Oil and gas companies and their suppliers must collectively take ownership of the risks inherent in a dangerous industry

The recent anniversary of the Deepwater Horizon tragedy revived debate around the way that oil and gas companies manage risk. The blowout at BP’s Macondo well in the Gulf of Mexico killed 11 people and spilled as much as 200m gallons of oil, the worst environmental disaster in US history.

While Deepwater Horizon was an unusual event, it is well known that the oil and gas industry carries social and environmental risks. Less well known are the challenges the industry faces as a result of its complex contracting chains. We tend to think of the sector in terms of a handful of brands, including BP, Shell and ExxonMobil. But about 75% of industry activities are performed by service providers and their subcontractors.

Indeed, BP was not alone in attracting criticism following the Gulf of Mexico spill. BP’s contractors have also come under scrutiny, including Transocean, the rig owner; Halliburton, which did the cement job; and Cameron International, which built the blowout preventer. The incident highlighted the complexity – and vulnerability – of today’s oil and gas contracting arrangements.

To address this complexity, the industry has evolved performance standards and complex management systems and procedures. While good industry practice is prevalent in many places, there is a danger that many assume these systems are enough to avoid serious failings. Deepwater Horizon was a wake-up call, demonstrating that devastating (and preventable) failures can happen even in developed countries with high levels of civil society awareness and ostensibly effective regulatory regimes.

Our report recently published by the International Institute for Environment and Development (IIED) – Shared Value, Shared Responsibility: a new approach to managing oil and gas contracting chains – argues that a shift in industry mindset is required. A move away from what the US national commission on the Deepwater Horizon incident called a “culture of complacency” is required to manage the challenges posed by complex chains of oil and gas contractors in increasingly risk-laden environments.

New frontiers, new risks 

A combination of factors has made the oil and gas operating environment more complex than ever before. These include the move into ever more difficult, remote and challenging environments, such as deep water, tar sands, areas of high biodiversity, areas used for traditional livelihoods, regions of extreme poverty, and areas where governance and regulation may be weak.

Meanwhile, societies continue to look to the industry to deliver better development prospects. Yet many oil-rich countries such as Nigeria, Venezuela, Iran, Angola and others have all failed to realise the full potential of their oil wealth. In a bid to increase control over and benefits arising from oil and gas development, governments increasingly set targets for local hiring and procurement in international projects. With low levels of technical capacity and high levels of corruption in many less developed regions, this increases the challenges of delivering benefits simultaneously to shareholders and local communities while also avoiding major environmental damage.

Major oil and gas companies contract out to specialised service providers such as Halliburton, Schlumberger, Transocean and Amec as a way to increase efficiency and outsource risk. Contractors also subcontract many tasks. With contractors and subcontractors directly responsible for activities on the ground, their success can determine a given project’s overall performance. They are also essential to fulfilling the industry’s potential for delivering sustainable development benefits locally.

Complex contracting chains raise a number of questions:

 

  • Who is responsible for ensuring that contractors and subcontractors are properly prepared to address all risks, however unlikely? 
  • What actions must an operating company take to ensure that their contractors and subcontractors meet their contractual requirements and that they work to international good practice standards?
  • How do you ensure high environmental and social performance standards are maintained, even when speed and low cost of delivery are priorities?

Shared value: local content and economic benefit

The increasingly common government requirements to hire local people and source goods and services from local firms are known as “local content” obligations. The ability of a company to meet these targets depends on the availability of a sufficient number of people with the right skills to do the job, whether construction work, catering or clothing and equipment manufacture.

Specialised contractors capable of performing technical or resource-intensive work are increasing in number in some oil-producing countries. However, in many regions of the world, local content targets may be unrealistic. Rather than maximising the numbers of jobs created, regardless of quality, industry and governments together should seek to optimise local content in oil and gas projects, in order to deliver socio-economic benefits, while also preserving high standards of health and safety, environmental protection and societal wellbeing.

Shared responsibility: beyond the legal contract

In recent decades, business has become subject to a greater range of responsibilities enshrined in national legislation and regulatory frameworks. In addition, oil and gas projects are increasingly subject to a variety of environmental, social and other performance standards. These range from internal company standards and international standards systems to voluntary codes (such as the UN Global Compact or Voluntary Principles for Security and Human Rights), and obligations imposed by international financial institutions (including the International Finance Corporation, regional development banks, and the Equator Principles financial institutions).

These standards have potential to simplify, co-ordinate and make consistent the expectations and practices employed throughout a project. Yet they are not always consistently applied across contracting chains. They also tend to rely on a management system or a commitment to follow a certain set of principles, which may or may not be sufficient to change behaviour in desired ways.

The primary tool for managing responsibilities and performance throughout the contracting chain remains the legal contract – and a range of procedures and processes that have evolved in support of the contract. In practice, operating companies focus primarily on their relationship with the first-tier or lead contractor. This means that environmental and social performance further down the chain is often given less attention.

A major disaster such as Deepwater Horizon always shakes up the industry and its regulators, demonstrating that despite the industry insistence that standards couldn’t be higher, there is always room for improvement – and the required improvement is often systemic. 

Following the Gulf of Mexico spill, the US government restructured its regulating body, the Minerals Management Service, in light of allegations of inadequate oversight (and a history of corrupt practices). The new Bureau of Ocean Energy Management, Regulation and Enforcement introduced what it called “aggressive and comprehensive” regulations. BP’s own accident investigation report made 25 recommendations to avoid such a disaster happening again, with an emphasis on sharpening up its standards and increasing oversight and assurance.

But what really changed in the industry as a whole? Transocean, the world’s largest offshore rig company, lost nine employees in the explosion but still awarded its executives bonuses for 2010, calling it “the best year in safety performance in our company’s history”.

It’s all about incentives

The new US regulations stipulate that an operating company’s chief executive must certify that a well has complied with all regulations. But can a chief executive’s signature guarantee that standards are upheld by everyone involved in the oil operation? Integrating good practices is not a one-off event – employees and colleagues need to be able to question each other, review ongoing challenges and deliver good decisions in the moment, something no chief executive can deliver personally.

Issues arise when top-down enforcement of standards rubs up against a contracting, reporting and bonus-giving culture that incentivises corner-cutting when it comes to environmental and social protection.

 

  • Incentives and penalties in contracts between operating companies and contractors tend to prioritise speed and cost of project delivery over responsible practice. This provides a disincentive to individuals to “blow the whistle” – and cause delays – if minor incidents happen.
  • In fixed-sum contracts, environmental and social budget lines are rarely ring-fenced, so could be used to cover other costs of project delivery.
  • Vital information about sustainability performance, such as a company code of conduct or a 10,000-page environmental impact assessment might be appended to contracts at the last minute, leaving contractors to constantly play catch-up.
  • Reporting that consists of ticking boxes in multiple spreadsheets may or may not capture the reality of what is happening on the ground.
  • The false sense of security provided by complex procedures and technology can undermine individuals’ preparedness for a catastrophic event, especially if state-of-the-art equipment is in place or if a risk assessment judges the event to be highly unlikely.

Evolving responsibilities

Companies and their stakeholders respond to a set of responsibilities that are constantly evolving. Failure to meet any of these responsibilities comes with significant risks, such as increased costs and delays, increased financial liability, contractual disputes, environmental damage, community tension, reputational damage and, ultimately, loss of investment opportunities.

Figure 1 sets out a typology of oil company responsibilities and their consequences. We emphasise the importance of managerial responsibility. This refers to the efforts required to apply standards and procedures right across the contracting chain. Managerial responsibility extends over and above legal requirements, more than the adoption of standards and procedures on paper, and beyond simple stakeholder consultation processes. Good communications, training, oversight and corporate culture may be taken for granted in complex situations involving multiple organisations and multiple responsibilities.

Our new report offers a set of insights into why the industry as a whole still has a lot of work to do:

 

  • Many companies and contractors lack a sense of shared responsibility for the overall outcomes of a project. Their legal obligations, and their customary business practices, mean they tend to focus on their individual roles and responsibilities, and no one owns the totality of a project’s impact.
  • There is no lack of systems and processes at the industry’s fingertips that can be used to define and enforce performance standards. Rather, good systems and processes are often not adequately implemented. Sometimes, it borders on being a paper exercise, and much more effort should go into supporting and ensuring contractors and subcontractors are able to meet expectations.
  • There are cultural and contextual challenges associated with operating in diverse oil and gas regions. Sometimes these challenges hamper contractors’ ability to meet international standards, such as when local contractor markets are underdeveloped, or corruption is endemic, or operating companies are unfamiliar with local practices.

As far as solutions go, each situation is unique, but our IIED report offers a general set of actions for companies to follow:

 

  • Early-stage planning and assessmentare key to success, and companies should collaborate across stakeholder groups to understand the local context and enable clear planning, as early as possible, even before contracts are signed.
  • Underdeveloped local marketsare a limiting factor. Companies should work proactively to build long-term capacity in local markets to service the oil and gas sector (and broader economy) in the future.
  • Company procurement processescan play a role in proliferating performance standards, sharing good practices, resisting corruption and increasing transparency and accountability.
  • Contractsthemselves need to contain a balance of incentives and penalties, to ensure that environmental and social performance are given equal treatment alongside speed and cost of delivery, and to ensure that standards and expectations are clearly understood and contractors are empowered to make the right decisions.
  • Training and capacity buildingon the job will help improve contractors’ ability to deliver in the real world, and to keep the focus on the overall outcomes, rather than just on distinct and limited tasks.
  • There are many good mechanisms for providing oversight and good quality communication throughout the contracting chain, including encouraging contractors to do more of the front-line engagement with stakeholders in the community.
  • Reporting, responsiveness and good community liaison activities will help build trust and accountability with external stakeholders.

Can the industry change?

The oil and gas industry needs to foster a culture of teamwork and shared ownership. Companies need to put the right procedures and incentives in place to promote risk-preparedness, openness and collaboration throughout oil and gas operations. There should be less reliance on paper exercises, more on culture and communication. 

International and national oil companies, lead contractors and subcontractors will need to develop tools and attitudes that support a joint approach to project success. Project partners must support one another in identifying and resolving problems and challenges, not avoiding them or deferring them to others. An emphasis on long-term time horizons and outcomes is critical, regardless of the timeline of individual activities.

There should be a common agreement to improve industry-wide practices to increase capacities and participation among local firms. This may include common procurement practices, a code of conduct or industry commitment, common audit mechanisms and other tools.

The responsibility for action does not lie only with the industry itself. Governments can make it difficult or even impossible to ensure good performance. National oil companies are often inadequate in their response to the environmental and social challenges, and impossible to influence. Under-developed local contractor markets are the result of long-term failures of markets and society.

We need to move away from our reliance on standards and commitments on paper to judge oil industry performance and guide ethical investment. And civil society has a responsibility to become more aware of these challenges and be prepared to challenge accepted ways of thinking.

The solutions are long term and require a lot more research and collaboration. We hope this is the beginning of a lively and responsible debate with greater and deeper collaboration to come.

Judy Kuszewski is a UK-based consultant specialising in sustainable business.

Emma Wilson is a senior researcher in the Sustainable Markets Group at the International Institute for Environment and Development.

Kuszewski and Wilson are authors of the new International Institute for Environment and Development report, “Shared Value, Shared Responsibility: a new approach to managing oil and gas contracting chains”.

  



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