Across many industries, oil and gas included, audit committees are placing an increasing priority on risk issues, with regulations, mergers and acquisitions (M&A) and information technology leading the list of top concerns. Those are the findings of an in-depth survey of audit committee chairs and members, conducted by Ernst & Young.

The 2006 Audit Committee Survey took place between August and November of last year. Among the participants were nine oil and gas firms.

The overall results indicate that audit committees are evolving with the changing business landscape, including developing an increased awareness and understanding of the risks

Figure 1. Respondents rely heavily on management and industry knowledge but not at all on regulators to ensure that all issues are addressed. (Graphics courtesy of Ernst & Young)
facing businesses today. Yet the survey results reflect a growing concern relating to escalating responsibilities, the increasing need for continuing education, and the shrinking pool of available and qualified members to serve in these critical corporate governance roles.
One of the most interesting results is the growing attention that boards are placing on proactively identifying and managing risks related to business strategies and objectives.

Making the risk transition
Oil and gas audit committee members describe their current primary responsibilities as providing oversight for financial reporting, internal controls and emerging risks. The focus on emerging risks is relatively new and is a byproduct of Sarbanes-Oxley (SOX).

SOX required companies, their auditors and audit committees to more closely scrutinize, document and measure the effectiveness of processes and controls for financial reporting. While daunting at the outset, many companies realized the value, and the savvy have begun to extend those controls to operations.

Extending reporting requirements to operations is causing audit committees to expand their understanding of the business beyond the core competencies of accounting, capital structure, tax and credit risks. And the payoff is proving to be worth the effort. In effect, by improving operational processes and controls, companies are experiencing fewer risks and service disruptions.

Like other industries represented in the survey, the oil and gas industry reported a clear and comprehensive understanding of risk profiles from a strategic, operational, financial and compliance perspective. For the exploration and production (E&P) industry, this clarity stems, in part, from consistency in managing many of the same geologic, engineering and environmental risks today that it managed a decade ago.

Despite the industry environment, the survey showed oil and gas audit committees appear
Figure 2. Sarbanes-Oxley requirements have had little or no effect on reserves estimates for more than 70% of survey respondents.
to move more slowly than companies in other industries when it comes to fully transitioning audit committee responsibilities to include oversight of emerging risks. Again, because oil and gas audit committee members know their industry so well and do not consider the risk profile to be highly volatile, they may be less apt to consider emerging risks.

The survey revealed leading practices from other industries, such as having a separate risk committee, holding periodic meetings with regulators to understand the breadth of emerging issues, and receiving monthly or quarterly reports on risk from management.

Audit committee composition
Of the companies surveyed, more than half of audit committee members were between the ages of 61 and 70 years old. This means that there will be an increase in the level of turnover among audit committee members across many sectors, representing both a challenge and an opportunity.

In anticipation of the impending turnover, corporate boards across all industry sectors may be well served to reevaluate their recruiting practices and identify a pool of potential audit committee members under the age of 50 who can bring a more diverse range of thought and experience to their roles. Along these lines, there are strong opportunities now to expand the knowledge and skill of boards with men and women who have backgrounds in managing risk and deep experience in finance, accounting, legal and regulatory affairs.

The challenge, of course, is for organizations to find and attract talented, experienced and diversified directors who fully understand the complexity and requirements of serving on an audit committee. Recruiting such candidates can be more challenging in today’s E&P environment with the advent of commonly used complex financial structures such as derivatives and hedging.

The oil and gas sector
Given the market fundamentals facing oil and gas companies today — with volatile commodity prices, shifting geopolitical environments, calls for new energy-related mandates and a shrinking pool of qualified employees — it is not surprising that oil and gas audit committees identified people/human resource issues and reputation as two of the top five most important risk factors their organizations face.

Respondents indicated that the oil and gas industry’s five top risk concerns are:
• Legal issues;
• Regulatory issues;
• Hazards (environmental and safety);
• Reputation; and
• People/human resource issues.

In terms of managing risks, 75% of the oil and gas industry respondents indicated they had a comprehensive process and structure in place to identify and manage risks related to business goals and objectives. Yet 25% also acknowledged that their audit committees had experienced significant surprises in the past 24 months with respect to new risk developments in areas not addressed by existing processes.

One area deserving attention for oil and gas audit committees is that of continuing education. While two-thirds of oil and gas audit committees have a formal orientation program, only 11% have a formal continuing education program. Oil and gas audit committee members specifically pointed to accounting and reporting financial risk and regulatory compliance risk as the two top areas where greater education is needed for the audit committee. Outside counsel is often helpful in providing continuing education to keep audit committees up to speed on new accounting rules and risk opportunities.

Other key oil and gas findings
With regard to industry risk, most survey respondents said they were planning for a decrease in oil and gas prices within the next 12 months.

Nearly 60% said they had not revised their company’s process for estimating oil and gas reserves, and 71% said there was no need to revise existing Securities and Exchange Commission rules governing reserves.

And while adding to their reserve base was the primary motivation for seeking M&A partners, it appears there was not as much focus on building relationships with national oil companies to improve access or develop partnerships.

Future challenges
New regulatory requirements, as well as the expectations of the investing public, are just a few of the issues weighing on the minds of those leading today’s oil and gas companies.

To meet the standards that are expected of them and deliver value to their shareholders, oil and gas companies are working to bring more structure and transparency to their operations and develop more effective methods to identify and control potential risks as well as prevent risk surprises. By increasing time and activities focused on risk, diversifying the talent on boards to capture new areas of expertise, and increasing the level of continuing education, audit committees will be better positioned to identify, evaluate and manage risk exposure for companies.