Lower Oil Prices : Oil majors need to shift gear from”Volume to Value”
Oil prices have fallen quite dramatically over last year. It is at its lowest level that it’s been for four years giving a jolt to the oil & gas companies across the globe. While the reasons for this fall have been many e.g. American Shale boom, OPEC decision not to cut production, less demand from China etc., this has affected oil & gas companies severely. Oil & Gas companies are facing pressure on returns driven by both margin and capital intensity effects and intensified by the recent sharp fall in oil prices. In addition to this sharp fall in the oil prices , Oil & Gas companies had been dealing with the decline in the average return on the invested capital as McKinsey research shows average return on invested capital among international oil companies declined from 27% to 11 % in the period between 2008 to 2013 driven by escalating cost. The cost escalation is linked to several underlying organizational issues, the impact of which is compounded by the sharp fall in the oil prices. This has put more pressure on upstream part of the business and particularly on cash flow growth.
Oil Majors have already started reacting to this sharp fall in the prices e.g. Shell shelved the plan for investment in Qatar, Aramco put on hold its deep water exploration in Red Sea , Schlumberger plans to fire 9000 people etc and there is certainly more unwinding to come .As many analyst believe that oil will trade in the range between $50 to $60 in next few months, a level few predicted even a few months ago when OPEC signaled it would not cut the production to defend prices. If the market stays this depressed, global spending on exploration and production could fall more than 30 % this year, the biggest drop since 1986 according to the forecasts from Cowen & Co , a New York based investment bank.
In view of the falling oil prices and resultant squeeze on the cash flows , oil and gas industry has been challenged to adapt and optimize their performance to remain profitable, while maintaining a long-term investment and operating outlook. In that context, oil & gas companies need to shift their capital market proposition away from the traditional emphasis on volume growth, to focus more intently on creating value through Opex and Capex optimization .Some majors like Chevron, BP have already announced their intent on focusing on value over volume push. We would also see more response from the oil and gas majors in the following area:
- Delaying investments in risky upstream projects e.g. deep water drilling etc.
- Better Portfolio Management e.g. balance long term vs short term and rationalizing between Upstream, Downstream and Petrochemicals.
- Improve Performance across business
- Operational Excellence
- Headcount Reduction
- Mergers and Acquisitions,
To achieve this, these companies will spend more efforts on managing their capital programs, optimize the cost across the business and manage their talent better. Energy enterprises will also need to gain insight into opportunities and risks across the enterprise’s full capital and asset portfolio to enable effective planning. They will also need to execute capital and operating plans flexibly and flawlessly, while providing transparency and encouraging stakeholder engagement.
Upstream Oil & Gas companies will need shift their approach from production at all costs to producing in context. They will need to do the P& L management at the well level and optimize the production cost per barrel. For doing this they need to integrate all aspect of production management and collect the data for analysis and forecasting. Downstream companies will spend effort in minimizing the risk in crude procurement, maximizing the margins and optimize the supply chain cost. They also need to collaborate better with suppliers across the globe and improve savings in the procurement of indirect material.
As companies cut the headcounts due to cost pressure right now, they will find it difficult to source the right talent later as they need to operate and grow and hence talent management will be extremely critical for these companies to manage. Another area for cost optimization would be to look at the contingent work force which constitute a major expense for the oil & gas companies
Having spent billions of dollars in the asset, the key to create value would be to “sweat the assets” and leverage the real time operational data to identify the potential improvement areas. This approach will help the oil & gas companies to identify the value activities in a few weeks and rather than the months or years to deploy a full system. Oil & Gas companies need to establish a real time enterprise to enable its executives to analyse, identify potential improvement areas and optimise to create value for the organisation and its stakeholders.
Oil & Gas companies can turn this crisis into an opportunity and lay the foundation for long term success as volatility in the oil prices would be the new norm and the “Value over Volume” push would be the key to be successful.