Audits will protect your environmental compliance investment

Timothy A. Wilkins Bracewell & Giuliani LLP Houston

One of the most significant financial issues for both upstream and downstream companies in the oil and gas industry is not often considered in financial terms: the cost to ensure environmental compliance. Many companies view the $4 million average annual cost of complying with the Sarbanes-Oxley Act as a sizeable financial burden. Yet a 2007 American Petroleum Institute report estimates that the US oil and natural gas industry has invested more than $160 billion since 1990 toward improving environmental performance. In 2006 alone the industry spent nearly $13 billion on environmental compliance.

Despite these facts, most media coverage, environmental groups, and public opinion polls assume that environmental quality is getting worse despite strong evidence to the contrary on the issues we currently regulate. The stereotype is that corporate polluters, led by “Big Oil,” don’t care about the environment, while enforcement agencies are in bed with industry and offer only a slap on the wrist for even the worst violations. The result is political and media pressure to step up the frequency and harshness of environmental regulation, even though punishments are already severe:

• Civil penalties can run up to $32,500 each day for each violation
• Cleanup obligations can quickly reach into the millions of dollars and more
• Criminal penalties include both fines and prison time that can apply to many types of violations at the discretion of sometimes headline-minded prosecutors.

Notably, every indication is that environmental policies and enforcement activity – whoever wins the Presidency – will be even more vigorous in the next federal administration than during the last eight years.

Audit program

Given such stakes, no energy, pipeline, or natural gas company should take a fragmented or inconsistent approach to its investment in environmental compliance. In this arena, there is no “finish line.” These laws require action daily, weekly, monthly, and annually.

Even in the best of circumstances, laws change, key people leave, and regulated equipment breaks down, so compliance is always a fresh challenge. This is true not only with regard to direct compliance costs, but also with respect to compliance issues that may be uncovered through merger and acquisition due diligence.

The only way to ensure that your company’s environmental compliance investment is effective is through an ongoing, consistent compliance audit program that is every bit as effective as a financial auditing process. Without frequent, comprehensive, independent compliance assessments carried out through outside expert eyes, energy companies inevitably overlook certain duties and fall out of compliance. Indeed, no reputable company would audit its books on the premise of “We’ll get to it when we can.” The principle of regular, consistent assessment that applies to financial compliance should also apply to environmental compliance.

In addition to the compliance benefits and peace of mind that come with a vigorous environmental audit program, audits can also help minimize the consequences of potential environmental enforcement for violations that are discovered. In fact, federal environmental policy – and the policies of some states – allow for penalty leniency or immunity for companies that self-audit. Using good faith efforts to find, fix, and disclose environmental problems can bring relief from the toughest penalties.

EPA’s Audit Policy (65 Fed. Reg. 19618, April 11, 2000) specify nine criteria that regulators weigh in granting relief from penalties for companies that self-audit. First on the list is voluntary conduct of a systematic audit or compliance due diligence effort. Other requirements include prompt disclosure (within 21 days of independent discovery) and prompt correction (within 60 days) of compliance problems that are not repeat violations and did not result in significant environmental harm.

Environmental management systems

One of the most effective tools for assuring compliance is a formal “environmental management system,” or EMS, that begins with a strong statement by the board of directors or the CEO supporting the need for compliance, followed by documenting and implementing a step-by-step compliance program. The key elements of most EMSs include:

li >Periodic evaluation of all the ways each facility or operation interacts with the environment
• Written, measurable objectives and performance criteria (including legal compliance) for each facility or operation documented
• Written plans and procedures for achieving objectives and evaluating performance, as measured against calendars to ensure timely completion
• Written assignment of all environmental responsibilities to specific positions and personnel
• Documented training of all employees on their responsibilities and procedures
• Periodic internal and independent auditing to confirm the effectiveness of the process
• Systems to track performance and document and demonstrate correction and prevention, and
• Regular management EMS review with updating of the EMS to reflect the feedback received.

This is a big undertaking, but there are valuable tools to help efficiently manage EMS implementation and maintenance tasks. These can include project scheduling and management, documentation of training efforts, audit report compilation, and scheduling of corrective or preventive actions.

EMS software shared on an enterprise-based system facilitates communication between environmental and project staff at multiple installations and can give easy online access to routine environmental and EMS documents and records. The system database can provide an online calendar for and shared email notification of EMS milestone audit events, including deadlines for permits and other compliance requirements.

By centralizing environmental compliance management documents, data, and activities into a single shared network, EMS software can be invaluable for companies facing limits on time and resources to address crucial environmental concerns. In addition to these benefits, a systematic EMS approach institutionalizes continuous improvement and has a much better chance of earning regulatory favor than informal or ad hoc efforts to comply.

Transactional audits

On a related note, of particular interest to corporate finance officials is EPA’s recent effort to more clearly apply its audit policy – and the kind of leniency envisioned for self-auditors – to transactional environmental due diligence. Buyers have long performed environmental “audits” to evaluate a target’s environmental liability risks and potential capital obligations. But EPA has recently announced an “Interim Approach” to applying its audit policy in transactional contexts to allow a buyer to “wipe clean” a target’s past violations by auditing, fixing, and disclosing those violations, formalizing an approach pioneered by the author and senior EPA officials in several recent corporate transactions.

The Interim Approach represents a major leap forward in EPA’s efforts to help purchasers and acquirers of businesses avoid environmental penalties to which they might otherwise succeed through a program of voluntary assessment, disclosure, and corrective action.

Since codifying its voluntary audit policy in April 2000, EPA had resolved violations involving more than 3,500 entities and at nearly 10,000 facilities through September 2007. As written, however, the audit policy did not clearly explain how the program might be applied to parties contemplating the purchase of facilities or businesses with potential environmental violations that are a key area of focus when conducting due diligence in transactions.

Since EPA’s audit policy focused specifically on existing owners, there were significant uncertainties as to whether and how the agency would credit audit disclosures made by acquirers of facilities who discovered environmental violations during transactional due diligence.

Under the Interim Approach, the value of the deal and the positive environmental impact are both enhanced by giving the new owners a “clean start” to find, correct, and obtain penalty relief for existing violations at the target facilities. The result allows purchasers to avoid material environmental penalties associated with the target company’s pre-acquisition violations, while still taking remedial action on the actual problems.

Necessary caution

Energy companies need to scrupulously comply with a complex array of environmental laws, regulations, and permits. Audits and environmental management systems provide valuable tools to help achieve this goal. Do not assume, however, that creating an EMS and undertaking compliance audits automatically ends compliance problems. Companies should launch these efforts only after consulting with experienced legal professionals. Their guidance can reduce the potential liability risks of uncovering and creating evidence of legal violations, for example by appropriately using legal privileges and policy protections while addressing possible concerns.

Experienced counsel can also help identify the best strategies for correcting problems, documenting the solutions, working with the relevant agencies, and obtaining leniency or immunity from liability – whether at your own facilities or in conjunction with an acquisition. When done right, with the help of qualified technical and legal experts, these programs can help protect and enhance your company’s environmental compliance investment.

About the author