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Issue #1. Volatility hitting the cost base,and impacting capex6The response of oil and gas businesses tothe huge fall in prices recently witnessedis having a significant impact on the roleof the finance organisation. The problemis this: no one is entirely sure about whenthe price can be expected to rebound,and commentator estimates vary from themore immediate future (next 12 months)to a much longer time frame – ‘the howlow, and how long’ question resonatesacross the industry.Many CFOs will continue to undertakesignificant cost reviews to identify whichcosts can be cut, and which expenditure isnecessary to ensure ‘business as usual’operations. Part of the challenge for thefinance team here is the need for a deepunderstanding of the nature of the costbase, and clarity about which costs can bereduced without necessarily affectingfuture growth or performance. As always,the challenge in the industry is to balanceshort-term against long-term trade-offs,but there are some prominent areas thatare most likely to attract attention in areview, particularly the more discretionaryspending on areas such as training, or theuse of contractors. In addition, financeteams are likely to spend more timeconsidering the structure of workingcapital and trying to improve the liquidityfundamentals.It is no surprise, given the volatility in themarket, that management of theenterprise cost base is a key priority forthe finance function. For some markets,part of the cost base problem is historic,exacerbated by oil basins that arerelatively mature and where theinfrastructure is degraded enough towarrant significant expensive upkeep. Inaddition, in the good times, otheroperating costs such as salaries havesometimes reflected the sentiment inindustry, which has contributed to makingoperating costs expensive for manyenterprises in the sector.Longer-term investment programmes andthe efficacy of capital expenditure activityare other significant priority areas. Withthe trade-off between short-termpriorities and long-term opportunitiesFigure 2: Brent crude oil prices – 12 months to 21 April 2015120100USD80Source: Financial Times, Wednesday 22 April 2015.AMFJDNOSAJJ60MManagementChapteropeningof theboxcostbase, and scrutiny of theefficiency of investmentprogrammes is now critical.

Oil and gas – priorities and challenges for the CFO enterpriseever present in the industry, financeprofessionals have a more critical role toplay than ever in judging whichinvestments will continue to be needed toprotect longer-term revenue streams andthose that can be cut. In the market todaythere are many examples of capitalexpenditure programmes that are beingeither cut or, at least, deferred, reflectingthe prevailing market conditions.In the push for significant cost savings,and as the cost of acquiring new reservesfalls owing to diminishing share prices andoil prices, the other key activity that wemay now see is a major upturn in mergersand acquisitions, and naturally the financeMajor oil and gas operatorswill shave 140bn ( 94bn)off their capital expenditurebudgets in 2015, followingthe fall of over 50% in theprice of crude oil over theprevious year, according toresearch by RBC CapitalMarkets.Telegraph, 24 March 2015.7department has a critical role to play inboth pre- and post-merger acquisitionactivity. In early April 2015 Royal DutchShell announced a proposed 47bntakeover of BG group, yet opinion isdivided as to whether this heralds thestart of major acquisition activity acrossthe industry. Much of this depends on theextent to which particular enterprises havehedged their future barrel sales atprevious higher prices, but there is somenoise in the market to suggest thatrefinancing costs are generally increasingfor many companies with significantfinancing debts, reflecting generalinvestor concern in the oil market.

Issue #2. Pressure on forecasting anddecision support capabilitiesThe effectiveness ofplanning and forecasting,and decision supportactivities are now in thespotlight.Other key priorities for the CFO functionin the sector are the effectiveness of theplanning and forecasting processes, andthe need for more effective commercialdecision support. Rebalancing theresources and time spent on attemptingto predict the future environment moreaccurately is critically important given thevolatility in the market.Simon Constant-Glemas, vice president offinance at Shell explains: ‘As finance, wewant to operate in a space that indeedreports the future, and to do that we needto better understand what it is that weneed to report about the future. In thepast we have used historical informationto try and provide insight, which in theworld that we live in today is so far out ofdate – even if you do improve theprocesses such that you can provideinformation quicker, if you are using onlypast data the information will still bemeaningless for driving the futureperformance of the business.’8Nicholas Stevenson, oil and gas partner atPwC adds: ‘Clearly, there is a lot of focuson prospective financial information at themoment. As an audit partner I spend a lotof my time looking historically at financialinformation, but what’s really interestingabout the last few months is that I’vespent much more time with clients lookingat prospective financial information; it’sabout budgeting, it’s about forecasting,it’s about understanding what this newprice environment really means for thebusiness’.One area of concern in forecasting futureoutcomes is the efficiency of capitalexpenditure programmes. Stevensoncomments: ‘I think the industry has apatchy track record in executing costeffective, to-budget capital expenditureprogrammes. The investor community hasbeen worried for some time about theindustry’s track record, and investors weregiving oil and gas companies messagestwo years ago around the capex getting

Oil and gas – priorities and challenges for the CFO enterprise9growing interest in the new forms ofenergy and renewables (the US shale gasrevolution is of particular note), as well asthe proliferation and emergence of newgeographies for exploration for traditionaloil and gas resources (albeit typicallyreserves that will be harder to access) theinvestment and risk landscape continuesto evolve, driving a need for moreeffective scenario planning and financialmodelling. On the flip side, decommissioningof mature fields is increasing and the costforecasts are escalating, raisingsustainability concerns. All these issuesaffect the role of finance professionals inassessing enterprise finance opportunity,and in accounting for and reporting onthese developments.out of control. The industry has a trackrecord of costs rising in times of highcommodity prices, and you can see that[reflected] in some of the overspends thathave been witnessed in the capitalexpenditure projects. The reduction incommodity prices has brought realurgency to that debate’. He goes on toadd ‘being able to tweak different modelsto different price environments ordifferent hurdle rate assumptions is reallyimportant. The resource allocation for oiland gas companies right now is essential.The pool of funding has shrunk andtherefore making tough choices is goingto be really important in the next fewyears, so having accurate prospectivefinancial information to make thosedecisions is going to be really important’.There are other issues that also affect theplanning and forecasting process,particularly capital expenditure. WithIn delivering wider business decisionsupport activities, the challenges CFOfunctions in the oil and gas sector face aresimilar to finance challenges in otherindustries. In ACCA’s report, Tomorrow’sFinance Enterprise, technology and dataare identified as two of the key issuesimpacting the effectiveness of finance inproviding the quality of decision supportneeded. Like other sectors, in oil and gasfinance teams still face barriers to gainingcredible data on the activities that driveenterprise value. For many financefunctions there is no single interpretationof the available data across the enterpriseand data governance processes remain achallenge, yet the pressure remains fromdata-hungry executives for ever-quickerinformation from the finance team. Financehas to get better at articulating theoutcomes it is trying to achieve and usingthe right data to enable effective reporting.Access to the right data is one thing, butleading finance functions also need toprioritise investment in technology to tapinto the most relevant data and help drivevalue, and digital technologies in thesector can be expected to increase inimportance as a core finance leadershipenabler. ACCA research has consistentlydemonstrated the limitations of prevailingtechnologies in many financeorganisations, and new technologies arecentral to driving richer informationinsights and supporting greatercollaboration across the enterprise.However, in practice, many finance teamscontinue to struggle, risking inaccuracyand low confidence in the numbers.

Issue #3. Corporate reporting challengesInvestorsChapter openingare becomingboxmuch more selective; qualityand transparency ofexternal corporate reportingacross the industry is nowvital.Although one challenge is providing theinternal information that enterprises in thesector need, oil and gas companiescurrently face many external corporatereporting issues as well. Pension costaccounting for defined benefit schemes isalways a difficult and complex area. Forexample, judgements are required aboutactuarial assumptions on mortality, futuresalary increases and length of service.Judgement is also needed when decidingthe appropriate discount rate to useduring a period of prolonged general lowinterest rates but with pronounceddifferentials between government andcorporate bond rates in some countries.Many oil and gas companies were inexistence with large workforces at a timewhen defined benefit obligations weremore common than now.In relation to corporate reportingstandards, two major new standards werepublished in 2014 affecting companieswhose accounts are prepared under eitherUS GAAP or IFRS – revenue recognition(IFRS15) and financial instruments (IFRS9).These have application dates in 2017 and2018 respectively and so are beingassessed for impact by oil and gasenterprises, as by all other companies.The impact of the first may be reduced bythe typically clear-cut physical delivery ofthe oil or gas involved. The impact of thefinancial instruments standard is likely tobe principally in the relaxation of some ofthe hedge accounting restrictions. Incommon with enterprises in other sectors,accountants working in the oil and gassector have had to take notice of the moreinnovative approaches to non-financialreporting, including integrated reporting,that have been developing to improve thedialogue between companies and theirdifferent stakeholders.While both the above issues are generallyrelevant to all sectors, certain reportingissues seem of particular significance tothe oil and gas sector. Generally, accurateand meaningful corporate reporting onkey performance metrics highly relevantto the industry, such as productionvolumes, cash, pricing and reserves, andreplacement cost accounting (and relatedprofitability reporting), is essential for theinvestor community and affects theperception of management quality.Investors are becoming more selective,particularly with the recent price volatilityin the market, rising development costs,10increasing geo-political risk and a morecompetitive situation.Some reporting issues have existed forsome time: for example, the treatment ofexploration costs. For those using IFRS,the current version of IFRS4 makes fewrestrictions on the extent to which thesemay be deferred or treated as part of thecost of exploration of properties. At theone end there have been successfulefforts to assess recoverability on awell-by-well basis and, at the other, tocapitalise all such expenditure under thefull cost method. In between, a variety ofmethods are also used. Likewise IFRS4allows comparable variability when itcomes to assessments of impairment.Perhaps more than in other sectors, thereporting of certain non-financialinformation for oil and gas companies hasbeen almost equal in importance to thatof earnings. The disclosure of the differentcategories of reserves and resources (forexample, proven, probable, possible) iscritical information that analysts consider.The most significant information is oftencaptured in the reserves replacementratio, which tracks the balance betweenfinding new reserves against the depletionof the assets due to production.Some of the sector-specific issues are alsovery current. Owing to the nature of theindustry and the way it has developed,joint arrangements (joint ventures set upas separate entities, production sharingarrangements, etc.) have been veryimportant. IFRS11 changed the accountingframework within which theseorganisations reported and there havebeen some continuing clarifications andamendments made to the standard thatneed assessment against the particularagreements a company may have.The other issue concerns the greaterdemands of transparency placed on thesector (along with mining companies) toshow the value of payments to governments.This has appeared, for instance, as part ofthe Dodd–Frank Act in the US and in theAccounting Directive of the EuropeanUnion. The different sorts of payment willneed to be disclosed – taxes, royalties,infrastructure contributions and so on –and on a granular basis. It was referred toas ‘country-by-country’ reporting but itmight sometimes be better described as‘project-by-project’ reporting.

Issue #4. Asset impairment and stranded assetsChapterThe issueopeningof strandedbox assetsis dominating the agendaacross the global industry.The decline in the oil price in 2014–15 hasalso increased attention on the issue ofimpairment of assets. It has challengedthe comfortable assumption that thehistorical costs of exploration will beexceeded by the value of the oil that canbe extracted. Price volatility has alwaysbeen a fact of life for the sector but thecurrent prices are potentially a ‘trigger’ forcarrying out impairment tests. Equally, thelarge change in price is making it muchmore difficult to estimate the longer-termprice expectations that are needed forvalue-in-use calculations. Upstream,recent investments in unconventionalresources such as tar sands and deepwater fields may no longer be justified bycurrent prices for crude. In some regionsthese changes have been combined withlonger-term excess capacity issues thatare triggering the impairment of refiningand other downstream assets.The potential impairments raised by theoil price collapse mirror the concerns thatsome investors have already been raisingabout ‘stranded assets’ that the sectormay have, i.e. assets worth less on the11open market than their balance sheetvalues. Estimates show that many of thecurrently known reserves and resources ofcarbon will have to remain in the groundand will never be sold and burnt ( if theinternationally agreed global warminglimit of 2ºC is not to be exceeded), unlesstechnologies are developed to capturethe waste gases. Companies owning orexploiting these reserves may need torecognise their worthlessness, includingwriting them off. This issue almostcertainly affects the coal industry morethan oil and gas, but both are involved.The climate change issue brings into playthe debate on alternative forms of energyand developments in governmental andregulatory policies that could have animpact.The other issue to contend with here is theincreasing reaction of institutionalinvestors. In some quarters, concerncontinues to grow about the investmentpotential of enterprises that have investedheavily in carbon, and there might begrowing scrutiny of the risk exposure ofenterprises from the investor community.In response, many of the major oilcompanies continue to point to growingglobal demand for fossil fuels and theneed to continue to meet global energydemands that for the foreseeable futurecannot be met by alternative forms ofenergy.Nicholas Stevenson from PwC comments:‘The biggest issue facing the industry isimpairment. With oil and gas pricesfalling, I think there is an expectation inthe investor community that we will seeimpairments as we go through the season.But it’s a more much subtle anddifferentiated topic depending on thenature of your assets and where you areoperating. An upstream producer that hasshort term assets is going to have someimpairment issues whereas longer-termassets where the cash flows will take 30 or40 years may not be so prone if you thinkoil prices are going to recover in the shortto medium term’.

Oil and gas – priorities and challenges for the CFO enterprise12Dealing with therisks of strandedassetsDrivers of asset strandinginclude water scarcity.Companies in the mining, oil and gas sectors are ignoring a big riskto their valuations and predictions of future revenue.This is the risk that assets will become stranded, unexpectedlylosing all or most of their value due to external events. Givenincreasing consensus that as much as 80 per cent of proved fossilfuel reserves will have to be left in the ground to avoid catastrophicclimate change, this risk should not be dismissed lightly.This is why F&C [Foreign and Colonial] Investments, the UK fundhouse, has put stranded assets high on its agenda, according to itsannual responsible investment report. Over the past year, F&C hasbeen working to make sure senior executives in the oil and gas,mining and utility sectors are aware of the concept.‘Many companies continue to focus on short-term riskmanagement in response to the current weak oil price, rather thana robust long-term risk management approach that considersclimate change policy risks’, says the report.Although individual analysts at companies may be aware of theissue, frequently the awareness stops there, rather than rising tothe board.‘It needs to be a strategic board-level discussion’, says VickiBakhshi, head of F&C’s governance and sustainable investmentteam. ‘It is a risk management question, it is a stress-testing question’.The issue of stranded assets may not yet be at the forefront of thecorporate board’s mind, but its profile is growing quickly in theinvestment community.When FTfm [FT Fund Management] covered this topic four yearsago, with specific reference to fossil fuels, it was easy to findcommentators to scoff at the idea. It was seen as an ideologicalproposition driven by climate-change campaigners.By contrast, in 2015, mainstream outfits such as MSCI, the stockmarket indices provider, and Towers Watson, the consultancy, haveput out discussion documents on the topic, while OxfordUniversity’s Smith School of Enterprise and the Environment has aprogramme dedicated to systematic analysis of the subject.The director of this programme, Ben Caldecott, says investmentmanagers are slowly coming to terms with the new landscape:‘There are some real leaders, but there are lots of investmentmanagers who do not really know what they are doing. There is lotsof research showing this stuff is financially material [but they havenot yet integrated it into investment processes]’, he says.An understandable preference for looking for opportunities insteadof mitigating risks may be to blame for investment managersfinding it tricky to engage with the issue, Mr Cald

Oil and gas – priorities and challenges for the CFO enterprise 5 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 industry’, a