Professional Documents
Culture Documents
2. SHIFTING DEMAND
under-developed such as some African way. Here the issue of stranded assets is management of the organisation, running
markets, lending new risk, tax and permit particularly relevant for the industry as the finance activities as efficiently and
premiums to exploration activity, and environmental cost of extraction is too effectively as possible, extracting
recalibrating the investor risk return ratio. high, and many currently known reserves maximum value from capital funding
of carbon will have to remain in the activities for the enterprise, and driving
4. SUPPLY SHIFTS ground. Exploration activity is changing analysis and insights that support better
too in the sense that many new finds are investment choices and commercial
Finally there are significant changes across made by smaller, less capitalised junior decisions, the role of todays finance
the supply side of the industry, and the explorers in new, previously unexploited professional in the sector is critical. It is
costs of exploration continue to change. fields. The industry has also seen more brought into even sharper focus by the
On the one side, we can expect corporate finance activity through significant turbulence and volatility we are
technological innovation to continue to acquisition and joint ventures between now seeing in the oil and gas market.
put downward pressure on the exploration bigger and smaller players, driven by the
costs, and better technology is enabling changing risk profile of investors, less There are seven key issues at the top of
oil enterprises (often smaller exploration appetite for risk, and the need to secure the finance agenda right now:
companies) to start to exploit less appropriate financing as financing sources
volatility hitting the cost base and
conventional sources. In the UK the across the industry proliferate.
impacting capex
agenda is dominated by the fracking
discussion, and the US exploration of OPPORTUNITIES IN THE CURRENT pressure on forecasting and decision
shale in particular is changing supply side CLIMATE support capabilities
dynamics owing to shorter exploration
corporate reporting challenges
and production times, We can expect The chief financial officer (CFO) function
further interest in these exploration has a critical role to play in safeguarding asset impairment and stranded assets
alternatives as traditional sources of the longer-term prosperity of oil and gas
capability and talent
energy exploration become more enterprises.
inaccessible to extract, or where the funding
technology is still not available to make From ensuring excellence in the
this happen in an environmentally sound stewardship, governance and risk cyber security and penetration testing.
Figure 1: Structural downward price corrections in the oil market (1986, 2008 and 2014)
Climate change
and risks to
the oil and gas
sector
The havoc wrought by cheap
crude on oil companies may
be only the beginning.
Climate change will profoundly affect the economics of the Meeting climate challenges must go hand in hand with ensuring
industry, a group of institutional investors will contend on Friday. that Americans have the affordable and reliable sources of energy
With risks mounting, they are urging energy companies to better necessary to grow our economy American Petroleum Institute
disclose how environmental factors will change companies bottom
lines. Cleveland said that on Thursday BP [had] adopted a shareholder
resolution for better carbon-risk disclosure.
In a letter to the Securities and Exchange Commission to be
announced Friday, 62 investors ask for better monitoring and The Carbon Tracker Initiative estimates that oil and gas companies
disclosure of material risks to energy companies. They argue that will spend more than $1 trillion on exploration projects from 2014
rising exploration costs, renewable oil alternatives and carbon to 2025. Those will require at least an $80 per barrel break-even
regulations will squeeze profits enough to warrant more price, well above where US crude oil currently sits, at around $56.
transparency in financial filings.
Cheap oil effectively creates a stress test for planning projects
Throw that in with much broader investor awareness and support under future climate pressures, the letter says.
for better evaluation of these risks, and were in an entirely new ball
game, said Shanna Cleveland, senior manager at environmental The decreasing viability of exploration projects comes as oil
advocacy nonprofit Ceres, which organized the letter. demand is projected to fall and the European Union, United States
and China, among others, have pledged to reduce greenhouse gas
Transparency is crucial, she said, as more investors consider emissions. Those converging factors form known trends that
climate risk in their strategies. The letter outlines initiatives such as should be disclosed under SEC regulations, the letter argues.
the Montreal Pledge, a commitment to measuring and disclosing
the carbon footprint of companies in investors portfolios.
The response of oil and gas businesses to Many CFOs will continue to undertake
Management
Chapter opening
of the
boxcost the huge fall in prices recently witnessed significant cost reviews to identify which
base, and scrutiny of the is having a significant impact on the role costs can be cut, and which expenditure is
efficiency of investment of the finance organisation. The problem necessary to ensure business as usual
is this: no one is entirely sure about when operations. Part of the challenge for the
programmes is now critical. the price can be expected to rebound, finance team here is the need for a deep
and commentator estimates vary from the understanding of the nature of the cost
more immediate future (next 12 months) base, and clarity about which costs can be
to a much longer time frame the how reduced without necessarily affecting
low, and how long question resonates future growth or performance. As always,
across the industry. the challenge in the industry is to balance
short-term against long-term trade-offs,
It is no surprise, given the volatility in the but there are some prominent areas that
market, that management of the are most likely to attract attention in a
enterprise cost base is a key priority for review, particularly the more discretionary
the finance function. For some markets, spending on areas such as training, or the
part of the cost base problem is historic, use of contractors. In addition, finance
exacerbated by oil basins that are teams are likely to spend more time
relatively mature and where the considering the structure of working
infrastructure is degraded enough to capital and trying to improve the liquidity
warrant significant expensive upkeep. In fundamentals.
addition, in the good times, other
operating costs such as salaries have Longer-term investment programmes and
sometimes reflected the sentiment in the efficacy of capital expenditure activity
industry, which has contributed to making are other significant priority areas. With
operating costs expensive for many the trade-off between short-term
enterprises in the sector. priorities and long-term opportunities
120
100
USD
80
60
M
ever present in the industry, finance department has a critical role to play in
professionals have a more critical role to both pre- and post-merger acquisition
play than ever in judging which activity. In early April 2015 Royal Dutch
investments will continue to be needed to Shell announced a proposed 47bn
protect longer-term revenue streams and takeover of BG group, yet opinion is
those that can be cut. In the market today divided as to whether this heralds the
there are many examples of capital start of major acquisition activity across
expenditure programmes that are being the industry. Much of this depends on the
either cut or, at least, deferred, reflecting extent to which particular enterprises have
the prevailing market conditions. hedged their future barrel sales at
previous higher prices, but there is some
In the push for significant cost savings, noise in the market to suggest that
and as the cost of acquiring new reserves refinancing costs are generally increasing
falls owing to diminishing share prices and for many companies with significant
oil prices, the other key activity that we financing debts, reflecting general
may now see is a major upturn in mergers investor concern in the oil market.
and acquisitions, and naturally the finance
Other key priorities for the CFO function Nicholas Stevenson, oil and gas partner at
The effectiveness of in the sector are the effectiveness of the PwC adds: Clearly, there is a lot of focus
planning and forecasting, planning and forecasting processes, and on prospective financial information at the
and decision support the need for more effective commercial moment. As an audit partner I spend a lot
decision support. Rebalancing the of my time looking historically at financial
activities are now in the resources and time spent on attempting information, but whats really interesting
spotlight. to predict the future environment more about the last few months is that Ive
accurately is critically important given the spent much more time with clients looking
volatility in the market. at prospective financial information; its
about budgeting, its about forecasting,
Simon Constant-Glemas, vice president of its about understanding what this new
finance at Shell explains: As finance, we price environment really means for the
want to operate in a space that indeed business.
reports the future, and to do that we need
to better understand what it is that we One area of concern in forecasting future
need to report about the future. In the outcomes is the efficiency of capital
past we have used historical information expenditure programmes. Stevenson
to try and provide insight, which in the comments: I think the industry has a
world that we live in today is so far out of patchy track record in executing cost-
date even if you do improve the effective, to-budget capital expenditure
processes such that you can provide programmes. The investor community has
information quicker, if you are using only been worried for some time about the
past data the information will still be industrys track record, and investors were
meaningless for driving the future giving oil and gas companies messages
performance of the business. two years ago around the capex getting
Oil and gas priorities and challenges for the CFO enterprise 9
Although one challenge is providing the increasing geo-political risk and a more
Investors
Chapter opening
are becoming
box internal information that enterprises in the competitive situation.
much more selective; quality sector need, oil and gas companies
and transparency of currently face many external corporate Some reporting issues have existed for
reporting issues as well. Pension cost some time: for example, the treatment of
external corporate reporting accounting for defined benefit schemes is exploration costs. For those using IFRS,
across the industry is now always a difficult and complex area. For the current version of IFRS4 makes few
vital. example, judgements are required about restrictions on the extent to which these
actuarial assumptions on mortality, future may be deferred or treated as part of the
salary increases and length of service. cost of exploration of properties. At the
Judgement is also needed when deciding one end there have been successful
the appropriate discount rate to use efforts to assess recoverability on a
during a period of prolonged general low well-by-well basis and, at the other, to
interest rates but with pronounced capitalise all such expenditure under the
differentials between government and full cost method. In between, a variety of
corporate bond rates in some countries. methods are also used. Likewise IFRS4
Many oil and gas companies were in allows comparable variability when it
existence with large workforces at a time comes to assessments of impairment.
when defined benefit obligations were
more common than now. Perhaps more than in other sectors, the
reporting of certain non-financial
In relation to corporate reporting information for oil and gas companies has
standards, two major new standards were been almost equal in importance to that
published in 2014 affecting companies of earnings. The disclosure of the different
whose accounts are prepared under either categories of reserves and resources (for
US GAAP or IFRS revenue recognition example, proven, probable, possible) is
(IFRS15) and financial instruments (IFRS9). critical information that analysts consider.
These have application dates in 2017 and The most significant information is often
2018 respectively and so are being captured in the reserves replacement
assessed for impact by oil and gas ratio, which tracks the balance between
enterprises, as by all other companies. finding new reserves against the depletion
The impact of the first may be reduced by of the assets due to production.
the typically clear-cut physical delivery of
the oil or gas involved. The impact of the Some of the sector-specific issues are also
financial instruments standard is likely to very current. Owing to the nature of the
be principally in the relaxation of some of industry and the way it has developed,
the hedge accounting restrictions. In joint arrangements (joint ventures set up
common with enterprises in other sectors, as separate entities, production sharing
accountants working in the oil and gas arrangements, etc.) have been very
sector have had to take notice of the more important. IFRS11 changed the accounting
innovative approaches to non-financial framework within which these
reporting, including integrated reporting, organisations reported and there have
that have been developing to improve the been some continuing clarifications and
dialogue between companies and their amendments made to the standard that
different stakeholders. need assessment against the particular
agreements a company may have.
While both the above issues are generally
relevant to all sectors, certain reporting The other issue concerns the greater
issues seem of particular significance to demands of transparency placed on the
the oil and gas sector. Generally, accurate sector (along with mining companies) to
and meaningful corporate reporting on show the value of payments to governments.
key performance metrics highly relevant This has appeared, for instance, as part of
to the industry, such as production the DoddFrank Act in the US and in the
volumes, cash, pricing and reserves, and Accounting Directive of the European
replacement cost accounting (and related Union. The different sorts of payment will
profitability reporting), is essential for the need to be disclosed taxes, royalties,
investor community and affects the infrastructure contributions and so on
perception of management quality. and on a granular basis. It was referred to
Investors are becoming more selective, as country-by-country reporting but it
particularly with the recent price volatility might sometimes be better described as
in the market, rising development costs, project-by-project reporting.
Issue #4. Asset impairment and stranded assets 11
The decline in the oil price in 201415 has open market than their balance sheet
Chapter
The issueopening
of stranded
box assets also increased attention on the issue of values. Estimates show that many of the
is dominating the agenda impairment of assets. It has challenged currently known reserves and resources of
across the global industry. the comfortable assumption that the carbon will have to remain in the ground
historical costs of exploration will be and will never be sold and burnt ( if the
exceeded by the value of the oil that can internationally agreed global warming
be extracted. Price volatility has always limit of 2C is not to be exceeded), unless
been a fact of life for the sector but the technologies are developed to capture
current prices are potentially a trigger for the waste gases. Companies owning or
carrying out impairment tests. Equally, the exploiting these reserves may need to
recognise their worthlessness, including
writing them off. This issue almost
certainly affects the coal industry more
than oil and gas, but both are involved.
The climate change issue brings into play
the debate on alternative forms of energy
and developments in governmental and
regulatory policies that could have an
impact.
Drivers of asset stranding The director of this programme, Ben Caldecott, says investment
managers are slowly coming to terms with the new landscape:
include water scarcity. There are some real leaders, but there are lots of investment
managers who do not really know what they are doing. There is lots
of research showing this stuff is financially material [but they have
Companies in the mining, oil and gas sectors are ignoring a big risk not yet integrated it into investment processes], he says.
to their valuations and predictions of future revenue.
An understandable preference for looking for opportunities instead
This is the risk that assets will become stranded, unexpectedly of mitigating risks may be to blame for investment managers
losing all or most of their value due to external events. Given finding it tricky to engage with the issue, Mr Caldecott suggests.
increasing consensus that as much as 80 per cent of proved fossil
fuel reserves will have to be left in the ground to avoid catastrophic With climate change, there is a risk/opportunity division. A lot of
climate change, this risk should not be dismissed lightly. attention has been on the opportunities. But on the other side,
[stranded assets] throws up a whole range of issues about how to
This is why F&C [Foreign and Colonial] Investments, the UK fund preserve value in sectors undergoing major change.
house, has put stranded assets high on its agenda, according to its
annual responsible investment report. Over the past year, F&C has The leaders named by Mr Caldecott are Wheb, Impax Asset
been working to make sure senior executives in the oil and gas, Management and Generation Investment Management, all asset
mining and utility sectors are aware of the concept. managers set up with environmental, social and governance issues
at the forefront of their investment philosophies. To truly enter the
Many companies continue to focus on short-term risk mainstream, the idea of stranded assets needs to be taken on
management in response to the current weak oil price, rather than board by investment consultants.
a robust long-term risk management approach that considers
climate change policy risks, says the report. You also have to look at the role of investment consultants, says
Mr Caldecott, And you have to ask whether they have the
Although individual analysts at companies may be aware of the understanding needed.
issue, frequently the awareness stops there, rather than rising to
the board. The preliminary findings of a Smith School report due out shortly
imply that investment consultants need to man up on this issue,
It needs to be a strategic board-level discussion, says Vicki he says.
Bakhshi, head of F&Cs governance and sustainable investment
team. It is a risk management question, it is a stress-testing question. [Management consultants] Towers Watson would disagree, having
put out a 14-page report on the topic in January. The report
The issue of stranded assets may not yet be at the forefront of the looked only at probable restrictions on carbon emissions (other
corporate boards mind, but its profile is growing quickly in the drivers of asset stranding might include water scarcity, pollution
investment community. limits and policy changes such as abandoning nuclear fuel). It
attempted to consider a range of scenarios and assess the
When FTfm [FT Fund Management] covered this topic four years potential impact on the entire value chain, down to residential
ago, with specific reference to fossil fuels, it was easy to find electricity use.
commentators to scoff at the idea. It was seen as an ideological
proposition driven by climate-change campaigners. The time horizons of investment as well as risk are significant
there may be a high risk of asset stranding within 10 years, but if an
By contrast, in 2015, mainstream outfits such as MSCI, the stock investment horizon is two years, it is immaterial. Likewise, if the
market indices provider, and Towers Watson, the consultancy, have payback time on an asset is short (shale gas investments, for
put out discussion documents on the topic, while Oxford example, are expected to pay back within a couple of years), you
Universitys Smith School of Enterprise and the Environment has a might not care about a problem likely to arise by 2020.
programme dedicated to systematic analysis of the subject.
SOURCE: FINANCIAL TIMES, INVESTMENT CONSULTANTS TOLD
TO MAN UP ON STRANDED ASSETS, 22 MARCH 2015.
Issue #5. Capability and talent 13
If there is one issue that is causing more value adding areas of finance such
Access to the right talent is a sleepless nights for CFOs and other as decision support and performance
key priority for CFOs across finance leaders in the sector it is the issue managementbut we should not forget
the oil and gas sector. of talent and capability. Many of the that there is a lot value in getting the
worlds leading oil and gas organisations basics right, we get well paid to make sure
have been front runners in transforming the numbers make sense and along with
the finance organisation to drive down professional judgement a lot of that
cost, improve process standardisation, comes from the execution of processes
achieve the scale and agility to support right first time.
flexibility, and critically to gain better
control across the enterprise. Strong controllership provides the
mandate for the function to gain access to
Simon Constant-Glemas from Shell says: what some see as more added-value
On one hand, it is the operation of our finance business partnering activities that
core financial processes, being custodians typically take place in the retained finance
of the control framework and organisation. Yet it is here that many
understanding risk management that is finance teams continue to struggle with
our licence to operate and we need to get the existence of shadow finance
that right first time to earn the credibility organisations and a paucity of the skills
to play in any other space, and having got needed for the insight and commercial
that right, then you can move into the support required.
Oil and gas priorities and challenges for the CFO enterprise 14
ACCA and IMA have previously reported1 Yet the real unspoken talent question is
three key solutions in making financial this. For major oil and gas enterprises that
business partnering work effectively from have continued to offshore entry and
the perspective of the people involved. mid-level finance roles, where will the
future finance leadership team come
1. Creating effective structures from? The traditional talent equation has
creating appropriate finance business been disrupted, putting a new strain on
partnering structures was identified, in a how these future finance organisations will
CFO survey conducted by ACCA and IMA, attract, develop and retain talent in future.
as a key priority. The fundamental Critically, the issue becomes one of
question is this: should these resources mobility, and how enterprises can secure
have reporting responsibilities into finance sufficient exposure of finance talent from
only, or be embedded in the business with delivery centres into the retained
reporting into business leadership, or organisation and vice versa. Perhaps a
should there be some hybrid model? The two-tiered approach to off-shoring will
trick is to ensure that the finance team emerge, with transactional finance
retains its independence and objectivity activities being run from traditional shared
yet is close enough to the business to service centres while higher-value finance
understand its fundamental commercial activities are consolidated into dedicated
realities. hub centres of excellence. Whichever model
is adopted, the implications for developing
2. Investing in the capabilities that matter the next cohort of global finance leaders
many finance enterprises continue to in the sector are significant.
under invest in developing the capabilities
that matter among business partners; Perhaps the current crisis in the sector
rotation and mobility programmes and provides finance teams with an excellent
exporting finance talent into the broader opportunity to demonstrate the value
business to build commercial capabilities, they bring to the enterprise, from driving
the establishment of clear competency cost efficiency programmes, providing
frameworks, coaching and mentoring superior commercial decision support,
practices, and recruitment from disciplines ensuring more effective longer-term
outside traditional accounting roles. capital expenditure and financing
activities, and bringing increased
3. Changing the finance mindset the transparency and understanding of future
ACCAIMA study emphasised the enterprise performance through improved
behaviours, attitudes and mindsets that corporate reporting to the investor and
are as essential as specific skills to future wider stakeholder community. What is
success in business partnering. This absolutely certain is that future finance
includes the capacity for finance business teams in the oil and gas sector will need a
partners to challenge the business and wide range of technical, leadership and
bring that independent vision to its management skills to hold the seat at the
commercial decision making, and the table and demonstrate their continued
desire to create effective relationships value to the enterprise. In the oil and gas
outside the finance function. With so sector, as with other leading sectors,
much volatility in the oil and gas sector at finance functions need to think through
present this is a particularly relevant issue, very carefully how they future proof the
and finance teams need to be able to talent needs of the function, and what the
operate successfully in an environment demands of the future enterprise will be.
which may be more ambiguous and
uncertain than they have previously
experienced.
By many standards, the approach of the Historically, the larger global oil
With less reliance being oil and gas industry to financing its companies have relied heavily on cash
placed on traditional bank activities has been conservative; flows for many of their funding activities,
loans new sources of traditional bank loaning has been the yet the downturn of 2014 has now placed
bedrock of capital provision across the significant challenges on how they can
funding are increasingly industry, with total global fund raising now efficiently fund many of their
available in the market. across the sector at the end of 2013 activities, and in the present environment
approaching $1,000 billion per year.2 they must continue to look to balance
their investment programmes carefully; it
Yet today the industry is seeing an places new strains on their effectiveness
increasing proliferation of funding of their working capital processes and the
options, with less reliance being placed on efficiency of existing banking arrangement
traditional bank loans, and new sources of must now continue to fall under review.
capital increasingly available in the
market. Finance professionals across the For the increasing number of smaller and
sector and in all sizes of organisation have medium-sized independent enterprises in
a significant role to play in helping the the sector, the challenge of funding is
enterprise source the most effective forms particularly acute. With no demonstrable
of financing for the business. There is longer term track record in the industry,
more competition for access to capital but there is less visibility to the investment
also a wider range of finance providers in community of the inherent investment
the marketplace, and the CFO risk. Typically these businesses have less
organisation needs to become substantial cash flow evidence on which
increasingly familiar across this diversified investors can price in the risk of the
portfolio. investment, or they may be operating in
incredibly niche markets or narrow
The proliferation of capital sources that geographies which inhibits the
we are seeing is not surprising. With opportunity to hedge, they may simply
growing uncertainty on future revenue not have the scale of operations or hold
streams across the industry, there remains sufficient assets which provide investors
significant tightness in traditional with the required assurance levels; in short
banking lending controls. Moreover, as some investment wariness persists.
previously mentioned, the sector faces
ongoing infrastructure, logistics,
environmental and social challenges.
Significant price volatility is driving much
greater diversification of sources of
finance, and the sources of funding used
at different stages of the investment life
cycle is also continuing to shift. From
traditional bank loans and public and retail
bonds through to more complex
mezzanine finance, specialised energy
funds, sovereign wealth funds and other
emerging sources of capital, financing
options are becoming increasingly
complex.
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