Oil and Gas Companies: A Risky Business

Operating on foreign deposits can lead to issues like sudden nationalization or shifting political winds. Companies should thoroughly analyze and establish sustainable relationships with international partners to mitigate this risk.

Fremont, CA: Investors should understand the risks a company must face in a new industry to succeed. General risks, like management risk, apply to all stocks, while more concentrated risks affect specific industries. In this article, we'll look at the most significant risks oil and gas companies face.

Political Risk

Political risk is a significant concern for oil and gas companies, especially in regulatory aspects. These regulations dictate location, timing, and extraction methods and can vary across states. Operating on foreign deposits can lead to issues like sudden nationalization or shifting political winds. Companies should thoroughly analyze and establish sustainable relationships with international partners to mitigate this risk.

Geological Risk

Oil and gas exploration has shifted from easy-to-get areas to less friendly environments like ocean platforms, using unconventional extraction techniques. Geological risk refers to the difficulty of extraction and the possibility of smaller reserves. Geologists minimize this by testing frequently and using terms like "proven," "probable," and "possible" to express confidence in their findings.

Price Risk

The price of oil and gas is the main factor determining the economic feasibility of a reserve, as higher geological barriers to extraction increase price risk. Conventional extraction costs are typically higher than vertical drilling. Oil and gas companies don't automatically cease operations due to price dips; they forecast likely prices over the project's term to decide whether to start. Price risk remains a constant companion once a project has begun.

Supply And Demand Risks

Oil and gas companies face significant risks from supply and demand shocks due to the high capital and time required for operations, which can be challenging to shut down or ramp up during price fluctuations. The uneven nature of production contributes to the volatility of oil and gas prices.

Cost Risks

The oil and gas industry faces significant operational costs due to strict regulations and complicated drilling processes. Uncertain prices due to global production beyond control further exacerbate these costs. Additionally, companies struggle to find and retain qualified workers during boom times, leading to increased payroll and a capital-intensive industry with fewer players. These factors contribute to the industry's overall cost concerns and the need for continuous investment in the sector.