In the first two blogs in this series, we laid out why geopolitical factors play an important role in the energy industry and some of the drivers of risk that point to potential futures. Having highlighted and explained the problem, this final installment suggests some methodologies to help the energy industry understand and manage geopolitical risk.
Seeing the whole risk landscape
The key to managing geopolitical risk is to take a holistic approach with a broad overview of the risk landscape. As previously shown, geopolitical risk covers not only a global geography but also a wide range of issues, whether that be risks to or from employees, hostile regulatory environments or threats from new technologies.
An important part of this holistic view involves understanding the linkages between different drivers of risk and the relationship between these drivers and risks. Drivers and risks are in a “many to many” relationship, where one driver can cause multiple risks, and one risk is caused by multiple drivers. Sometimes these causalities are not direct but manifest as second- or third-order effects, and some risks only manifest through a unique combination of drivers.
For the energy industry, a good example might be the risk from stringent new environmental regulation. Such regulation, of course, is the product of greater public awareness of climate change pressuring governments into action, combined with improvements in technology that enable cleaner energy at reduced cost. Without any one of these factors, new regulation is unlikely to be forthcoming but taken together they form a potent driver of risk.
Making sense of such a complex picture is not easy, as the U.S. military’s infamous spaghetti diagram of the Afghanistan insurgency illustrates.
A more useful method to think about these issues is through distinct lenses. These can help isolate risks so they can be viewed more clearly, enabling them to be recombined into a holistic picture. For the energy industry, six particularly useful lenses might be:
- Investment and return
- Business resilience
- Climate and environment
These capture the core geopolitical drivers, some of which have been explained above, and can be expanded into a network of interconnected risks. However, in order to prevent these connections from becoming a U.S. military-style spaghetti diagram, the drivers and risks must be married to a nuanced understanding of an organization’s goals, strategy and structure. The organizational context should be used to inform what types of risk pose the most pressing threat and help delineate directions from which second- and third-order effects are liable to materialize.
Useful analytical tools
Understanding the context and identifying risks is only part of the risk management process. In order to evaluate the potential impact of risks, it is also possible to utilize analytical tools such as VAPOR from Oxford Analytica, which turn qualitative findings into quantitative assessments. By assigning monetary value to risk percentages (likelihood multiplied by consequence), these tools turn the risk from intangible problems that merely provoke questions to tangible opportunities that can be understood in business terms. Moreover, no deep geopolitical expertise is required here, with the heavy analytical lifting being done by the tools themselves and the analysts that run them.
Nobody can credibly claim to predict the future with certainty, but we can collectively observe geopolitical signposts that illuminate a range of potential futures. By employing lenses to identify and understand the complexity and relationships between geopolitical drivers, it is possible to manage and mitigate risks, and beyond this, to turn them into advantageous opportunities.
Previous in series: 7 key geopolitical drivers impacting the energy industry