What are the top political risks for energy companies in 2021? To answer this question, perhaps there is no one better to ask than the energy companies’ own in-house analysts. After all, companies in the energy sector have only been able to operate long-lived, capital-intensive investments in some of the world’s most politically unstable countries by cultivating significant capabilities in political risk management.
A few months ago, we convened a panel of external affairs and risk management professionals at five of the world’s largest energy firms. The geopolitical consultancy Oxford Analytica then conducted in-depth interviews with these professionals, to produce the risk radar that appears below. Scholars in Oxford Analytica’s expert network then produced peer-reviewed essays on two of the top risks that the executives identified: “strategic competition between Chinese and Western companies;” and “natural resource fiscal policy after COVID-19,” which you can read in the full version of our report, “Political Risk in Natural Resources,” released in late January 20211.
Here, we provide a summary of Oxford Analytica’s findings. We sincerely thank the expert panel of natural resource executives who guided the research for their time and insights.
China has proved to be top of mind for the panelists, accounting for two of the top five risks on our list. Perhaps China’s dominance is unsurprising. In a sense, 2020 was China’s year. The Year of the Rat began in tragedy, as the pandemic exploded in Wuhan and threatened to overwhelm the city’s medical system. And yet, by the end of 2020, China appeared to have gained control of the virus and restarted its economy – even as many Western countries continued to struggle. Indeed, despite much talk of “reshoring,” and a trade dispute with the United States, during the first half of 2020 China’s share of world exports actually rose. Say this for China’s government: it can manage adversity. Both China-related risks in the radar relate to the emerging geostrategic contest between China and the West. Perhaps surprisingly, much of the concern expressed by panelists was not on China’s side of the ledger. “The Americans are the problem,” one panelist contended. “Can you continue to export to a given country? Work with a given supplier? Employ foreign individuals in the US? No idea.”
Regarding resource competition, the panel’s concerns related to the fact that China’s economy has been recovering rapidly even as many resource-rich countries continue to struggle. “In countries where there are high levels of indebtedness or civil unrest, China could be a beneficiary in a geostrategic sense by contributing to the public goods that help those countries to get back on their feet,” as one panelist put it.
The other main category of risks on the radar had to do with recovery from the pandemic. One member of our executive panel threw down the gauntlet: “simply trying to get back to where we were pre-pandemic is not enough – it would condemn us to go through the same thing again relatively soon. We need a sustainable recovery.”
This comment encapsulated several of the panel’s most frequently mentioned concerns. For instance, panelists worried that recovery would be unsustainable because environmental and other objectives would be abandoned in a race to rebuild economically, and that much of what was learned in the world’s response to the pandemic would be forgotten.
The other recovery-related risk on the radar, “aggressive tax and royalty regimes,” had to do with the fiscal positions of resource-rich countries. Even before the lockdowns began, countries were pummeled by international economic shocks, including a collapse in energy prices. Many emerging markets were able to remain solvent by drawing on international bailouts. When the lending taps are turned off, energy utilities may face difficulty in collecting payments from state-owned distributors and oil and gas companies may find that tax and royalty regimes shift.
Although we asked our panel to focus on identifying global risks in their sector, the Middle Eastern region was felt to involve political risks of such significance that they are globally relevant. Many of the panel’s concerns had to do with well-known issues such as tensions between the US and Iran. A military conflict between the US and Iran could lead to oil price shocks, as well as disruptions of global shipping. Another often-expressed concern was regional rivalries. The diminishing US presence in the region has arguably unleashed a struggle for regional dominance, most notably between Saudi Arabia and Iran, but also at times Turkey. “One thing all sides are realizing is Washington will be less active in the region going forward,” an oil and gas panelist claimed. During the launch webinar for the report, an Oxford Analytica analyst, Dr. Laura James, contended that Middle Eastern countries face risks in part because of the unusual nature of the “social contract” in certain resource-rich regimes. The public in some these countries does not necessarily expect full democratic representation, she said, but nor do they expect to be taxed. With climate transition looming and the need to repair fiscal positions in the wake of the pandemic, countries such as Saudi Arabia are contemplating new taxes, or a reduction of benefits provided by the state. Over the long term, such measures could pose a challenge to political stability.
Globalization and the removal of trade barriers meant that some types of political risks had been in steady decline until recently. However, the global pandemic has contributed to dramatic changes in political and economic circumstances - resource-rich nations, which are dependent on strong and stable global demand for commodities and international trade, are particularly exposed.
During 2020 and 2021, we have seen sovereign defaults or restructuring in Lebanon, Ecuador, Argentina, Belize, Suriname and now Zambia. Even in those countries not at immediate risk of default, tourism revenue will drop, tax revenue will reduce and medical expenditure will need to increase, placing further strain on already stressed economies.
It is not uncommon (or for that matter illegal) for governments under stress to unilaterally amend contracts, but it is essential that foreign companies are given adequate channels for complaint and given fair compensation for a breach. If there is a breach of contract with no compensation paid, financial losses are all but inevitable.
A political risk insurance policy can address such issues and provide some certainty in an increasingly uncertain world. Political risk insurance was born out of the turmoil of the 1970s which saw a spike in political risks and nationalizations. This insurance covers business losses caused by restrictions in capital mobility, or overt political action.
We have also seen a steady rise in politically motivated conflict, from violent street protests to the threat of civil war or the occurrence of actual war. Even if a country avoids large scale conflicts, social division, protests and/or labor disputes can easily escalate and the financial consequences which arise, either through physical damage or the interruption in activity, can be severe.
With much of the world distracted by fires on the home front, there is noticeably less scrutiny being given to actions of foreign governments. There has never been a more important time to measure these risks, to manage those that can be and to mitigate those that can’t.
For those companies that can manage these risks, this crisis should also bring opportunities. Difficult fiscal conditions in the emerging world are sometimes associated with efforts to attract foreign capital. In the years ahead, areas off limits to foreign oil and gas firms may open; countries may seek to make up shortfalls in energy provision or reduce their carbon footprint by bringing in foreign utilities.
Of course, as we have learned over the past year, such favorable political circumstances can quickly reverse. Political risk insurance plays a vital role in supporting the energy sector through such reversals of fortune.
Sam Wilkin is Director of Political Risk Analytics at Willis Towers Watson. Sam.Wilkin@willistowerswatson.com
