In today’s increasingly global marketplace every investor has to consider particular risks involved in expanding its operations. Risk is a constantly present factor in business decision making process, and determining appropriate ways to manage and mitigate risks is crucial to the ultimate success of any new investments or expansion of already existing business operations. Risk management is of paramount importance to the economic consequences of investments in oil and gas industry where such investments can exceed US billion, and many years to complete.

By : Alan Berlin, Aitken Irvin Berlin & Vrooman LLP

I. Introduction

In today’s increasingly global marketplace every investor has to consider particular risks involved in expanding its operations. Risk is a constantly present factor in business decision making process, and determining appropriate ways to manage and mitigate risks is crucial to the ultimate success of any new investments or expansion of already existing business operations.

Risk management is of paramount importance to the economic consequences of investments in oil and gas industry where such investments can exceed US$1 billion, and many years to complete.

The general types of risk faced by all businesses can be grouped into five broad categories:

1) market risks, such as unexpected changes in interest rates, exchange rates, stock prices, or commodity prices;

2) credit/default risks;

3) operational risks, such as equipment failure, fraud;

4) liquidity risks, such as inability to pay bills, inability to buy or sell commodities at quoted prices; and

5) political risks.

The key test for whether a risk can be covered by political risk insurance is determining whether the occurrence was caused by a government action (a ‘political’ risk) or was the result of a commercial activity. Insurers make a distinction between these two types of risk because a political risk is presumably not within the control of the investor, and a commercial risk is.

Due to the extreme volatility of energy commodity prices it has long been considered that businesses operating in the petroleum, natural gas, and electricity industries are particularly susceptible to market (price) risks and other commercial risks. However, political risk management in the energy industry plays an increasingly important role since the world’s oil and gas production pattern is directly related to the geopolitical location of reserves. As shown in the table below major oil reserves are located in the regions of the world characterized by an unstable political environment.

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