The EI Value Chain: Possible Audit Topics

Supreme Audit Institutions (SAIs) can play a role in ensuring that countries reap maximum benefits from the EI sector and keep negative effects to a minimum. The type of audit to be carried out will depend on the competency level at SAI, their audit mandate, access to relevant data, the maturity of government institutions and the lifespan of extractive industries in the country. This presents a selection of possible risks and audit topics to be considered within the different phases of the EI value chain, and give examples of recent EI sector audits from around the world.

Audit of the management of extractive industries (EI) is gaining more significance for SAIs. For many countries their EI play a vital role in generating government revenue, ensuring employment, attracting investors and developing new technology. Notwithstanding these benefits are possible negative effects such as environmental damages, affected local communities, too much dependency on EI revenue, tax evasion and corruption. Supreme Audit Institutions (SAIs) can play a role in ensuring that countries reap maximum benefits from the industry and keep negative effects to a minimum.

The decision of what to audit should be based on an assessment of sector risks, but will often depend on the competency level at SAI, the audit mandate, access to relevant data, the maturity of government institutions and the lifespan of the extractive industries in the country. Audit topics however can usefully be categorized within the different phases of the EI value chain. The value chain describes from a governance perspective the different steps or phases to be undertaken, from discovery, through extraction to lasting value creation for society. The group of English-speaking African SAIs (AFROSAI-E) had in 2013 developed an EI value chain, based on the World Bank classification. The EI value chain shows the role of government in managing the extractive industries in the following areas:

  1. Legal framework
  2. Exploration, including seismic and magnetic surveys and drilling
  3. Award of contracts and licenses
  4. Monitoring of operations
  5. Collection of revenue
  6. Revenue management and allocation
  7. Implementation of sustainable policies

This article will focus on audits which may be carried out within each phase of the EI value chain, including some examples of audits which have been carried out in the last years.

Legal framework

A common risk is lack of operationalization of overall legal framework. Petroleum and/or mining acts may not be supported by regulations and guidelines, which may lead to government not exercising their oversight role in an effective way. The Office of the Auditor General of Uganda (OAGU) reported in 2014 that the government failed to complete relevant environmental guidelines on time, which reduced government’s ability to manage waste from oil and gas activities in a proper and efficient way. By this OAGU referred to government’s responsibility to ensure that overall legislation by Parliament is understood and implemented.

Exploration

If Parliament decides that certain areas shall be open for exploration, government must ensure that exploration activities are taking place and that data gathered are kept in systematic and secure way. The Comptroller and Auditor General of India conducted a performance audit (report no 11 of 2012-13) of how India’s government owned Oil and Natural Gas Corporation Limited (ONGC) carried out exploration activities. It showed that ONGC failed to complete its work commitments in a majority of the exploration blocks, that monetizing of offshore discoveries were almost non-existent, and that exploration costs were unnecessary high.

Award of contracts and licenses

Contracts and licenses should normally be awarded to competent companies through a competitive and transparent bidding process. A number of audits have been carried out on this area, e.g. by the Brazilian Court of Audit[1], TCU, which has audited every single bidding round. In 2007 it reported lack of transparency, publicity and openness regarding dialogue between government and bidders. The Office of the Auditor General of Norway did a similar audit in 2010 which concluded that Government issued petroleum licenses based on clearly defined criteria which were in compliance with relevant acts and regulations[2].

Monitoring of operations

When production commences, it is important that government has measures in place to ensure that activities on the ground are carried out in accordance with relevant laws and regulations, e.g. that health and safety regulations are met and that equipment used for measurement of production is correct. The Government Accountability Office of USA concluded in 2008[3] that relevant government agencies did not carry out sufficient inspections of metering equipment, which raised uncertainty about accuracy of oil and gas measurement.

Collection of revenue

An effective taxation system which brings in a fair share of the economic rent, which is easy to administer and facilitates investment should be implemented. Also, the system should enable realistic revenue projections to be made. The New South Wales Audit Office in Australia did an audit of collection of coal mining royalties in 2010[4]. The audit showed that the relevant government agency responsible for collecting the royalties cannot assess from the royalty returns whether the royalty being paid is likely to be correct. In 2013 the National Audit Office of China reported that the China National Petroleum Company was crediting substantial current period natural gas sales revenues to the following year, which resulted in significant understatement of profits[5].

Revenue management and allocation

Revenue streams from EI are significant and it is therefore common to have specific procedures for how these shall be handled in a way which does not damage the economy, but secure lasting positive effects for the country. The Netherlands Court of Audit[6] did recently an investigation of how much money had been earned from its biggest natural gas field Groningen since production began in 1960, and how it was spent. They discovered that the designated gas revenue fund, which was supposed to be used for “additional projects”, was used to finance projects which were part of the annual state budget. Spending policies were changed numerous times which made long term investments difficult. The report concluded that the precise use of natural gas revenues cannot be identified.

Implementation of sustainable policies

Extractive Industries should create lasting benefits for the country and negative impacts, e.g. environmental degradation, should be reduced to a minimum. It is important that a country with an emerging extractive industry benefits from investments by increased participation from local staff and services, and through engagement of  local suppliers of goods and services. The Office of the Auditor General of Uganda (OAGU) discovered in 2014 that a substantial number of supposedly local suppliers to the oil and gas industry in Uganda were in fact wholly foreign owned[7]. The local supplier companies it was suspected had been set up just to fulfill legal requirements without effecting local value addition. In the same year OAGU reported that the government environmental authority did not systematically verify self-monitoring reports submitted by oil and gas companies operating in highly vulnerable areas with rich biodiversity[8].

There are many more examples of audits that have been carried out within the different phases of the value chain. The above mentioned audits may serve as inspiration for SAIs that want to expand their audit scope and identify risks which have led to audits in other countries.

References

[1] http://portal3.tcu.gov.br/portal/page/portal/TCU/Rio20/fichas/en_07_oil.pdf

[2] https://www.riksrevisjonen.no/rapporter/Sider/utvinningstillatelser.aspx

[3] http://www.gao.gov/assets/100/95735.html

[4]http://www.audit.nsw.gov.au/ArticleDocuments/142/208_Coal_Mining_Royalties.pdf.aspx?Embed=Y

[5] http://www.cnao.gov.cn/main/articleshow_ArtID_1374.htm

[6]http://www.courtofaudit.nl/english/Publications/Audits/Introductions/2014/10/Use_of_natural_gas_revenues_facts_figures_and_scenarios

[7] http://www.oag.go.ug/implementation-of-national-content-in-the-oil-and-gas-sector-by-the-ministry-of-energy-and-mineral-development/

[8] http://www.oag.go.ug/value-for-money-reports/

By Trygve Christiansen, OAG Norway

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