Heading into 2016, energy companies are having to adapt their regulatory compliance efforts to increasingly account for risk, according to Deloitte & Touche LLP’s “Top Regulatory Trends for 2016 in Energy.”
Companies can no longer afford to take a “box-checking” approach to comply with rules, as regulators shift to a “risk-based focus” incorporating “enhanced analytics tools that allow them to zero in on specific areas,” the consultant said in its annual regulatory outlook.
“For organizations under the microscope, the enforcement process of the future is more likely to spend less time on the ‘check the box’ portion of assessments, devote less focus to administrative compliance, and go straight to risk-identified areas where the questions may be tougher,” Deloitte researchers said. “As the industry becomes more sophisticated at identifying, prioritizing, and measuring compliance risk, regulators are also more likely to reserve major enforcement actions for matters of greater significance that affect market integrity and stability, allowing for more effective use of their resources.”
Paul Campbell, an advisory principal with Deloitte who leads the firm’s energy regulatory risk and consulting services, told NGI that companies have to take a “risk-based approach to compliance” that allocates resources based on evaluating both the likelihood of a compliance violation and the potential costs. This requires overlap of activities that may have been kept separate in corporate structures of the past, he said.
“Often you’ll have someone that’s very focused on safety, and then you’ll have another group that’s focused on market rates, what the FERC says, somebody else that thinks about the [Environmental Protection Agency]. They operate within different silos within the organization,” Campbell said. “And it’s very difficult to say, what is the risk of an environmental issue versus an operational issue…or a violation of a market or regulatory pricing issue, what’s the higher likelihood of each of those, because they all sit in silos.”
Energy operators “have to know, should I be hiring more people to work in my environmental group or should I be spending more money on a system that might provide trading surveillance over my trading operations?”
After the passage of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enforcement actions by the Commodity Futures Trading Commission (CFTC) and the Federal Energy Regulatory Commission targeting market manipulation create regulatory risks for many companies operating in the energy space, Campbell said.
In its report, Deloitte researchers aid FERC and CFTC continue to show “heightened attention to commodity trading activities that can cut across both physical and financial markets, and the agencies continue to be vigilant about commercial and operating decisions that appear to run contrary to market signals.” The report noted that the appointment of FERC Chairman Norman Bay, the former head of enforcement, “seems to indicate the focus on enforcement is here to stay.”
Any local distribution companies (LDC) or exploration and production (E&P) companies involved in commodities trading now have to allocate additional resources to comply in an environment where these agencies now have “tremendous penalty authority” and are exercising that authority, Campbell said.
Energy companies “are dealing with a new regulator than they were dealing with five years ago. So if you’re a gas LDC that primarily deals with physical gas or you’re an E&P…and you hedge using derivative products, five years ago your awareness of the CFTC was probably relatively small,” Campbell said. But CFTC now “has significant penalty authority, and they’ve been using it,” with fines in the tens of millions of dollars.
“You’re seeing similar behavior in the level of fines from the FERC as it relates to...market manipulation issues or disruptive trading behavior.”
The year ahead is also likely to be marked by regulatory uncertainty, especially with the upcoming presidential election, he noted. In the last year of his term, the Obama administration may try to get a lot done, but the next administration may take a completely different approach, requiring flexibility from companies.
“When you have an uncertain situation, there are a couple things you can do. You can do nothing and you can hope, and hope tends to not be a very good strategy,” Campbell said. “What we talk to our clients about every day and what we work with them a lot on is have a strategy. Because we have a period of uncertainty over the next year, how can we remain very flexible and not necessarily get locked into something that would be difficult to move around, move resources around, if we think there’s a change in the compliance focus going forward.”