OCI Compliance & Governance, Part I
Introduction
Compliance & Governance, the module everyone loves to hate. It is my hypothesis that everything went wrong here, at compliance and governance. What I mean by that is in the 1960’s when computers were introduced to oil & gas companies. The question arises: what will we do with them? And of course the answer is accounting. As they became ever more powerful and successful, they added more tasks to their duties and added the natural follow-on concerns of tax, royalty and compliance. Soon the culture became focused on those “compliance” requirements of the “firm” and the Joint Operating Committee developed into something that is used there. Soon after this engineers and geologists began speaking a different language to "business" types. Divisions grew and the corporation focused on the need to file the necessary paperwork with the appropriate agency in the required time frame on the appropriate colored form.
Anyway the real business of the business, the Joint Operating Committee somehow survived. When we align the compliance and governance frameworks of the hierarchy to the Joint Operating Committees legal, financial, operational decision making, cultural, communication, strategic and innovation frameworks everyone can start speaking the same language as the engineers and geologists and get some real business done. And as People, Ideas & Objects research shows this would provide the oil and gas producer with heightened speed, innovation, accountability and profitability.
Compliance & Governance is the eleventh module in the fourteen module Preliminary Specification. It’s also no accident that I added Compliance & Governance last, as the question that should be asked is this one. How are we able to ensure compliance with all the regulations for all the module specifications we've discussed so far? And I would assert that this is why these are user-based developments. One thing governments seem to like today is regulations on oil & gas companies. Information Technology enables various governments to issue technical business rules, technical specifications, XBRL syntax and other technological frameworks for these regulations. The ability to write these "frameworks" has only encouraged governments to write more regulations. The larger point is that these frameworks provide software developers with distinct advantages in enabling regulations within software.
Earlier, we indicated that the scope of People, Ideas & Objects was determined by our user communities. Part of that scope determination will include which regulations it must comply with. With so many jurisdictions requiring compliance, each transaction may need to be assured of compliance with multiple jurisdictions. In addition, a transaction may be generated through a Joint Operating Committee owned by a variety of producers. Who may come from an international background and the Compliance & Governance module gains importance.
From the point of view of a producer, maintaining the database and applications for all of the compliance frameworks producers have to worry about is a difficult task. The number of people you need to keep your applications up to date is significant. However, with People, Ideas & Objects, as one software developer acting on behalf of the industry as a whole, the job becomes much more specialized and manageable. Then again if we were building these applications to serve an industry we would use the division of labor and specialization to manage these tasks in a way that would significantly lower the costs of compliance, and increase the quality of the producers' compliance.
These applications must comply with dozens of different jurisdictions in terms of royalty compliance. Approaching this from a software engineering point of view as a sole producer is not cost effective. When these costs are replicated within each producer organization, we begin to see the costs of compliance escalating to the levels that they are today. There is another way, and that is we move away from individual producer compliance and governance capabilities and rely on industry wide capabilities. That is what is proposed here in People, Ideas & Objects. In addition, we are proposing many other innovative ways to deal with oil & gas industry issues.
Automation, Specialization and the Division of Labor
We noted the opportunity of centralizing software development costs and efforts for Compliance & Governance frameworks under one roof. That is to say that instead of each producer building the in-house capacity to keep software and compliance up-to-date, it is preferable to have it organized and managed through People, Ideas & Objects. I want to take that concept a bit further and break down another element of the cost of compliance. I want to discuss how that element could also be done in a centralized manner. That element is of course the accounting and administrative costs incurred in meeting the regulations requirements. The costs of which are incurred in the human resources and associated overhead. These costs are an area where specialization and the division of labor could be applied and build real value for the producer firms.
It comes down to the question of where is the compliance work done, at the Joint Operating Committee, or at the firm? It needs to be done at the firm as all the variables are unique to each producer. Within the Preliminary Specification we use the decentralized production model. This sees the prototypical producer firm reduced to C class executives, earth science & engineering resources, some land, legal and support staff. In the case of compliance and governance resources they are provided to the producer firms through industry-based service providers. This moves the producer's compliance and governance to be relied upon through the industries compliance and governance capabilities of service providers.
If we approached accounting and compliance reporting requirements on an industry wide basis and used specialization and division of labor we could add significant value to the industry. Taking the organization of accounting across the industry and building compliance and governance needs for all producers would provide value at lower costs and better service. This is because of the advantages of the division of labor and specialization. Where the accounting and administration service providers specialize in one and only one compliance requirement. Particularly in the area of compliance reporting, especially royalties, where the knowledge of the people employed in the compliance service would be so specialized that they could ensure that their clients' royalty obligations are the lowest possible. With royalties being the largest cost component of a producer this would certainly be of value but there are greater efficiencies than these available. There would also be the ability to manage the process with the most efficient team available.
These are two elements of compliance costs. As we mentioned earlier, maintaining compliance with the regulations is expensive. And two, accounting and administration done to keep the firm up to date by service providers. If the software can be maintained on a global basis on behalf of the industry by People, Ideas & Objects then the one-time costs of the software can be amortized over the industry as a whole. And if accounting and administration costs can be managed through the centralization of the accounting and administration function within an industry wide capability within service providers, then automation, specialization and the division of labor come into play. And the industry benefits by reducing their costs by reducing the two largest components of compliance costs in the most cost effective way. Yet, they have also done so in the manner where their compliance quality is high.
Another element of quality also comes into play due to the proposal from People, Ideas & Objects. That element is time. If the timeliness of the information is within the guidelines, or earlier, the quality of that information is much higher. It seems that the high levels of automation, specialization, and division of labor contained here will ensure that the information we are building is timely and will exceed the regulatory deadlines. This timeliness doesn't come at the expense of accuracy.
Lastly when we discuss moving the compliance and governance frameworks of the hierarchy into alignment with the Joint Operating Committees legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks. We state that this provides increased speed, innovativeness, accountability and profitability. When you align compliance and governance with operational decision making, accountability results.
Compliance for Everyone
In a capital intensive business such as oil & gas, access to capital is a critical capability producers need to develop within their operations. In order to have access to capital you must meet the regulatory requirements and compliance needs of the capital markets. Therefore the Compliance & Governance module of the Preliminary Specification is a critical capability for all those dedicated to building an innovative oil & gas producer. This principle applies equally to ExxonMobil as to the startup oil & gas company.
And ExxonMobil should be concerned that the start-up oil & gas operation maintains its compliance and governance in good shape. Why? You can’t pick your neighbors and all of your partners. Sometimes you have to deal with partners with a history you're unfamiliar with. You want to make sure that they can operate in a fashion that is consistent with standard industry practices. It is those standard industry practices that include high levels of compliance and governance in today’s oil & gas industry operations. What about tomorrow’s environment?
As we've discussed, regulators' expectations with respect to compliance are high. It appears that no relief will be forthcoming. On the contrary, we should expect requirements to grow. This is the only reasonable expectation. However, I would ask, have we implemented these compliance frameworks correctly? Have the regulations submitted in technical frameworks been integrated into the ERP system, or just attached?
We can see the answer to that question when we find that no current ERP system calculates the Gas Cost Allowance for royalty calculations. To conduct these types of calculations you would need to integrate the royalty frameworks deeply within the ERP systems, and that’s not been done. So when it comes to the automation of the compliance frameworks, which is the objective of the regulators in publishing these technical frameworks, nothing’s been done from the industry side.
I have argued that there are two ways to approach oil & gas problems. One is to automate processes. This requires the high capital costs of software development such as what People, Ideas & Objects have proposed. Or, you can employ human resources to maintain compliance requirements manually. This is the method the industry chose to pursue. I would ask when;
The cost of capital remains historically low.
- The demand for human resources is somewhat constrained.
- Regulators have published technical frameworks.
- Why wouldn't oil & gas producers develop the People, Ideas & Objects applications?
Automation of the compliance frameworks within the People, Ideas & Objects applications would provide many benefits to the innovative oil & gas producer. The costs of this engineering work are amortized over the entire producer population. Making these highly engineered software solutions incidental in terms of actual cost to each producer. Access to these systems would benefit all producers in the industry. Providing each producer with the capability to meet or exceed the minimum industry standards. In a world of increasing demands, your partner's capabilities could become a critical issue for your operation. There is a compelling argument here about the compliance aspects of the Compliance & Governance module.
Governance of Self-Organizing Groups
The manner in which much of the work is done in the People, Ideas & Objects Preliminary Specification resonates with the ideas of how work will be done in the future. Direct supervision is replaced by self-organizing groups motivated and directed by their property's performance. This creates the environment that people aspire to work in; and the governance issues that this creates for the firm. This discussion deals with governance issues and how the governance areas of the Compliance & Governance module reels in the vision of self-organizing groups to something that is more workable and sensible in the commercial environment.
Firstly, Industrial Command & Control isn't just for Joint Operating Committees. Although we have discussed it in terms of just the Joint Operating Committee, there is nothing stopping the firm from using the organizational overlay within the firm. This also applies to the Work Order system. These two tools would provide the firm with the ability to make sure that tasks were assigned and completed as budgeted. In addition, execution was consistent with firm expectations. With the use of these systems, it is understood that no other work is undertaken without the ability to charge time or costs for a Work Order. Assuring that no unauthorized projects are undertaken. The Work Order system would also provide the internal control necessary to ensure that the appropriate people necessary to achieve governance are assigned to approved projects. These people are capable of meeting the tasks requirements. When “things” turn out wrong it’s usually at the beginning and having that “governance” information available is the objective of this capability.
Internal controls of firms and Joint Operating Committees seem to be a lost art in the toolkit of today's executives. The ability to set up a control to trigger a warning that something is happening that is inconsistent with normal policies may have been implemented more in the past than today. The power of technology seems to work hand in hand with internal controls. I think they provide a strong governance method that should be built into the People, Ideas & Objects governance area of the Compliance & Governance module. That there needs to be a section devoted to building database “triggers” and “stored procedures” that are used by the firm to monitor areas of the firm's activities. These of course are available to those individuals with the appropriate authority to access the data and information necessary to run queries, and to fully appreciate the art and science of internal controls.
Governance in the Service Industry
Discussion of the governance of one of the capabilities processes documented in the Research & Capabilities and Knowledge & Learning modules. The specific process takes the ideas generated throughout the oil & gas and service industries. It funds them, develops commercial products and services, develops the producers capabilities, transfers those capabilities to the Joint Operating Committee and learns through their application. As we can see this is a long term process with many open ended elements that could be lost in the shuffle. In addition, there are aspects of the process that are too tempting.
It's advisable to take a step back and discuss why we are implementing this process in the Preliminary Specification. Simply put, we have two choices for providing producer firms with service industry products and services. We can let the market provide all of the products and services, or we can have the producers conduct all of the work. This includes manufacturing drill bits to produce oil. We currently have a situation where producers are dissatisfied with the service industry and micromanage that industry through control of the market. Today the service industry has been fundamentally destroyed. Access to capital is unavailable, and may be for a generation or more owing to oil & gas producers' actions. A comprehensive and involved rebuilding of the service industry by oil & gas producers on a philanthropic basis will be the only way forward.
It is here within this “capabilities” process that the firm's governance must enforce the firm's boundaries. The division between the market and the firm, and where that division lies, needs to be enforced within this process. The producer firm is only concerned with their land & asset base and earth science & engineering capabilities. Everything else must be provided by the marketplace. The producer's role is to provide vision and leadership to the marketplace and seed that market with funding. In a paper written by Professors Richard Langlois and Nicholas J. Foss entitled “Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization," they note.
The organizational question is whether new capabilities are best acquired through the market, through internal learning, or through some hybrid organizational form. And the answer will depend on (A) the already existing structure of capabilities and (B) the nature of the economic change involved. p. 20.
The economic change the producer is facing is commodity prices reward the innovative producer. Focusing on purchasing more drilling rigs is not where producers generate value. Governance by the producer must maintain the focus on where the producer can generate the greatest value, on finding and developing oil & gas reserves, otherwise...
If by contrast, the old configuration of capabilities lies within large vertically integrated organizations, creative destruction may well take the form of markets superseding firms. History offers many examples of both. p. 20.
To ensure focus and governance on this process, the producer should rely on the Work Order and Industrial Command & Control of the Preliminary Specification. Distraction away from the producer firm's objective is possible when dealing with marketplace noise. The Work Order will ensure that no work is done on unauthorized projects and that a chain of command is implemented in the administration of each project. This will help to ensure that each project is ultimately focused on providing the producer with the highest returns on oil & gas reserves discovery, enhancement and production.
This discussion may seem like a fundamental contradiction regarding producer involvement in the service industry. I am critical of the way producers have involved themselves in the service industry. The producers' dissatisfaction with the costs, products and services provided to them by the service industry is due to the high levels of involvement of the producers in the service industries business. Micro-managing, cost control and direct ownership of things like drilling rigs are counter to the producers' interests. At the same time there needs to be stronger representation made by the producers in focusing and leading the service industry marketplace. Leadership is lacking and missed. My argument is that we need to remove the direct manipulation of the service industry marketplace by the producers and replace it with a more constructive leadership role so that the service industry marketplace can better respond to the needs of innovative and profitable oil & gas producers.