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3 Risks to Know About the Oil and Gas Industry

Singapore boasts two of the largest oil rig builders in the world. Unfortunately, the recent decline in oil prices has seen these two companies, along with other oil and gas companies suffer major downturns in their fortune. 2015 and 2016 were especially difficult as profits and revenues were cut in half and some of the smaller companies even struggled to stay afloat.

Before diving into the reasons behind this decline, investors should know that there are two types of businesses that operate in the oil and gas industry.

The first is the exploration and production segment, which searches for and extracts the oil and gas.

The second is the oil and gas services or the downstream segment of this industry. This is the segment where most Singapore companies operate in.

Both these segments are related to the profitability and expansion of upstream businesses, leading to the growth of downstream businesses as well.

It is important that the upstream businesses are profitable and, in turn, have the cash to pay off their downstream business partners. Because of how the fortunes of all these companies are intertwined, investors who wish to invest in oil and gas companies should be familiar with the risks that these companies can face.

Price risks

The price that a company can sell the oil it extracts is the primary factor that affects the profitability of the upstream oil and gas business. An analyst team usually decides whether a particular oil reserve is economically feasible depending on the price of oil and the extraction cost.

Unfortunately, the price of oil is highly volatile. After beginning operations and spending exuberantly on building new oilrigs, companies may suffer when oil prices suddenly drop.

This inevitably affects downstream businesses as well. In 2014, a prominent Brazilian oil company could not pay off their business partners, resulting in default.

Political risks

Oil and gas reserves occur all over the world. Therefore, oil and gas companies are prone to any political risks within the country where they are operating in. This can sometimes range from unstable government policies to war and civil unrest.

Companies that operate in these environments may face sudden policy changes or even disruptions in day-to-day operations due to unrest or strikes.

Operational hazard risks

Oil and gas reserves are a perilous place to work. The Bureau of Labour Statistics report in 2014 confirmed that there were 142 deaths in the United States alone.

Therefore, companies spend generously on safety precautions to minimise the risks. Even then, there are still numerous reports of accidents and fatal deaths each year. This can lead to increased cost of operation, which also affects profitability as a whole.

The Foolish bottom line

Recent times have been extremely challenging for oil and gas companies in Singapore and around the world. Investors who wish to invest in companies operating in this segment should be wary of the risks that these companies may face.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.