MAXIMIZING VALUE FROM TECHNICAL

(OPERATIONAL) AUDITS IN OIL AND GAS

Agenda for the day…

◎ Background to Internal Audit

◎ Introduction to Technical Audits

◎ Practice Exercises

◎ Generating value from Technical Audits

BACKGROUND TO INTERNAL AUDIT

Introduction

The role of internal audit is to provide independent assurance that an organization's risk management, governance and internal control processes are operating effectively. Internal auditors deal with issues that are fundamentally important to the survival and prosperity of any organization. Unlike external auditors, they look beyond financial risks and statements to consider wider issues such as the organization's reputation, growth, its impact on the environment and the way it treats its employees.

Governing Body / Board /Audit Committee

Senior Management

1st Line of Defense

Management Control

Internal Control

Measures

2st Line of Defense Financial Control

Security

Risk Management

Quality

Inspection

Compliance

3st Line of Defense

Internal Audit

Ext

ern

al A

ud

it

Reg

ula

tor

The Three Lines of Defense Model

Adapted from ECIIA/FERMA Guidance on the 8th EU Company Law Directive article - 41

Evolution of Internal Audit

The origin of auditing goes back to times scarcely less remote than that of accounting. Whenever the advance of civilization brought about the necessity of one man being entrusted to some extent with the property of another, the advisability of some kind of check upon the fidelity of the former would become apparent.

Establishment of a formal internal audit function for assurance to management was started to be seen as a logical answer.

1

1910s

Establishment of IIA and statement of responsibilities of an Internal Auditor

2

1940s

Broadening of Internal Audit’s role in the services to management (such as compliance and quality)

3

1960s

1. Performance measurement of internal audit departments

2. Planning, Fieldwork & Reporting

4

1970s

Internal audits not just limited to financial and compliance – Performance, Projects, etc.

5

1990s

Internal Auditors with specialized industry backgrounds – Oil & Gas, Technology, etc.

6

2000s

Need of technical audits

Effectiveness & efficiency of operations

Profit maximization

• Defined ‘Vision’ of the company • Business Plan and Business Strategy • Business Process Risk Management • External & Internal Audits • Policies & Procedures • Engineering & Technical Services • Defined ‘Key Performance Indicators’

Accuracy of financial reporting

Adherence to quality standards

Safeguarding of assets

Return over investment (ROI)

Compliance with laws & regulations

Achieve company’s mission & vision

Health, safety & environment

Process Safety

Stakeholders Assurances

Business Assurances

Steps taken to achieve them…

Technical Audits ?

Piper Alpha Disaster

• The root cause of the Piper Alpha disaster in North Sea that resulted in 167 casualties in 1988 was traced

to inadequate risk assessment exercise conducted by the oil & gas industry as a whole.

• Routine maintenance of a pressure safety valve (PSV) was not completed, and Pump A’s status was not

communicated to the incoming crew. A breakdown of Pump B caused the crew to restart Pump A,

unaware of its PSV status. In the absence of a working PSV, the pump A leaked gas, causing an

explosion. The control room was destroyed. As the crew waited for evacuation orders, subsequent fires

engulfed the platform, and the death toll surged.

Series of events resulted in catastrophic disaster

• In Piper alpha the major problems were the platform design and the permit to work system.

• The platform management failed to provide a safe workplace.

• Piper Alpha had been audited and passed by the regulator 7 days earlier.

• The regulator had failed to audit the system.

What were the risk?

“The Cullen enquiry made

106 recommendations for

changes to North Sea

safety procedures”

INTRODUCTION TO TECHNICAL AUDITS

What are technical audits

Audit of Technical Aspects in Oil & Gas Industry Investments and Capital Projects

Audit of Functional Areas

The internal auditor of an oil and gas company, needs to devote attention to certain processes around technical areas of the industry, such as, geological and geophysical activities, engineering and construction activities, HSEQ etc.

Identification of associated risks that can impact the business and inclusion of cost containment strategies that undermine profitability and affect the company by reducing the amount of capital available for capital projects.

Capital project required focus on effective project management, cost management, supplier performance management, risk assessment, safety provisions, contracting strategy and operating model design to minimize the cost and completions of project on time. Audit Plan

Characteristics of oil & gas operations

Substantial Business Risks Capital Intensive Highly Regulated Operations Unconventional Accounting

• Non-discovery of reserves in any one location.

• Subject to rapid market changes in supply and demand.

• Significant health, safety & environmental risks.

• Companies must recoup enough products from successful ventures to recoup investment in dry holes as well as overheads.

• Geopolitical and market risks.

• Significant upfront capital cash outlays yield recovery over long-term

• Capital expenditures do not always result in economically viable outputs (wells / transactions / projects).

• Rights for exploring are given by the government.

• The manner of protecting environment is highly regulated.

• Environmental & quality regulations.

• No relationship between costs and underlying assets. In most industries, at the date an asset is acquired, its value exactly equals its cost whereas in oil and gas exploration, the underlying values of Oil & Gas reserves has no relation with the cost of exploration.

• Dynamic characteristics of hydrocarbon product resulting in uncontrolled fuel & loss.

• Value of discoveries is recognized over time as hydrocarbons are produced long after the economic event giving rise to them has occurred.

Focus Areas for Middle East Oil and Gas Business Stated Need of Businesses

Text

Text

Awareness

of Risk Governance

Assimilating & Exploiting Advanced Technologies

Accelerating Asset Development

Improving Operational Reliability, Effectiveness and Performance Management

Enterprise Risk Management

Investments and Capital Projects

Creating Local Capabilities and Opportunities

Focus Areas for Middle East Oil and Gas Business

Meeting Expectations

Finance Audit Procurement Audit

Project Management Audit Support Function Audits

Exceptional

Audits focusing on: • Operations reliability,

efficiency and effectiveness • Technical competency

assessment • Audit of new technology

proposed

Stated Industry Requirements The Real Objective Overall Value

The Real Problem

Redefining and redesigning the company’s core strategies to be competitive in

current scenario and at the same time containing

risks within ALARP levels

Greater Context

Progress to be in line with changing competitive landscape

Mechanisms

Substantial investments in advanced technologies

SMART KPIs

Risks

Failure to adopt Failure of technology

Incorrect reporting

Mitigation Measures

Strong Internal Controls frequently tested and reported by Internal

Audit

Stated Need

• Assimilating & Exploiting Advanced Technologies

• Accelerating Asset Development

• Improving Operational Reliability, Effectiveness and Performance Management

• Enterprise Risk Management

• Investments and Capital Projects

• Creating Local Capabilities and Opportunities

EXERCISE 1: INTERNAL AUDIT PLAN

Exercise 1: Internal audit plan Based on your historic (last 5 years) assessment of your organization’s risks and the Internal Audit Plans in place in your organization, kindly list down your top 5 (actively managed) auditable areas.

Upstream Midstream Downstream

• Crude Oil/ Gas Production (Offshore/ Onshore Operations)

• Rig Operations • Production Planning & Mass Balancing • Field Development • Reservoir Management & Monitoring • Asset Integrity Management • Well Control Activities • Drilling Services

• Vessel Construction / Chartering • Vessel Fleet Management • Vessel Mobilization • Vessel Maintenance • Vessel Disposal Management • Operations – Pipelines and Terminals • Freight, Chartering & Demurrage

• Economic Scheduling & Planning • Technical Services • Oil Storage & Movement • Fuel & Loss Accounting • Refinery Operations • Crude Oil / Product Trading • Risk Management (Paper Trade) • Energy Management

Enabling Functions Across the Value Chain

• Procurement & Contracts • Logistics • Inventory Management • Health, Safety and Environment (HSE) • Process Safety Management • Finance & Accounts • Legal and Insurance • Facilities & Services (Admin.)

• Human resource • Utilities Management • Fixed Asset Management • Business / Expansion Planning • Knowledge Management • Research & Development • Technology & Skills Management

• Business Continuity Planning • Joint Ventures / Tie-ups • IT infrastructure and controls • Asset Integrity • Turnaround /shutdown maintenance • MIS • Laboratory

Do we have answers for…

Minimizing NPT and recovering NPT

losses from Contractors

Consistency & accuracy in accounting

assumptions of crude oil & products

Unsafe operating conditions and

compliance with Process Safety

guidelines

Periodic inspection and corrosion monitoring of critical assets

Compliance with environmental

regulations for air emissions, effluent, ground water & sea

water Update of Reservoir Simulation model in

line with current geographic & plant

operating conditions

Accuracy and reporting of

identified (flaring, etc.) & unidentified

refinery losses

Increasing turnaround and

maintenance costs over the years

Refining Production &

Operations Audit

Process Safety Management Audit

HSEMS Audit

Maintenance Management Audit

Hydrocarbon Accounting Audit

Rig Operations Audit

Asset Integrity Management Audit

Reservoir Management Audit

TECHNICAL AUDITS

EXERCISE 2: TECHNICAL AUDIT SIMULATION

Crude oil losses could be significant value for oil and gas company in the GCC

2%

6-8%

Production losses

O&G companies’ production losses

What is the value at stake?

Best in class

GCC

Oil companies often do not have a precise material balance Material flow chart for crude oil (simplified)

Pipelines 2nd stage

Storage

Major Pipeline

Railcars

Tankers

Production from well

1st stage Gas separation

Water separation

Losses occur along the full chain

Group metering

station

Illustrative Risks Typical Consequences

• Frequently inadequate or outdated norms of technological losses • Incorrect measuring systems • Inadequate tracking process • Accounting system not adequate for accounting for losses • Separate accounting tracking of losses at different stages not aligned • Lack of integrated system • Inaccurate tracking of water drainage quantities

• Management lacks precise information on production potential

• Lost profit • Environmental damage • Inaccurate financial reporting

Crude oil losses happen due to several components Crude oil loss components

Vaporizing Pipeline and

transportation leakages Fraud Inaccuracy in measurement system

• Under-loading during terminal uploading operations

• Stealing from pipelines /wagons using tabs

• Calibration of equipment

• Physical tampering

• Lack of in-house oil load control

• Spurious errors – instruments are misread

• Systematic errors – incorrect calibration of tanks and metering systems

• Random errors – parallax errors in thermometers held with stems not perpendicular

• Operating conditions - flow rate, temperature, pressure, fluid viscosity, API gravity factor

• Absence/insufficient amounts of meters at key measurement points

• Dirty or dented filled measures • Tilted tanks, tanks with flexing

bottoms or insides are • coated with sludge and encrustation • Meter factor sensitivity to flow rate,

temperature, pressure and API gravity

• Difference in oil accounting methods by departments

• Quality of loss norms • Pipeline shut down

losses – line pack effect

• Calculations of crude oil bank formula for main pipelines

Physical Losses Accounting Losses

Inconsistent methods of calculation

• During marine transportation

• During loading and discharging operations

• During storage in onshore tanks

• Corrosion of pipelines • Pipe plugging • Lack of new technologies

in pipeline infrastructure • Irregular visual

examination of pipelines • Load and discharge

difference • Tank leakage due to

incorrect strapping – tape, tilted tanks,

• flexing bottoms, walls with sludge and encrustation

• Incorrect use of chemical reagents

• Irregular pipelines intelligent pigging

Approach to reducing oil losses is based on systematic and structured identification and elimination of root causes

Analyze Identify sources Define root causes Develop actions to

eliminate root causes

Monitor and manage

performance

• Understand the data entry process and the integrity of the data used to populate the report

• Put in place and analyze - loss/gain report - daily observation report - pipeline repair plan - inspections report - oil production

calculation - non-routine

maintenance report

• Investigate potential source areas of losses: personnel, procedures, facilities, equipment and its calibration, piping, computers/ calculations, security, accounting changes

• Interview the personnel responsible for the measurement systems and accounting systems

• Visit measurement facilities to review the measurement system design, equipment, and procedures

• Determine if the proper procedures are being followed in accordance with company and industry guidelines

• Understand the problem, how the problem led to a loss (or gain) and most importantly what is required to resolve the problem

• Provide detailed recommendations and responsibility assignments to ensure complete resolution

• Upgrading measurement equipment using improved operational procedures and instituting on-going training program for measurement personnel should help pipeline loss/gain stability

• Monitoring losses and gains on pipeline systems is an essential part of the measurement process

Ke

y

Insi

gh

ts

Analysis of the current situation based on reports

Share ownership of the problem as well as the credit for its resolution

Facility review and procedures check

Resolving the loss or gain Improving the measurement system

Act

ivit

ies

Examples of measures to reduce losses Crude oil loss components

Vaporizing Pipeline and transportation

leakages Fraud

Inaccuracy in measurement system

Inconsistent methods of calculation

Actions that do not require major investments

Actions that require investments

Fundamentals • Good inventory controls • Good measurement system implementation • Good accounting system: continuous monitoring of data – loss/gain report

• Accurate calculation of vapor loss

• Regular thorough inspection of the facilities

• Introduce procedure to catch loss/ gain for pipeline shutdown periods

• Regular visual examination and maintenance of pipelines

• Management to introduce continuous monitoring of losses/gains

• Complete offloading/fully loading of marine tanks

• Regular measurement training of personnel

• Consistent measurement procedures – process and timing

• Analysis of fluctuations in manual measurement data

• Regular calibration of control and measuring equipment

• Oil accounting methods unification for different departments

• On-going training of personnel

• Proper approval of changes in the calculation methodology

• Procedure to calculate extraction loss norms

• Tone at the top, hotline and communication

• Preventative regular operational audits by internal audit

• External security company

• Timely fraud investigations

• Replacement of equipment/ tanks to catch oil vapors

• Oil pipes replacement • Construction of reserve pipelines • Installation of valves in pipelines • Installation of missing control

equipment • Bottom loading

• Installation of missing control equipment

• Replacement of outdated measuring equipment for higher precision

• Software solution implementation that allow to control material balance.

• Video monitoring

• Technology/ERP system implementation

GENERATING VALUE FROM TECHNICAL AUDITS

Technical Audits – generating value Technical audits penetrate through company’s core business processes to not just identify non-compliances or inadequate governance, but also long-term process improvement opportunities.

Time

Ben

efit

Continuous reduction in Gross Refinery Margins (GRM).

Inadequate controls to restrict unauthorized changes to refinery linear programming (LP) model.

Basis of inputs received by EPS from other departments (operations, trading etc.) is not standardized.

Improper monitoring of production activities may lead to financial loss Absence of quality check process may result in possible excess giveaway to customer leading to financial loss.

Work Stream Driven Examples of Risk in O&G

Inadequate preparation and maintenance of control room activity log books may result in absence of complete information for actions performed and authorized in previous shifts.

Non compliance to maintenance schedule of data acquisition equipment may delay data acquisition process. Absence of defined critical path may delay the data acquisition process.

Inadequate measurement and reconciliation of gas and liquid quantity supplied / invoiced to relevant receiver may result in high unidentified losses.

Short Term (Compliance)

Longer Term (Process Improvement)

Total Benefit

Thanks! Any questions?

You can find us at:

@ Anuj Agarwal | Anuj.A@protivitiglobal.me

@ Saurabh Dubey | Saurabh.Dubey@protivitiglobal.me

Case Study I – Flaring on offshore platforms

• Monitor and analyze flaring quantity from each flare stack periodically. • Define a standard maximum flaring quantity guideline from each offshore platform as done for onshore flaring (0.3% of lean gas

production). • Identifying root cause for instances with high flaring and high variations from routine flaring in platform P2.

Observation

The client had two offshore platforms for production of natural gas. Both platforms have similar operations. There were meters installed in flare stack of each platform to measure the flaring of pilot burner gas, purge gas and process gas. Pilot gas and purge gas were maintained at constant flow rate. We noted that: • There was no process to analyze the daily flaring quantity within a platform and among the two

platforms. • The average quantity of pilot and purge gas flaring from P2 platform was higher than P1 platform

average by 10% (40,000 SCFD) daily. • The quantity of pilot and purge gas flaring is constant each day on P1. However there is inconsistency

in rate of flaring for P2. The quantity of pilot and purge gas flaring varied with a standard deviation of 15,295 SCFD.

A large JV company with gas explorations and production, transportation and distribution.

Cli

en

t Upstream Midstream Downstream

Oil Gas

Efficiency Business Continuity

Profitability Safety & Environment

Comparative Flaring Analysis (in MSCFD)

P1 Avg.

P2 Avg.

Key Recommendations

Case Study II – Standard T&Cs for NPT in contracts A large JV company with gas explorations and production, transportation and distribution.

Cli

en

t Upstream Midstream Downstream

Oil Gas

Efficiency Business Continuity

Profitability Safety & Environment

• Implement Standard Terms & Conditions for NPT in drilling contracts for avoiding any possible financial loss. • Identify and implement possibilities of including penalty / deduction clauses for contracts where NPT was not applied previously. • Document the process for NPT monitoring and reporting.

Observation

Non Productive Time (NPT) is the time elapsed between the non-conformances and returning back to

the same position before the event occurred. It is the time spending to recover from the consequences

of the incident. NPT only includes time where operations could proceed normally (e.g. waiting on

weather is not included in NPT). We noted that:

• There was no documented process for monitoring and reporting of NPT.

• The standard terms and conditions in relation to NPT were not applied consistently across all

contracts.

• Absence of a penalty clause for NPT in major service provider contracts that led to potential loss

(approx. USD 1.1 Million).

NPT Computation (Year 2010 to 2012)

Key Recommendations

Case Study III – Stock accounting of Crude Oil A large oil exploration company operating in onshore.

Cli

en

t Upstream Midstream Downstream

Oil Gas

Efficiency Business Continuity

Profitability Safety & Environment

• Calculate and report the year-end based on actual water content in storage tanks as on year-end date.

• In instance of repetitive differences between ATG readings and manual dips across multiple months, the frequency of

correction of ATG reading with manual dips should be increased to weekly for specific tanks.

• Analyze the hydrocarbon content in sludge each year. If possible the analysis should be conducted in the month of December

to improve the accuracy of year end stock estimation.

Observation

We noted an inaccuracy of 17,083 barrels in year end crude oil stock accounting for the year 2013. Following were the contributing process gaps resulting in incorrect crude oil stock calculation: • The water content in tank was considered based on manual dips measured in November 2013 and did not account for quantity of water drained

from tank in the month of December 2013. Incorrect estimation of water content in storage tanks as on 31 December 2013 resulted in underestimation of crude oil stock by 12,355 barrels.

• Uncorrected continuous difference between automatic tank gauge (ATG) and month end manual dip readings resulted in underestimation of crude oil stock by 4,727 barrels.

• There was no defined frequency for assessment of hydrocarbon content of sludge in the storage tanks. In the last 8 years, the sludge sample was analyzed for hydrocarbon content only 2 times. This may result in incorrect estimation of crude oil stock by 1,397 to (1,985) barrels.

Key Recommendations

Case Study IV – Integrity Inspections of Pipelines A large JV company with gas explorations and production, transportation and distribution.

Cli

en

t Upstream Midstream Downstream

Oil Gas

Efficiency Business Continuity

Profitability Safety & Environment

• Update the details of these new pipelines in pipeline inspection planning and monitoring application. • Conduct baseline inspection for these pipelines and develop asset integrity inspection plans. • Include the process of application update and asset integrity plan update as a part of project closeout procedure for pipelines

commissioning.

Observation

In January 2012, 2 new gas pipelines were installed in the gas distribution pipeline network of the company. As per the Pipeline Inspection and Surveillance Procedure of the company baseline inspection was required to be conducted within 12 months of pipeline commissioning. We noted that: • It has been over 2 years the pipelines have been commissioned and taken in operation

however, the details of these pipelines were not present in the application which is used for planning and monitoring of inspections for pipelines.

• Subsequently, these pipelines were not included in asset integrity plans for visual inspections, ultrasonic testing, inline or outline inspection etc.

Details of 2 New Pipelines Installed

Pipeline Diameter

Length of Pipeline

Type

24 inch 425 m Above ground

18 inch 481 m Above ground

Key Recommendations

Case Study V – Dip in stock level of ‘Static’ Tanks An oil refining company operating two refineries and producing over 30 million metric tons per year of products for the local and export markets.

Cli

en

t Upstream Midstream Downstream

Oil Gas

Efficiency Business Continuity

Profitability Safety & Environment

• Conduct physical inspection of all the tanks for verifying that isolation valves of storage tanks are working effectively.

• Monitor & record shift wise closing stock levels for tanks in static condition and highlighting to the Supply Division in case of

significant difference observed in tank levels.

Observation

Supply Division provides the Daily Disposal Report to the Oil Movement section for storing the crude oil received and moving products in the Refinery as per requirement. Senior Operator manages all transfers online through Distributed Control System (DCS) from control room and provides instruction to field operator for isolation. Based on our review of hourly ATG readings of crude oil and product tanks for the month of December 2012, we noted following: • Difference in transferred Gas Oil quantity from intermediate tank to final product tank in 4

instances in the range of -13 KL to 271 KL. • In 20 instances though the tank was in “static” condition as per log book there was a continuous

dip in stock levels as per the ATG readings even after considering the drained water level. Deviations were in the range of 9 KL to 102 KL for 10 tanks.

Analysis for dip in ‘Static’ Product Tanks

Key Recommendations

Rig Operations – Key Focus Areas

• Review effectiveness of rig acceptance and safety surveys.

• Compliance to company and country specific standards for rig inspection and acceptance.

• Review of NPT accounting process and cost impact analysis.

• Effectiveness of Rig Bar Chart preparation and periodical revision.

• Review of equipment certification as per industry standards.

• Adequacy of visual equipment inspection.

• Compliance to procedure for onsite acceptance testing and commissioning.

• Rig Utilizations.

• Review of rig maintenance procedures and benchmarking against international standards.

• Monitoring and evaluation of Rig deployment.

• Review efficiency and effectiveness of the Management of Change procedure.

• Incorporation of emergency response procedures as part of safety procedures.

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Process Safety (PS) – Key Focus Areas

• Preparation of risk Analysis of the key Process Safety (PS) risks for each site.

• All aspects of modern integrated PS management systems are considered.

• Check PS compliance to ensure that the Corporate PSM system as outlined in the HSEMS manual has been effectively implemented;

and that the necessary changes to the Control Procedures to attain current PS standards such as in OSHA and other standards are

identified and recommendations made.

• Potential Hazards have been identified at all existing facilities and new facilities.

• The enhancements to HSEMS and Control Procedures necessary to meet current PS standards are identified and recommendations

made.

• PS plans and Objectives are in accordance with Country’s Laws.

• Sufficient Human, Physical and Financial resources have been allocated to attain PSM Objectives.

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