Risk Management in ONGC

Ad i t h y a B A

I n t h i s b u s i n e s s w o r l d , r i s k i s e v e r y w h e re fi re s ,
n a t u r a l d i s a s t e r s , ex c h a n g e r a t e fluctuations, changes in
interest rates, credit ratings and commodity prices. Its the wildcard
that can upset even the most carefully crafted business plan. So it is
not surprising that over the past couple of decades, executives have
become ever more adept at neutralizing risk with a battery of
instruments, including not just insurance but a variety of
derivatives based on currencies, securities and credit ratings,
as well as customized contracts with counterparties. Its even
possible to hedge the weather. As per revised clause 49 of the SEBI
notified Listing Agreement (effective 01, Jan 2006) all listed
companies are required to assess the business risk and steps taken
to minimize the same. Accordingly, every company shall lay down
procedures to inform Board members about the risk assessment and
minimization procedures. These procedures shall be periodically
reviewed to ensure that executive management controls risk
through properly defi ned framework. A s o f n o w o i l a n d g a s
industry is of very hazardous nature due to its
v o l u m e o f transaction and its importance because of its limited
resources. Therefore in recognition of possible risk to which this
industry is exposed, many companies has started to mitigate their
risk through a proper route of risk management Therefore,
risk management is the process of defi ning and analysing
risks, and then deciding on the appropriate course of action in
order to minimize these risks, whilst still achieving business goals.
The current scenario of risk management in ONGC is in a
decentralized way, which is handled by different departments
depending on the risk faced by them.
Therefore the object of this report is to:

Identify the potential risk factors of ONGC specifically.

Redesign the existing risk management policy on a centralized basis.

Provide a solution for existing risk factors with any alternatives. The limitation faced
by Oil and Natural Gas Corporation in risk management until now are:

Decentralization of responsibilities and power which create hurdle in immediate

decision making.

Lack of creative decision making ability, because of centralized decision

making power.

Structural limitations, due to high no. of hierarchy level which create

difficulties
in proper
communication.A l l c o m m e r c i a l o r g a n i z a t i o n s a r e e x p o s e d t o d i f f
e r e n t t y p e s o f b u s i n e s s r i s k s . Assessment and management of these risks
are essential to insulate / mitigate the effects of these risks on the financial health of
the organization. ONGC is predominantly exposed to following types of risks.
(1)Operational
Risk (2)
Financial Risk (3)
R e g u l a t o r y R i s k (4) Economic and Industry risk
OPERATIONAL RISK
Exploration Risk
E&P industry world over is fraught with the basic exploration risk which refers to
the p r o b a b i l i t y o f s u c c e s s i n e x p l o r a t i o n e n d e a v o r s . I n t h i s i n d u s t r y
t h e i n p u t s a r e 107

Deterministic but output is probabilistic. Before making any hydrocarbon

discovery and establishment of reserves substantial cost are incurred in survey,
processing and interpretation of data to firm up a prospect and exploratory drilling
which may or may not result into hydrocarbon discovery. At times, such costs is
enormous particularly in frontier areas, deep water and logistically tough terrain.
Reservoir Behaviour Risk
The reservoir is delineated and assessed based on the result of survey,
exploratoryd r i l l i n g , i n i t i a l p r o d u c t i o n t e s t i n g r e s u l t s a n d d a t a o b t a i n
e d t h r o u g h s u s t a i n e d p r o d u c t i o n . T h e r e s e r v o i r b e h a v i o r i s l a r ge l y
u n k n o w n a t i n i t i a l a s s e s s m e n t , b u t becomes clearer with continued
exploitation.
The
reservoir
is
affected
by
a
host
of f a c t o r s , c o n t r o l l a b l e a n d n o n - c o n t r o l l a b l e , w h i c h m a y i m p a c t t h e
r e c o v e r a b i l i t y factor.
Production Life Cycle Risk
During production life cycle, of a field, it is a common phenomenon that some wells
get de-optimized with respect to intended/expected production, which has
its own bearing on the targeted production. Then at any point of time,
production field has certain percentage of wells as non-flowing wells i.e. the wells
which dont flow at all. Efforts to optimize them as well as making them flow
warrants further investment which is normally unplanned in nature. These
unplanned expenditures have a risk associated with it in the sense that it may not
fetch us targeted return. During the production life cycle of a field, we also
witness some risk arising out of non-compliance of benchmark and standard and
not adopting the change management philosophy in its entirety. All this has
significant bearing on the utilization of the available capacity within
field and within the company and thereby putting pressure on the
investment/expenditures of the company.

Input Cost Fluctuation Risk

ONGC is a capital intensive company and the oil industry is technology intensive.

Thus the variation in the coat of inputs associated with equipments,

stores and spares and manpower cost aff ects the future
probability of the company. The cost of input increases
substantially when the crude oil prices in the international market
are high and vice versa

Damage to property risk

ONGC has operations spread over a vast geographical area covering both
offshore and onshore. It may not be possible to provide fool proof security
to
each
and
everyi n s t a l l a t i o n . T h i s e x p o s e s O N G C t o t h e r i s k o f d a m
a g e o n a c c o u n t o f f i r e , earthquakes, hurricane, terrorist/miscreants
attacks, accidents etc.
Project Execution Risk
Project Execution Risk refers to the probability of time and cost over an
attached to t h e p r o j e c t e x e c u t i o n . I n c a s e o f a n d i n t e g r a t e d E & P
c o m p a n y l i k e O N G C e a c h activity like survey, drilling, testing, platform
installation etc. is a project by itself. Therefore the time or cost overrun in
any one of such activity can have cascading effect on the companys exploration
and exploitation plan.
Employee Turnover Risk
Every organization is faced with the risk of employees turnover. With the
NELPregime in vogue, more private players are entering the E&P industry and
therefore the chances of existing employees leaving the organization are
more. Higher employee a t t r i t i o n r a t e h a s i m p a c t o n t h e b o t t o m - l i n e o n
a c c o u n t o f i n c r e a s e d c o s t t o w a r d straining, relocation of employees etc. E&P
activities,
particularly
related
to
reservoir e n g i n e e r i n g a n d d r i l l i n g , h i g h l y s p e c i a l i z e d O N G C e m p l o y e
e s h a v e g a i n e d t h i s expertise he last few decades. Employees leaving from the
core areas expose ONGC to a great risk.
Directors & Officers Liability
I n c a s e o f a n y C o r p o r a t e , r e g i s t e r e d u n d e r t h e C o m p a n i e s Ac t ,
1956,
day-todaym a n a g e m e n t o f t h e e n t i t y i s d i v e s t e d f r o m t h e s h a r e
h o l d e r s a n d r e s t s w i t h professional management team consisting of
Directors and Executives. ONGC is listed company and the shares are widely
held within India and abroad. The shares are h e l d b y F I s , F I I s a n d H i g h N e t
w o r t h I n d i v i d u a l s ( H N I ) a c r o s s m a n y c o u n t r i e s . Therefore the company

is exposed to risks arising out of commission and omission of the management

team. Similarly, Directors and officers are also exposed personal liability for
loses/liability arising in discharge of their official duties.
Risk pertaining to safety and occupational health
Risk arising out of unsafe operations is enormous and is well understood by each one
of us. Managing occupational health too has an element of risk in it-the risk which is
rather intangible. Stress, fatigue & other work related ailments along with
loss
of c o n f i d e n c e a n d a s s o c i a t e d n o n d e l i v e r a b i l i t y h a s i t s o w n b e a r i n g o n t h e Productivity of
an employee (and on other employee as it works in contagious
fashion) and on productivity of an organization. This has more relevance in a
company like ours particularly in offshore.
Environmental Risk
Risk arising out of pipeline ruptures, oil spills, produced water over boarding, flaring
of gas above and below technical flaring level etc. This also needs to be
reflected while deciding for the policy on risk management.
Technical risk
Since upstream industry is very capital intensive and technical savvy
industry, so there is always a risk of technical faults and difficulties (including
technical problem that may delay start up or interrupt production from an upstream
project or that may lead to unexpected downtime of refineries or petrochemical
plants).The outcome of negotiations with co-ventures, governments, suppliers,
customers or others (including, for example, our ability to negotiate favourable longterm contracts with customers, or the development of reliable spot
markets, that may be necessary to support the development of
particular production projects)
FINANCIAL RISK Commodity Price Risk
P r i c e s o f O N G C p r o d u c t s , i . e . , C r u d e o i l a n d Val u e a d d e d p r o d u c t s
a r e l i n k e d t o import parity. The fluctuations in the price of crude oil and
Value
added
productsh a v e i m p a c t o n t h e s a l e s r e v e n u e o f t h e c o m p a n y w h i c
h o n t u r n a f f e c t s t h e profitability.
Foreign Exchange Risk
The functional currency of ONGC is Indian Rupees (INR).
H o w e v e r, O N G C i s exposed to foreign currency risk, both directly as well as
indirectly. Direct exposure refers to those liabilities which are settled in
foreign currencies. This includes the requirement arising out of Debtserving as well as Import transactions (includes goods and services).
Indirect exposure refers to those foreign currency transactions which are
settled in INR but the underlying currency is a foreign currency (viz
USD).T h i s i n c l u d e s t h e s a l e s r e c e i p t s f r o m r e f i n e r i e s w h i c h a r
e b e n c h m a r k e d t o international prices in dollar terms but are ultimately paid in
INR.
Interest Rate Risk

Interest rate risk can be defined as the risk to the profitability or value of a company
resulting from changes in interest rates. ONGC is exposed to Interest rate
risk on following counts:

Interest rate applicable to long-term debt obligations.

Interest rate applicable on short term investments made by ONGC.

Liquidity, financial, capacity and financial exposure
The group has established a financial framework to ensure that it is able to maintain
an appropriate level of liquidity and financial capacity and to constrain the
level of assessed capital at risk for the purposes of positions taken in
financial instruments.
Failure to operate within our financial framework could lead to the group
becoming financially distressed leading to a loss of shareholder value. Commercial
credit
risk
ism e a s u r e d a n d c o n t r o l l e d t o d e t e r m i n e t h e g r o u p s t o t a l c r e d i t r i s k .
I n a b i l i t y t o adequately determine ONGC credit exposure could lead to financial
loss.
REGULATORY RISKS Fiscal Regime Risk
E&P industry in India is affected by the changes in the tax and royalty regimes. Tax
includes both direct taxes like corporate tax as well as indirect taxes like
sales tax, service tax, turnover tax etc. In addition, the tax regime can also
affect
the
cost
of i n p u t s . R o y a l t y i s g o v e r n e d b y t h e p r o v i s i o n s o f O i l f
i e l d ( R e g u l a t i o n a n d D e v e l o p m e n t ) Ac t , 1 9 4 8 u n d e r w h i c h
r o y a l t y c a n b e c h a r g e d u p t o 2 0 % o f t h e wellhead value in case of Crude
oil and Natural gas production. At present royalty is charged @10 % in respect of
natural gas and offshore crude oil production. In case of deep-water production of
oil & natural gas, the royalty is 50 % of the rate specified for offshore
production. However, Govt. can increase the royalty rates if it so desires. Any such
increase will have a direct bearing on the profitability of ONGC since the
crude oil prices are linked to international prices.
Other Regulatory Risks
ONGC is subject to regulation and supervision by the Government of India
and its departments. ONGC is a Public Sector Undertaking (PSU) and is subject to
mandates of GOI. The award of licences for exploration, production, transportation
and sale of hydrocarbons are dependent on the policies of the Govt. Existing
Indian regulations require that ONGC has to apply for and obtain Govt.
licences
and
other
approvals,
including extensions of exploration licences awarded in some cases
, g r a n t a n d renewal of mining leases, which are basic requirements of E&P industry.
Any change in the Govt. policies/regulations can affect ONGCs operations.

ECONOMIC AND INDUSTRY RISK

Economic disruptions
Slowdown
in expected economic growth
rates
and the
occurrence of economic
recessions, can bring down slowdown
i n d e m a n d a n d s u p p l y, t h i s u n e x p e c t e d occurrence can be very harmful for
industry.
Weather risk
This risk is very common in every country. Since ONGC is multinational company it
operates in many countries, this kind of risk is very common for it. This kind of
risk involves seasonal variation in supply, at the time of regular demand.
This includes seasonal patterns that affect regional energy demand (such as demand
for heating oil or gas in winter) as well as severe weather events (such as hurricane)
that can disrupt supplies or interrupt the operations of ONGC facilities.
Alternate energy source
The competitiveness of alternate hydrocarbon and energy source can be a risk
factor for ONGC as there can be an introduction of new alternate fuel source,
comparatively cheaper and less hazardous and easy to access, whereas at same time
ONGC can lose fortune of revenue because of decrease in sales and
consumers
will
switch
over
to
low
cost
of
fuel
source.
MANAGEMENT OF FINANCIAL RISKS
Commodity Price Risk
1) Effective from April 2002, the Government introduced full de-regulation
in the petroleum sector. As a result of the decision of the government, the crude
prices and prices of petroleum products are linked to international prices.2) As
witnessed over the past one year of price movements, both the crude prices and prices
of petroleum products are highly volatile and subsequent to the de-regulation, the
revenues and cash flows of ONGC are thus directly exposed to volatility in
the international prices.3 ) S o f a r t h e c r u d e o i l p r i c e s h a v e i n c r e a s e d
c o n s i s t e n t l y a n d t h e s a m e h a s n o t affected the bottom line. Instead, it
has improved the profitability by enabling full realization in tandem with
international prices (except for the Govt. imposed subsidy burden). However the
price level has reached a level from where it can move
bothw a y s ( i . e . u p w a r d a s w e l l a s d o w n w a r d ) t h e r e b y r e s u l t i n g
i n v o l a t i l i t y . T h e necessities the formulation of a corporate risk
management
policy
to
protect

thec o m p a n y f r o m u n d e r l y i n g c o m m o d i t y r i s k m a n a g e m e n t p o l
i c y t o p r o t e c t t h e company from underlying commodity price exposures.4) as
of now, ONGC has no hedging against the fluctuation on crude oil or value added products prices. However, ONGC is contemplating to appoint a professionally
competent Agency (consultant) to undertake this study and advise ONGC suitably as
hedging itself exposes the company to risk and cost.
Foreign Exchange Risk
1) Foreign Exchange risk management is generally done on Net basis. In
other words, the exposure on both receivables and payables are considered
and the risk m a n a g e m e n t i s l i m i t e d t o t h e n e t e x p o s u r e s o a s t o
minimize the cost ONGC is having a natural hedge, in respect of
U S D , i n t h e f o r m i f s a l e s r e c e i p t s l i n k e d t o international prices in dollar
terms.2) However, ONGC is also having exposure to other currencies like Euro, GBP,
JPYe t c a r i s i n g o n a c c o u n t o f i m p o r t o f g o o d s a n d s e r v i c e s . F
u r t h e r , t h e e f f e c t o f Commodity Price risk and Foreign Exchange risk are to
be considered together before deciding on the hedging strategies.3 ) T h e j o b o f
establishing a frame-work for Commodity Price risk and Foreign
Exchange risk may be mandated to a consultant as mentioned at Para. Above.
Interest Rate Risk
1) ONGC, at present, is having only one foreign-currency loan,
d e n o m i n a t e d i n Japanese Yen, drawn from State Bank of India at a fixed
interest rate of 2.60% and m a t u r i t y i s s c h e d u l e d i n 2 0 1 0 . T h e
outstanding as on 31
Set
March
2005
was
J P Y 2160.78
million (equivalent
INR
being Rs.88.29 Cr). The domestic interest rates on deposits are averaging
above 6% for a one year deposit. Further the fluctuation es py: INR
conversion is less than the interest rate differential. Therefore, it is would not be
beneficial to pre-pay the loan.2) the investment portfolio mainly consists of
investment in short term deposits with banks. Generally the investments under
the portfolio are held till maturity and the time horizon is limited to one
year. Hedging was not considered necessary in view of the short
investment tenure and the associated hedging costs.
PRESENT PRACTISES FOLOWED BY ONGC
As of now there is no such uniform policy for risk manageme
n t . O N G C h a s decentralized system risk management, where different offices,
assets all over India have their own departments, which have their own policies to
manage their potential risk factors by themselves. Due to this there has been uneven
cost expenditure for risk m a n a g e m e n t , a n d t h i s l e a d t o h i g h v a r i a b l e c o s t .
T h i s m e t h o d h a s a l s o n o t b e e n effective due to lack of knowledge of risk
factors of different process handled by their respective departments; employees
are not given proper training for handling any unforeseen risk.