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Insights on the oil and gas sector - EY - India

The Fraud Watch: January 2011

Insights on the oil and gas sector

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Although India has improved its Bribe Payers Index, it continues to be one of the five most corrupt countries in the world.

An article on fraud in the Indian oil and gas sector by Dip Mehta, Manager at EY. This article explores some of the pain points in the oil and gas sector in India, and suggests how companies can strengthen their defense against fraud.

India’s oil and gas industry constitutes around 15% of the country’s GDP and is one of the key industries in its rapidly growing economy. However, high growth due to the ever-increasing demand for energy and the Government’s focus on it has made this sector lucrative and corruption-prone. Fraud is rampant in the sector and exists in different forms.

It primarily includes illegal or unethical activities that relate to irregularities in oil and gas exploration, corruption in global oil and gas operations and fraud at gas stations or retail outlets. Fraud can be broadly classified into the following categories:

Bribery and corruption

Although India has improved its Bribe Payers Index (BPI) score from 4.62 out of 10 in 2006 to 6.8 out of 10 in 2008, it continues to be one of the five most corrupt countries in the world. The BPI survey reveals that public work and construction companies in sectors such as real estate, land development, oil and gas, and mining are most likely to bribe officials to exert undue influence on the policies, decisions and practices of governments.

Government interaction in this sector is also very high, since government licenses are vital for its operations and form an integral part of a company’s expansion plans. Therefore, procuring a license from government authorities can involve Foreign Corrupt Practices Act (FCPA) violation, especially in developing economies. In India, the Government controls the majority of businesses in the oil and gas sector, and there are very few private players dominating the sector.

Therefore, liaising with large buyers, which are government organizations, is a prerequisite in this sector.

The general perception of developing economies such as India is that infrastructure and controls required to combat corruption are lacking, which creates opportunities for undetected bribery in the public and commercial sectors.

Employees in such developing countries believe that this is the way business is conducted. The supply chain in the oil and gas sector is very complex, since there are various middlemen and agents involved at every stage. Many such agents either have a historical relationship with government organizations or have, in the past, served with government organizations or agencies.

The situation is aggravated since a great deal of work with respect to people, the import or export of machines, and permits and visas for people travelling on-shore needs to carried out regularly.

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Procurement fraud and irregularities in vendor management

The majority of companies in the oil and gas sector are public sector enterprises. Setting up infrastructure for a company in this sector entails activities such as developing offshore fields and building pipelines, as well as refineries that require heavy capital expenditure.

Corruption in the bidding process is prevalent due to the high value of the contracts offered by many public sector enterprises. The sector is also afflicted by unethical practices, such as cartelization between vendors and payment of kickbacks.

Irregularities in dealings with vendors include the creation of fictitious vendors with inaccurate or incomplete details in the Vendor Master, booking invoices and releasing payments without purchase orders (POs) or raising multiple invoices against these or open POs.

Such inadequate control on vendors’ activities can increase exposure to risks such as excess payments made to vendors. In addition, unauthorized advances disbursed to vendors may not always be recoverable.

Our study has also identified several instances of irregularities in logistics operations, such as collusion with transport vendors to avail of kickbacks and indulge in unethical practices such as coupling trucks and misrepresenting kilometers and the number of trucks. 

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Exploration, development and production costs

Companies in this sector incur heavy expenditure on the “upstream process” of discovering oil and gas reserves, since it involves the selection of highly specialized professionals or technicians, the deployment of expensive equipment and extensive infrastructure costs. Some of the key risks associated with the upstream process include:

  • Cost overruns often arise due to the inflated or fictitious costs of material or services. This may also be due to payment of bribes.
  • Tender processes are sometimes rigged or orchestrated to favor preferred vendors.
  • Material at sites is often misappropriated if contractors siphon off or divert it.
  • The period for which equipment or resources is deployed is often misrepresented, since it is difficult to assess the number of days required to complete a process in a particular region.
  • Low-grade equipment is used in processes, whereas charges for high-quality equipment are billed by vendors, , since it is difficult to assess the quality of such equipment.

Such irregularities may continue to be undetected due to the involvement of insiders such as project managers, work-certification agencies and project management agencies. To combat such challenges, companies should conduct background checks on vendors that handle large volumes and have long-standing relationships with operators. Furthermore, the company should opt for a background check on employees in critical and sensitive positions such as procurement, work certification, bill approval and project site management.

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Discounts and credit controls

EY’s study indicates that lack of strong controls has increased companies’ exposure to potential irregularities in dealings with discounts and credit control — This includes discounts that can be reimbursed on the basis of fake invoices submitted by a stockist.

The sector sees fast and compulsive sales, wherein fraud risks such as execution of unauthorized credit limits to a customer are likely to occur. At times, higher than usual discounts may be given to selected customers.

There are several other instances of fraud, such as identity theft, short measuring and price gouging of target consumers as victims.

With the risk and incidence of fraud and corruption becoming rampant, it is imperative for companies in the oil and gas sector to aim for the following:

  • Adoption of robust internal controls, backed by strong data analytics, to mitigate key fraud risks and raise “red flags” early
  • Monitoring of the bidding process for high-value deals
  • Establishing a framework to comply with anti-bribery laws and putting in place strong controls relating to procurement of licenses and permits as well as in dealing with third party agents
  • Development of a whistleblower policy or an ethics hotline that enables employees, customers and vendors to report malpractices directly to the management

With increasing challenges in this sector, the key to success is to remain competitive without compromising on quality. Cost effectiveness is a necessity, and it is in this context that fraud risk management is likely to help companies identify potential irregularities, and combat bribery and corruption.

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- Dip Mehta, Manager, Assurance, EY

*Refer to the attached PDF for source information.

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