8 minute read 13 May 2021
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How tax can play a critical role in transforming oil and gas companies

Derek Leith
By Derek Leith

EY Global Oil & Gas Tax Leader; UK&I Tax Sustainability Leader

Advisor, commentator, speaker, believer, aspiring bassist and an avid Aberdeen Football Club fan.

Contributors

Andy Brogan

8 minute read 13 May 2021
Related topics Oil and gas Tax compliance Tax function operations Tax planning Tax
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In a sector undergoing tumultuous change, the tax and finance function has a significant role to play in delivering enterprise-wide change.

In brief
  • The oil and gas sector was already in a state of transformation and under pressure to decarbonize when COVID-19 hit, creating a new set of challenges.
  • Organizations are addressing the green agenda in the face of cost reduction and digitization, and this is being felt acutely by the tax and finance function.
  • There is, however, an opportunity for oil and gas companies to reimagine their tax and finance functions and help chart a new course for the broader business.

If 2020 marked a tumultuous year for the majority of the world, oil and gas was arguably one of the hardest hit sectors. The short-term issues it faced were cumulative and unforgiving.

First, Russia and Saudi Arabia had a dramatic, and very public, dispute at the OPEC meeting in Vienna, where they failed to agree on the reimposition of oil production limits. This sparked an oil price war. The resulting fall in price was then exacerbated, as the impact of widespread COVID-19 lockdowns caused a slump in demand, with oil consumption dropping by around 20 million barrels per day. The price for West Texas Intermediate (WTI) attracted worldwide attention in April, when it went negative for the first time, trading at around negative $371.

Faced with this confluence of challenges, the sector is estimated to have lost $1 trillion of revenues in 20202.

“In terms of financial performance, last year was the most challenging of the past 30 for oil and gas,” says Andy Brogan, EY Global Oil & Gas Leader. “The sector suddenly had this two-fold, short-term cash-flow management issue — the price of what the sector produced dropped, as did the absolute amount of what it sold.

“Capital providers invest in the sector primarily because it has transparent cash flows that get distributed to them on a fairly regular basis. But because of these pressures, the industry just hasn’t produced the cash it’s used to.”

While the industry is now showing signs of recovery, with commodity prices returning to sustainable levels, oil and gas companies have been left reeling by the impact, and this has amplified calls to reduce costs across the sector.

The bigger transformation picture

At the same time, there are other, equally serious, medium to long-term challenges in the pipeline — which already existed prior to the COVID-19 crisis — and these are exerting further pressure on oil and gas companies to change.

First, there’s the looming energy transition. The world is currently following a clear path from carbon-intense to renewable sources of energy, which will have a telling impact on the future of fossil fuels. Faced with constrained demand, oil and gas companies will have to transform into energy companies, producing, processing and selling greener fuels too.

Meanwhile, those companies are facing investor pressure to decarbonize their own operations. They will have to become more efficient, more sustainable and cleaner, reducing the carbon intensity of their processes, and introducing systems of carbon capture and storage.

“The industry has to manage this transition in its capital base,” says Derek Leith, EY Global Oil & Gas Tax Leader. “Going from asset classes in which it has a competitive advantage, to new asset classes where it has a lot less experience. All while reinventing its existing asset base to be cleaner and cheaper to run, and with less cash flow coming through the door.”

The digitalization challenge

In addition to the need to transform their operating models, the second longer-term driver of change is digitization. And it is here tax and finance functions come under specific pressures that will be felt more broadly across the business.

Tax authorities have been incredibly nimble in adopting technology to boost their revenue enforcement. Increasing numbers of jurisdictions are demanding that tax information is provided electronically, in real time, and tax and finance functions in the sector have realized their existing, often outdated, ERP systems don’t provide the data they need to keep up.

Failure to adapt may lead to increasing scrutiny, greater tax controversy and reputational damage — and even greater costs. As it is, oil and gas companies estimate they will spend an average $9.4 million on digital tax filing compliance over the next five years3, according to the EY Tax and Finance Operate (TFO) 2020 survey.

This focus on compliance may also draw their talent away from doing the work that matters — on average, oil and gas companies spend 65% of their time on routine compliance work and would prefer to spend much less time doing so4. Meanwhile, 89% of oil and gas companies anticipate an increase in their workload to meet digital tax filing requirements5. As much of this work is retrospective in nature, rather than creating any new value, it can feel like treading water.

“If you’re running a tax function on a tight budget and you want value, it’s surely infinitely better to employ a talented team to look forward, not back,” says Leith.

 

If you’re running a tax function on a tight budget and you want value, it’s surely infinitely better to employ a talented team to look forward, not back.
Derek Leith
EY Global Oil & Gas Tax Leader; UK&I Tax Sustainability Leader

Just to add to the list of knock-on effects, there are implications for attracting and retaining talent here too — 38% of oil and gas companies say they’re unable to attract and retain their talent for the tax and finance function of the future, which will depend far more on data, process and technology skills, in addition to technical knowledge.

This inability to recruit isn’t helped by unfortunate narratives around the role of oil and gas in the world’s greener future. But even those companies who successfully shift to more forward-looking technologies won’t be able to attract bright people if the workload they’re offering is an unchallenging stream of routine box-ticking tasks.

Faced with the drive to cut costs and to deliver greater value from their cost base, companies across the sector are turning to digital to automate whole swathes of the tax and finance function formerly handled by their workforce. Others are going even further – handing appropriate tasks to technology-enabled managed services providers, to drive additional savings and value.

But in many instances, this may not be happening quickly enough — oil and gas businesses have historically turned towards new technologies no faster than the proverbial tanker adopting a new course at sea.

An invaluable partner

Yet the drivers in tax and finance in the sector aren’t all negative and defensive. It’s important to highlight the opportunity that the function has to exert a positive influence on oil and gas businesses, by becoming a true, invaluable, strategic partner.

With the move towards decarbonization, for example, governments will be offering a huge range of incentives and other initiatives to spark and support transformation. Given the right focus, tax and finance has the chance to lead the business to where the most lucrative opportunities lie.

It may also be called upon to employ its expertise in transfer pricing, for example, as the tax enforcement environment becomes even more stringent post-COVID; and to guide the business through new tax challenges that come with switching to more sustainable operating models. These tasks require the best minds to be free to focus on the bigger picture; and for digital and managed services to take up the slack.

“We haven’t seen a transition like this digitization in the last 50 years,” says Leith. “Not since the introduction of the internal combustion engine have we seen this amount of capital being moved from one technology base to another. And it’s a tremendous opportunity.”

It’s time, then, for the tanker to turn, in what will be a fundamental transformation for the tax and finance function. Its task now is to rethink how it can best serve the strategic needs of the business.

The first step here is to decide what work it should retain in-house, which tasks to automate internally, and which it can push out to an external provider. Solutions such as EY’s TFO solution, for example, offers organizations the opportunity to build a nimble, forward-facing tax and finance function — without incurring further crippling costs. This is critical because 89% of oil and gas companies are planning to reduce the costs of their tax and finance functions over the next two years, aiming to cut their expenditure by an average of 8.2%6.

How EY can help

Tax and Finance Operate

Gain efficiencies through the right mix of outsourcing, technology and internal capabilities.

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“For oil and gas companies, the fixed cost of their tax and finance function becomes a variable cost, as it can now scale up and down in capacity as the times demand. So they no longer have to carry excess capacity, and they can instead focus on employing specialists to deliver what really matters to the business.” says Craig Mitchell, EMEIA Tax and Finance Operate.

The result is a tax and finance function that walks in genuine step with the organization through the constantly changing business and global tax landscape, efficiently and effectively handling all the tax implications of its transformation.

Digital transformation becomes about far more than mere cost-cutting and risk mitigation. Instead, technology creates an opportunity for the business to free its own highly trained, well paid, technically proficient team from mundane tasks, and push them towards high-value work, so they become better partners to the wider business.

“In today’s world, organizations need to work closely with providers who know the operating environment like their own back yard,” says Mitchell. “For an oil and gas company, tax isn’t their business. Their business is extracting, refining, distributing or selling natural resources. A tax person wouldn’t even begin to suggest they should get involved in the front-end strategy there. 

“So the question is: why would an oil and gas company attempt to build substantial capability in a back-office function like tax, when they have a far more compelling alternative?”

Five steps to transformation

How EY can help

  • Know what your stakeholders need

    The starting point of any transformation journey is being sure of what you’re aiming for. That means understanding the needs of the broader business, and what it requires of a strategic partner.

  • Understand the changing landscape

    Knowing what’s happening in the sector and the regulatory environment, and what that means for your business, is key to establishing what measures you need in place.

  • Spot the gaps

    Map the above needs against the systems and resources you have in place. Identify where the gaps are and what level of change is required.

  • Build the business case for change

    This has to balance the never-ending tension between value delivery on one hand, and cost-effectiveness and risk mitigation and management on the other.

  • Establish who does what

    What high-value work does your team need to focus on internally; which processes could you automate; and which could you hand over to an expert partner with tailored systems, to best maximize value?

  • Show article references#Hide article references

    1. https://www.cnbc.com/2020/06/16/how-negative-oil-prices-revealed-the-dangers-of-futures-trading.html
    2. https://www.cnbc.com/2020/04/30/coronavirus-creating-1-trillion-revenue-loss-for-oil-and-gas-companies.html 
    3. EY 2020.
    4. EY 2020.
    5. EY 2020.
    6. EY 2020.

Summary

The move toward renewable energy sources and decarbonization will continue to drive change within the oil and gas sector, but this is now also allied to increased digitization, transparency and a growth in green incentives. The tax and finance function has a pivotal role to play in the shifts currently taking place, to ensure businesses are fit for a very different future.

About this article

Derek Leith
By Derek Leith

EY Global Oil & Gas Tax Leader; UK&I Tax Sustainability Leader

Advisor, commentator, speaker, believer, aspiring bassist and an avid Aberdeen Football Club fan.

Contributors

Andy Brogan

Related topics Oil and gas Tax compliance Tax function operations Tax planning Tax
Upvote