The Middle East crisis, cooperation between some of the most sanctioned states in the international community (‘axis of rogue states’)[1] and the fight for critical minerals are creating massive challenges for energy markets and organizations. In this article, we explore how these top risks are impacting the energy sector and examine the influence geopolitics is having on financial performance across the industry.
We are living through a period of great change. Geopolitical obstacles are unlikely to disappear any time soon. To date, the energy industry has displayed impressive adaptability. European countries successfully weaned themselves off Russian energy while avoiding debilitating shortages, American suppliers increased output to meet increased demand, and global energy prices have returned to near pre-COVID levels.
However, the outlook is for geopolitical volatility to continue to intensify, with disruptive events coming more frequently, lasting longer, and having deeper impacts. As such, quick pivots and adaptations will no longer be sufficient. Longer-term strategies for the energy and natural resources sector to build resilience and navigate geopolitical risk, as well as take advantage of opportunities, are increasingly essential.
Conventional energy — especially oil and gas — is susceptible to developments in the key Middle East region, which is witnessing extended conflicts. The Russia-Ukraine war is also casting long shadows on energy and critical minerals. And we are witnessing a return to protectionism in key economies. An extended stalemate or worsening of these challenges can easily push things over the cliff in a year where much of the democratic world goes into elections.
KPMG’s Top risks forecast takes a close look at some of the many geopolitical risks that threaten to upend the world order. Here are the three that are most likely to impact the ENR sector today and in years to come along with recommendations for how businesses can seize the opportunities and manage the risks.
Middle East Crisis
Amid escalating tensions in the Middle East, energy businesses are at a critical juncture, grappling with the implications of geopolitical instability on global energy markets. The ongoing conflict between Iran and Israel, which has intensified in recent weeks, has heightened concerns over potential disruptions to oil supplies and increased volatility in fuel prices. As Israel deliberates further response, the risks to global energy security loom large, with significant implications for energy businesses worldwide.
The assumption that the Strait of Hormuz will remain open is now under scrutiny, raising concerns for energy businesses reliant on smooth maritime transport. Despite efforts to reroute liquefied natural gas trade and mitigate risks, uncertainties persist, impacting market stability and investor confidence. Both Israel and Iran appear to have returned from the brink (for now), but the situation remains unpredictable.
It’s important to pay attention to what the US and its allies do to attempt to mitigate wider conflict. Increased sanctions targeting Iran, as well as potential military responses, could disrupt supply chains and elevate geopolitical risks for energy businesses. Heightened military activity in the Persian Gulf and potential sanctions on Iranian transactions could lead to increased shipping costs and challenges for insurance clubs.
Axis of rogue states
In what the Eurasia Group terms the ‘axis of rogue states’, the growing collaboration between rogue states like Iran, Russia and North Korea presents a complex challenge for energy businesses. Indeed, geopolitical tensions topped the list of concerns for energy CEOs KPMG International’s 2023 CEO Outlook.
Joint strategic agreements among these nations raise concerns over potential disruptions to critical energy infrastructure, including oil refineries, pipelines and shipping routes. COVID-19 demonstrated how supply chain disruptions can impact scaling renewables. Higher prices and lack of access to equipment led to many projects being delayed and cancelled, a pattern that could repeat if geopolitical tensions continue to grow.
Additionally, the prospect of conflicts or coordinated cyberattacks poses significant risks, potentially leading to supply shortages and heightened market volatility. Energy businesses must bolster their security measures and contingency plans to mitigate these threats effectively.
The weaponization of energy resources for political leverage adds another layer of complexity for energy businesses. Russia’s strategic use of natural gas supplies in regional disputes illustrates how energy resources can be wielded to advance geopolitical objectives, destabilizing energy markets in the process. Diversifying supply chains and reducing reliance on high-risk areas is essential for energy companies in these volatile situations.
The potential evasion of international sanctions through closer cooperation among rogue states also poses regulatory challenges for energy businesses. Iran and North Korea’s history of circumventing sanctions and Russia’s recent provision of oil to North Korea underscores the need for enhanced due diligence efforts and compliance frameworks.
The latest tariffs are another indication of decarbonization being caught in the crossfire of geopolitics. There are genuine security concerns and economic interests in play, but punitive tariff rates, blocking of trade flows and tit for tat actions in this critical theatre will set back the climate change containment efforts significantly. One cannot but wish that we had a global agreement to cooperate and minimize barriers in this area, at least.
Fight for critical minerals
The battle for critical minerals has emerged as a pivotal arena in today’s geopolitical landscape, reshaping the dynamics of global energy markets. As demand escalates for essential elements like lithium, cobalt and rare earths crucial to renewable energy technologies, energy businesses are at the center of geopolitical rivalries and strategic maneuvering. They face heightened risks that supply chain disruptions and market volatility could impact operations.
In October 2023, China implemented new regulations mandating export permits for specific graphite products, underscoring the geopolitical complexities surrounding critical minerals. In a similar vein, on 14 May 2024, the US imposed new or increased Section 301 tariffs on US$18 billion of imports from China, continuing the tariff increases started in 2017. The tariffs mostly target China’s emerging green and high technology industries, with measures on lithium-ion batteries making up two-thirds of the total taxed value. Such actions reflect the challenges of creating globally integrated supply chains for critical minerals and green technologies at a time of increasing geopolitical competition.
Financial Performance Indicators (FPI) analysis
The big question is how geopolitics is influencing the financial performance of companies operating in the sector. To gain some insight, we analyzed KPMG’s Financial Performance Index, a tool that distills a range of market and financial performance indicators into one index, covering nearly 40,000 public companies worldwide. The index scores companies on a scale of 0 to 100. Zero indicates serious distress, while 100 is the best performing.
The scramble for metals associated with the electrification agenda abated in recent months, paired with news of EV sales growth declining. Lithium mines have been closing in Australia, contributing to FPI scores for mining companies there dropping from 93.14 to 79.45 in just two years and ranking near the bottom (at 31 out of 33 countries). In Canada, another major mining economy, FPI scores for miners have fallen from 87.70 to 69.97 in the same period.
Australia, renowned for its mineral exports, has seen its FPI scores in metals and mining decline consistently over the past two years. Australian mines are scaling back or shutting down due to an oversupply that renders mining uneconomical, despite lithium being the country’s second-largest commodity in terms of committed capital expenditure through to 2030. In contrast, China is developing its own lithium resources using lower-grade ore, which is more expensive and more environmentally damaging to extract and refine. Australia’s strict environmental policies and labor laws make it difficult to compete in this aggressive market.
On the energy side, the situation is rather unremarkable overall — particularly considering the geopolitical tensions in the Middle East. Saudi Arabia has an exceptionally high score, at 98.24 for the sector. The high global demand for energy equipment and services has kept its FPI score the highest of the global subsectors, growing from 92.71 to 94.93 in the last two years.
What Energy & Natural Resources businesses can do
Closely monitor geopolitical developments:
As market volatility intensifies and geopolitical uncertainties persist, stay up to date on developments that may impact your organization. Remaining vigilant and agile in your response strategies is crucial in these uncertain times.
Conduct a dynamic risk assessment:
Energy businesses must implement robust risk management measures and proactively engage with geopolitical developments. This is essential to safeguarding your interests and ensuring resilience in an increasingly uncertain world. Adopting proactive risk management strategies and maintaining flexibility in your operations can help mitigate the impact of geopolitical risks and ensure resilience in the face of evolving threats.
Be strategic and proactive:
As regulatory scrutiny intensifies, energy businesses must proactively address compliance risks to avoid penalties and reputational damage. By strengthening your compliance practices and diversifying regulatory exposure, you’ll set your businesses up to better navigate the evolving geopolitical landscape and safeguard operations. As well, strategic approaches that balance geopolitical realities with the imperatives of the energy transition will be essential for ensuring your business remains resilient and sustainable.
How KPMG can help
As a global leader in professional services, KPMG can provide valuable assistance in navigating geopolitical risks. Here are some ways KPMG can support energy businesses:
- Risk assessment and management: KPMG’s experienced professionals can help you conduct a dynamic risk assessment, identify vulnerabilities, and develop tailored risk management strategies. They can provide insights into emerging risks and help you prioritize actions to mitigate potential challenges.
- Geopolitical intelligence: KPMG’s extensive network and research capabilities enable us to provide timely and relevant geopolitical intelligence. Their experts can help you stay informed about geopolitical developments, assess their impact on your business, and develop proactive strategies to navigate risks.
- Cybersecurity and data protection: With the increasing cyber threats arising from geopolitical tensions, KPMG’s cybersecurity professionals can help you strengthen your organization’s cybersecurity posture. They can assess your cybersecurity readiness, develop robust defense strategies, and provide ongoing monitoring and incident response support.
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1 Eurasia Group “2024 Top Risks Report” (January 8, 2024).