Oil firms in Middle East must resist temptation to cut compliance spending because of lower oil price, says expert

Out-Law Analysis | 05 Jan 2016 | 10:17 am | 3 min. read

FOCUS: Compliance programmes may be seen by many as a cost drag on business but, rather than cutting back, Middle Eastern oil firms should actually be thinking about increasing their compliance spend despite the downturn.

With global oil markets falling by a third since May and still under half their value a year ago, there remains considerable pressure on energy companies to reduce costs and raise efficiency. But as oil prices fall, risks rise - making weakening compliance functions in times of economic difficulty a false economy.

Western energy companies now operate under imposing compliance requirements governing both their trading activities and operations, and their Middle Eastern counterparts are increasingly following suit. For any business to thrive in the medium and longer-term, consistent investment needs to be made in compliance, risk and control functions. With heightened scrutiny and accountability, it has never been more vital for boards to continue to support compliance functions with the budget, resources and tools that they need to ensure a culture of trust, transparency and accountability.

The link between price and risk

There are several reasons for the link between falling prices and risk. Firstly, there is pressure to increase profits and maintain forecasts and liquidity, manifesting as pressure on production, exploration and infrastructure. Expansion into new markets, engagement with more third parties and potential M&A opportunities raise their own compliance issues including change of control issues, legal and compliance due diligence, anti-bribery, corruption and regulatory issues.

Companies also assume more risk from their acquisition of more licences and permits, and alliances with new entities. Meanwhile, tighter revenue projects exacerbate pre-existing risks. Frontline business teams may be put under pressure to "get the deal done" and to increase sales and expedite existing projects; and management may be tempted not to ask questions of employees who manage to meet forecasts in an environment of revenue reduction.

At the same time, companies struggling with reduced revenue experience concurrent pressure to decrease costs. As revenue models and forecasts are recalculated based on market conditions, it is inevitable that companies will also revisit their expense and spending projections – and it can be tempting to cut corners on regulatory, social and governance risk management. Cutting compliance programmes and staffing can lead to less oversight, less monitoring, less transparency and less accountability. As a result, the business is less able to prevent bribery and corruption and is less responsible to bribery and corruption issues that may arise.

But scrimping on compliance is a false economy. In fact, cutting compliance functions is likely to actually cost energy companies more in the short and long term.

Risk profiles do not change when the price of oil drops. Extractive resources will still be located largely in countries with a high perception of corruption. Inherent compliance risks for energy companies such as opaque bidding, heavy subcontracting, high risk environments and significant government interaction – all industry norms - will not lessen, while other risks will emerge. Cutting compliance personnel without beefing up oversight through monitoring or other mechanisms means companies could be setting themselves up for serious and expensive compliance failures.

Amidst an ever-increasing volume of regulation, and with a raft of investigations into major energy companies ongoing, the risk of sanctions for non-compliance should not be taken lightly. Some of the most significant penalties incurred for non-compliance have been handed out by regulators to companies within the oil and gas industries and, as cases against the likes of Petrobas and Afren this year have shown, any issues around fraud can have a dramatic effect on the market.

Access to finance

A poor record on compliance can also impact on firms' access to finance. Financial institutions and other potential lenders may be reluctant to lend if they feel that a business does not have adequate compliance procedures in place. Lenders and potential investors or business partners want and need to see that appropriate mechanisms are in place for managing risk. There is therefore a need to adopt good compliance procedures to avoid being deemed an unsuitable commercial partner.

This is particularly the case in the Middle East where – in the absence of credit rating agencies, security registers and an efficient mechanism for debt recovery - lending carries a particular risk. Any business in the region treating compliance as a 'tick-box' exercise is therefore likely to be given short shrift by lenders and investors.

Jason Rosychuk is an oil and gas industry expert at Pinsent Masons, the law firm behind Out-Law.com.