Balancing act: the right approach to managing risk

Mark Robson on how National Oil Companies can redefine the future

Oliver Wyman recommends that NOCs undertake a four-step program to create a more dynamic financial planning process, based on risk management.
Oliver Wyman recommends that NOCs undertake a four-step program to create a more dynamic financial planning process, based on risk management.

Mark Robson, a partner at Oliver Wyman, on how National Oil Companies can redefine the future for the Middle East

Around the Middle East, National Oil Companies, commonly referred to as NOCs, are supporting massive infrastructure programs designed to help the region keep up with its fast rising domestic demand for energy relative to GDP.

For example, Saudi Aramco recently committed to two projects that will require $230 billion with Sinopec and Dow Chemical. Meanwhile, the United Arab Emirates 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.

To achieve their goals, NOCs must overcome significant hurdles presented by volatile oil prices and a changing competitive landscape. It is not unusual for companies to be challenged to manage risk when making critical decisions regarding new investments, existing projects, and operations.

But for NOCs, the stakes are even 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.

To date, 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 a 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.

The current situation presents an opportunity for NOCs to increase the value that they create for their countries and to reduce the volatility in their financial performance by applying best practice risk management methodologies and tools.

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By developing an incisive understanding of the risks they face, NOCs can avoid catastrophic errors and instead capitalise on new opportunities to swell 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 commiting to 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 a 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 importantly, NOCs will be able to play an even larger role in bringing about a brighter future for the countries and citizens that they serve.

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