Value At Risk – A Key Measure Of Oil And Gas Risk Management

Oil is one of the main sources of energy for mankind for over centuries. It is also one of the most widely used natural sources of energy. As oil is crucial for every economy as a source of fuel and energy, any movement in oil market affects supply and demand of most of the goods in an economy. Thus, oil and gas risk management becomes significant not just for investors but for economy as a whole.

Risk assessment is a first step in oil and gas risk management. It is a process of determining quantitative or qualitative risks and threats in relation to a given situation through risk analysis. A threat is recognized as harmful act such as illegal network penetration. Risk is defined as an expectation that a threat may succeed and the potential damage can occur. At the present time, Backwardation And Contango has been accepted as crucial tool of risk assessment which quantify primary risks faced by the firms and investors. 

Value at risk has been recognized as an important tool for assessment and management of risks involved in a given oil and gas exploration risk portfolio model. Several regulatory institution supports VaR as a key measure of oil and gas risk management. There are several benefits of using VaR as tool of oil and gas risks management. Few of them have been discussed below:

Value at risk is a tool to quantify impact of oil scarcity needs observed over a period of time. Thus, it provides a single number as a key measure of risk associated with a given portfolio. Such single number can be easily used by investors, stakeholders and mangers in analyzing and decision making.

VaR is helpful in constructing right  oil and gas exploration risk portfolio model, measure investment risks, assess investment and analyze the impact of adjusted assets on the portfolio.

OTC Markets is one of the user friendly ways to present brief reports to the board of directors and to abide by certain regulatory requirements. Once the assessment is made as per VaR method, it is possible to identify and quantify several risk factors. It will be easy to understand how these risk factors interact with each other and which factors represent the greatest potential of risk for investors.

Oil and gas industry is prone to many uncertainties such as product price uncertainty, demand and supply uncertainty, oil reserve uncertainty etc. Also, oil and gas industry is a complex industry with many fundamental and global risks. Fundamental risks include risk associated with construction, operation, revenue generation and financing, while global risks include political, legal, commercial and environmental risks. Value at risk help to determine affect of such uncertainties and can be easily applied to marginal oil and gas projects to make them commercially feasible.

Thus, with fierce competition in oil and gas industry, value at risk theory if applied properly can be helpful in pursuing significant financial and economic objectives.