Saturday, June 13, 2009

Thesis evaluates oil projects - SDM Pulse, Summer 2009

Emad D. Zand, SDM ’08
By Emad D. Zand, SDM ’08

Editor’s note: In this article, Emad D. Zand, SDM ’08, outlines the major points covered in his SDM master’s thesis, “Risk Analysis in Oil and Gas Projects: A Case Study in the Middle East.”

Large complex infrastructure projects, such as those involved in the development of oil and gas fields, are inherently risky, yet the demand for energy continues to grow. According to the International Energy Agency, global energy demand will grow at a rate of 1.6 percent until 2030. In 2030, fossil fuels will account for 80 percent of the energy mix, with oil and gas contributing close to 60 percent.

In light of these facts, risk analysis and the development of strategies to manage risk in the oil and gas industry are crucial to ensuring that our needs for energy are met with a minimum of cost overruns, delays, and other disruptions.

The lessons I’ve learned in the System Design and Management Program are particularly well suited to addressing such large and seemingly intractable problems, so I chose in my thesis to apply them in an analysis of two similar oil and gas projects. Based on publicly available information, I examined two distinct projects with similar geologies [see Figure 1] under two separate legal regimes in Iran and Qatar:

Figure 1: The South Pars/North Dome
gas field is divided by the
Iran/Qatar maritime border.
South Pars (Iran)
Companies involved: National Iranian Oil Company formed the Pars Oil and Gas Company to develop South Pars
Project name: Phases 6, 7, and 8
Project goals: To produce 104 Mscm of sour and dry gas per day; 158,000 barrels of gas condensate per day; and 1.6 million tons of liquefied petroleum gas (LPG) per year

North Dome (Qatar)

Companies involved: Qatar Petroleum Company established two joint ventures, Qatrgas and RasGas, to develop North Dome
Project name: RGX
Project goals: To produce 4.7 million tons per year of liquid natural gas (LNG) from each of three new LNG trains

Both projects undertook to develop areas of South Pars/North Dome, the largest gas field in the world, which is located on the border of Iran and Qatar in the Persian Gulf. The goals and obstacles for both were remarkably similar, but the strategies pursued in the two countries differed significantly. Examining these projects jointly not only provides a useful case study in risk management, but also illustrates the necessity of taking a systems approach to problems. In the end, the different outcomes were the result of differing management and engineering decisions.

Evaluating risk

Large engineering projects face three broad categories of risk: market-related risks, technical risks, and institutional risks. In all cases, the framework for risk management that I learned in SDM [see Figure 2] recommends identifying risks and analyzing them as early as possible in the project life cycle in order to come up with an action plan. Possible actions fall into four broad categories: avoidance (don’t take the project), mitigation (shape the project to reduce risk), transference (pass the risk to someone else—as you do when you buy insurance), and embracing (accept the risk as well as any consequences and opportunities that come along).

With this framework in mind, I examined how the two projects handled technical and institutional risks, as well as the results of their different strategies. (Note that I was unable to study market risks because such research requires access to proprietary corporate information.)

In analyzing the technical risk, I considered three categories: technological, construction, and operational risks. In the case of Iran’s Phase 6, 7 and 8 project, I found the technological risks were minimal because the required technology for both offshore and onshore facilities were well known. The project also mitigated its operational risk by using an experienced company to operate its facilities.

However, one of the goals of the Iran project was to develop domestic technical and managerial expertise for executing complex oil and gas projects. Since local contractors had limited managerial and technical capability to execute the project, the Iranian project faced increased construction risks. The risk management strategy employed centered on shifting these risks to other firms (transference)—for example by giving the responsibility for the offshore project to Statoil, a Norwegian company. But, while Statoil managed its own overall risk through diversification, it failed to manage construction risk at the project level in South Pars. Pipeline and platform construction issues contributed to severe delays and cost overruns.

By contrast, the Qatar project confronted increased technological risk because its design was based on an innovative solution—creating the largest liquid natural gas train (or processing facility) at that time in the world. However, the risk was specific to the project and therefore highly controllable. The Qatari firm, RasGas, was able to mitigate risk by shaping the project—for example by awarding multiple projects simultaneously to a single set of contractors and replicating the design and execution for additional trains. Replication in design and execution resulted in cost reduction, schedule reduction, more effective commissioning and start up, and safety and quality improvements. This strategy also facilitated applying execution lessons learned in the first LNG train to the future ones and therefore reduced construction risk. As in Iran, an experienced operator was used to reduce operational risks.

Institutional risks

Institutional risks can also be divided into three categories: regulatory risks (such as delays in obtaining licenses), social acceptability risks (i.e. public protest), and sovereign risks (which refers to cases in which the government abrogates or renegotiates the terms of agreed contracts).

In the two cases under discussion, regulatory risks differed because the hydrocarbon industry in Iran is highly fragmented, while in Qatar it is monolithic. Those working in South Pars therefore had to embrace the risk of working with multiple entities. In addition, different kinds of contracts were involved in the two projects. North Dome was developed under production sharing contracts, while South Pars used buyback contracts.

Both kinds of contracts pose risks, but with production sharing, the oil company has an incentive to prolong the life of the reservoirs and maximize the value of the project. In these kinds of contracts the state partners with an international oil company to develop the field and shares profits once production begins. The incentive to develop a domestic work force is also higher in this case because the company is engaged for a longer period of time than in a buyback contract.

In buybacks, the company develops the fields on behalf of the state and then turns over the whole operation. Once the company is paid for its work, the state gets all subsequent profits. Such contracts give the international oil company less of a vested interest.

As for the other kinds of institutional risk, neither Iran nor Qatar faced much social pressure; in both countries the public has been accepting of oil and gas projects. However, I found the geopolitical risks associated with oil and gas projects in Iran were significantly higher than in Qatar. While both countries experience the systemic risks endemic to the Middle East, Iran bears higher risks in having remained a major force against the western policies in the region.


These projects both faced a variety of risks. But in the Qatari scenario, replication of design and execution turned out to be a very effective risk management strategy. The project finished ahead of schedule and within budget. In contrast, the technical risk factors faced in the Iranian project were compounded by institutional risks and an absence of effective risk management. The result was significant delays and cost overruns.

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