Oil industry adapting to evolving new paradigm on corporate governance, accountability

Oct. 28, 2002
Enron Corp.'s implosion and the wave of corporate scandals that has followed it in the past year have become the business world's financial equivalent of the 1989 Exxon Valdez tanker oil spill off Alaska.

Enron Corp.'s implosion and the wave of corporate scandals that has followed it in the past year have become the business world's financial equivalent of the 1989 Exxon Valdez tanker oil spill off Alaska.

In other words, nothing will ever be the same again, and businesses must begin adapting to new paradigms for corporate behavior.

And nowhere will that be more keenly felt than among energy companies. That is partly because the scandal plague started with one of their own and continues with newly disclosed allegations of malfeasance in California's energy crisis by Enron and other integrated energy firms. The other reason is that the oil and gas industry—long in the vanguard of globalization—already was fighting an uphill battle to gain credibility on issues of social responsibility.

It now falls to the petroleum industry to pick up another gauntlet thrown before it, one that relates to the over- arching issues of corporate governance and accountability. A new emphasis on corporate governance and accountability is propelled by today's fast-breaking events; it informs and accelerates the urgency with which industry must address challenges regarding environmental care, human rights, geopolitical concerns, and a host of lesser issues outside the normal scope of operations.

Injected into this bewildering panoply of change is the growing competition among companies that must position themselves before a broad spectrum of stakeholders as favorably as possible on an equally broad spectrum of measurements. Because the stakeholders include investors and prospective employees, both of whom have regarded the oil and gas industry with flagging interest of late, nothing less than an oil and gas company's future is at stake.

It was to this end that Oil & Gas Journal asked several dozen oil and gas companies to participate, with brief contributed essays by their top executives, in an industry forum on the subject of corporate governance and accountability in a post-Enron world. The two contributed essays that resulted from this solicitation appear on pp. 34 and 35. While some companies cited time constraints in not being able to participate, others evinced skittishness over tackling such a sensitive topic when declining.

It is apparent, nevertheless, that a new paradigm is emerging on the conjoined issues of corporate governance and accountability. Change is already afoot in the US, Canada, and Europe and is certain to spread to other regions. Some of this change is self-imposed at the corporate level, some emanates from professional associations policing their own, and some is the result of new regulations being imposed in response to the scandals.

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For an industry not traditionally viewed as especially open and accessible to the outside world, the intensified scrutiny is seen by some companies as another hardship to endure alongside commodity price volatility and the shortage of qualified personnel. For others, it is seen as an opportunity to stake out a competitive advantage.

A fiscal 'Exxon Valdez'

The wave of corporate scandals in the past year has combined with the current economic downturn and the terrorist attacks on the US on Sept. 11, 2001, to create "a financial reporting environment unlike any in recent memory," according to a white paper prepared and distributed by the American Institute of Certified Public Accountants (AICPA) and the Big Five US accounting firms (Arthur Andersen LLP, Deloitte & Touche LLP, Ernst & Young LLP, KPMG LLP, and PricewaterhouseCoopers LLP).

"Investor confidence, already shaken by significant volatility in the capital markets, has been further unsettled by highly publicized restatements of financial statements, which have generated questions about the quality of financial reporting, the effectiveness of the independent audit process, and the efficacy of corporate governance," the white paper said. "This environment is creating significant challenges for US businesses and their management, boards of directors, audit committees, and auditors."

Unlike the remotely felt—for most Americans—effects of the Exxon Valdez spill in Alaska, this fiscal "grounding" of corporate America has hit millions square in the pocketbook. A coalition of consumer groups and labor unions earlier this month released a report that claimed that recent corporate scandals have cost Amercans more than $200 billion in lost investment savings, jobs, pension losses, and tax revenues.

Whether or not that number is accurate, it already has become part of the campaign rhetoric in a US congressional election year. And that merely helps fan the flames of anger and distrust already targeting US corporations. That anger has focused on irregularities in corporate financial and operations reporting that misled investors, and it is this area of corporate governance and accountability that has received the greatest scrutiny in the scandal aftermath. And because reserves disclosures have always created a special, added burden for oil and gas companies' reporting requirements, the increased scrutiny could pose an even greater challenge for the industry.

Reforms

Regulatory reforms designed to tighten corporate reporting and financial disclosure requirements are already being implemented in the US.

Earlier this year Congress passed and President George W. Bush signed the Sarbanes-Oxley Act, which requires a company that issues quarterly and annual reports to the Securities and Exchange Commission to have its principal executive and financial officers each certify financial and other information in the reports. SEC is now beginning to implement some of the rules envisioned in Sarbanes-Oxley, with the first rule, certification of disclosure by principal officers, having taken effect on Aug. 29 (Fig. 1).

The new rules also require these officers to certify that they:

Are responsible for establishing, maintaining, and regularly evaluating the effectiveness of the issuing company's internal controls.

Have made certain disclosures to the company's auditors and the audit committee of the board of directors about the issuers' internal controls.

Have included information in the company's quarterly and annual reports about their evaluation and whether there have been significant changes in the company's internal controls or in other factors that could significantly affect internal controls after the evaluation.

In addition, SEC is requiring companies to maintain and regularly evaluate the effectiveness of disclosure controls and procedures to ensure that information is recorded and reported on a timely basis.

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More reforms are likely to come, self-imposed as well as regulatory.

PricewaterhouseCoopers CEO Sam DiPiazza Jr. and PWC fellow Robert G. Eccles, in a new book, "Building Public Trust: The Future of Corporate Reporting," propose a new vision of corporate transparency as a means to restore investor confidence.

"Recent corporate failures and scandals have undermined the trust that investors and other stakeholders place in the corporate reporting supply chain: company executives, boards of directors, independent auditing firms, information distributors, and third-party analysts," according to an online abstract of the book, published in recent weeks by John Wiley & Sons, New York.

The authors contend that restoring public trust in corporations requires that every participant in the corporate reporting supply chain embrace and live by three core concepts:

A spirit of transparency. "Corporate executives must, for example, stop playing the Earnings Game, which seeks to manage earnings and Wall Street's expectations, and instead report forthrightly on their business's critical value drivers."

A culture of accountability. "Every member of the supply chain must hold itself accountable: management, for producing relevant and reliable information; boards of directors, for ensuring that management lives up to this obligation; independent auditors, for ensuring the objectivity and independence of their audit opinions; and analysts, for producing high-quality, unbiased research. Investors and other stakeholders must also hold themselves accountable for the decisions they make."

People of integrity. "Rules, standards, and frameworks can only go so far. Transparency and accountability will be achieved only by people committed to individual integrity."

The authors propose a new model of corporate transparency based on three integrated tiers: a set of global generally accepted accounting principles, industry-specific standards for measuring and reporting performance that the industry develops and applies consistently, and company-specific information.

Industry rift

The corporate scandals that started with Enron and the resulting liquidity and other financial problems that have spread to other integrated energy companies have also aggravated a growing rift between traditional gas producers and utilities and those former darlings of Wall Street.

Some producers and utilities have claimed that the energy merchants' debacle has even undermined US energy security. The Coalition for Energy Market Integrity & Transparency (EMIT), describing itself as a nonprofit coalition of natural gas and electric utilities and consumers, oil and gas producers, and energy services companies, in May called on Congress and the Federal Energy Regulatory Commission "to launch a full-scale investigation of natural gas and electricity price manipulation by marketer-speculators in light of new Enron revelations that prove such manipulation has occurred."

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A leading member of EMIT is Houston superindependent Apache Corp. Apache Chairman Raymond Plank testified on the effect of the Enron bankruptcy on the functioning of US energy markets before a congressional subcommittee on Feb. 13.

In his testimony, Plank maintained that the US energy market narrowly escaped a disaster in the wake of Enron's collapse because a recession and one of the warmest winters on record combined to keep natural gas demand in check. He contended that a climate of "excessive volatility" engendered by hedge funds and traders employed by energy merchants "has undermined the ability of Apache and other North American producers to meet the energy requirements ofUpower plants."

While commodity price cycles have existed for years, Plank testified, "Uas hedge funds and traders have come to dominate the market, the cycles have become shorter in duration and more pronouncedU(and) these traders acknowledge that they derive their profits from price volatility."

Plank claimed that the rules governing the conduct of regulated and unregulated affiliates at integrated energy companies are "weak and subject to abuse." He called for the separation of the affiliates and their dealings limited to "real transactions," regulation to enforce fair treatment of all parties on online trading platforms, ending mark-to-market accounting (requiring traders to book revenues and profits when incurred), and imposing capital requirements to assure customers that traders will be able to deliver gas and electricity.

Plank said the task before Congress is clear: "To introduce effective oversight and transparency in (energy markets), eliminate the 'casino mentality' that places price volatility above physical supplies, and restore an environment that will encourage producers to make the investments to meet the nation's vital energy needs."

Such criticism by one company of its fellows within the US energy fraternity has not inhibited politicians—in an election year—from competing with each other in tagging their opponents with even the remotest Enron-affiliation "smear." And because both President Bush and Vice-Pres. Dick Cheney have oil industry backgrounds, such political mudslinging at the national level tends to lump all oil and gas and energy companies in the same category as the scandal-plagued energy merchants. That in turn leaves a lingering perception among the general public that all energy companies have been tarred with the same brush.

Oil industry accountability status

The energy merchant corporate scandals have only added to an already growing burden for oil and gas companies trying to cope with increased scrutiny of their worldwide operations.

Oil and gas companies were already on the firing line in terms of defending their record on issues such as environmental concerns and human rights, even before the current antiglobalization campaign and the accounting scandals du jour.

The stepped-up scrutiny is forcing oil and gas companies to grope for new benchmarks for performance.

ChevronTexaco Corp. Chairman and CEO Dave J. O'Reilly dealt with this challenge in his Sept. 4 talk to the World Petroleum Congress in Rio de Janeiro.

"As the shape of our industry is changing, our stakeholders are too," he said. "They're increasing in voice and in what they expect from us. Companies are accountable not only to employees, stockholders, neighbors, partners, and host governments but also to nongovernmental organizations, multilateral organizations, and community leaders on a much wider range of issues.

"Accordingly, success is no longer determined solely by traditional financial or operational metrics. Today, we are held to new standards for corporate citizenship, human rights, and the environment that are no less rigorous than the financial requirements of the investment community."

O'Reilly cited several new benchmarks for corporate behavior and performance, such as the Global Sullivan Principles, the World Bank's newly required environmental and social impact assessments, and the United Nations Global Compact.

That a new economic paradigm is rewriting the rules for business today is underscored by research by Pamela Cohen Kalafut, a corporate valuation expert who participated in a recent online forum at Cap Gemini Ernst & Young's Focus E-zine.

Kalafut contends her research shows that as much as half of an organization's value is derived from elements that can't be seen, such as brand equity, strategy execution, workplace culture, leadership, and adaptability. She places at the top of the list work culture, leadership, and strategy execution.

So the indicators that are most critical for companies to measure and disclose to investors "Uall start with understanding a company's strategy and the metrics by which that company's managers will gauge the strategy's success.

"And if you are effectively measuring it and delivering against those measures, our research suggests that disclosure will rebound to your benefit."

Royal Dutch/Shell Group Chairman Philip Watts took note of that trend in his foreword to the 2001 Shell Report, in which the supermajor continued its pioneering effort to gauge its performance on social and environmental issues in addition to financial indicators (Fig. 2): "We believe long-term competitive success depends on being trusted to meet society's expectations."

For Watts, giving a speech at the 10th Annual Marketers' City Lecture in London Sept. 25, earning that trust also means creating value at Shell from its brand and reputation. To bolster its reputation, Shell strengthened its business principles, Watts said, by:

Making new commitments to contribute to sustainable development and to support human rights.

Introducing mandatory internal processes for assuring that its principles and standards are applied throughout Shell operations worldwide.

Being much more transparent with its stakeholders.

Other views

Not all oil and gas companies are quite as sanguine as Shell about the notion of embracing fealty to society's expectations as an oil and gas company's key strategic driver.

ExxonMobil Corp. Executive Vice-Pres. Rene Dahan dealt with that view in a talk on doing business in a world of conflict before the International Chamber of Commerce in Denver May 7.

"A fundamental role of business is to help create prosperity," he said. "This is what we are designed to do. There is overwhelming evidence, all around the world, of the enormous contribution that business makes to the well-being of societies.

"So far, no other institution has shown itself as adept at creating a better material life for more people than has private enterprise. Moreover, no other institution has shown itself as capable of developing advanced knowledge and applying it to practical problem-solvingU."

Dahan contends that, while few would contest these observations, "Umore will claim that the contribution of business is conditioned by its desire for profits. In this view, the search for profits limits its willingness to address broader social problems, particularly those brought about by conflicts."

ExxonMobil's answer to this view is straightforward, said Dahan: "Business enterprises are at base neither philanthropic nor peacekeeping organizatons."

Olav Fjell, Statoil ASA president and CEO, took a similar tack in a lecture at the Norwegian School of Economics and Business Administration in Bergen, Norway, on Sept. 27.

"We believe that, by running our business as profitably and efficiently as possible, we can help give people in our host communities a better life," Fjell said. "Our most important contribution is measured in terms of value creation."

He noted that Statoil has come under pressure recently to pressure host governments to be more responsible or even for the firm to withdraw from countries that fail to measure up.

"Our main concern will always be to create value for our owners. We seek to achieve this in such a way that the net outcome of our operations is also positive for the community at large."

However, Fjell said that while his company maintains a commitment to sustainable development, "a commercial player should be careful about adopting a role or a responsibility that belongs more appropriately to national authorities, international institutions, or voluntary organizations."

O'Reilly echoed that view in his WPC talk, noting that there are certain functions that only governments can undertake.

"But here's what international oil companies can do—we can:

Create jobs and spur economic growth.
Be a catalyst for positive change.

Provide the energy that countries need in order to increase growth and raise the standard of living for their people.

"And there's another thing we can do: We can stop making excuses. We can stop citing our limitations as reasons for keeping silent or looking the other way."

O'Reilly called on international oil companies instead to lead by example: "We have a crucial role in raising difficult issues directly with our partners—from good governance to transparency to equitable sharing of revenue—issues on which the world community is demanding action be taken by both governments and businesses."

Such an initiative includes incorporating an early role for industry critics, says ConocoPhillips Pres. and CEO Jim Mulva. Speaking at a conference in Sanderstolen, Norway, Feb. 6, Mulva said that there are many complex issues that governments must confront if industry is to meet the energy needs of future generations, and dealing with them includes providing a role for critics of the oil and gas industry.

"Most governments now provide for statutory consultation periods, which allow the public and special interest groups to comment on energy plans," he said. "We should encourage them to take this opportunity and participate in the process—but to do so from the outset.

"Too often, the voices of dissent aren't raised until studies have been done and decisions reached. This wastes resources. It thwarts government processes. And it delays, even scuttles, important projects."

Corruption concerns

In too many instances in the developing world, some projects run into delays not because of legitimate criticism but because of local demands for bribes or "facilitation payments."

Improvements in corporate governance and accountability standards will go a long way in the worldwide effort to root out business corruption, according to specialists in the field.

As a first step to combat the problem of corruption, John Bray, director of London-based Control Risks Group Ltd., said that companies need "to put their own houses in order. There is a growing body of best practice on anticorruption measures and on the most effective means of implementing them."

Bray cites as subsequent steps taking the initiative to find local allies and working with governmental and nongovernmental entities in order to push an anticorruption agenda.

Conversely, indulging in corruption can undermine a company's efforts to improve governance and accountability.

ExxonMobil, in a 2001 editorial, said, "Companies that participate in corrupted dealings also do themselves no favors. Although a business deal here or there may be obtained, the cost includes creating a culture of dishonesty within the company.

"If cheating or bribery or fixing the books are tolerated for certain purposes, a company can never again be sure that these dealings are not tolerated for others. The whole organization can come to believe that dishonesty is an accepted approach."

The oil and gas industry fares well in a comparison with other industries when it comes to measuring attitudes toward corruption, according to Bray.

"The oil industry comes out quite well compared with, for example, telecoms," he told OGJ. "That, of course, is far from meaning that there are no problems to discuss."

According to Control Risks' third survey and report on global corruption and its impact on business (Fig. 3), the oil and gas industry has made progress on anticorruption efforts, with 64% of companies in that sector reviewing their business practices in light of new legislation—namely the 1997 Organization for Economic Cooperation and Development antibribery convention. Oil companies based in the US have worked under that country's Foreign Corrupt Practices Act for 3 decades and long have complained of losing business to companies headquartered in other countries because no comparable laws existed there.

Still, according to Control Risks' survey, oil, gas, and mining companies were the most likely among the industries surveyed to have been deterred from an otherwise attractive investment because of corruption.

Social responsibility

Environmental safeguards, human rights concerns, corruption, and a welter of other nontraditional issues are increasingly being woven into oil and gas companies' evolving new paradigm on corporate governance and accountability.

According to the San Francisco-based Business for Social Responsibility organization, over the past decade, the issue of corporate governance has been the subject of increasing stakeholder attention and scrutiny, giving rise to a powerful shareholder activist movement. These shareholder activists, including multibillion-dollar pension funds, religious or social investor groups, and other institutional investors, "are now using a variety of vehicles to influence board behavior, including creating corporate governance standards of excellence and filing shareholder resolutions," BSR reported in a recent white paper. "These investors are concerned with such topics as board diversity, independence, compensation, and accountability, as well as a broad range of social issues, e.g., employment practices, environmental policies, and community involvement."

Companies taking the lead in responding to this trend are "developing a wide range of management systems to measure, apply, assess, and report their efforts to integrate corporate social responsibility (CSR) into all aspects of their operations.

"These systems are designed to build accountability within an organization and help shape a culture that supports and rewards CSR at all levels."

Such companies are burnishing their CSR credentials in efforts to gain attention from an investment community that increasingly places much stock in social and environmental concerns in considering what to add or subtract from their portfolios. Attesting to that trend is the proliferation of mutual funds and stock indexes—such as the Dow Jones Sustainability Index—focused on companies with perceived sterling CSR records.

Conversely, exposure to downside risk on CSR issues can mean not only investor flight but even problems with credit availability. That's a crucial concern for oil and gas companies, given the increasing competition for capital in the industry.

So it follows that, while CSR is partly about the ethical dimension of business, Statoil's Fjell said at the WPC in Calgary in 2000, "Uthe business world's main motive for social responsibility is long-term, educated self-interest, not altruism.

"Companies act responsibly in large measure because they can do well by doing good. From this perspective, (CSR) also becomes a strategy for gaining competitive advantage and a vehicle that helps business achieve its strategic goals."

Just as investors look increasingly at an oil and gas company's CSR standing, so too will they consider such issues as transparency and clarity in corporate reporting. As the dust settles from the Enron et al. debacle, it's likely that oil and gas companies will follow a route like the one Fjell cites to gain competitive advantage, positioning themselves as leaders not only on CSR but also on improved standards of governance and accountability.

Apache Chairman Raymond Plank
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The task before Congress is clear: "To introduce effective oversight and transparency in (energy markets), eliminate the 'casino mentality' that places price volatility above physical supplies, and restore an environment that will encourage producers to make the investments to meet the nation's vital energy needs."

ChevronTexaco Corp. Chairman, CEO Dave J. O'Reilly
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"As the shape of our industry is changing, our stakeholders are too. They're increasing in voice and in what they expect from us. Companies are accountable not only to employees, stockholders, neighbors, partners, and host governments but also to nongovernmental organizations, multilateral organizations, and community leaders on a much wider range of issues. Accordingly, success is no longer determined solely by traditional financial or operational metrics. Today, we are held to new standards for corporate citizenship, human rights, and the environment that are no less rigorous than the financial requirements of the investment community."

ConocoPhillips Pres., CEO Jim Mulva
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"Most governments now provide for statutory consultation periods, which allow the public and special interest groups to comment on energy plans. We should encourage them to take this opportunity and participate in the process—but to do so from the outset. Too often, the voices of dissent aren't raised until studies have been done and decisions reached. This wastes resources. It thwarts government processes. And it delays, even scuttles, important projects."

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Statoil ASA Pres., CEO Olav Fjell
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"The business world's main motive for social responsibility is long-term, educated self-interest, not altruism. Companies act responsibly in large measure because they can do well by doing good. From this perspective, corporate social responsibility also becomes a strategy for gaining competitive advantage and a vehicle that helps business achieve its strategic goals."