No. 1, 2010
AUDIT FOR OIL AND GAS
Interview with Dale Nijoka, Global Oil and Gas Leader of Ernst & Young
Today, the oil and gas industry faces challenges on a scale not seen in a generation. Responding to the risks and opportunities inherent in the financial crisis, climate change, and commodity price volatility requires a firm equal to the task. Global reach and deep industry knowledge are essential for oil and gas companies to optimize performance, effectively manage risk and increase operational effectiveness. Ernst & Young provides assurance, advisory, tax, and transaction services to help oil and gas companies address today's key industry challenges.
Q: Mr. Nijoka, Ernst & Young has already been working in Russia for two decades. When did the firm start providing services for the energy industry in this country?
A: In 2009 Ernst & Young celebrated the 20th anniversary of our operations in Russia. In 1989 we became the first international professional services firm to establish operations here. Our early work involved the audit of a number of green field investment projects and joint ventures which were emerging in Russia. We also served our multinational clients here such as Amoco, Chevron and BP who were keen to invest in the CIS. With the development of the Russian economy and its oil and gas sector we have focused on the provision of world class services to the Russian integrated oil and gas, transportation and service companies. We are proud that amongst our global clients there are major players in the Russian oil and gas industry such as Rosneft, Gazprom and Gazpromneft, LUKOIL and TNK-BP, amongst others.
We are now the leading and the most diversified provider of assurance, advisory, tax and legal, and transaction services in the CIS. EY CIS currently has over 3,500 personnel working in 16 offices located in Russia, Ukraine Belarus, Kazakhstan, Azerbaijan Uzbekistan Georgia and Armenia.
Q: The Russian economy is largely based on the oil and gas industry. Can you say that today this industry is the main sphere of interest for EY in Russia?
A: The oil and gas sector continues to play a key role in Russia's national economy. With the significant oil and gas reserves in Russia, it is also a critical component in the world's energy supply.
In recognition of this fact and to best serve the needs of our oil and gas clients in Russia and the CIS, we formed the Moscow Oil & Gas Centre. It serves as a regional hub for our network of highly skilled resources - professionals with deep experience in the oil and gas industry, and is fully integrated into the EY Global Oil and Gas Practice, which unites over 7500 professionals around the world. This industry is a priority sector for EY, not only in Russia and the CIS, but also globally. We in Ernst & Young recognize that Russia will continue to play a very significant role in the global energy space, and therefore we integrate our Russian professionals into our Global Oil and Gas Practice. For example, we are proud that a Russian national based in Moscow - Alexey Kondrashov - now heads our Global Oil and Gas Tax Practice.
In addition to oil and gas, Ernst & Young also has a major presence in other industries that are important to Russia such as mining, metals, telecommunications and banking. We are a strong player in these industries with our specialists focused on serving our clients within these important sectors.
Q: As far as the financial crisis is concerned, what would you name to be the main lessons for the oil and gas companies, particularly Russian ones, to learn?
A: The different sub-sectors of the oil and gas industry have been unevenly affected by the economic downturn and experiences among individual oil and gas companies vary widely. Consequently the learnings from the downturn may differ across upstream, midstream downstream and oil field service companies. There have, however, been some common areas of focus across the sector, such as optimizing working capital, minimizing costs, closely monitoring the tax positions and monitoring and proactively managing counterparty risk.
A key area of focus has been on maintaining upstream capital expenditure. All oil and gas companies understand the need to balance short-term delivery with the need to establish a platform for sustainable growth. A key learning is that the sector should attempt to continue to invest through the ups and downs of the economic cycles. The industry players should be wary of finding themselves in the position of having to play catch-up on investments when the upturn materializes. In this sense, Russian companies are no different from their global counterparts.
The new economic environment has made the benefits of partnership more compelling for some companies. Many state-owned oil and gas companies are less able to finance projects from cash generated from operations than they were 12 to 18 months ago. This may, therefore, lead to renewed government interest in foreign involvement, and possibly investment, in the hydrocarbons sectors. For any arrangements made in the current downturn to be sustainable through the cycle, it is important that they are transparent, comply with the regulatory environment and are seen as fair to all stakeholders involved at any point in the oil and gas price cycles.
Q: In your opinion, how seriously can the recession affect the global development of the renewable energy industry?
A: The renewable energy sector has certainly not been immune to the global downturn, but it has proven itself resilient. Lack of capital from debt and equity providers has slowed the deployment of renewable energy infrastructure, and the supply chain has probably suffered a shortage of capital at the same time. However, the downturn also created some significant positives for the outlook of the sector; as governments across the globe looked at measures to help stimulate their economies, a very significant proportion of stimulus monies have been allocated to the green or low-carbon sector to promote sustainable economic growth. This has resulted in the renewable energy sector emerging from the downturn in a stronger position than before it.
Q: Ernst and Young's clients include a good deal of top Russian companies. How efficient are these enterprises versus top western companies in general? What perspectives, in your opinion, do Russian energy companies have in the light of the globalization of the economy?
A: As one of the largest producers of oil globally and the owner of over 23% of the world's remaining proven gas reserves, Russia has a central role to play in fulfilling the world's need for reliable energy supplies. A number of Russian oil and gas companies are also key players in international energy markets. Four Russian companies are featured in the list of the top 20 global energy companies as ranked by Platts this year and have an important role to play in helping commercialize their country's hydrocarbon reserves. In many cases the Russian companies are working with foreign partners to advance large-scale projects and develop their reserves. The partners offer technical expertise, knowledge and access to low cost capital to help the Russian companies provide energy supplies for domestic and export markets. Russian companies are also actively investing in overseas oil and gas assets: LUKOIL was one of the pioneers in this space, now we see many other Russian companies involved in foreign upstream, midstream and downstream projects.
Q: What kind of services of EY are in most demand among energy companies?
A: Globally, upstream deal activity has been relatively subdued since the fourth quarter of 2008 as oil prices rapidly retreated from their record highs. However, there are signs that M&A activity in the oil and gas sector is slowly beginning to pick-up. Reserves-seeking NOCs in particular have become more active again in the M&A market now that targets are more affordable. Meanwhile, the carve-outs that followed the mega-mergers of the 1990s will continue as larger companies sell non-strategic businesses. Ernst & Young has been helping oil companies considering acquisitions or divestments with transaction support, such as buy and sell-side due diligence as well as tax efficient planning and compliance activities.
Many, if not all, of the keys players in the sector have longer term cost reduction initiatives in place that pre-date the downturn, striving for greater unit efficiency and a competitive cost advantage. We have, however, seen some players accelerating these initiatives and we are helping clients scope, implement and measure these programs.
One area of cost control that is critical to companies is within the supply chain. A recent Ernst & Young survey showed that respondents from the oil and gas sector were significantly more likely than respondents from all industries to report that they have closely scrutinized their relationships with customers and suppliers over the past 12 months.
Standardization and globalization of systems and processes has been on the agenda of larger oil and gas companies for a number of years now. However, the downturn is prompting companies to accelerate the roll-out of these transformation programs that have identifiable cost savings. Ernst & Young has been involved in assisting oil and gas companies to implement a number of these performance improvement programs.
Q: One of the spheres of Ernst & Young's business is tax services. How would you assess the current taxation system for the Russian oil and gas industry comparing to other leading hydrocarbon producing countries?
A: The Russian petroleum taxation system has worked well enough for Russia, as it can be easily administered and it is transparent. There is always a balance to be struck between creating an environment where investment in the oil and gas sector flourishes while meeting the Government need to raise revenue for its programs. The oil and gas sector frequently involves large and complex projects with long payback periods. The cost of new oil is constantly rising, and many experts now say that the times of relatively cheap oil are gone. The new projects face significant risks in terms of uncertainty regarding oil and gas prices, exchange rate fluctuations, and costs (which may arise, for example, from various technical risks). It is therefore critical that the fiscal regime enables investors to have confidence in this key variable in the investment decision process. The Russian oil taxation system is based primarily on the fixed rates per ton of produced (and/or exported) oil and does not take into account the rising costs of production. Over time this could impact and limit the further development of the Industry. Russia should carefully consider what changes could be made that will take rising production costs into account to ensure that the tax regime encourages long term investment in the industry.
Q: What would be your short-term prognosis for the world energy industry?
A: Many of the senior executives in the sector that we have spoken to are expecting the downturn to continue for some time, perhaps for another 12 months, and are preparing their strategies accordingly. Any recovery, when it does come, is widely predicted to be slow and uneven.
Oil and gas price volatility and uncertain demand are making it more difficult for companies to plan forward investments. Companies look for security of demand to underpin their long-term investments. The level of uncertainty about the path of future energy demand is probably now at its highest point in decades. Most market participants are monitoring their spending commitments closely and are considering deferring or cancelling all but the highest return projects.
However, in the long-term, the overall structural issues surrounding location of reserves and achievable levels of production have not changed. When the global economy recovers, the same supply/demand pressures evident earlier in 2008 will resurface. Oil and gas companies must not allow today's difficult operating environment to prevent them from addressing the need to replace reserves, nor from preparing themselves for the time when growth resumes. The industry has a long and successful history of coping with volatile prices and difficult operating environments; that experience will serve companies well in coping with the challenges that lie ahead.
