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BPP Mock 5
BPP Mock 5
BPP Mock 5
Additional (Unseen) information relating to the case is given on the following pages.
Read all of the additional material before you answer the question
The CFO of yJ has asked you, the management accountant, t0 provide advice and recommendations on the
issues facing YJ.
As an appendix to the main report, prepare a memo for the Board which summarises your evaluation and
recommendations in relation t0 the choice over the ZZZ and YYY oil and gas fields. The memo should include
no morethan 5 bullet points, including your recommendation and a line graph showing the expected oil and
gas outputs from these 2 fields over the next 5 years.
(Totat mar/a lor qaestion lb = 10 Marks) /
your script wilt be marked against the T4 Part b Case Study Assessment Criteria shown below:
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YJ - unseer material provided lor mock exam 5
New licences
Last week, Ullan Shah was delighted to report to the Board and YJ's institutional investors that two of the
four licences to drill for which YJ had applied had been granted. As a result ol this the share price of YJ rose
to $30.12.
However, YJ only has the financial and operational resources to drill a test wetl and turn one of the licences
into production. This hasn't been communicated to shareholders yet although Ullan Shah is confident that as
long as one of the fields does go into production the share price will be resilient and shareholder confidence
maintained.
The survey and exploration costs on both the Jields ZZZ and YYY amount to $1.5 million each and at present
these costs are capitalised as Non-current assets. Production will begin from 1 0ctober 2014 in whichever
field YJ decide to develop.
ZZZ
ZzZ is located in the same Asian country as CCC. The result of the initial exploration suggest the followlng:
0il production 0.27 mmbl in the first year ol operation rising by 10% p.a.
Gas production 0.41 mmbble in the first year of operation risins by 157o F.a.
Government taxes The government will apply a royalty tax of 10% on all revenues from this field
and will take a 25olo share of the operating profits.
The quality of both the oil and gas from this field will affect the price such that over the lifecycle 0f the field
the price per barrel of oil will be $105 and the price per barrel equivalent of gas will be $15.
The cost ol producing both oil and gas in this field will be higher than normal due to the unusual depth at
which the reserves have been found. Therefors the ratio of cost of sales to overall revenues from ZZZ will be
50% in the first year, increasing by 0.5 percentage points each yearthereatter. Distribution costs can be
ignored and administration costs can be assumed to be 157o o{ revenues.
YJ has built a strong relationship with the local government through its work in the CCC field and the
geological team at YJ believes that although the lield is in a deeper location than CCC, YJ does possess the
technical skills and know how required to successfully turn this field into production.
YYY
This field is located in Country V, an independent country between Russia and the Arctic Sea, an area into
which YJ have not yet extended their operations, The results of the initial exploration suggest the f0llowing:
0il production 0.67 mmbl in the 1$ year of opsration, then reducing by 10% pa
Gas oroduction 0.77 mmbble in the first year of operation reducing by 15% p.a. thereafter
Government taxes The government will apply a royaltytax of 15% on YJ's share of revenues from
this field.
Production sharing YJ owns the lirsl 60% of production of oil and gas each year to contribute
agreement towards their costs ('cost oil'). 0f the remainder ('profit oil'), YJ owns 30%
(except in year 1 where YJ's 'profit oil'share lalls to 0%) and the government
willown 70%.
The quality of oil and gas will be high and relatively easy to extract. Prices will begin at $109.84 per barrel of
oil, rising a|2.5Yo per year, and $18.25 per barrel equivalent of gas, rising at 1.5olo per year. Cost 0f sales will
be 40% of total revenues (i.e. not just YJ's share). Administration expens$ will be 5% of total revenues.
potential
0rit Mynde has asked you for an assessment of the options available to YJ in relation to these
produition fields together with your recommendations. You should carry out the assessment for 5 years
commencingl October20l4,atthispointthereisabreakclauseineitherlicenceandasignificantriskthat
the licence will terminate.
Accounling lssue
price rose
The financial statements to 30/09/1 3 were audited and published in November 201 3. The share
sharply as a result, closing $26.80
at at 31't December 2013'
oil and
Following a routine analytical review of monthly revenues and profits, you have ascertained that some
gas output from October 2013 was actually included in the month of September 2013. The elfect on the
i.renr.. and profits ol YJ as a whole is significant but not material to the accounts and would not alfect the
audit opinion or shareholder confidence.
The Financial Controller of YJ is your direct line manager and he reports directly to orit Mynde'
He has asked
profits
you to ignore this issue as it will create extra work for the department and does not afiect the overall
of YJ in the long run.
Securily
to escort all
ln 2013 yJ incurred significant extra expense by hiring SEAC, an internati0nal security company,
yJ employees and outsourced personnel whilst they are travelling to, and from, drilling sites and to
year contract with SEAC to cover the
safeguard the locations where drilling is taking place. YJ have a 3
locations at AAA, BBB & CCC.
SEAC has informed YJ that it will not provide security personnel in Country V, Lee Wang has not been able to
find any other security firms to provide security in V that fulfil the criteria for being chosen that
he
So that yJ's Board can make fully informed decision over which oil and gas licence to pursue
a {\fi
or 7}A),
you have been asked to perform a risk analysis on this issue. Assuming that YJ undertakes production at a
site where sEAC does not provide security your risk analysis should include:
Compliance audiling
law. At YJ's head
As a UK registered company, YJ must comply with Health and Safety (H&S) Iegislation by
policies and training
oflice a small team ol f ull time compliance auditors is responsible for ensuring YJ's
2 full-time and 3 part-time. The
reflect any changes in H&S legislation, YJ's team consists of 5 employees,
is 0'000.
total annual cost ass6ciated with the department, including salary and accommodation costs $11
Ullan Shah was surprised that YJ had its own compliance team as most E&P companies
outsource this to
one ol several well established compliance firms. He has stated that this department will close and
he has decided to keep this information confidential
compliance outsourced from 1't 0ctober 2014. However
to avoid causing distress.
Eustainability managemenl
Penn with putting into
When Lee Wang was app6inted in June 2011 he was tasked by Jeremy Lion and 0liver
place a rigoroui system for managing tho sustainability and CSR 0f YJ's activitles, something which the
then he has established and published the company's
institutional investors felt t0 be important. Since
policies and has been working hard to instil these values in the culture of the company. He has encountered
significant resistanco to this initiative from YJ's employees and the outsourced contractors.
The new proposal will involve the Board agreeing a set of key performance indicators (KPls) to ensure that
overall company performance, including CSR, is delivered. This system will be immediately trialled at Board
and senior manager level but the intention is that it will be rolled out across the organisation during 2014.
The Board would like your evaluation of this proposal and some brief suggestions on the specific CSR KPls
which could be included for each CSR perspective.
Capacity coIslraints
Much of the cost of hiring the outsourced companies to either YYY or ZZZ will be incurred up lront and then
recouped from the sale of the oil and gas once production begins. The lorecast costs associated with both
ZZZand YYY have already been accounted for in the cost of sales ratio described above.
Ullan Shah is concerned that these up front costs will place great pressure on YJ's ability to keep within the
overdraft limit set by the bank. He has therefore proposed that YJ increases the output from its existing fields
at no extra cost by lengthening the shifts of existing workers at these sites and speeding up the rate of
production. Because the drilling wells at MA, BBB and CCC are otfshore there are legislative restrictions on
working time which apply and YJ would be operating at the limit$ ol these. For safety and staff welfare
rsasons, YJ's rivals operate shorter shifts than the legal maximum.
Adebe Ayrinde is against this proposal because speeding up production to the proposed level will increase
health and safety risk and also the risk of oil spillage and pollution but he has calculated, at Ullan Shah's
request, that monthly output could be increased by 15% at all three fields. 0rit Mynde has confirmed that this
increased output would be sufficient to cover the short term outflows a$sociated with both lhe ZZZ and YYY
fields until production at these fields becomes self-financed lrom cashflows.
To: CFO
Date: 2014
Contents
(1) lntroduction
(2) Terms of relerence
(3) ldentification and prioritisation of issues
(4) Approaches to resolving the main issues
(5) Ethicalconsiderations
tO) Recommendations
(7) Conclusion
Appendices
I lxrnonucrc*
YJ is a small E&P listed company. lt is part o{ a massive global
industry that depends on the extraction of
finite resources at a cost that is lower than the resale value
at prices determinra ly tt, market. Success for
companies like YJ is determined by either an ability to focus
on a geographic area like salamander Energy
(Asia), or on an unusual technology such as hydraulic
fracking. ntlne moment vJ ,pprar. to lack a
specialism in either direction and as such risks being 'stuck
in the middle' per porteis generic strategy
classification.
A Trnms or n'rrarxcu
This report identifies and evaluates the issues facing
YJ and offers appropriate recommendations.
6 lrrrnrc*Tmx Atro
PHr0ntTr$ATmm CIr ls8ur$
The issues below have been prioritised based
on the potential impact each could have combined
with their
urgency. A full SWOT analysis is presented in Appendix
1.
It is clear that the shareholders are happy with the finds at YYY & ZZZ given the rise in the share price, but it
is important to maintain this laith by investing in the option that fits best with YJ's strategic direction. lf YJ
secures the best project here it is likely to boost the chances of securing future capital investment lor other
projects.
Both options will be appraised using Johnson, Scholes & Whittington's SAF model.
Suitability
zzz
ZZ is located in a country that YJ already operates in, which means that no time need be spent on dealing
with new suppliers 0r negotiating new contracts. lf anything setting up this new deal is likely to provide YJ
operating in this area does not offer YJ geographical diversity, which is a good risk management strategy if
one area in the globe struggles.
The fiscal regime is relatively attractive in that royalties are lowerthan in YYY and the profit share is only
payable if the field is profitable. So if costs are higher than anticipated or the price of oil falls (a risk at the
moment due to the possible re-entry of lran to the international oil market) then the government will receive
less. 0n other hand a change in the rate of tax cannot be ruled out in future.
YYY
YW is set in an area that YJ has never operated in before, which ollers it global diversification, but also
raises the risk that because YJ does not have experience of the local regulations (for example environmental
permits) delaying production, or raising the cost base significantly above those prolected in Appendix 3. YJ's
lack of familiarity with the geology must increase the risk that the test well will be unfavourable.
The fiscal regime here is much higher risk thanlarZZZ. The production sharing agreement means that
prof its will be low in year 1, and the government's take will be high in any year even if the field is not
prof itable for YJ.
Acceplability
Appendix 3 shows that profits over a full 5 years are higher lor Y\t by approximately 8o/o or $3m.
However, production levels at YYY are highest in the first year- and it is in this year that the government's
take is highest. This raises the prospect of the payback from this investment being longer for YYY thanZZZ,
this is indicated by the lower YYY profits in year 1.
Also, the linancial & business risks of the Y:YY project are much higher given its unfamiliar and remote
location. This risk is compounded by the lack of security support Jrom the company acting for YJ at present.
Feasibility
zzz
Research shows that some of the oil for extraction is quite deep in places. YJ specialises in more shallow
extraction, so there is a chance that this is somewhat out of its competencies, especially if the reserves are
deeperthan initial investigations show. The current view isthatYJ hasthe capabilityto drillforthis oil,
however, and so this could be a good chance to improve skills in this area. Tullow Oil, albeit a much larger
com pany than YJ, successfu lly built its com petences in this way in 201 1 and this has allowed it to develop
fu rther deepwater wells elsewhere:
YYY
The oil and gas at site YYY are in shallower waters, so drilling for them is well within the core competencies
of YJ. This presents a smaller risk in extraction compared to ZZ, which is a strong benerit.
YJ has established a framework to ensure that it operates ethically and with social responsibility, but in order
for this to have the impact the board is looking for all stafJ need to buy into the principles set out. The risk
that YJ faces here is that staff may behave in socially irresponsible ways because of ditfering views, and this
will tarnish YJ's reputation and negate the strong work Lee Wang has done previously.
Although a balanced scorecard can create a multitude of confusing and contradictory performance
measures,
it is common for E&P companies (Premier Oil for example) to adopt this style of incentivising
their senior
staff because environmental management is a critical success factor in winning licenses
to drill.
The consequences of poor CSR can be far reaching - part of the fallout from Bp,s
unethical actions in
connection with the Deepwater Horizon disaster is that it has been excluded from US government
federal
contracts.
YJ should link staff bonuses to the successful completion of H&S kaining. This will result
in staff
receiving adequate training to work in a safe manner and ensure high standards are maintained
. KPI 2 - All sites to have less than 5 health and safety concerns raised
lnternal reviews of all sites should continue to be conducted at random points throughoutthe year.
lf
fess than 5 issues are raised in the year this will be considered a positive for the staff
on site. This
should motivate statf throughout the year.
t{R
A measure like this will encourage all staif to work in harmony with one another. Care needs to
be
taken here though to ensure that if staff are being treated unfairly they are able to raise any concerns.
This measure will put pressure 0n management to recruit the right people whose views are aligned
with YJ's values. A bonus would be payable if staff remain with the company.
Environment
r KPI 5 - Less than 1% oil leakage per year irrespective of government tolerance
It is vital that YJ does not tolerate levels of leakage and takes measures to minimise the number
of
Ieaks. This measure will ensure staff keep on top of maintenance to reduce this from happening
YJ should choose sites that do not have a serious impact on local wildlife and keep under
c6ntinual
review its impact on the environment, considering also how any adverse impacts can
be rectified,
Social
ln areas where it ls drilling, YJ should set up c0ntact with at least one local conservation group,
attending regular meetings to understand if it can do anything more to protect the environment
. KPI I- All sites to conduct 5 off site days per year in schools discussing safe use of oil
Promoting avYareness in the local areas with children will boost the profile and reputation ol yJ for
being a socially responsible company, whilst giving the staff responsibility to get involved in these
discussions
KPI 9 - Honest and transparent relations with shareholders and other key stakeholders
Regular meetings to be had with shareholders explaining exact amount of production so honesty is
maintained at all times
Ullan Shah believes that YJ could encounter cash flow problems in the near future and is proposing new
ways in which to raise capital. ll YJ did come under liquidity pressure it may not be able to extract any oil
from any location, which could cause the company to fold in the absence of alternative funding. Mr Shah's
current proposal is to increase production and therefore output and cash flow. Although this is likely to
succeed, it is unsustainable t0 putthis pressure on a workforce, the ethicality of issue is review in section 5.
This is likely to increase health and safety concerns, and goes against what Lee Wang is trying to achieve
with the balanced scorecard, since it is likely t0 increase staff turnover. Cash llow is the most important thing
a business requires to survive, so other options are considered belore exploring the solutions Ullan Shah has
proposed.
YJ has the option to sell the findings from the proiect that it chooses to ignore at this time. Given research
shows that there is oil at both locations, the research dah will hold economic value and could be sold to a
competitor for a quick cash gain. Although this will lmprove cash flow in the short term, YJ will be forgoing
any long term benefit from the site in question, as well as passing on a good opportunity to an competitor.
This may not be received in the best light to shareholders given the buzz created around the two licences.
YJ could approach a number of suppliers about ext€nding creditterms by 30 days. This willalleviate short
term pressures and allow YJ to benefit from the income the new oil field will bring. This would be a sign t0
the market that YJ is struggling for cash flow, however, and could mean shareholders become nervous.
lnstead of risking reputation and operational damage by overworking its workforce, YJ could approach
shareholders about a rights issue in order to improve cashflow. Given investor excitement after recent licence
news this could be taken up quickly and be a sign of strength that YJ is looking to expand. This approach
was taken by Salamander Energy in 201 3 when they raised over $200m through a rights issue, which
illustrates that this approach may be feasible. However YJ may want to investigate other methods first to
rectity a short-term liquidity problem, and leave a rights issue to Jinance a bigger expansion in f uture.
YJ cunently has a contract with security firm SEAC to reduce security concerns on its ships and its sites.
SEAC will not operate in Country V, thus adding a lot more risk to this option. lt is important to analyse what
risks could develop as this is could be important when making the ultimate decision on which licence to
accept. Each risk is discussed below with a priority and urgency rating, as well as a risk mitigation strategy.
Financlal Bisks
'1. Stolen inventory - high impact / low urgency
YJ's shipments may be more prone to pirate attacks if there is a lackof security, resulting in a
reduction in inventory. This will hit YJ's income directly and place it under financial pressures. ln
order to reduce the risk YJ should operate in popular shipping lanes which may discourage pirates
0perational Risks
lf YYY is perceived to be located in a risky area to work a lower grade of staff may be attracted, as
staff with higher skills will be able to choose to work at other, safer, locations. This will make it harder
for YJ to recruit staff that are aligned to its vision. This risk can be reduced by offering higher wage
incentives to stafl on this site.
Thefts of oil and gas from staff could increase with less security present. YJ could transferthis risk by
taking out insurance on alt of its inventory and complete reconciliations of all inventory to deter staff
from this behaviour.
Repulalional risk
lf it is known that YJ is operating in an area that is not protected by security, shareholders may well
be concerned. YJ may have to accept this risk, but must manage this message to shareholders
immediately if YYY is chosefl.
il [rHrcu, rs$u's
5.1 * A*saunting errors, asksd tn ignar* thesn
Why is lhis an ethical issue
The financial controller has asked for errors to be ignored due to other work happening at present. This is not
a prolessional attitude and means bad practices are tolerated. The financial controller is in a position of
responsibility, so it is wrong of him to adopt this unprofessional attitude. This could also cloud investors'
decisions when they review the accounts going forward.
Orit Mynde should be made aware of this issue, and etforts should be made to correct this. lt is important
that shareholders put faith in the information that they view, so any known differences should be correcled.
YJ should c0ntact auditors to make them aware of what is happening.
YJ has a duty of care to stalf and forthis reason (and legal reasons) statf should be informed of the intention
to shut the department down as soon as this decision has been confirmed. They should be otfered
alternative jobs elsewhere in YJ if at all possible.. The ethical issue here is that YJ should treat its statf fairly"
lf YJ were to go ahead with this decision then it should try to offer alternative jobs within YJ or the
outsourced company if possible.
While YJ may have the power to impose longer shifts on its staff at no extra cost, if it did this it would be
treating statf unfairly and possibly causing higher stafl turnover with potentially damaging commercial
consequences. lt would also be raising the risk of poorer H&S standards as staff will be more tired increasing
the risks of accidents and iniury.
Statf shift patterns should be analysed t0 see if small increases could be negotiated with staff, but the
increase in hours should be compensated for by higher payments,
Wevgxxmnrlr,reTru*
This report recommends that YJ accepts lhe ZZZ proiecl, ln addition to this YJ should sell its f indings f rom
project YYV to the market in order to improve liquidity.
Justilicalion
SiteZZZ is in a location that YJ already has plenty of experience. 0n top of this, the proiect provides strong
long term cash flows for the company, which are likely to impress shareholders and raise funds for future
investments. Although there are risks inherent within this choice, such as deep extraction, there is also a
potential 'real option' in the sense that this project will allow us to develop a competence that may permit
further deepwater proiects in the future.
Despite the higher profitability from YYY, there are t00 many risks involved with project YYY, and this is not
adequately compensated lor by the $3.1m higher profits over the lifetime of this project.
Although ZZZdoes not offer global diversity to YJ, it will benelit from supplier relationships thsre and can
establish operations quickly, whereas a lack of security presence in YYY may suggest the area is not
completely safe. YJ should sell the findings from this proiect, as it is unlikety to invest here for a while and
other, more suitable, projects may become available.
Aclions to be taken
2. Commence test drilling to f irm up the estimates of resources and costs of full production.
This report recommends that YJ implements the balanced scorecard approach as soon as possible, using the
KPI's mentioned in 4.2
Justilication
The balanced scorecard is a great technique in order to align the company and its day to day operations to its
CSR targets. This needs to be implemented as an integral pan 0f stafl appraisals, given the lack ol passion
for CSR at the moment. lt is recommended that initial sessions are set up with all staff informing them ol the
new KPI's they need to achieve if they are to receive a bonus or a pay rise, encouraging them to hit personal
targets and help achieve companywide targets. lf this is positioned correctly all staff will buy into this and the
company's reputation for CSR wifl grow as a result, attracting the quality of client it wishes to do business
with.
Actions lo be laken
1. lnlorm Ullan Shah of what is required and the importance 0l this new approach
2. 0rganise sessions with senior managers b,efore setting up relevant team sessions to align allviews
This report recommends that the initial proposal by Ullan Shah is rejected and that YJ looks to raise enough
cash through the sale of YYY lindings in order to cover any shortfall.
Justilicalion
The proposal from Ullan Shah will put a lot of strain on the workforce. This is not acceptable in any industry,
but in one such as gas and oil extraction this could provide major problems. Workers that are being
overworked can suffer f rom fatigue and this may result in mistakes being made that could harm YJ greatly.
YJ is in a position to potentially sellthe findings for YYY for a significant amount of cash, considering the
field is readyfor drilling with all research completed. This should not harm YJ's reputation, considering that
selling findings is relatively commonplace in this industry.
Actions lo be laken
This report recommends that proiect YYY is reiected, so SEAC can still work on location ZZZ. lf YY{ was t0
be accepted YJ must consider all of the solutions in order to mitigate risks
Justilication
ln recommending YJ proceeds wilhZZZ,the correct level of security should be provided by SEAC to protect
YJ, and the risk will sit with SEAC. lf YYY is chosen, it is important for YJ to understand why SEAC does not
operate in this country, whetherthis is a geographical issue or one of increased security rlsk,. lt is also
important that YJ attracts the right sort of statf to work on this site so it must be public knowledge that YJ
takes its security very seriously in order lor staff to feel safe.
U suxcr.u*rsx
This report has identified and evaluated the issues facing YJ and has otfered appropriate recommendations.
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zzz
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Gas mmbble 4.77 0.65 0.56 0.47 0.40
OUTPUTS
ONZZZ 0.27 0.30 0.33 0.36 0.40
GaSZZZ a.41 0.47 0.54 0.62 0.72
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