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By Jeffrey Harfenist and Eric Cothran
SEC Mandates Additional Reporting Requirements for Resource Extraction Companies
On June 27, 2016, the SEC issued its final guidance
for Rule 13 (q)-1, as well as an amendment to Form SD to meet the requirements mandated by section 1504 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. The primary goal of these regulations, as stated by the SEC, is to combat global corruption and increase governmental accountability by boosting transparency in resource-rich countries around payments resource extraction issuers make to foreign governments, the U.S. federal government or entities controlled by governments.
The SEC defines resource extraction issuers to include “all U.S. companies and foreign companies that are required to file annual reports pursuant to Section 13 or 15 (d) of the Exchange Act and are engaged in the commercial development of oil, natural gas or minerals.” 1
The rules will become effective for the fiscal year ending on or after Sept. 30, 2018. The required disclosures must be filed with the SEC no later than 150 days after the end of the fiscal year on Form SD, and must also be filed electronically through EDGAR in an XBRL exhibit with certain required tags. The SEC has also permitted an alternative reporting mechanism, but the issuer must meet certain additional requirements both with filing disclosures and methods.
The rule requiring payments to be disclosed has purposefully been issued as an explicit list rather than a broad statement. Those payments that are not explicitly listed are not required to be submitted in the disclosures of the issuers. The payment types include, but are not limited to, taxes, royalties, licenses, fees, production entitlements, bonuses, community and social responsibility payments (CSR payments), dividends and infrastructure improvements. Payments that do not use cash, sometimes referred to as in-kind payments, are also required to be reported in the disclosures. In-kind payments should be reported at historical cost, but if this information is not determinable or readily available, they should be reported at their fair market value. The SEC does provide an exemption on disclosure of payments deemed to be de minimus
, and has defined de minimus
payments as a single payment or a series of related payments that does not equal or exceed $100,000 for a discrete project. In an effort to curtail any competitive harm that could be imposed by the disclosure of such relevant and potentially proprietary payments, the SEC has granted that disclosure of payments related to the exploratory phase of projects can be delayed until the following fiscal year after the payment has been made. Disclosed payments are to be reported by the type and total amount of payments made for each project of the issuer, as well as the type and total of such payments made to each government.
Opportunities and Challenges
Due to the nature of the information that needs to be collected and reported, companies should investigate how they can incorporate the data capture and reporting requirements of Section 13(q) into their existing anti-corruption compliance programs. Existing forensic protocols and data mining tools currently being used to test the classification, propriety and nature of targeted disbursements can be expanded to take into account Section 13(q)’s requirements.
As with most issues related to anti-corruption compliance efforts, those individuals tasked with ensuring that their companies comply with Section 13(q) will face a range of challenges. For example, as previously discussed, only payments for a discrete project exceeding $100,000 must be reported. However, those individuals who want to circumvent the spirit of the law will have an opportunity to “game the system” by misclassifying payments associated with “Project A” as a “Project B” expense in order to keep totals under the $100,000 threshold. However, companies can mitigate this type of risk by providing internal auditors or other groups with compliance oversight with the necessary forensic tools and training to spot behaviors and transactions intended to bypass reporting requirements and, more importantly, implement corrective measures on a timely basis.
As with all compliance-related issues, having a thorough understanding of the reporting requirements and the methods by which individuals can circumvent them is critical to developing and executing a comprehensive and effective compliance program. In addition, we believe in the axiom Trust but Verify
. The processes, controls and policies implemented to ensure compliance with Section 13(q)’s requirements must be tested periodically to ensure that they are operating as intended, and that all risks have been identified and properly addressed.
1 Disclosure of Payments by Resource Extraction Issuers No. 34-78167 (June 27, 2016), 81 FR 49359 (July 27, 2016). This document is available at https://www.sec.gov/rules/final/2016/34-78167.pdf
2 As further defined by the SEC the term “project” refers to… “operational activities that are governed by a single contract license, lease, concession, or similar legal agreement, which form the basis for payment liabilities with a government.”
Jeffrey Harfenist is a managing director with BDO Consulting’s Global Forensics practice. He can be reached at firstname.lastname@example.org.
Eric Cothran is a senior associate with BDO Consulting’s Global Forensics practice. He can be reached at email@example.com.
By Janet Smith
Vendor Auditing in a Depressed Energy Sector
With only a few months left in 2016, “Lean Until Late 2017” is an almost-certain reality for most energy organizations. Delayed projects, non-existent capital budgets and wide-sweeping layoffs are once again the norm in the cyclical energy sector. However, for some companies, innovative and aggressive champions of vendor auditing are realizing tangible—and in some cases, substantial—results in the form of credits and recoveries from contracted vendors.
Vendor auditing is a tool organizations use to review and evaluate a vendor’s compliance with stated contractual terms, including pricing and discounts. A vendor audit covers an organization’s total spend with a vendor for a set look back period, typically one to three years, and can cover all payments an organization has made to the vendor, as well as other key provisions and terms of the contract. It gives an organization access to a vendor’s billing records, pricing files, labor records and any other documentation supporting a vendor’s invoicing and contract compliance practices.
How to Achieve Success
A successful vendor audit program starts well before a vendor is even selected. The contract terms and provisions can be highly complex and difficult to interpret, monitor and verify, which could in turn directly impact an organization’s ability to audit and recover overcharges. As a matter of practice, organizations should ensure contracts contain several key provisions:
- The right to audit for a specified period of time
- The preservation of records, book and accounts for a stipulated “look back” period
- The accounting and project-related records the provider (contractor) is required to generate, retain and provide to the owner
- The requirements that the provider have adequate internal controls to provide assurance that financial management is effective and that claimed costs are reliable and supported
- The specific costs that are subject to the audit and specific limitations (if any)
- The allowances for the owner to recoup the cost of the audit if the audit detects overcharges by the provider
However, it is important to note that even without the “right to audit” provision in a contract, it is still possible to proceed with a vendor audit. Good business partners are generally open to audits, regardless of contract provisions or the lack thereof. It may take some persuasion by company management, but it can be accomplished.
Organizations also need to know where to look during a vendor audit. Complex contracts, large numbers of invoices and inexperienced vendor billing personnel can all lead to mistakes, and organizations may be leaving substantial amounts of money on the table. It’s typical to see recoveries from:
- Labor hours not supported by timesheets
- Labor rates not supported by personnel records
- Unsupported union labor rates
- Improper labor or equipment markups
- Unsupported material charges
- Unapplied or miscalculated discounts
- Improper pricing
- Non-compliance with “most favorable” contract terms
- Unapplied credits
The magnitude of these recoveries can be sizable. Here are just a few of the recoveries we have seen in our recent client work:
- Identified recoveries of $3.7 million on $89.8 million in spend related to the construction of a manufacturing facility
- Identified recoveries of $2.4 million on $86 million in spend related to an electrical plant system installation
- Identified recoveries of $2.3 million on vendor spend totaling $234 million for a publicly traded natural gas company
- Identified recoveries of $220,000 on a $1.97 million media licensing agreement
Objections to Vendor Auditing
Given the potential recoveries, why wouldn’t all companies aggressively audit all their vendors? Often, an organization’s operational personnel raise objections, citing the relationship with their vendors as the primary concern. No one wants a long-standing, hard-working vendor to be inconvenienced or upset. On the flip side, organizations can no longer afford a long-standing, hard-working vendor that consistently overbills. There is a balance. Vendor audits do not need to be unnecessarily confrontational or inconvenient. In fact, most vendor audits can be done in cooperation with the vendor and with little disruption to the vendor’s normal course of business. Just as good fences make good neighbors, vendor audits can also result in solid vendor relationships.
“We often have vendors thank us for highlighting weaknesses within their processes that they are able to correct and improve, making the entire relationship between vendors and their customers better,” says Dawn Williford, BDO Risk Advisory Services Regional Leader.
Most procurement experts agree that vendor overbilling is one of the most common forms of contract non-compliance, and the potential dollar recoveries from a vendor audit are undeniable. However, the benefits of a vendor audit can be even more far-reaching. Routine vendor audits send the message that an organization is always monitoring its vendors and full compliance with contract terms is a requirement of doing business with the organization. Strong vendor compliance programs can also fine-tune an organization’s contract language and terms, strengthen third-party relationships and improve overall process and internal controls.
For the battered energy industry, ensuring productive vendor relationships is essential to riding out the current storm. Not only can a strong vendor compliance program help find savings, it can also help both companies and their vendors emerge from the downturn leaner, nimbler and more prepared to move quickly to capitalize on opportunities for growth.
Janet Smith is senior director with BDO Risk Advisory Services. She can be reached at firstname.lastname@example.org.
How did you come to be interested in the accounting field, and the oil & gas industry in particular?
BDO Spotlight: Q&A with Tom Elder, Assurance Partner and Co-Leader of the Natural Resources Practice at BDO
During the last year of my pursuit of a geology degree in the early to mid-1980s, I decided to change majors to business and started taking accounting courses at my university. Realizing I had a knack for accounting, I went on to graduate with an accounting degree and worked for one of the Big Four. While there, I leveraged my background in geology to develop a specialty in the energy sector. It’s now been three decades since I first got involved in the energy industry, and it’s a niche I hope to continue to explore throughout the remainder of my career.
What is your outlook for the oil & gas industry in the second half of 2016?
Current market conditions will continue to challenge the industry, and we will likely see more bankruptcies, particularly among exploration & production and oilfield services companies. E&P companies are struggling with liquidity, as borrowing base redeterminations continue to limit their ability to secure additional capital. As a result, E&Ps are reining in their spending and, in turn, oilfield services companies no longer have much work to do.
With respect to prices, I don’t expect to see them significantly increase during the remaining half of 2016. Looking at global supply and demand, Chinese demand remains weaker than we had hoped, and the Middle East continues to pump the market with production. However, from the U.S. perspective, we are seeing supply start to come back down as E&Ps continue to lack the capital to maintain high rates of production—so there is some hope that, at the very least, prices will have stabilized by the end of the year.
2017 looks brighter for the industry, and I would expect to see prices creep back up. But I do not believe we will see $100/barrel oil for several years. What’s important is getting the market back to $60-70/barrel and, if the prices are able to sustain themselves, the industry will see momentum again.
What are the biggest challenges that your clients are currently facing?
The most consistent themes we’re seeing are liquidity and impairment. As I mentioned, E&P companies are having a difficult time borrowing much-needed capital to keep their operations going, which is harming both their businesses and those of their service providers. We’re seeing continued impairment concerns among services companies because so much of their equipment remains idle.
When oil prices hit $100/barrel, we saw many companies spending rather than reserving liquidity or cash for times like these. Right now, there are a lot of assets on the market for attractive prices, but the problem is that there aren’t a lot of companies out there with the funding to act on the opportunity. Banks are reticent to lend the necessary funds, while private equity firms aren’t quite ready to leave the sidelines.
The slow response of private equity has been troubling, as well. The challenge we’re seeing is that the PE firms with solid expertise and experience in the energy space continue to have much of their funds tied up on these distressed assets, having bought in while prices were still high. Generalist firms, however, remain uneasy about investing so long as the industry outlook remains in flux.
With oil prices where they are, and amid disappointing earnings, how can oil & gas companies strategically work to stay afloat?
E&P companies are cutting capital expenditures where they can and delaying major projects. Of course, there will be properties where companies have drilling commitments or acreage that is expiring, so they have to drill or they will lose them. Due to this, we’re seeing companies drilling wells—but not completing them—so that they don’t incur the completion costs or put production online at these prices. We’re also seeing many companies push their suppliers for lower prices and better payment terms.
Cutting costs is tricky during these times, but companies must be careful not to downsize too much. Consider staffing, for example. Some layoffs may be necessary, but what companies don’t
want to do is reduce headcounts to the point where they find themselves severely understaffed once prices rebound. Companies must keep in mind the time it will take to replace that staff later—especially since the skills gap between seasoned workers and the next generation of engineers and operators remains quite wide.
The bottom line is: Cut costs, but do it smartly, and be prepared for when the market turns around. The companies that are cutting to the bone may be some of the ones we see going into bankruptcy or restructuring later on.
What are the biggest investment considerations for oil & gas companies to make today to ensure long-term growth?
We’re seeing companies getting back to the basics and focusing on what they’re good at, rather than diversifying into sectors that are not their bread and butter. There is also a lot of innovation underway. Companies, particularly within fossil fuels, will continue to invest to find ways to do things more efficiently and effectively, as well as to reduce the carbon footprint. It’s imperative that companies aiming to innovate invest in the right talent and allocate funds for research and development.
Another consideration lies in the people that make E&P companies tick: The industry is aging and it will need new, young, smart people with fresh ideas, particularly those with a technology perspective.
How do you foresee oil & gas M&A performing in the coming years?
In the next couple of years, I’d expect to see a lot more consolidation, particularly on the service side of the industry, and specifically in the drilling sector, which is currently somewhat fragmented. In the near-term, we may still see some failed deals and some extremely skittish buyers, but as prices recover and stabilize, we can anticipate to see deal flow start to move again.
And deals are unlikely to be limited to any one revenue segment. Certainly, we’ll continue to see the majors and larger independents remain highly acquisitive and snap up assets at low prices—after all, right now, they’re in a much better position to do so than their smaller peers—but as conditions improve, the smaller independents will be looking for opportunities to join forces to find synergies and savings.
Are there any trends in the oil & gas industry that you are particularly excited about at the moment?
Innovation. In a market like this, we’re seeing more companies thinking outside of the box in terms of doing things differently, more efficiently and effectively. For example, the majors are looking at ways that drone technology may be used to monitor and inspect assets in remote locations. Technology will continue to play a key role in advancing efficiencies and lower cost applications and it will be exciting to watch these unfold over the next few years.
Alternative energy is an interesting space to be in right now, as well. We will continue to see growth in renewables as our country works to diversify its power sources and improve environmental stewardship. The major oil and gas players have a role to play in this, of course, and it’ll be exciting to see how traditional energy companies work with up-and-coming alternative energy players to create a robust, diversified national energy industry.
What lies ahead for the Natural Resources practice at BDO?
BDO’s continued expansion has been very positive for the Natural Resources practice. As we continue to grow, we’re assembling a team experienced in an increasingly diverse variety of industry subsectors. Additionally, we’re seeing greater depth
of experience in these subsectors. I look forward to seeing what the future brings for the practice given the depth, breadth and enthusiasm of our team.
Tom Elder is partner and co-leader of the Natural Resources practice at BDO. He can be reached at email@example.com.
PErspective in Natural Resources
Dealmaking is finally heating up in the oil and gas sector as private equity buyers look to deploy substantial capital raised for energy deals—and then banked—during the last couple of years’ market rout. Natural gas and crude prices have recently risen above the multiyear lows plumbed earlier in 2016. As hopes of a recovery start to rise, investors are beginning to find value in oil and gas sector acquisitions once more.
Blackstone Group has invested nearly 20 percent of its $9 billion energy fund—one of the largest in the world—since March this year, mostly in oil and gas deals, according to The Wall Street Journal
. According to Fitch Ratings, PE firms were responsible for a quarter of the $30 billion paid for large drilling properties since September 2015. Data provider Preqin estimates that PE firms have $162 billion set aside specifically for energy deals. Funds with broader mandates contain billions of dollars more that could also be used for such deals, The Wall Street Journal
Smaller mid- and upstream companies are attractive targets. American Securities closed an all-cash deal for equipment maker Ulterra Drilling Technologies in July, in a deal valued at under $500 million. The PE firm had spent more than a year looking at firms that provide the equipment and services needed to pump oil and gas, but had not found any value until now, according to The Wall Street Journal.
Deals are not confined to any particular region. PE firms were behind the recently announced merger between Scotland-based oil and gas firms Centurion Group and ATR Group. Centurion’s backer, SCF Partners, will become the majority shareholder in the newly formed group, while ATR’s owner, NBGI Private Equity, retains a stake. The group will have a combined turnover of more than $100 million, according to Energy Voice
Western Canada is also proving attractive for PE firms looking for bargains before an anticipated oil price recovery next year. Newly created junior oil and gas producer Rising Star Resources raised $25 million from Canadian PE firms Lex Capital and 32 Degrees Capital to finance a $30 million purchase of oil-weighted production from Calgary junior Petrus Resources, according to Business News Network
(BNN), a Canadian business and financial news channel. The public markets remain out of reach for small firms such as Rising Star Resources, but PE is increasingly willing to step in. 32 Degrees has done two new deals and two top-ups of existing deals in 2016, after only one financing in 2015, BNN reports.
Corporate buyers are also seeking new deals. ExxonMobil, the world’s biggest natural resources company, offered more than $2.5 billion for Papua New Guinea firm InterOil and a stake in its undeveloped gasfield Elk-Antelope, outbidding Australia’s Oil Search, which was backed by French oil giant Total. Energy companies have raised more than $30 billion through secondary stock offerings since early 2015, according to Reuters,
which means PE firms will face stiff competition for deals as they try to put their dry powder to work.
Future PErspectives: What’s Next for Natural Resources Investors?
With rising oil and gas prices signaling the worst of the slump may be over, PE firms are seeking to cash out their investments. Yorktown Partners-backed Extraction Oil and Gas, and Vantage Energy, backed by Quantum Energy Partners, Riverstone Holdings and Lime Rock Partners, have both filed confidential registrations with the SEC in advance of going public. More than a dozen such firms are currently considering an IPO, especially in areas with a relatively low cost of drilling, Reuters
reports. If the deals go ahead, they will end a yearlong IPO drought in the sector. But the firms could attract buyers before they get that far. PE owners might prefer outright sales, which would enable them to fully realize their investments.
Sources: Business News Network, Energy Voice, Reuters, The Wall Street Journal
BDO Introduces New Roles, Leaders in Southwest Region
This past June, BDO announced a new reporting structure for its core assurance and tax business lines, introducing leadership opportunities for professionals across the firm—particularly in the Southwest.
Our own Ron Martin, based in the Houston office, is assuming the role of Managing Partner for the Southwest region. Kevin Hubbard, former co-leader of the Natural Resources practice and also based in Houston, has assumed the role of Assurance Regional Managing Partner for the Southwest, while Scott Hendon, located in Dallas, remains the Tax Regional Managing Partner.
As Kevin transitions into his new role, BDO’s Natural Resources practice is pleased to announce that it has appointed Thomas Elder, assurance partner, to serve as the practice’s co-lead. Tom will be working alongside Charles Dewhurst to serve and support the United States’ energy industry, leveraging his extensive experience in the E&P segment to further BDO’s work with this vital sector.
For more information on BDO’s recent reporting structure changes, please view our press release here
Did you know...
According to The Wall Street Journal
, Exxon Mobil, Royal Dutch Shell, BP and Chevron hold a combined net debt of $184 billion—more than double their debt levels in 2014.
Just 2.7 billion barrels of new oil supply were discovered globally in 2015, the smallest amount since 1947, according to figures from Wood Mackenzie Ltd
A report by Canada’s Mining Industry Human Resources Council
warns that if the mining industry in Canada returns to growth, employers could face a cumulative hiring requirement of up to 127,000 workers.
According to Haynes and Boone, LLP’s Oil Patch Bankruptcy Monitor
, as of Aug. 1, 90 North American E&P companies had filed for bankruptcy since the beginning of 2015.
Emissions from burning natural gas are expected to be 10 percent greater than those from coal in 2016, according to U.S. Department of Energy
The BDO 2016 Global Energy Middle Market Monitor
found that the median market cap among middle market oil and gas companies dropped 58 percent between 2014 and 2015—USD $219 million to $91 million.
For more information on BDO USA's service offerings to this industry, please contact one of the following practice leaders: