OPEC Review

 0 Recovery rate
g) Produetion rate
h) Underestimated equipment proeurement time
i) Underestimated facility construction time
j) Mishaps e.g. well-kicks, blowouts

2. Economic risk
a) Domestic interest rate
b) Foreign interest rate (US dollar)
e) Crude oil price
d) Domestic and foreign inflation rates
e) Depreeiation of local currency

3. Environmental risk
a) Force ma/cure, earthquake, floods or heavy winds
b) Oil spillage (unintentional)
c) Oil spillage (sabotage)
d) Water disposal;
e) Drilling waste disposal
f) Gas-fiaring
g) Community agitation, based on environmental degradation
h) Fnvironmental laws and policies

4. Political risk
a) (Un)expected eivil disorder losses: such as riots, strikes, civil war, etc
b) Anned conflict between host counti'y and external forces
c) Sudden expropriation: with or without adequate compensation
d) Increase in local share of projeet equity and management
e) Fiscal changes: tax, MOU, etc.
f) Domestic price control: domestic sale of oil below world price
g) Restrictions on oil exports for political reasons by host nation
h) Restrictions on produetion to prevent recovery of investment
i) Restrictions on remittance: delays in reparations of investments

The response ofthe expert(s) for eaeh faetor was recorded by checking the eor-
responding box in the questionnaire to express his/her opinion on the impaet ofthe
factor. Each ofthe completed response fonns represented an assessment ofthe prob-
ability that a particular event would be true. The probability, expressed in qualitative
terms, was quantified by assigning numerical values to the qualitative degree of sup-
port expressed. From the eonsideration of eaeh ofthe influencing faetors, a series of
degrees of influence of each risk element was generated for the truth of the propo-
sition. The total influence of all the risk factors was obtained by eombining the in-
fiuenee ofthe individual risk faetor. The fiow diagramme (fignre 2) illustrates the
step-by-step procedure of assessing risks in oil and gas ventures in this study.

December 2004 ©2004 Organization ofthe Petroleum Exporiing Countries 257

 Figure 2
Assessment procedure of risks in oil and gas venture

Risks in oil and

gas venture

Solution lo
managerial kieinitkaiiaii
problem of risks

J.
Answer to Managerial
managerial question New qiieslion question relating?

Aiisucr lo statistical Statistical formulation

problem of problem

Source: AJaplfdfrom McChivc undBciisnii."

Selection of experts
In this study, ail oil exploration and produetion eompanies operating in Nigeria.
both indigenous and multinationals, were eonsidered. Only six companies were iden-
tified as study samples, namely: Agip. Chevron, Hlf, Mobil, Shell and Texaeo. At the
time of eonipilation of this work, four companies had responded and these constituted
70 per cent ofthe expected response.
The questionnaires were completed by experienced personnel {senior man-
agement staff) with a good baekground in all the areas — teehnical, economic,
environmental and political issues — ofthe Nigerian petroleum industry. Although it
is extremely dilTieult for one person to be expert in all fields, a panel of experts with
experienee in all the areas was assumed to be adequately suited to the requirements.

Data analysis and interpretation

It is important to note that the degree of undesirability of events, as assessed in
this study, does not in itself present an exaet evaluation ofthe desirability or not of
a country for oil investment. The study provides the opportunity to weigh expected

25S ©2004 Oi-ganization ofthe Petroleum Exporting Coutitric.s OPEC Review

rewards on the basis ofthe probability of oecurrenee of undesirable events, as as-
sessed by the panel of experts.
Another benefit of this proeedure is that it highlights speeitlc areas of risk that
ean be given speeiai attention, if a company decides to invest in an oil venture in Ni-
geria. This study also pemiits eomparison of perceived risk from one company to an-
other. Analysis ofthe responses of different experts for each factor provides valuable
insights into the reasons for the differences. Figures 3-6 illustrate these differences
for each expert for a particular proposition and for the panel's average opinion. The
experts were identified by firms' levels of oil produetion. These plots allowed the
identification of experts with extreme judgments (in terms of the other pane! mem-
bers) and of a with similar judgments.

Experts' aggregate opinions

Technical risk
Figure 3 indicates the vulnerability of oil and gas ventures to the identified
technical risk factors. They are ranked according to their influence on the eeonomie
perfonnaneeofoil and gas projects, as indicated by experts from oil companies. All the
experts from the firms agreed that the area extent of hydrocarbons and the net pay
thickness of hydrocarbon zones have the strongest influence on the economic per-
formance of oil and gas projects. This is follow^ed by the porosity ofthe formation,
the recovery rate and production mechanisms, which were rated by 75 per eent ofthe
respondents as having very strong influences, while water saturation and the produc-
tion rate were each rated by 50 per eent of the respondents as having a very strong in-
fluence. Mishaps, such as well-kicks and the extreme eases of blowout, were rated by
50 per cent ofthe respondents as eaeh having a strong intluenee. Twenty-five per
cent ofthe respondents rated changes in retlnery teehnology that allow for erude
substitution as having a weak infiuence.

Economic risk
The inOuenee of economic risk faetors on oil and gas projects was assessed
and ranked according to their degrees of infiuence, as shown in figure 4. Among
al! the identified risk elements, joint venture (JV) partner eash calls were rated as
having the strongest infiuenee on the economic performance of oil projects by all
the companies. 50 per eent of the respondents also agreed that input cost changes
have a very strong influence. Fluctuations in exchange rate {naira/$) follows, with
25 per cent of the respondents rating it as having a very strong degree of influenee on
economic risk. Suiprisingly, the crude oil price and changes in the domestic interest
rate were rated by 75 per cent ofthe respondents as having a weak influence on eco-
nomic risk, while changes In domestic interest rates were ranked as having little or no
intliicnce on economic risk.

Environmental risk
As illusirated in figure 5. 75 per cent ofthe respondents agreed ihal force mu-
Jt'itre has a very strong infiuence on their business, while the remaining 25 per cent

December 2004 ©2004 Organization ofthe Petmleum Exporting Countries 259

 Figure 3
Vulnerability of oil and gas ventures to technical risk

Area extent of HCs

Net pay thickness
Porosity
Production mech.
Reeovery rate
Water saturation
1
Production rate
Mishaps
Faeility constr. time
Change in drill, tech.
0 20 40 60 80 100
per cent
• Do not infiuence Not certain n Weak influence
n Strong infiuenee Very strong infiuence

Figure 4
Vulnerability of uil and gas ventures to economic risk

JV cash call
Input cost changes
Exchange rate nairci/$
Exchange rate $/others
Crude oil price
Interest rate S "I
Inflation rate $
Domestic interest rate
0 20 40 60 80 100
per eeiu

• Do not infiuence Not certain D Weak infiuence

• Strong infiuence Veiy strong infiuence

260 ©2004 Organization ofthe Petroleutti E.xporting Counn-ies OPEC Review

 Figure 5
Vulnerability of oil and gas ventures to environmental risk

Force majeure

Community agitat.

Env. laws, policies

Oil spill, (sabotage)

Oil spill, (unlntent.)

Water disposal C

Drill, waste disposal C

Gas-flaring p
10 20 30 40 50 60 70 SO 90 100
per cent

m Do not influence Noi certain n Weak influence

D Strong influence Ver>' strong influence

Figure 6
Vulnerability of oil and gas ventures to political risk

Armed conflict
Fiscal changes
Restrictions on remittance '_
Restr. on production
(Un)expected civ. disord.
Sudden expropriation ~_
Incr. in share of proj. eq.
Restrictions on oil exports
Domestic price control
20 40 60 80 100
per cent

• Do not influence Not certain n Weak influence

a Strong influence Ver>' strong influence

Deeember 2004 ©2004 Organization ofthe Petroleum Exporting Countries 261

agreed that its influence is weak. 50 per cent ofthe respondents agreed that commu-
nity agitation, caused by environmental degradation, has a very strong infiuenccwhile
25 per cent of the respondents rated its influence as being strong. Only 25 per cent
of the respondents agreed that oil spillage has a very strong influence on business.
25 pereentof the companies agreed that water and drilling waste disposal have a strong
influence. They all agreed that gas-fiaring, which seems to be the major headaehe of en-
vironmentalists, has a weak infiuence on the eeonomie performance of their finns.

Political risk
Figure 6 shows that 75 per eent ofthe respondents agreed that changes in fiscal
regimes and restrictions on remittance have a very strong influenee on their business,
while the remaining 25 per cent agreed that these faetors have only a strong infiuence.
50 per eent ofthe respondents agreed that the restrictions on oil exports for politi-
eal reasons and/or eivil disorder have a very strong influenee on the performanee of
projects. 75 per eent agreed that an inerease in the loeal share of equity and manage-
ment and domestie priee control have a strong infiuence on the economic perfonnance
of oil and gas projeets.

Individual risk assessment

Figures 7-10 refiect the aggregate panel's judgments on the degree of each ele-
ment of risk on the economic performance of oil ventures, based on the current fiscal
regime in Nigeria.-Probability values have been assigned to the qualitative expres-
sions, based on discussions with the experts:

Very strong influenee 90 per cent

Strong infiuence 68 per cent
Weak Influenee 45 per cent
Uncertain 22.5 per cent
Do not influence 0 per cent

It was postulated that the average experts* opinion would lie on the curve on the
bar eharts.

Technical risk
Figure 7 indieates the experts" opinion ofthe influence of identified technical
risks in this study. Their opinions are ranked in descending order, based on the de-
gree of influenee, and are eategorised according to the level of erude oil production
in their finns. Net pay thickness and the area extent of hydrocarbons were assessed
to have a very high infiuenee by all the experts, while opinion varied with regard to
the influenee ofthe produetion inechanism on the economic performance of oil and
gas projeets. This, aecording to the survey, is followed by porosity of fonnation, wa-
ter saturation and the production rate. Al the end ofthe ladder are equipment procure-
ment time and changes in refinery technology that allow for crude oil substitution. It
ean be eoneluded from the chart that there was a large degree of variation of opinion

262 ©2004 Organization ofthe Petroleutn Exporting Countries OPEC Review

on the infiuence ofthe identified technical risk elements, as shown by the average ex-
perts' opinion line on the bar chart.

Economic risk
Just as the net pay thiekness and the area extent of hydrocarbons were assessed
as having a strong influence on teehnical risk, cash calls from joint venture partners
were also assessed as having a strong infiuence on economic risk. This was followed
by input eost changes (operating expenditure), the (S) infiation rate, the exchange rate.
the crude oil price and the domestic interest rate. Unlike the chart on technical risk, the
average of experts" opinion shows that variation in the infiuenee ofthe economic risk
element on economic performance of an oil and/or gas project was slight.

Knvirunmental risk
Among all the elements identified under environmental risk, fora' tna/eitre was
ranked as having the highest infiuence, with about 80 per eent of the respondents
agreeing with this. This was followed by the influence of community agitation caused
by environmental degradation, oil spillage (sabotage), environmental laws and poli-
eies, unintentional oil spillage, effluent 11,0, drilling waste and gas-flaring (which
most oil companies claim to be a major concern on environmental risk). Figure 9 in-
dicates that there was a gradual change in the opinion ofthe experts on the infiuence
of these risk elements ou the economic perfonnance ofthe oil and/or gas projeets. as
the ranking ofthe elements reduces, except with gas-fiaring.

Political risk
.lust as the financial commitments of oil ventures in Nigeria have been treated
with a high degree of caution, so also is the political aspect ofthe business. Answers
provided by the experts are shown in figure 10. From the analysis ofthe degree of in-
fiuenee of eaeh ofthe politieal risk elements on the economic pertbnnance of oil and
gas projects, restrictions on remittance and fiscal changes were ranked as having the
highest influence. This was followed by the effect of armed confiict between host na-
tion and external forees, restrictions on produetion, due to quota impositions, an in-
erease in the share of project equity and management, (un)expected civil disorder and
sudden expropriation. The effect of restrietions on oil exports for politieal reasons and
domestie price control scored lowest. The average panel's opinion indicates that there
was a sharp variation of opinion tov\ards the latter part ofthe ehart.

Comparative analysis of risk with oil production level

The foregoing presents the summary of experts' opinions on the impact of risk
on the economic perfonnance of oil and gas projeets in Nigeria. Also, individual ex-
perts' assessments ofthe risk elements as they affect oil-producing ventures have been
highlighted.
This section intends to assess risk as a funetion of daily production. The amount
of crude oil produced was used as a factor in scoring the individual risk element, as
it affected oil ventures. This was achieved by summing the total oil produetion of all

Deeember 2004 ©2t)04 Organization ofthe Petroleum Exporting Countries 263

 Figure 7
Impact of technical risk on economic performance of uil venture

Experts measure of influence

80
60 I
40
20
0^ -*^T r "

cF -.^"

>400mb/d • 200-400 nib/d n l 0 0 200mb/d a<100mb/d PariePs average

Figure 8
Impaet of economic risk on economic performanee of oil venture

Experts' measure of influence

100

80

60

40

20

ED <100 mb/d n 100-200 mb/d •200-400 mb/d • >400 mb/d Panel's average

264 ©2004 Organization ofthe Pefroleutti E.xporting Countries OPEC Review

 Figure 9
Impact of environmental risk on economic performance of oil venture

Experts' measure of inlluence

100
T
SO
T' ^ 1—mJH 'n_ n
Ii —r
60

40
1 I i
20
1
n i

#^ /^ . /

<?''^

>400rab/d • 200-400 mb/d D 100-200 mb/d D<100mb/d Panel's average

Figure 10
Impact of political risk on economic performance of oil venture

• J p • I
• II

0 -J 1 1

D <100 inb/d I 100-200 nib./d • 200-400 nib/d • >400mb/d ^ P a n e l ' s average

December 2004 ©2004 Organization ofthe Petrolewtt Exporting Countries 265

the eompanies that responded to the questionnaires used for this study. The pereent-
age share ofa eompany's oil production was used to factor the proportion of response,
rather than the ratio of respondents, in assessing the influence ofthe different risk ele-
ments on the four major types of risk.
With this approach, a more praetieal influence ofthe risk type on the eeonomie
perfonnance of oil and gas ventures could be determined. The use of other parameters
(such as capital expenditure, operating expenditure and profit after/before) that relate
to the finaneial commitment of oil ventures would have been appropriate, but for the
inability to obtain sueh data from the oil companies. Henec, oil production levels were
used as the performance eriteria. based on;

(i) their direct relationship to revenue and profit in the net cashflow calcula-
tion; and

(ii) their direct relationship to operating and capital expenditure, all things
being equal.

Technical risk
Figure 11 indicates the experts' opinions, when measured against the oil pro-
duction level ofthe individual firms to which the experts belong. With this method,
a weighted average can be seen, and an expert's influence was based on his compa-
ny's contribution, in terms of production. Equipment procurement time and changes
in drilling technology scored high, with about a 70 per eent influenee on the eeonom-
ie perfonnance of oil and gas projects in firms producing above 400 mb/d. Net pay
thickness and the area extent of hydrocarbon accumulation were scored 44 per cent,
by firms producing over 400 mb/d. Other technical risks, such as facility construction
time, operational mishaps, the recovery faetor, the production rate, water saturation,
porosity and the production mechanism, were adjudged to have a 59 per eent. 55 per
cenl, 42 per cent. 49 per eent. 49 per cent, 47 per cent and 47 per eent influence, respec-
tively, on the eeonomie performance of oil and gas projects for firms produeing above
400 mb/d. The degree to which the economic pcrtbrmanee is affected by the variables
for companies in the other production categories (200^00 mb/d, 100-200 mb/d and
less than 100 mb/d) is shown in figure II.

Economic risk
The impact of each risk element on the economic performance of oil and gas
projects is similar to the trend indicated by experts' individual opinions. The larg-
est oil producers are most affected by joint venture partner cash calls, input cost
changes, the inflation rate, exehangc rate changes, the crude oil price and inter-
est rates (foreign and domestic). Figure 12 shows that finns producing between
200^00 mb/d arc most affected by changes in the foreign interest rate. Input cost
changes, the inflation rate, the erude oil price and exchange rates have varying de-
grees of influence on the economic perfonnance of projects, for different oil compa-
nies having different production rates.

266 ©2004 Organization ofthe Petroleum Exporting Countries OPEC Review

Environmental risk
Figure 13 indicates that intentional oi! spillage has the largest impact
(60 per ccnl) on the eeonomie performance of oil and gas projects in finns produeing
over 400 mb/d, followed by community agitation andforce majeure. each having about a
55 per eent impact. Unintentional oil spillage was adjudged to have a 54 per cent in-
Huenee on the performance of projeets iu fimis producing over 4(10 inb/d. Gas-flar-
ing and environmental law policy were each adjudged to have a 44 per cent influenee,
while drilling waste disposal and water disposal were seen to have the least influence.
For finns in the category of 200^00 mb/d, oil spillage, community agitation and
force majewe each, separately, have about a 20 per cent impact on economic perform-
ance. Drilling waste disposal, unintentional oil spillage and environmental laws and
polieies have an influenee of about 30 per cent each. For finns in the 100-200 mb/d
category, drilling waste disposal, environmental laws and policies influenced the eeo-
nomie performance of projects by 16-20 per cent. The economic pcrfonnance of mi-
nor producers (less than 100 mb/d) is less alTeeted by the identified risks (an influenee
of less than ten per cent).

Political risk
Figure 14 illustrates the influence of political risk on the economic perfonnance
of oil and gas projects in Nigeria. Fiscal term changes MOU and tax — restrietions
on remittance and restrictions on oil exports, armed conflict, restrietions on produc-
tion and domestic price controls have about a 45 per cent infiuenee on finns producing
above 400 mb/d. Sudden expropriation was adjudged to influence the perfonnanee of
these companies by about 48 per eent. Unexpected civil disorder losses, restrictions
on oil exports and an increased share of projeet equity and management have influ-
ences of about 56 per cent, 54 per cent and 52 per cent, respeetively. The infiuenee
of political risk factors on the performanee of finns producing between 200 and 400
mb/d was adjudged to range between 31 per cent and 40 per cent, except for unex-
peeted civil disorder, that was adjudged to be about 23 per eent. The infiuence ofthe
risk faetors on the performance of flnns producing between 100 and 200 mb/d varied
between eight per eent and 14 per cent, while their influence on the performance of
firms produeing less than 100 mb/d ranged from four to eight per cent.

Qualitative assessment
The experts also qualitatively assessed the identified risk factors. The results of
the investigation are shown in table I.

Semi-quantitative assessment
A semi-quantitative assessment ofthe probability (P) ofa risk event and the
impact(s) it would produce on economic performance was made by assigning magni-
tudes or values lo the quantitative descriptions ofthe probabilities and impacts, based
on discussions with the experts. An example ofthe probability-impact (P-l| table, that
characterises the impact ofthe identified risk factors on the eeonomie perfonnance of
oil and gas projeets in Nigeria, is shown in table 2.

December 2004 ©2004 Otganizati<m ofthe Petroleum Exporting Countries 267

 Figure 11
Exposure of oil aud gas ventures to technical risk

Net pay thickness

Area extent of HCs
Production mechanism
Porosity
Water saturation
Production rate
Recovery rate
Operational mishaps
Facility construct, time ;
Change in drill, tech. ;
Equip, procur. time
Change in refmery tech.
0 to 20 30 40 50 60 70 80 90 100
per cent

• >400 mh/d • 200-^00 mb/d n 100-200 mb/d n<!OOmb/d

Figure 12
Exposure of oil and gas ventures to economic risk

JV cash call
_
Input cost changes

Inflation rate $

Exchange rate N/$

Crude oil price

Exchange rate S/other.s

Interest rate $

Inflation rate $

Domestic interest rate

20 40 60 80 HK)
per cent

>400 mb/d • 2 0 0 ^ 0 0 mb/d D lOO 200 mb/d U <100 mb/d

268 ©2004 Organization ofthe Petroleum Exporting Countries OPEC Review

 Figure 13
Exposure of oil and gas ventures to environmental risk

Force majeure
Community agitation
Oil spillage (sabotage)
Environ, laws and polieies
Oil spillage (unintentional)
Water disposal
Drilling waste disposal
Gas-flaring
0 10 20 30 40 50 60 70 80 90 100
per cent
>400tnb/d 1200^00 mb/d D 100-200 mb/d G<100mb/d

Figure 14
Exposure of oil and gas ventures to political risk

Restrictions on remittance

Fiscal changes

Anned conflict

Restrict, on produclion

Increase in share of project equity

(Un)expected civil disorder losses

Sudden exproprialion

Restrictions on oil exports

Domestic price control

0 10 20 30 40 50 (SO 70 m 90 100
per cent

>400mb/d • 200-400 mb/d T 100-200 mb/d I l< 100 mb/d

Decctnber 2004 ©2004 Organization ofthe Petroleum Exporting Countries 269

 Table 1
Risk categories

Qualitative
description
Risk elements of impact
1. Area extent of hydrocarbons very strong
2. Porosity of formation very strong
3. Net pay thickness of hydrocarbon zone very strong
4. Water saturation very strong
Technical 5. Production mechanism strong
6. Recovery rate strong
7. Production rate very strong
8. Mishaps e.g. well-kicks, blowouts weak
9. Underestimated facility construction time weak

10. Joint venture partner cash call very strong

11. Input cost chiingcs very strong
Economic 12. Inflation strong
13. Exchange rate weak
14. Crude oil price strong
15. Interest risk weak

16. Armed conflict strong

17. Fiscal changes: tax. MOU. etc very strong
1S. Restrictions on remittance weak
19. Restrietions on production weak
Political 20. (Un)expected civil disorder losses not certain
21. Sudden expropriation nil
22. Increase in local share of project equity weak
23. Restrictions on oil exports, due to OPEC quota nil

24. Force majeure., earthquake, floods, ete not certain

25, Oil spillage (sabotage) strong
Environmental 26. Community agitation very strong
27. Environmental laws and polieies weak
28. Gas-flaring (pollution) weak

A scaling factor or weighting is assigned to each phrase used to describe each

type of impact. Table 3 provides sample-scaling factors used with each phrase/itnpact
type combination.
The P-I table (table 2) is then used to calculate P-I scores for each ofthe identi-
fied risk factors. The P-I score ofa risk factor is the product ofthe sealing factor for
the impact and that ofthe probability ofthe risk producing the type of impact. The
P-1 score is a measure ofthe severity ofthe risk, as it pertains to the projeet. The P-I
scores (table 4) are then used to determine the most important risk faetors (i.e. those

270 ©2004 Organization of the Petroleum E.xportitig Countries OPEC Review

 Table 2
Probability-impact (P-I) table

Impact of identified risks on economic performance

VST 16 11 1.3,7

ST 17 25 10,16.26 5,6 2,4,14

WK 9.19 8,13,18 12,15,23 28

Impact
NCT 24 20

NIL 21

NIL NCT WK. ST VST

Probability

VST Veiy .strong

ST Strong
H'K Weak
NCT Not certain
NIL Non-existertt

Table 3
Probability-impact conversion chart

Rating Probability score Impact score

VST o.y 0.8
ST 0.6,S 0.5
WK 0.45 0.2
NC 0.225 O.I
NIL 0.0 0.0

Deeember 2004 ©2004 Organization ofthe Petroleum Exporting Countries 271

with the highest P-1 scores), enabling management to focus resources on reducing or
eliminating such lisk factors from the project in a rational and efficient manner.^

Table 4
P-I scores (can be used to segregate risks into degrees of severity)

One dimensional P-I scores

VST () 0.18 0.36 0.544 0.72
ST 0 0.113 0.225 0.34 0.45
WK 0 0.045 0.203 0.136 0.18
Impact
NC 0 0.023 0.045 0.068 0.09
NIL 0 0 0 0 0
NIL NC WK ST VST
Probabilitv

Conclusions and recommendations

Analysis of the data reveals that the technical risk eletnents, such as reservoir
area, hydrocarbon thickness, porosity, recovery factor and production mechanism, are
the most dotiiinant uncertainty factors in oil and gas exploration and production. The
major economic uncertainties identified include the etude oil price and joint venture
cash call. Joint venture cash call risk is currently on the decline, as a result of an im-
proved Govemment commitment to cash cali obligations. Political and strategic risks
arising from possible anned cotitliet were, however, observed to be ofa much lower
significance to investors in the oil and gas industry. Environmental and heaith risks
were also seen to be of relatively low significance.
The future ofthe Nigerian oil industry will depend greatly on the ability of com-
panies to foster greater co-operation, in terms of exchange of ideas and teehnology,
backed by an efficient decision-making proeess. Stronger ties should also be devel-
oped with host communities and all otber parties that bave stakes in the oil and gas
business. Environmental issues, such as gas-flaring, should be given greater attention
and their negative impacts translated into revenue, for the mutual benefit ofthe com-
panies and the Nigerian Govemment.

272 ©2004 Organization ofthe Petroleum Exporting Countries OPEC Review

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274 ©2004 Organization ofthe Petroleutn Exporting Countries OPEC Review