Section A – This ONE question is compulsory and MUST be attemptedCoastal Oil is one of the

Section A – This ONE question is compulsory and MUST be attempted

Coastal Oil is one of the world’s largest petrochemical companies. It is based in Deeland and is responsible alone for 10% of Deeland’s total stock market value. It employs 120,000 people in many countries and has an especially strong presence in Effland because of Effland’s very large consumption of oil and gas products and its large oil reserves. Coastal Oil is organised, like most petrochemical companies, into three vertically integrated business units: the exploration and extraction division; the processing and refining division; and the distribution and retailing division.

Because of the risks and the capital investment demands, Coastal Oil has joint venture (JV) agreements in place for many of its extraction operations (i.e. its oil and gas rigs), especially those in the deep-water seas. A joint venture is a shared equity arrangement for a particular project where control is shared between the JV partners. In each of its JVs, Coastal Oil is the largest partner, although operations on each rig are divided between the JV member companies and the benefits are distributed according to the share of the JV.

As a highly visible company, Coastal Oil has long prided itself on its safety record and its ethical reputation. It believes both to be essential in supporting shareholder value. Its corporate code of ethics, published some years ago, pledges its commitment to the ‘highest standards’ of ethical performance in the following areas: full compliance with regulation in all jurisdictions; safety and care of employees; transparency and communication with stakeholders; social contribution; and environmental responsibility. In addition, Coastal Oil has usually provided a lot of voluntary disclosure in its annual report and on its website. It says that it has a wide range of stakeholders and so needs to provide a great deal of information.

One of the consequences of dividing up the different responsibilities and operations on an oil or gas rig is that Coastal Oil does not have direct influence over some important operational controls. The contractual arrangements on any given oil rig can be very complex and there have often been disagreements between JV partners on some individual legal agreements and responsibilities for health and safety controls. Given that Coastal Oil has JV interests in hundreds of deep-water oil and gas rigs all over the world, some observers have said that this could be a problem should an accident ever occur.

This issue was tragically highlighted when one of its deep-water rigs, the Effland Coastal Deep Rig, had an explosion earlier this year. It was caused by the failure of a valve at the ‘well-head’ on the sea floor. The valve was the responsibility of Well Services, a minor partner in the JV. Eight workers were killed on the rig from the high pressure released after the valve failure, and oil gushed into the sea from the well-head, a situation that should have been prevented had the valve been fully operational. It was soon established that Well Services’ staff failed to inspect the valve before placing it at the well-head at the time of installation, as was required by the company’s normal control systems. In addition, the valve was attached to a connecting part that did not meet the required technical specification for the water depth at which it was operating. The sea bed was 1,000 metres deep and the connecting part was intended for use to a depth of up to 300 metres. There was a suggestion that the need to keep costs down was a key reason for the use of the connecting part with the inferior specification.

Reports in the media on the following day said that the accident had happened on a rig ‘belonging to Coastal Oil’ when in fact, Coastal Oil was technically only a major partner in the joint venture. Furthermore, there was no mention that the accident had been caused by a part belonging to Well Services. A journalist did discover, however, that both companies had operated a more lax safety culture on the deep-water rigs than was the case at facilities on land (the ‘land-side’). He said there was a culture of ‘out of sight, out of mind’ on some offshore facilities and that this meant that several other controls were inoperative in addition to the ones that led to the accident. Information systems reporting back to the ‘land-side’ were in place but it was the responsibility of management on each individual rig to enforce all internal controls and the ‘land-side’ would only be informed of a problem if it was judged to be ‘an exceptional risk’ by the rig’s manager.

The accident triggered a large internal argument between Coastal Oil and Well Services about liability and this meant that there was no public statement from Coastal Oil for seven days while the arguments continued. Lawyers on both sides pointed out that liability was contractually ambiguous because the documentation on responsibilities was far too complex and unclear. And in any case, nobody expected anything to go wrong. In the absence of any official statement from Coastal Oil for those seven days, the media had no doubts who was to blame: Coastal Oil was strongly criticised in Effland with the criticism growing stronger as oil from the ruptured valve was shown spilling directly into the sea off the Effland coast. With no contingency plan for a deep-water well-head rupture in place, the ruptured valve took several months to repair, meaning that many thousands of tonnes of crude oil polluted the sea off Effland. Images of seabirds covered in crude oil were frequently broadcast on television and thousands of businesses on the coast reported that the polluted water would disrupt their business over the vital tourist season. Public statements from Coastal Oil that it was not responsible for the ruptured valve were seemingly not believed by the Effland public. Senior legislators in Effland said that the accident happened on ‘a rig belonging to Coastal Oil’ so it must be Coastal Oil’s fault.

A review by the Coastal Oil board highlighted several areas where risk management systems might be tightened to reduce the possibility of a similar accident happening again. Finance director, Tanya Tun, suggested that the company should disclose this new information to shareholders as it would be value-relevant to them. In particular, she said that a far more detailed voluntary statement on environmental risk would be material to the shareholders. The annual report would, she believed, be a suitable vehicle for this disclosure.

Because of the high media profile of the event, politicians from Effland involved themselves in the situation. Senator Jones’s constituency on the coast nearest the rig was badly affected by the oil spill and many of his constituents suffered economic loss as a result. He angrily retorted in a newspaper interview that Coastal Oil’s CEO, Susan Ahmed, ‘should have known this was going to happen’, such was the poor state of some of the internal controls on the Effland Coastal Deep Rig.

As the oil spill continued and the media interest in the events intensified, CEO Mrs Ahmed was summoned to appear before a special committee of the Effland national legislature ‘to explain herself to the citizens of Effland’. The Coastal Oil board agreed that this would be a good opportunity for Mrs Ahmed to address a number of issues in detail and attempt to repair some of the company’s damaged reputation. The board agreed that Mrs Ahmed should provide as full a statement as possible on the internal control failures to the special committee.

Required:

(a) Describe the general purposes of a corporate code of ethics and evaluate Coastal Oil’s performance against its own stated ethical aims as set out in its code of ethics. (10 marks)

(b) Explain, using examples, the difference between voluntary and mandatory disclosure, and assess Tanya Tun’s proposition that additional voluntary disclosure on environmental risk management would be material to the shareholders. (10 marks)

(c) In preparing to appear before the special committee of the Effland national legislature, CEO Mrs Ahmed has been informed that she will be asked to explain the causes of the accident and to establish whether she can give assurances that an accident of this type will not re-occur.

Required:

Prepare a statement for Mrs Ahmed to present before the committee that explains the following:

(i) The internal control failures that gave rise to the accident; (10 marks)

(ii) The difference between subjective and objective risk assessment (using examples). Argue against Senator Jones’s view that Mrs Ahmed ‘should have known this was going to happen’; (8 marks)

(iii) ‘Health and safety’ risk and the factors that can increase this risk in an organisation; (4 marks)

(iv) Why Coastal Oil cannot guarantee the prevention of further health and safety failures, using the ALARP (as low as reasonably practicable) principle; (4 marks)

Professional marks will be awarded in part (c) for logical flow, persuasiveness, format and tone of the answers. (4 marks)