The Ernst & Young Business Risk Report 2010

The top 10 risks

for oil and gas
Sometimes the About this report
difference between a The Ernst & Young Business Risk Report 2010 has been structured to help today’s busy
executives find the information they need as efficiently as possible. We have summarized
risk and an opportunity our list of top risks with a tight focus on key issues and high-level developments. Together
with Oxford Analytica, we have also updated our popular Ernst & Young risk radar,
is the right information providing an at-a-glance assessment of the top 10 industry risks and their relative
importance in 2010.
at the right time.
In addition, readers can move directly to a more granular discussion of risks according
to the following industry subsectors:

• Upstream — exploration and production (E&P) by integrated oil companies (IOCs),

independents and national oil companies (NOCs)
• Midstream — gathering, field processing, transportation and storage
• Downstream — refining and marketing
• Oilfield services (OFS) — including service companies and the supply chain

This information can support a variety of risk management initiatives designed to

help companies:

• Identify both upside and downside risks

• Encourage new insights and “out-of-the-box” thinking
• Prioritize issues to coordinate risk management at the enterprise level
• Mitigate risks with a practical approach based on leading practices
• Support strategic planning with a broad-based understanding of current industry issues
 Contents

Introduction 2
The Ernst & Young business risk radar 3
The top 10 risks for oil and gas 4
Below the radar 11
Key risks by subsector: 12
Upstream risks 13
Uncertain energy policy: the implications of the
Gulf of Mexico spill for offshore drilling 15
Midstream risks 16
Downstream risks 17
Oilfield services risks 19

The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas 1
 Introduction

Last year’s underlying theme of “managing risk in uncertain times”

remains valid as the oil and gas industry is still recovering from the
greatest global economic shock in more than 75 years. While a mood
of cautious optimism has emerged, economic uncertainty remains. Like
the aftershocks following a major earthquake, financial jolts and market
worries will continue to impact a global economy recovering from the
worst downturn since the Great Depression.

The global economy remains in a fragile state and additional stress is anticipated because
of slow job growth, continued deleveraging and the struggle of riskier currencies. The
emerging Asian economies have been slowed by the global recession, and the developed
economies — the US and Europe in particular — continue to struggle. Most analysts predict
a difficult and uneven road toward recovery, and a full return to economic strength is not
expected until 2011 or even later.

Oil and gas companies have not been impervious to the existing economic climate, which
has been the backdrop for the risks noted in our report for this year, nearly all of which are
long-term in nature. However, their relative importance will fluctuate each year based on
current economic and market conditions. In fact, the challenges to the industry that were
identified in our previous reports are largely still in place. “Uncertain energy policy” is at
the top of the risk radar this year, not surprisingly, given that regulatory uncertainty has
been top-of-mind for many oil and gas companies during 2010. The Gulf of Mexico spill has
exacerbated this sentiment.

The oil and gas industry can expect a renewed and expanded regulatory focus on safety
and environmental risk preparedness and mitigation. The industry must remain ever
vigilant with respect to these and other risks it faces, and must re-examine them both from
a current portfolio perspective and a future investment perspective. In light of corporate
social responsibilities and the economic and regulatory pressures the industry is exposed
to, it has become increasingly clear that managing these risks is vital, not only to short-
term profitability, but also to long-term sustainability for oil and gas companies.
Accordingly, this report also outlines how we believe these risks can be mitigated through
improved capital management, investments in technology, financial and operational
processes and other strategies.

As you read the following pages, we hope that you will find our report and shared insights
useful, and that these will serve as a catalyst for the further development of your own risk
identification and mitigation strategies.

2 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
The Ernst & Young
business risk radar
The Ernst & Young risk radar is a simple device that allows us to present a
snapshot of the top 10 business risks for a company or an industry. Risk weighting and
risk prioritization
The risks at the center of the radar are those that the analysts we interviewed thought
would pose the greatest challenge to the leading global companies in the oil and gas We interviewed commentators and
industry in the year ahead. academics representing the oil and gas
industry, asking each interviewee to
The radar is divided into four sections: financial, compliance, strategic and operations. identify the top business risks for 2010.
Compliance threats originate in politics, law, regulation or corporate governance. Financial We asked the panelists to focus on risks
threats stem from volatility in markets and the economy. Strategic threats are related to for the leading global companies in the
customers, competitors and investors. Lastly, operations threats impact the processes, oil and gas industry. We also asked each
systems, people and overall value chain of a business. panelist to provide commentary on why
each risk was important, how each risk
had changed since last year, and which
of a company’s value drivers might be
The top 10 risks for oil and gas impacted by each risk. Based on these
interviews, we drew up this list of risks,
which we believe is comprehensive, for
the oil and gas industry.

Key to symbols
Up from 2009

Down from 2009

New entry

The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas 3
The top 10 risks
for oil and gas
The top 10
Ranking from 2009 in brackets
1 Uncertain energy policy (2)
2 Access to reserves: political constraints
and competition for proven reserves (1)
3 Cost containment (4)
4 Worsening fiscal terms (5)
5 Climate and environmental concerns (7)
1 Uncertain energy policy
The general view is that this risk, ranked second last year, has
increased. Uncertainties in the direction of energy policy have been
prolonged, partly by the vague outcome of the Copenhagen
climate conference in December 2009 and partly by the inability of
the US to adopt a clear energy policy. The Gulf of Mexico spill has
only further complicated policy decisions across the globe.
Uncertain energy policy hinders operators’ ability to plan, invest
and respond to supply and demand changes. Consequently, it can
increase the likelihood of future supply and demand crises by
delaying investment. Broadly speaking, the absence of clarity
around regulatory and legislative changes will undoubtedly impact
the industry in the future and create an uncertain framework for
long-term investments.
4 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
6 Price volatility (3)
7 Human capital deficit (6)
8 Supply shocks (9)
9 Overlapping service offerings for IOCs
and oilfield service companies (8)
10 New operational challenges, including
unfamiliar environments (new)
Steps companies can take to respond
to this risk
• Adopting an organized approach to educate and lobby
political leaders and the general public about the need for
a coherent and consistent energy policy. This is a long-term
goal to which companies should commit sufficient
resources.
• Understanding and anticipating the national energy policy
of the country in which operations take place. This may
include making use of policy advisors on the ground, even
for smaller companies.
• Creating broad-based initiatives for compliance, including
new reporting structures to implement compliance and
other proactive measures to meet anticipated regulatory
changes. The relocation of sourcing or manufacturing
operations to countries or regions that offer lower
compliance costs is an option to consider.
 Access to reserves: political
2 constraints and competition for
proven reserves
As in 2009, ensuring sufficient access to oil and gas reserves at a
reasonable cost will remain a significant challenge. The location of
many of these reserves in difficult environments where the E&P
costs are high — such as the Canadian oil sands, the Arctic or deep
water — will increase the risk of making new investments.
Perhaps more importantly, oil and gas companies will face a
number of political factors that might limit or even prevent access
to these reserves. For example, in the US, a number of changes in
regulations and tax laws could discourage industry growth by
subsidizing electric cars, renewables and other alternative fuels.
In developing countries, political unrest or the nationalization of
resources might lead to disruptions in supply.
At the same time, competition for reserves will probably increase
between IOCs and NOCs. In some cases, IOCs will face significant
risks from NOCs that have the backing of sovereign funds, local
government support and a greater proximity to emerging markets
in Asia.
3 Cost containment
Cost containment moved up one spot on the list this year, from
fourth to third. Controlling costs will help improve cash flow, and in
the current economic environment, this has become a key strategy
for many companies in order to sustain profitability.
Regardless of the strategy, cost-containment measures always
carry a degree of risk related to return on investment (ROI), as well
as possible disruptions to operations, revenue streams, customer
relationships and vendor agreements. In 2009, many companies
focused on cost controls to preserve margins during the downturn;
as the economy improves, companies should look to sustain those
cost cuts. Going forward as the economy recovers, companies will
need to plan for increased risks as a result of project cost inflation.
Moving forward, both operational and production costs will be on
the rise, especially given potential new mandates around safety
and the environment.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Steps companies can take to respond
to this risk
• Investing time and resources in fully understanding the
risk environment in which operations are conducted; no
two operational environments are the same. To completely
grasp the political climate on the ground, a company may
consider a local partner to take advantage of existing
opportunities.
• Improving access to reserves by increasing joint ventures
globally and re-evaluating the viability of current
operations. Companies can also strengthen alliances and
partnerships with NOCs to help mitigate the risk of losing
access to key reserves in the event of increased prices or
political disturbances.
• Knowing the alternatives. Although oil will remain
strategically important for some time, companies should
already be looking to the future. Gas is likely to become a
more significant commodity, as it is a cheaper alternative
than renewables. The current major problem with gas — its
location and complex transportation — is likely to be resolved
as technology improves and new infrastructure is built.
Steps companies can take to respond
to this risk
• Tightening operational costs can help to manage this risk.
This may involve streamlining processes, making more
effective use of shared services, including IT services,
improving business processes and trying to reduce costs all
the way through the supply chain.
• Ensuring that the management of cost-reduction programs
has accountability and bottom-up reporting. A company
must be able to communicate the strategy and the
execution plan. Companies are advised to align all cost
reduction initiatives with an execution strategy and adhere
to it. Those companies that have already implemented cost
reduction initiatives should be continually reviewing the
success of these initiatives.
• Increasing the focus on rigorous working capital
management to raise liquidity levels, introducing new
technology to enhance operational efficiencies and
outsourcing non-revenue-generating services, such as
accounting and payroll management, are cost control
measures that should be evaluated.
5
Failure to be seen to be responding to climate change and oil’s perceived
role as a driver of this change will have huge reputational risks.
4 Worsening fiscal terms
This risk moved up one spot this year, from fifth to fourth. Due to
the current economy, many developing countries now face a sharp
decline in income from their sovereign investments and tax
regimes. As a result, oil and gas companies will continue to be
targeted with increased tax rates and other fiscal measures. IOCs
might have to renegotiate their joint ventures with NOCs, agreeing
to new models that favor the local country.
The risk of worsening fiscal and tax terms for the industry can also
be found in developed countries. Influenced by both economic and
political factors, governments are considering or implementing
higher taxes, lower incentives for exploration, new royalty fees and
other measures.
6 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Steps companies can take to respond
to this risk
• Having a thorough understanding of the local fiscal
regimes, including tax laws in the country where operations
take place. In emerging markets, the way things are
done in practice can differ greatly from the published tax
laws. Working with a local advisor can help in overcoming
this challenge.
• Striking the right balance between managing worsening
fiscal terms and investing in new development
opportunities, including scenario planning for fiscal risks
against varying economic conditions.
• Strengthening the tax supply chain management through a
global approach that can include transfer pricing, business
restructuring, partnering to gain foreign tax credits and
other initiatives.
• Having a good working relationship with local regulators
and governments can be very helpful when terms begin to
change. Also, having international arbitration clauses in
agreements can be useful.
 5 Climate and environmental concerns
Climate and environmental concerns moved up from seventh place
to fifth. Although the debate continues over climate change and
the impact of carbon emissions on global warming, governments
have already taken regulatory steps that directly affect the oil and
gas industry.
In the European Union (EU), a number of environmental goals and
standards have been introduced, including a drive to reduce
carbon dioxide (CO2) emissions at least 20% by 2020. The EU has
also implemented measures, such as the Emission Trading
Scheme, to encourage the use of renewables over fossil-based
power generation. China has implemented a number of
environmental regulations designed to curb greenhouse gas (GHG)
emissions and increase the use of nuclear and renewable energy.
Although many of these regulations are directed toward coal
rather than oil and gas emissions, the sheer size of China and its
growing importance as a global player will affect the climate
debate for almost every industry in 2010 and beyond.
Steps companies can take to respond
to this risk
• Integrating climate and environmental concerns with
the core business model rather than treating it as a
separate issue. Climate and environmental concerns have
become a core business risk and must be managed in a
routine manner.
• Performing enterprise risk assessments to assess exposure
across segments and ensure mitigation and incident
response plans are in place.
• Anticipating stricter regulations around carbon and making
the appropriate amendments and investments now. An
opportunity exists for those who want to be leaders in
low-carbon energy.
• Partnering with the NOCs in the country where operations
take place to better understand the local environmental
regulations.

In the US, additional legislation that would affect oil and gas
companies is under consideration, including measures that would
increase safety and environmental compliance requirements, as
well as civil penalties and fines that would be levied for violations
of various environmental laws. Companies will have to continue to
monitor legislation to follow these and other proposed changes as
they develop.
• Improving non-financial reporting, including carbon
emissions data, and the environmental impact of
operations. Companies can seek third-party verification of
their climate change disclosures, including statements of
performance and claims about the positive impacts of
products or services.

For oil and gas companies, environmental issues have created not
only increased regulations but also difficulties in predicting how
these regulations will be implemented over time. Government
regulatory policies are based on a number of competing goals,
such as energy security, affordability and response to demand. For
example, a sudden decline in the global economy might discourage
additional regulations or prompt governments to extend
compliance deadlines.

Aside from governmental scrutiny, companies are facing increasing

pressure from shareholders to disclose risks related to environmental
concerns. Following the spill in the Gulf of Mexico, some investors
are looking for full disclosure of the risks associated with offshore
drilling operations and the potential environmental impact, as well
as the prevention, response and governance measures companies
have in place to address those risks.

Looking ahead, the climate debate will continue to complicate

the strategic decision-making of oil and gas companies across
the industry.

The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas 7
Oil prices have become more, rather than less, volatile in recent years and
there is no sign that this will change, despite proposed action by various
regulatory authorities to curb speculative trading in oil futures.
6 Price volatility
The risk of price volatility, ranked as the third most important
strategic risk last year, noticeably decreased in importance this
year. The relationship between oil and natural gas prices has
changed dramatically.
Oil prices in 2010 have been relatively stable due to modest
consumption habits, and weak developed economies have eased
demand pressures. However, natural gas prices are currently low
by historical standards as a result of oversupply. There are still
significant variations between regions in how gas prices are set
and the level of government subsidy in some countries.
A truly global gas market will not emerge until there is greater
flexibility in gas supplies, increased transportation between
regions and more gas-on-gas competition.
The global economic recovery is fragile and any setback could
dampen demand. Additionally, political or regulatory changes, as
well as geopolitical events, could alter prices almost instantly.
While price volatility impacts companies differently, capital-
intensive projects are the most vulnerable when oil and gas prices
go down. Falling prices will affect revenues and reduce companies’
capacity to finance projects off their balance sheets. On the other
hand, refiners’ margins will continue to be squeezed by rising
prices in crude oil.
7 Human capital deficit
Regardless of economic conditions, the availability of qualified
personnel cannot be taken for granted. When the economy
improves, without sufficient growth in human resources the
industry will face project delays, canceled projects, lower
productivity and higher operational costs. Many NOCs in particular
are faced with severe shortages of experienced personnel as they
expand their operations and enter new markets.
In developed countries, many senior engineers, managers and
other professionals are now reaching retirement age, with no
assurance that enough college graduates and younger workers will
be ready to take their place. Many universities in Europe and the
US report declines in the number of engineering and geoscience
students. By contrast, schools in developing countries are
producing record numbers of graduates, but these young
professionals will still require years of training and experience to
fully support the industry’s needs in the 21st century.
8 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Steps companies can take to respond
to this risk
• Carefully re-evaluating all investment strategies, including
the balance between oil and natural gas investments. This
involves conducting scenario planning for investments and
divestments against low to moderate prices even if current
prices are high. It also involves having plenty of liquidity
before investing in a project as protection against any
potential volatility.
• Engaging in econometric modeling to better understand oil
and gas market developments. This is an often overlooked
practice outside of IOCs — but potentially a very useful one
that companies can use to anticipate price volatility.
• Applying prudent management techniques, including
cutting costs, evaluating the supply chain process and
re-evaluating the capital plan and expectation of returns.
• Companies can also consider hedging strategies for
margins and costs, and tax management strategies to
improve cash flow.
Steps companies can take to respond
to this risk
• To reduce duplication and inefficiency, companies must
manage, define and coordinate HR processes on a
centralized level to help HR professionals focus on
workforce challenges.
• Creating an inviting business culture to attract young
people — for example, highlighting the technological
advances in the industry in order to create awareness that
the industry is constantly developing, modernizing and
evolving technologically.
• Leveraging older workers’ knowledge. Be creative with
retirement arrangements to retain intellectual capital.
Consider slower, phased-in retirement arrangements and/
or re-enlist retirees as part-time consultants.
• Developing local and regional talent. This must be
accompanied by investment in culture and language
training to avoid issues with language barriers and
miscommunications as expatriate managers try to bridge
the cultural gap with their local workforce.
 8 Supply shocks
Ranked ninth in our 2009 risk report, supply shocks based on
geopolitical events will remain a significant risk for the oil and gas
industry. Major issues include chronic tensions in the Middle East;
the threat of attacks on pipelines, refineries and harbor facilities;
continued tensions between Russia and its former republics;
political tensions in Nigeria; and the general unpredictability of
political changes in Latin America.
At the very least, these risks can result in highly volatile prices that
make strategic planning and investing more problematic.
Companies could face even greater challenges from unexpected
government interference, changes to joint ventures, the annulment
of contracts and civil unrest.
Overlapping service offerings for
9
IOCs and oilfield service companies
This risk remains low on the list this year, having ranked as eighth
last year. For some, depending on industry segment, this risk is
seen as an industry evolution rather than a risk. There is a shifting
of focus away from IOCs toward NOCs in response to protectionist
measures enacted by various countries to develop their own
resources. This shift in focus leaves IOCs and OFS companies to
compete for opportunities with NOCs. OFS companies are
increasingly taking on roles that were traditionally limited to IOCs.
At the same time, IOCs have overlapping competencies with OFS
companies, as they seek to partner with NOCs. This poses both a
risk and an opportunity for IOCs and OFS companies as their roles
evolve in the global energy market.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Steps companies can take to respond
to this risk
• Investing in more stable markets, even if this means a lower
return, and making use of longer-term hedging tools such
as re-allocating capital to projects with longer-term
stability.
• Adopting a flexible, shorter lead-time capital structure
would allow the generation of peak supply to help endure
the downturns.
• Focusing on assets that allow production to be maximized
between supply shocks.
• Restructuring agreements to ensure supply. Companies
should carefully analyze the current strength and
capabilities of their supply chain and identify bottlenecks
or weaknesses.
Steps companies can take to respond
to this risk
• For IOCs, taking advantage of the fact that they have a
strategic advantage over OFS companies in the area of
program management, due to extensive experience.
• For OFS companies, developing long-term strategies that
recognize that price fluctuations will affect them more
severely than NOCs and IOCs.
9
The technical challenges of new operating environments, both above and
below the surface, have been a feature of the oil industry since its very
earliest days. As oil and gas exploration moves into ever deeper waters
and into the Arctic regions, these challenges will remain.
New operational challenges,
10
including unfamiliar environments
This risk was an emerging risk last year and is a new entrant to the
top ten. These challenges have grown significantly over the past
year, due mainly to the increased focus on E&P in challenging
environments, such as the Arctic region and deepwater areas. In
many cases, this development is requiring a new generation of
technical and operational solutions, as well as special training and
support for personnel in the field. The costs and physical dangers
involved in tapping these new reserves far exceed previous levels,
adding to the risk of oil and gas companies. Furthermore,
companies have no assurance that prices will continue to justify
heavy investments in these areas.
In addition, oil and gas companies must continue to adopt new
technologies to mitigate the risk of losing their competitive
advantage. This process includes a strategic commitment to
research and development (R&D), ongoing investments to upgrade
existing facilities and the development of joint ventures with
technology providers.
10 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Steps companies can take to respond
to this risk
• Continued heavy investments in new technologies,
including those for unconventional oil and gas. IOCs have
been at the forefront in developing new technologies for
E&P and transportation. However, independent oil and gas
companies further developed technological advances that
unlocked the potential of unconventional natural gas
resources. To remain competitive and gain access to new
opportunities, this investment by oil and gas companies
must continue.
• Closely managed joint ventures (JVs) that can increase
business opportunities and mitigate risks among IOCs,
subcontractors, NOCs and local governments. Companies
should evaluate current and potential JVs for counterparty
and political risks in order to effectively establish
safeguards and manage exposures.
• Strategic acquisitions in diverse geographies or challenging
environments. These acquisitions can help companies
expand their operations and give them access to trained
personnel and required R&D.
• A dedicated focus on capital project management.
Coordinating capital and project management activities in
connection with capital design and construction programs
and projects will help identify and mitigate capital program
risks, thereby potentially improving project cost controls
and schedule performance.
Below the radar
Our industry commentators have identified
risks that fall directly “below the radar,”
and may rise to the top of the risk list in
years to come.
1 Uncertain energy policy (2)
2 Access to reserves: political aging offshore structures and components require continuous
constraints and competition for inspection, monitoring, maintenance and repair, while older
proven reserves (1)
3 Cost containment (4)
4 Worsening fiscal terms (5)
5 Climate and environmental
concerns (7)
6 Price volatility (3)
7 Human capital deficit (6)
8 Supply shocks (9)
9 Overlapping service offerings
for IOCs and oilfield service is the main sector for new gas demand growth. In addition, fuel cell
companies (8)
10 New operational challenges,
including unfamiliar environments
(new)
11 Aging oil and gas infrastructure
12 Competition from new technologies, (OECD) is a group of 32 member countries that discuss and develop
including alternative fuels
13 Access to consumers in new
growth markets
11 Aging oil and gas infrastructure
A former top 10 risk that remains relevant to the industry but has
fallen below the radar this year. An aging oil and gas infrastructure
can pose serious operational threats to companies and jeopardize
their public reputations and business relationships. For example,
refineries have greater difficulty in complying with environmental
regulations. Although the costs and difficulties in rebuilding an
aging infrastructure are clear, the risks are equally clear for the oil
and gas industry if it fails to act. Government support and stimulus
might become available for new projects, but individual companies
will carry the main responsibility for execution.
Competition from new technologies,
12
including alternative fuels
Developments in the power sector — possibilities like
microgeneration or zero carbon homes — will rearrange the
consumer/producer relationship, and the market for power, which
technology and biofuels are continuing to make advancements to
compete with traditional fossil fuels for use in daily life.
Access to consumers in new
13
growth markets
The Organisation for Economic Co-operation and Development
economic and social policy. Energy demand in the non-OECD
countries is expected to grow rapidly, while oil demand in the OECD
countries is expected to contract. Restricted access to these new
markets in terms of being able to provide downstream services will
curb companies’ ability to grow. This is already evident in terms of
the shift in refining capacity from the OECD countries to the
non-OECD countries. IOCs will be able to expand as upstream
producers but may contract as vertically integrated companies.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas 11
 Key risks by subsector

New to the report this year, we have taken our top 10 risks that apply to
the industry overall and identified the key risks of most importance to
the upstream, midstream, downstream and oilfield services subsectors.
All the subsectors are interrelated and they rely on each other at various
points in the energy value chain; however, their business models are
very different. Thus, while each risk is important to the overall industry,
each risk affects the subsectors in different ways. In addition, the risk
rank varies among the subsectors, as each one has its own priorities. For
example, when prices on crude oil rise, the upstream subsector benefits,
while at the same time, refiners’ margins are squeezed.

Once again, we are defining the subsectors as the following:

• Upstream — exploration and production (E&P) by integrated oil companies (IOCs),

independents and national oil companies (NOCs)
• Midstream — gathering, field processing, transportation and storage
• Downstream — refining and marketing
• Oilfield services (OFS) — including service companies and the supply chain

12 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Upstream risks
Upstream companies continue to operate in a dynamic
environment and face significant unknowns that impact their
ability to manage risks and make long-term investments. Below
are the key risks identified for upstream companies in order of
greatest importance.
Uncertain energy policy
The absence of clarity around regulatory and legislative changes
creates an uncertain framework for long-term investments, which
are essential for the long-term survival of upstream companies.
Uncertainties in the direction of energy policy have been prolonged,
partly by the vague outcome of the Copenhagen climate conference
in December 2009 and partly by the inability of the US to adopt a
clear energy policy.
In the US, the Obama Administration is suggesting a number of
changes in regulations and tax laws that could discourage industry
growth. Many countries around the globe, most recently as a result
of the Gulf of Mexico spill, will also be reviewing their safety
regulations for offshore activities. In addition, increasing concerns
around the exploration and development of shale gas using hydraulic
fracturing may give rise to additional regulatory requirements.
Increased regulations, inspection times and potential liabilities
need to be factored into global operations. The added regulations
are expected to drive up costs. In order to maintain margins and
the ability to absorb unsuccessful exploration costs, upstream
companies must continue to find ways to reduce operational costs,
while maintaining safety and environmental standards.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Access to reserves: political constraints and
competition for proven reserves
Risks involving access to reserves are based on both geographical
and geopolitical factors. As companies seek new reserves, they are
exploring in more difficult environments, often increasing the cost
involved, therefore raising the risk.
In developing countries, political unrest or the nationalization of
resources might lead to disruptions in supply. Geopolitical
uncertainty creates another set of risks related to reserve access.
In developing countries, IOCs must gain access and then be able to
maintain that access if they are to realize a profit. Unfortunately,
access does not always guarantee production for IOCs, especially
in regions that have a history of resource nationalizations and
sudden regime changes. Strong competition from NOCs also
increases the uncertainty that IOCs can maintain access to
reserves, much less the profitability of the project.
Upstream companies must also balance their oil to natural gas
reserve ratio. Compared to oil, natural gas is considered to be a
relatively clean fossil fuel. Russia, the Middle East, North America,
Africa and other regions possess huge gas reserves — enough to
satisfy world demand for the next century or longer, according to
some estimates. Additionally, natural gas is being viewed as a
bridge to a low-carbon future. The potential for natural gas is large,
as it could become the major fuel for multiple end uses, such as
electricity, heating and transportation.
The growing importance of natural gas will lead to a shift in
investment priorities by many oil and gas companies. Even
companies now involved only in oil-related areas have increased
or most likely will increase their involvement in natural gas.
13
 Price volatility
Oil prices in 2010 have been relatively stable due to modest
consumption habits, and weak developed economies have eased
demand pressures. However, the global economic recovery is
fragile and any setbacks could put downward pressure on prices.
Falling prices will affect revenues and reduce companies’ capacities
to finance projects off their balance sheets. Despite some modest
gains, natural gas prices have remained at historically low levels.
Low natural gas prices threaten the economic viability of many
natural gas fields.
Climate and environmental concerns
For oil and gas companies, environmental issues have created not
only increased regulations but also difficulties in predicting how
these regulations will be implemented over time. Government
regulatory policies are based on a number of competing goals,
such as energy security, affordability and response to demand.
How each goal is weighted can change almost overnight. A sudden
decline in the global economy, for example, might discourage
additional regulations or prompt governments to extend
compliance deadlines.
Currently in the US, there is considerable controversy surrounding
the environmental impact of oil and gas operations, including the
use of hydraulic fracturing technology for enhanced oil and natural
gas recovery. In the rest of the world, as in the US, environmental
safety and health concerns have emerged and are being debated.
This debate will continue to complicate the strategic decision-
making of oil and gas companies across the industry.
14 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Worsening fiscal terms
Worsening fiscal terms seem almost inevitable for the upstream
subsector in 2010 and beyond. Many governments are seeking
new ways to increase revenues after watching revenues drop
during the recent recession. Large upstream companies provide a
highly visible tax target, and many companies are re-evaluating
their tax positions and developing new strategies to manage their
tax supply chain management.
New operational challenges, including
unfamiliar environments
Upstream companies that undertake E&P in extreme environments,
such as the Arctic, often need to develop or invest in new
technologies. The added costs and difficulties of building, operating
and maintaining infrastructures in these environments also
increases risk; if commodity prices fall below a certain threshold,
once-viable fields become uneconomical to produce. As demand
rises with limited reserves available, pursuing E&P in harsh or
challenging environments may be the only way to significantly
increase reserves, and therefore future revenues.
Uncertain energy policy: the implications of the Gulf of Mexico spill for offshore drilling
The recent spill in the Gulf of Mexico
has implications for the offshore
exploration and production industry that
go well beyond the region, and the
cleanup and liability debates seem likely
to run for some time.
Offshore oil and gas resources are an
important part of the energy mix and
seem unlikely to be ignored or banned in
the longer term. In addition to existing
offshore fields, significant new reserves
reside in deepwater and in frontier waters
off Brazil, Africa, Southeast Asia and
Oceania, as well as the Arctic and
Antarctica. However, the industry’s ability
to operate in a number of existing and
new areas is likely to be under threat until
confidence in those operations is fully
restored. The root causes of the
Deepwater Horizon incident need to be
fully understood and the appropriate
measures need to be put in place to
reduce the chances of a recurrence.
The industry needs to convince regulators
and stakeholders that the lessons have
been learned in terms of incident
response and that any future event could
be resolved quickly, safely and with
minimal leakage. For this to happen, the
following areas need to be addressed:
1. Risk assessment of current
offshore operations
All offshore operators should complete
a full technical assessment of their
current offshore facilities. This will include
looking at all critical equipment in terms
of type, age, service history and other
factors.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
In addition, an assessment of ongoing
operational procedures with regard to the
regular testing and maintenance of this
critical equipment should be undertaken.
This assessment also should include
evaluating potential upgrades or
additional equipment that could be
deployed to reduce the risks in this area,
even if such upgrades or equipment are
not necessarily required by regulation.
Finally, a review of the contractual
relationships that exist between partners
and contractors should be undertaken to
ensure they support the highest levels of
safe operation.
2. Risk assessment of future offshore
operations
When organizations are considering
entering into new offshore ventures, a
number of areas in the investment
process seem likely to come under
increased scrutiny:
• Technologically groundbreaking
projects need to address how to deal
with a catastrophic failure and whether
clear action plans and the supporting
technological capabilities are in place.
• There will be an increased focus
on partner and contractor expertise
for the types of projects that are
undertaken.
• Partner and contractor financial
strength, and their ability to fund
cleanup and liability costs in a
worst-case scenario, will be
scrutinized.
• The area being explored will need to
be considered in terms of its proximity
to major population centers or areas
of commercial or environmental
importance.
3. Incident response
It is clear that there will be significant
lessons coming out of this incident that
will further the understanding of how best
to prevent a blow-out, and in the event of
a catastrophic failure, how to stop a
deepwater leak and manage the cleanup.
But it is also clear that incident response
techniques and technologies have not kept
up as companies have expanded into
deepwater exploration, drilling and
production.
The lessons learned should be shared
across the industry and collaborative
efforts such as those undertaken by
ExxonMobil, Royal Dutch Shell,
ConocoPhillips and Chevron in the
formation of the non-profit Marine Well
Containment Co. should be applauded and
encouraged. The plans for the
development of a containment cap,
specially designed subsea manifolds, and
flexible riser pipes to link a damaged well
to the water surface are clearly responsive
to the need to have measures in place to
address this type of incident in the future.
Having available ships capable of
capturing and storing oil and dedicated
crews to ensure regular maintenance,
inspection and readiness of equipment are
also key measures in addressing the
industry’s ability to respond to another
event of this nature. However, existing
collaboration and support may need to go
a step further by engaging regulators and
other stakeholders in the process, thus
providing them further reassurance that
while deepwater exploration and
production does in fact contain inherent
risks, these risks are manageable.
15
Midstream risks
Companies in the midstream subsector include those focused
on the gathering, field processing, transportation and storage
of crude oil, petroleum products and natural gas. In general,
midstream companies are less exposed to the risks of volatile
energy prices than their counterparts in the upstream or
downstream subsectors, as the majority of their operations are
typically performed on a fee-for-services basis. Below are
the key risks identified for midstream companies in order
of greatest importance.
Cost containment
Project costs continue to be an issue for midstream companies, in
particular, as they engage in planned infrastructure expansions. As
the demand for natural gas increases and is projected to be
satisfied by new sources of gas reserves, such as those found in the
shale gas plays in the US, China and Eastern Europe, midstream
companies need to build additional pipeline infrastructure, including
new extraction and gathering facilities. Midstream projects typically
carry higher investment risk because of the significant costs
associated with construction of the physical assets. Therefore,
effective project management, including cost containment, is
critical to the success of the planned expansions. It is important for
midstream companies to maintain a balance between managing
costs while sustaining and expanding activity levels. Continuous
process improvements, including effective strategies around
enterprise resource planning in order to strengthen the supply
chain, will help to minimize costs in the long run. Reductions in
operational costs are key.
Managing the cost of capital associated with infrastructure
expansions is also critical. Companies will need to remain vigilant
with respect to financing availability, security issues related to the
physical assets, regulatory intervention that could delay the
construction period, and transit and cross-border risks, all of which
are factors that could have an impact on the project cost of capital.
16 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Uncertain energy policy
Uncertainties around energy and regulatory policy pose substantial
risks for this segment of the industry. Government policies are
based on a number of competing goals, such as energy security,
affordability and response to demand. How each of these goals is
weighted can change almost overnight. Regulations typically
impose costs, some of which may not be recoverable in a
competitive environment.
Regulatory uncertainty may delay investment decisions, while
some regulatory changes may cause some investments to be
canceled, or cause some assets to be impaired. For example,
regulatory uncertainty is affecting such proposed major midstream
projects as the Alaska Natural Gas Pipeline, as well as the proposed
expansions of oil pipelines carrying Canadian oil sands to US
refineries. Limits on deepwater drilling could remove the need for
additional pipeline infrastructure and possibly impair the existing
infrastructure. Similarly, limits to hydraulic fracturing could reduce
the access to new gas reserves and, thus, change the economic
dynamics around potentially necessary new infrastructure for the
processing and transportation of shale gas.
Climate and environmental concerns
From an environmental perspective, carbon emission regulations
will also impact this segment. The ongoing debate over how carbon
emissions will be regulated and reported has made it difficult for
companies to predict what the long-term outcome will be.
Particularly important for midstream companies is to determine if
the emissions at their facilities will be aggregated to one reporting
number or if each facility will be considered independently. In
addition, when expanding transportation infrastructure, midstream
companies need to address community concerns when building in
environmentally sensitive areas.
Downstream risks
With global refining capacity expanding beyond demand needs,
refiners will need to cut back throughput by eliminating old and
inefficient plants. This could lead to additional costs for
environmental remediation liabilities. Additionally, operating
safely will remain a key concern for the refining subsector.
Below are the key risks identified for downstream companies
in order of greatest importance.
Uncertain energy policy
An energy policy that seeks to move away from oil, either for
economic security or environmental reasons, would limit or
reduce demand growth and constrain profitability. In contrast,
an energy policy that constrains domestic oil production would
notably affect the upstream and OFS subsectors, and may
only increase dependence on imported oil. In either case, the
lack of clarity around energy policy poses challenges for
downstream companies.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Climate and environmental concerns
More specifically, a strong energy policy with regard to climate
change, depending on how it is structured, could significantly
affect refiners and marketers. The most recent cap-and-trade
proposals before the US Congress primarily target the power
generation and utility segment of the energy industry, but
alternate proposals, if adopted, could impose higher burdens on
the transportation fuels industry.
The EU, China and other countries are either currently assessing
their carbon reduction potential or implementing policies to
stimulate emission reductions. The oil refining subsector will play a
pivotal role in the future as a continued reliable, resilient and
secure source of transport fuels and feedstocks for other
industries. In doing this, refiners should consider the introduction
of alternatives capable of being blended with or distributed
alongside conventional fuels, which would keep options open on
future diversified supply sources that are less carbon intensive.
To fulfill this role and to meet the changing patterns of demand as
well as future environmental requirements, refineries will likely
require substantial investments.
17
 Price volatility
Price volatility, as reflected in refiner and marketer margins, will
impact portfolio management and investment strategies. Pressures
on refiners to maintain liquidity are driven by capacity exceeding
demand. New refinery construction and debottlenecking of existing
refineries over the past decade has significantly increased global
capacity beyond demand needs. Active portfolio management in
the downstream subsector has been a feature of the large,
vertically integrated oil companies for many years, but must also
be addressed by independent refiners. As strategic aims and
market conditions change, so do the requirements of the portfolio
needed to achieve management and shareholder goals.
The biggest worry for independent refiners in 2010 has been
liquidity and cash flow; margins can affect not just their
profitability but also their survival.
Access to consumers in new growth markets
If the global economy continues to recover and that recovery
is sustained, refiners will stand to benefit from a gradual but
steady increase in oil demand. Access to that growing demand,
most prominently in Asia, will be critical for refiners, particularly
for the integrated IOCs. However, the challenges of economic
uncertainty will remain a critical part of risk management for this
subsector in 2010.
18 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Aging oil and gas infrastructure
Aging refineries present risks from a safety, environmental and
competitive standpoint. Older refineries have greater difficulty in
complying with environmental regulations. In addition, they often
cannot refine the heavier crudes that are being used more today
as sweet crude reserves are depleted. Both factors increase the
need for new refinery construction or modernization.
Faced with excess capacity and aging infrastructure, refiners might
consider whether to consolidate operations or shut down specific
refineries. In some cases, refinery shutdowns will be determined by
the local cost of compliance, as this cost can vary enormously from
country to country and even, such as in the US, from state to state.
Strategic investments to upgrade plants can help mitigate some of
these risks, but the investments themselves can introduce other
risks. Refiners, for example, can invest in new technology to run
sour crude, but this investment can only be justified by markets
that support specific crack spread margins. The ability to run
significantly different crude slates might or might not turn out to
be the right investment for a particular refinery.
In 2010, new refineries will continue to be built, especially in
developing countries such as China and India. However, a number
of construction projects will be delayed or canceled due to lower
demand for gasoline, tight credit and general economic
uncertainty. In contrast, additions to refining capacity in the US
and Europe have been confined to expansions of existing refining
capacity. In addition, many companies lack the capital to maintain
their aging infrastructure. The result is a paradox — an industry
with high capacity that is also experiencing growing problems with
age, rust and decay.
Oilfield services risks
The OFS subsector continues on its path of developing and
competing on the latest technologies, while navigating its shifting
partnerships with E&P companies. It faces risks equally as
challenging as those of the other subsectors. Below are the key
risks identified for OFS companies in order of greatest importance.
New operational challenges, including
unfamiliar environments
The risk associated with new operational challenges, including
unfamiliar environments, is very significant for the OFS subsector
because a large portion of OFS companies are increasingly
operating in challenging international locations. Tax regimes,
business practices and the local sourcing of personnel in
international locations can increase operational risks for OFS
companies. Complexity of the project, remote locations, new
technology and environmental impacts will also add to the
operational challenges. Further, the alignment of interests
between operators and the OFS companies, as contractors,
has become essential.
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
Cost containment
Cost control at all levels of the supply chain is a key component of
project execution. Good project execution is the key to delivering
margins. As projects increase in complexity, they generally become
more challenging and riskier to complete on time and on budget
while maintaining quality and safety.
Because manufacturing and engineering companies usually have
a number of options in the sourcing of supplies, more OFS
companies are calculating the relative costs of compliance for their
operations, in many cases offshoring production to developing
countries, where compliance costs — as well as manufacturing and
other costs — can be lower. However, offshoring can also involve
local content requirements for NOC contracts in regions such as
South America and Africa. The enforcement of local content laws
has increased during the global recession, adding to risks for OFS
companies. Governments can levy fines, force contracts to be
renegotiated and even shut down operations if OFS companies are
found to be in non-compliance with these laws.
In addition, increasing regulations are likely to increase offshore
drilling costs due to more frequent inspections, certifications and
equipment redundancies. In particular, equipment manufacturers
should benefit from retrofitting, redundancies and escalated
obsolescence. However, the overall demand for services and
equipment could be reduced if the increased costs and reduced
economics force operators to scale back spending. With higher
offshore costs, some spending may also be redirected to domestic
and international onshore markets.
19
 Overlapping service offerings for IOCs and
oilfield service companies
To address the risk associated with cost containment, some OFS
companies have consolidated units, divested assets or made
strategic acquisitions to strengthen their market position. Some
OFS companies have also taken on wider roles and built
competencies within areas that traditionally have been an
integrated part of an IOC’s core business in order to deepen their
service delivery to the market. This has led to some overlapping
services between IOCs and OFS companies. In order to further
compete with IOCs, some OFS companies have developed joint
ventures with non-competing companies, although international
joint ventures carry legal, political and economic risks that must be
properly managed, both internally within the participating
companies and externally with NOCs and local governments. As
margins for this subsector continue to be squeezed, many OFS
companies will pursue new ways to sustain profitability and will
need to manage the risks within new operating models.
Aging oil and gas infrastructure
In addition, ownership, maintenance and safety compliance
costs associated with maintaining infrastructure will continue
to increase. Aging oil and gas infrastructure was identified this
year as a below-the-radar risk but is still very relevant to this
subsector, where extensive aging infrastructure needs to be
maintained. Safety of the infrastructures and equipment
remains of great importance.
Climate and environmental concerns
For a significant part of the OFS subsector that is taking on more
ownership of the day-to-day operational activities across the value
chain, issues around health, safety and the environment have risen
in importance. As activities move deeper and deeper offshore, in
harsher environments and more remote locations, OFS companies
must reassess and identify ways to reduce their risk and manage
the environmental impact of their activities.

 
Worsening fiscal terms
Worsening fiscal terms is another concern for the OFS subsector.
OFS companies, most of which are multinational in their operations
and business partnerships, are facing higher taxes and the growing
demands of complex tax supply chain management across multiple
tax regimes. Some OFS companies are relocating their headquarters
to more tax-favorable countries. We expect this trend will continue
as countries continually review their tax structures amid market
and currency fluctuations.

20 The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas
The Ernst & Young Business Risk Report 2010 — The top 10 risks for oil and gas 21
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