CHAPTER 6 ASSESSMENT OF POLITICAL RISK

• Jurisdiction: United States

International Resources Law: A Blueprint for Mineral Development
(Feb 1991)
CHAPTER 6
ASSESSMENT OF POLITICAL RISK
Malcolm J. Garratt
BP Exploration Company
London, England

INTRODUCTION

The oil industry is no stranger to operating in what are arguably some of the most unsettled countries in the world, indeed recent events in the middle east have highlighted how exposed investments in foreign countries can be. Political and economic changes can lead to serious repercussions on a company's assets or on its ability to do business, and often these changes are outside the control of the individual company. For example, the recent Iran/Iraq war resulted in considerable damage to oil installations and subsequent loss of production. My own company, BP Exploration, has suffered in the past from political actions by host governments particularly in Iran, Libya and Nigeria where assets have been nationalised. Within the oil industry we spend considerable energy and time on assessing the technical risks involved in prospecting for hydrocarbons, that is to say, in assessing the probabilities of finding hydrocarbons of a certain accumulation size in a particular area. We employ many geologists and geophysicists, experts in their field, to do that analysis, which has such impact on investment decisions. But what about the analysis of a country's political future? Can the anticipation of the risks associated with investing in unsettled regions be anything more than crystal ball gazing? Those risks are equally as important as technical risks, and should be considered seriously. Account should be taken of whether the possible rewards are adequate to cover the perceived risks.

As mentioned above, BP has had some difficult experiences in the past in its overseas production areas but now the majority of our assets are in the "secure" areas of the world such as the UK and US. However, the BP Exploration Company now has a stated policy of exploration for hydrocarbons in frontier areas. We believe that there are "frontier" regions of the world outside of the "traditional" areas that hold significant potential for discovery of hydrocarbons. However, these countries may offer the oil industry particular difficulties, perhaps because they are politically unstable, or because there are chronic economic problems. Take two fictional examples:-

Laputa is a basket-case. It is in the midst of civil war and has been unstable for the past decade. The right-wing military government is barely in control; enclaves of rebel-backed forces control large areas of the country. The rebels have access to funds and are well-armed. Coastal areas often fall under temporary rebel control. Various guerilla groups, when not driven by interfactional rivalry, are prone to attacking foreign companies and their staff. The economy is a mess, the black market flourishing, and the currency is non-transferable. Experts agree that conditions are most likely to worsen over the next decade. In complete contrast, Arcadia is a haven of democratic peace. The right-of-centre government is stable, wealth is evenly distributed. The market is open and robust. Oil companies have a long history of producing Arcadian oil. At the same time environmental pressure groups are gaining strength. The next election, due in three year's time, is likely to return the government, but a not-inconceivable swing could see the left gain ground. In a hung parliament, the five seats held by members of a very vocal environmental party could give them a significant influence.

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It goes without saying that the risks of investing in the former would be considerable — but how big? What's the likelihood of the investment failing because of the conditions in that country? How does that likelihood of failure compare with the risks for similar investment in Arcadia, and how is the latter different? What level of reward would the oil industry expect in order to give it confidence to invest in Laputa? What can a company like BP do to manage the perceived risks? It is questions like this that we have to attempt to answer when looking at priorities for investment.

So when we looked to assess political risk to assist in compiling our frontier exploration strategy we wanted something that would...