Competition and risk

According to page 12 of their 2006 10-K, the crude oil and natural gas industry is very competitive. WTI explores for oil mainly in the Gulf of Mexico region. They compete with numerous other companies, many of which are much bigger in acreage and value of assets. Many of the competitors are well established and have financial and technological resources much greater than WTI’s, which give then an advantage in evaluating potential reserves and other prospects.

Truth is however WTI has to outline all its possible risks in their financial statements and they would prefer to err on the side of caution. In reality competition should have decreased in the past few years because many oil companies have divested away from the Gulf of Mexico and WTI decided to acquire many of the divested assets.

Risks for WTI and other Oil Companies

Generally the risks that oil refinery and exploration companies face are the same. Included below are the main risks faced by WTI (and its competitors).

Risks Relating to the Natural Gas and Oil Industry and WTI

The price of oil and natural gas strongly affects WTI’s balance sheet. The revenues received for selling the products are strongly correlated to global prices which are affected by global demand and supply. Minor changes in commodity prices have a significant impact on the bottom line. Factors that affect the price of oil include: - actions of OPEC, acts of war and terrorism, political conditions and effects including embargoes, the level of natural gas and global oil production, weather conditions, price and availability of alternative fuels and technological advances affecting the consumption of energy. Extended declines in the price of energy will substantially affect revenues, ability to borrow to finance capital expansion and liquidity. Capital expenditure is funded by a combination of debt and equity. The debt payments are paid from the cash flow created by the company. If energy prices come down significantly they might have difficulties borrowing in the future.

WTI’s treasury desk engages in hedging activities by buying oil futures but this has a limited effect. The hedging only covers a proportion of the planned production quantity, however.

WTI engages in some smaller reservoirs with shorter production periods. This means that WTI is exposed to a larger amount of reserve replacement needs and requires significant capital expenditure to replace reserves. Capital expenditure is a huge proportion of costs for energy companies, and the less individual exploration projects that a company has, the better. Other companies might have lower reserve replacement periods, making them more competitive relative to WTI.

WTI conducts deep shelf exploration, exploitation and production. This presents unique risks because the costs to building production sites are much higher due to complications, and amount and sophistication of machinery needed to build the wells.

Operating risks common to all fossil fuel companies include: - adverse weather conditions such as tropical storms and hurricanes in the Gulf of Mexico, equipment shortages, explosions and fires, surface craterings, uncontrollable flows of oil and natural gas, inability to obtaining insurance at reasonable rates, failure to receive insurance claims in timely manner, or the full amount claimed, mechanical failures, abnormal pressure formations, environmental hazards such as oil leaks.

Substantial financial losses can be incurred as a result of: - loss of life or injury, severe damage to property and equipment, pollution damage, regulatory investigations and penalties, cleanup responsibilities, repairs to resume operation and suspension of operations.

Due to a lack of diversification in oil and gas field locations, WTI is subject to geographical risk. Adverse weather conditions will have an impact on all the sites at the same time, which will impact WTI’s bottom line much greater than other companies which have more geographically diverse fields. Geographical risks are not just subject to bad weather but also by regulatory changes in a region and availability of adequate transportation.

Due to the many acquisitions that WTI undertakes they are also subject to integration risks. When WTI acquires new companies, very often they need to create a network to be able to coordinate production with other entities. This can create technology and management complications. Furthermore acquisitions increase WTI’s indebtness and working capital requirements as well as key customer and employee loss of the acquired company.

The balance sheet might be inaccurate due to the fact that many of the long term assets are reserves owned by WTI and the reserves are evaluated by the amount of oil and natural gas they can extract from it. This amount is an estimate and can be far from what the reality is. Estimating oil and natural gas reserves can be very complex. It requires interpretation of complicated technical data, and any inaccuracies can significantly diminish the final estimate. If the engineers change their estimates on the amount of extractable oil and gas, this can hugely affect the company’s balance sheet and net book value. 

The oil and gas industry shoulders an onerous regulatory burden. These regulations are unpredictable, and be very costly to oil companies.  Regulations are related to exploration, development, production, transportation and safety. Companies may be required to make unanticipated capital expenditures to comply with government regulations in areas such as land use restrictions, drilling bonds, and plugging and abandonment responsibilities.

Other risks include the fact that WTI is not the operator of approximately 25% of proved developed non-producing, and proved undeveloped reserves. The fact that WTI does not operate certain fields means that the output of those fields are more difficult for WTI to predict.