Subcontracting in the extractive industries is big business. Many are familiar with the big-name private sector oil, gas and mining companies and state-owned enterprises that own the rights to explore or exploit natural resources, but these companies are hardly the only players involved. Through ongoing NRGI research, we estimate that anywhere between 50 and 90 percent of the costs of a typical extractive industry project actually go to third-party suppliers of goods and services. These companies range from huge multinationals providing specialist services such as drilling, engineering, procurement and construction, to smaller, often local companies that provide everything from catering to transport. The processes for selecting subcontractors are equally diverse: big contracts are usually awarded through international competitive tenders, which regulatory authorities may have to approve, while local managers usually award smaller contracts that are less subject to oversight. Subcontractors may themselves then subcontract other companies.
@bhp Geoff Healy - ‘there is so much more to do to root out corruption in our supply chains. We are seeking to identify #beneficialownership in our supply chains. We must redouble our efforts’ #18IACC #modernslavery #OGPau #auspol #auslaw #BizHumanRights pic.twitter.com/5BpSDkPzXz— Fi McLeod SC (@FiMcLeodSC) October 22, 2018
Due to the large sums of money involved, subcontracting carries risks. Procurement deals are less visible and more numerous than the high-profile processes used to award exploration and production rights, and they are harder for government regulators, the media and civil society to scrutinize. They are therefore a common node for corruption. For example, of 41 enforcement actions classified by the Stanford Law School FCPA Clearinghouse as belonging to the oil and gas sector, we count at least 31 that involved subcontracting processes.
Prominent subcontracting corruption cases from the petroleum and mining industries worldwide have involved a range of companies:
- The massive Brazilian “Operation car wash” corruption scandal exposed that national oil company Petrobras corruptly awarded contracts to companies which then paid off politicians, political parties and Petrobras executives with billions of dollars in bribes.
- Executives at Unaoil, a Monaco-based company, sold their political connections and intelligence in exchange for fees, part of which were channelled in the form of bribes to government and state-owned enterprise officials deciding on contracts.
- Oil services firm Halliburton awarded contracts to a local company connected to an official of the Angolan national oil company Sonangol despite weak qualifications, in order to improve relations with the national oil company and keep winning service contracts in Angolan oil fields.
- Texas-based businessman Juan Carlos Castillo Rincón bribed officials of the Venezuelan national oil company PdVSA to get only Rincón-affiliated companies on the shortlist of companies entitled to bid for PdVSA contracts.
- Kinross Gold contravened its own bidding and tender processes in Mauritania to award a lucrative logistics contract to a company preferred by Mauritanian government officials, despite “concerns that the company was a high-cost provider with poor technical capabilities.”
- Skanska S.A., Argentinian subsidiary of the global construction company, used shell companies to make bribes to influence the bidding process for gas pipeline infrastructure in Argentina. The investigations into this case started from a tax fraud enquiry into one of the shell companies.
Corruption in subcontracting is not just bad PR. Granting subcontracts to unqualified companies drives up costs, diminishes company profits and shareholder returns, and eats into government tax revenues, depriving states of funds that would otherwise be available for public expenditure. It can also undermine efforts to develop local supplier capabilities, and contribute to environmental or safety failures.
Closing the space in which this mismanagement occurs requires multiple interventions. Companies can improve due diligence processes by which they screen subcontractors, which BHP’s announcement points towards. Company executives should also consider how their internal controls allow them to better detect various corruption risks at the stage of subcontractor selection and subsequently, invoice approval and audit. For example, companies can ensure that: global procurement offices and local employees jointly conduct due diligence, authority for expenditure is set at the right level, whistleblower mechanisms are in place, the internal audit function is well resourced and reports to the board, and subcontractors and short-term staff are trained on integrity policies.
Government officials should consider whether existing processes are sufficient to monitor and oversee the design, award and monitoring of subcontracts. This is especially relevant for those subcontracts that have high public policy significance: those awarded by state-owned enterprises, those that aim to boost local procurement, or those big-ticket expenditures with large impact on revenue collection such as service and engineering contracts. Addressing corruption risks created by secret corporates, through which politically affiliated individuals can exploit public resources for personal gain, can be an important factor in these high-stakes subcontracts. The provision of more public information on subcontracting is also critical so that journalists and civil society actors can better scrutinize these processes.
Fortunately, a number of global initiatives are bringing more public attention to subcontracting. Ahead of the IACC, the Publish What You Pay coalition called on “oil, gas and mining companies to use beneficial ownership and PEP (politically exposed persons) data in their due diligence of business partners and subcontractors to reduce the risk of corruption within their business operations and supply chains.” Meanwhile, the Extractive Industries Transparency Initiative (EITI) is considering addressing subcontracting issues in its guide to implementing the EITI standard. In a recent review of local content reporting in EITI member countries, the EITI international secretariat revealed that Ghana, Liberia, Mali and the Philippines have all made some efforts to shine a light on extractive industry subcontractors.
Elsewhere, the Local Procurement Reporting Mechanism (LPRM), a voluntary disclosure standard for mining companies, provides a framework for companies to report on the context of operations, procurement systems, procurement spending, due diligence and anti-corruption policies, local procurement incentives and regulatory and other commitments. And IPIECA’s guidance on sustainability reporting for the oil and gas industry includes reporting on local procurement and promotes discussion of pre-qualification criteria for potential suppliers and reporting measures aimed at preventing corruption in subcontracting. These and other efforts give hope that the extractives governance space will engage more on the issue of subcontracting, to harness the development impacts that subcontractors bring through contributions to public revenues, jobs and skills.
Rob Pitman is a governance officer with the Natural Resource Governance Institute (NRGI). Kaisa Toroskainen is an Africa program officer with NRGI.