Capturing lost revenues

When energy prices rise dramatically, as in the past year, revenue leakage can become a significant problem for oil and gas companies. Even 0.1% leakage of the top 20 public oil and gas companies’ 2004 revenues would amount to more than $735 million in potentially lost or hidden income - and that’s in a year when the US wellhead price for crude averaged $36.77/bbl and spot natural prices averaged $5.49/Mcf - more than one-third below the $57/bbl and $9/Mcf averages expected for 2005.

Complex, fluctuating pricing and contracting structures inherent in the energy industry make it challenging for even the best-controlled company to consistently capture, record, bill, and collect all revenue. Distribution processes spread across the world further compound the problem.

The recent increase in energy prices only serves to heighten the need for companies to ensure that their processes, controls, and systems throughout the revenue cycle are optimized and consistently functioning.

Many energy companies have made it a priority in recent years to more rigorously manage and mitigate operational and financial risks, implementing robust risk management strategies, organizations, and processes. Combined with an array of cost-cutting measures to address increasing operating costs and price-pressures, this has produced increased operating revenues. In addition, when one also factors in the high price of crude, many energy companies have experienced healthy margins over the last three years.

However, as crude prices begin to stabilize, margin growth - if not operating profit levels - can be threatened. As a result, progressive energy companies are initiating new methods to maintain and further increase their operating margins. These companies are examining closely the other side of the cost ledger, implementing new strategies to stop revenue leakage and in the process, discovering hidden revenues, often resulting in the recovery of millions of dollars.

Exposure points

Throughout the value chain, companies are applying revenue assurance solutions to the numerous exposure points that permit revenue leakage. Revenue assurance is the systematic method to identify, capture, and remediate leakages throughout the revenue cycle - consumption capture, pricing, billing, and collections. It involves a series of activities to ensure that the business processes, controls, organizational structure, and information systems related to the revenue cycle work together effectively to maximize revenues and operating margins.

Opportunities for revenue leakage occur throughout the industry. It is challenging for even the best-controlled companies to consistently capture, record, bill, and collect all revenue.

Complex pricing and contracting structures are the rule rather than the exception, compounded by fragmented IT architectures and revenue capture, billing, and collection systems that are either manual or rely on simple spreadsheets. Distribution processes dispersed around the world further complicate the problem.

Risk factors

A number of specific risk factors and opportunity indicators can gauge whether a company might be susceptible to revenue leakage. Problems are more likely to occur where there are a large number of transactions, customers, or delivery locations or when activities are being combined. Examples of risk factors and indicators include:

• Multiple party ownership in oil and gas exploration activities requiring apportionment of revenue between parties

• Multiple and/or manual systems that track consumption, establish pricing, or determine billing

• Multiple pricing programs for various classes of customers

• Indexed and conditional price triggers that create complex and convoluted pricing structures

• Frequent changes in pricing

• Improper tracking and reconciliation of imbalances

• Varying ownership interests and participation obligations in joint venture arrangements

• Calculation and division of interest and royalty processing

To address these risks, a revenue assurance project assesses the process, organization, and technology a company relies on to identify control gaps and to deconstruct the drivers of existing leakages.

Following this process analysis, the project team tests the controls to determine effectiveness. Examples of typical steps include:

• Comparison of the invoicing and billing mechanisms to the contractual deals

• Comparison of royalty and joint interest distributions to the underlying contractual agreements and to the officially recorded mineral interest records

• Reconciling reported imbalances to original data sources

• Verify that consumption tracking methods capture all the data and that high low usage parameters are defined to prevent data entry errors

• Verify that pricing schedules and tables are current and change management methods are in place to periodically review and update price changes

Since most of the calculations are performed on dispersed and outdated technology platforms, data integrity tests are performed to validate the business logic programmed into systems such as billing and enterprise resource planning (ERP). Interfaces and processing functionality are also examined. Queries are executed to verify that data errors are being identified and properly reported.

Bottom-line results

In most instances, these revenue assurance measures can produce a range of process and bottom-line improvements, including:

• A decrease in unbilled revenues and the creation of integration points to reduce the manual effort spent reconciling between consumption capture, pricing, and billing systems

• The realization of merger synergies as fragmented systems and processes often result in “lost revenue”

• Improvement in the billing and collection of division of interest and royalty payments for multi-party agreements

Revenue assurance programs take on different characteristics at different companies. Some companies have leveraged revenue assurance to address leakages caused by revenue recognition and merger integration issues. At other companies, revenue assurance has been used to comply with corporate governance and or customer service requirements.

Case histories

At a West Coast energy company beset by rapidly increasing market pressures, increasing operational costs, and infrastructure limitations (i.e., outdated technology applications), a revenue assurance program was undertaken in an effort to improve bottom-line results by locating hidden or lost revenues.

Process documentation from an ongoing ERP implementation project revealed that many activities and calculations were performed manually and were therefore prone to error. In addition, by reconciling spreadsheet macros back to original contracts, a significant number of errors were identified, particularly in invoicing.

These leaks were resolved by rewriting the algorithms and by designing internal controls to prevent the mistakes from reoccurring. By implementing these revenue assurance steps, the company recovered previously lost revenue amounting to approximately 3% of the previous year’s total.

In the case of a Midwestern local distribution company, reorganization brought on by electric power deregulation resulted in significant disruptions and process inefficiencies among the customer enrollment, meter reading, billing, and collection functions. Invoices were incorrect or months late, producing a large increase in customer complaints and serious discrepancies between services delivered and subsequent bills and payments.

Application of a revenue assurance tool to track patterns and trends of complaints and billing problems identified the approximately 10% of suppliers with system interface issues that drove 80% of customer inquiries.

By resolving these issues, applying caps to keep individual account activity within estimated parameters, and improving coordination between field crews and the billing function to better match meter data and invoice totals, customer complaints and billing-related inquiries were cut within six months.

Despite the significant focus over the last decade upon “re-engineering” and “right-sizing” to reduce costs and improve business performance, relatively less attention has been paid to solving revenue leakages such as unbilled consumption, inaccurate pricing, etc. The opportunity cost of these leakages is often invisible to an organization because there is no impact on quarterly financial statements.

Stemming these kinds of leaks can be accomplished with much less disruption and internal reorganization than typical cost-saving restructuring initiatives. Many companies implementing revenue cycle improvements have collected millions in incremental revenue.

Given the scale of most companies in the energy industry, even a 0.1% revenue leakage translates into millions of dollars and ultimately has a material impact on a company’s cash flow.

SOX leverage

Companies have invested millions of dollars in Sarbanes-Oxley initiatives, with one of the unheralded benefits that they are able to leverage the SOX documentation and internal controls remediation with other operational initiatives, including revenue assurance. Similar to the typical Sarbanes-Oxley compliance methodology, revenue assurance examines a company’s business processes and tests the effectiveness of its internal controls.

There are synergies between the two types of projects. However, revenue assurance programs take this effort a step further, placing heavier emphasis on operational controls along with a focus on the interplay between financial and operational controls.

Improved and streamlined operating processes enable management to better track, monitor, and report revenues throughout the organization. System tools test the integrity of data and locate the source of any interfacing, programming, or control errors. This results in reliable data and remediation of system control defects.

Unlike the telecommunications and health care industries, revenue assurance is in the early stages of development and implementation in the energy industry. It is likely that oil and gas companies will soon take the typical next evolutionary step and begin designating specific organizations or departments to be solely dedicated to revenue assurance activities.

There are opportunities to learn and share leading practices from the telecommunication and health care industries, which will undoubtedly enable energy companies to leverage and accelerate the adoption of revenue assurance within this industry.

Gaining traction

Revenue assurance is gaining traction and attention from both financial and operational managers within the oil and gas industry. There is evidence that an effective revenue assurance program contributes to the bottom line while also providing operating and process improvements. Companies are beginning to capture losses and hidden revenues and are improving the process performance and managing risks more effectively within their revenue streams.

Operating in a highly competitive, potentially lower-margin environment, companies will continue to seek ways to increase margins and revenues. Revenue assurance will be high on the list of potential answers. $

The author

Rafael Hernandez [[email protected]] is associate director of Protiviti, a global provider of independent internal audit and business and technology risk consulting services. He is based in Houston.