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Do Diligence !

In our last post, we stressed the idea of undertaking robust risk-reward diligence before entering a new country. This time we will dig deeper into what that diligence investigation should be aimed – irrespective of whether you play in petroleum upstream, midstream or service sectors.

 

The starting point is an assessment of the financial risk. Always start with the money before looking at the rocks or the steel. Many make this mistake; probably because they are naturally most comfortable first working what they know best (like the rocks or the steel). If you cannot see a rateable, liquid return on the horizon, there is no point in investigating the opportunity much further. Key financial risk factors include:

 

 

 

 

 

 

 

Next, it is critical to examine endemic above-ground risks. A failure to identify, analyze and mitigate above-ground risks can spell disaster for a transaction. And those risks can be difficult to forecast. Here the usual suspects:

 

  • Political Risk: Political instability can emanate from political and social actors both inside and outside a host country. Governments, legislators, opposition parties, special interest groups and unions can all play a roll.

 

  • Macro-Economic Risk: The ugly sisters of political risk, macro-economic risks include inflation, forex fluctuations, bank liquidity, and changes to applicable law. Many of these risks are correlated to each other. One of these problems can be quickly compounded by the others.

 

  • Corruption: Corruption challenges international venturers in unanticipated ways with varying severity of consequence. Aside from prosecution concerns, corruption almost always erodes asset value in the long run – which is practical reason why compliance is so critical.

 

  • Operational Security Risk: Operational security risks pose: (a) cost issues (e.g. security private contractors or the State), and (b) liability and reputational risk when security enforcement exceeds merely defensive needs. The latter is not only morally repugnant, but can destroy entire companies while tainting the personal reputations of officers and directors alike.

 

  • Expropriation: In countries with no applicable bilateral investment treaty, protection against expropriation is purely commercial. Even where investment treaties apply, it is smart to guard against ‘creeping’ expropriation (the State’s accretive elimination of previously granted benefits).

 

  • Labour and Union Relations: Labour and union issues can impact cost and productivity issues ranging from inefficiency to strikes and blockades. In countries where unions and labour relations policies tend to influence the investment, a client should realistically identify the value burden of additional costs and operational delays from a mixed local and foreign workforce and incorporate this burden into its economic forecasts and assumptions.

 

  • Community Relations: There is a nexus between a project, community relations, surface access rights and local employment/labour relations. The project resistance or delay can be an NPV- killer. These risks are best mitigated with a clear engagement plan created by local experts and government relations personnel.When looking at the whole, risk factors should not be considered in isolation – risks and mitigants often overlap and are cross-correlated. In every deal or project, the degree to which each factor will impact the risk/reward analysis will change, and potentially evolve as the transaction matures. A strong transactional risk/reward profile will also integrate a client’s own tolerance for risk, factual peculiarities and specific instructions.