Jun 15 2016

A time for synergies and negotiations

Recent expectations regarding the oil supply and demand conditions have focused on the prices remaining low for the rest of the year as well as 2017. Conclusions have been drawn, that this in turn would reduce or defer exploration activities. Ajith Muralidharan, Vaangden Pte Ltd., Singapore has expressed uncertainty over the evolving situation and whether it would be as dismal as it is being made out to be. Muralidharan argues, instead, the presence of strategic opportunities to pursue future exploration activities cost-efficiently.

In spite of being a profoundly capital intensive industry that hugely impacts global economy, the oil and gas industry has been beset with various issues like inadequate costs control, poor planning and productivity during project execution, and inefficient third party risk management - all of which have directly or indirectly adversely affected the bottom-line.

As the profit margin percentages of the major oil and gas companies are usually in single digit numbers, when the prices went south, many companies found themselves in the red. The price drops have led to either marginal profits or significant losses to most operators. Sustainable oil and gas prices are a result of supply matching demand and for it to happen, hydrocarbons will have to be found and produced more efficiently. Several remedial measures are being undertaken, innovative technologies are being adopted and synergies of operations are being pursued at the organisation, industry and regional levels, to reduce NPT, optimise procurement processes and reduce the Capex and Opex costs; including cost of materials and services.

Drilling operations account for about 70 to 80% of Capex, depending on whether it is onshore or offshore activity. The high costs can be attributed to complex drilling and completion designs, higher rig and services costs, process inefficiencies, higher personnel cost and of course enhanced regulatory compliance requirements. Standardised, simplified, strategic, long-term and integrated (clustered, rig sharing, etc.) well planning is the key driver to cost reduction. Since cost of purchasing drilling tangibles and services account for almost more than three-fourth of a drilling AFE, it is easy to see that procurement and vendor performances are of critical importance.

According to data compiled by Rystad Energy, the average cost of production per barrel of crude oil for various countries (not adjusted for fiscal breakeven) is as follows: Canada (US$41), USA (US$36.20), Russia (US$17.20), Iran (US$12.60), Iraq (US$10.60), UAE (US$12.30), Saudi Arabia (US$9.90) and Kuwait (US$8.50).¹ These figures, which include Capex and Opex are almost half of their research figures in 2014. These numbers mean that many oil and gas companies are still profitable at the current price levels.

It also means that the cost of drilling i.e. costs of rigs, drilling support services, logistics services, tangibles, drilling engineering costs, inspections, certifications, etc. has reduced substantially. The service companies have significantly cut their prices just to stay afloat and tide over these tough times. Or perhaps, they have reverted to realistic and market determined prices that favor exploration and drilling. So, what does it mean, in terms of contracts and purchasing opportunities? It means, an opportunity to enter into strategic, long-term, procurement contracts at highly competitive prices. In a buyers’ market, entering into such contracts that are more favourable to the buyer would also effectively reduce the risk costs associated with contracting and procurement. This opportunity will also extend to midstream and downstream operation. Additional cost benefits can be attained by bringing about synergies of operations either between the various assets of the company or in partnership with other operators in the region.

To Muralidharan this means that for a company with a foreseeable positive cash flow forecast, this is the time for entering into strategic contracts to avail the benefits of low costs. If they don’t have enough work programmes for long-term contracts, they should consider joint drilling programmes with other operators in the region and explore the possibilities of availing benefits associated with rig share arrangements and common warehousing. As an example, for operations in the Caribbean Region, traditionally the services are provided from Houston with a minimal base in one of the islands; but if the operators in an island or even between the islands can put together a work programe that is big enough for long-term contracts extending to a minimum of, say 2 yrs, they could not only benefit from competitive prices, but also force rig and service companies to shift their hub to one of the islands, which in turn enhances reliability of services and reduces logistical risks.

Muralidharan writes that it is also time for companies to move away from the traditional centralised contract and purchasing models resulting in integrated service management to strategically-controlled decentralised contract and purchasing models with global sourcing and specialized vendor services. I must hasten to add here that there should be appropriate provisions in the contracts for reasonable price escalations as the market picks up, by 2H17 or 2018, because the current prices probably don’t allow service companies to make enough money to make reasonable profits.

A major concern for oil and gas companies wanting to pursue such opportunity of deriving benefits of contracting and purchasing at low prices is that fact that many of their technical and commercial staff would have been laid off. To source them in time to draw benefits from a buyers’ market is no mean task. However, there are solutions for that as well. One of the results of recession in the oil and gas industry is that many upstream professionals have come out of the industry and have branched out into various functional expertise areas. There are many start-up companies that provide excellent services in outsourcing of contract and procurement activities and many of them possess in-depth experience and expertise in handling such functions.

Technology, applications and solutions developed outside have so far not been easily adopted by oil and gas industry. Oil and gas professionals, who haven’t so far been doing enough with the large volume of data that they generate, understand that there now exist open source technologies to harness and make use of all such data, for efficient operations. The contracts and purchase experts also cannot escape this wave; they will need to gain knowledge in this area of advanced data analytics to make data based decisions that would safeguard the operators from price volatility and uncertainties in the future. Purchase planning and inventory management will become more efficient and effective when enhanced vendor data analysis becomes possible and potential failures can be predicted, and preventive or predictive repair and maintenance can be scheduled proactively.

Companies will have to resort to various innovative and new technology-based models of contracting and procurement strategies, involving decisions on procurement portfolio matrices, standardisation, benchmarking, vendor relationships, global sourcing, bidding methods, etc. that may deviate from the conventional methods. Where such strategic contracting and purchasing capabilities do not reside in-house, they may be outsourced to ensure that contracting decisions are made with a full comprehension of the price-cost iceberg.

The ostentatious years of inefficient and ineffective upstream management that remained concealed under high oil prices and good cash flows are over. Instead of being disheartened with the current state of affairs, it would be wise to seize the opportunity that is being offered by a buyers’ market to negotiate and enter into long-term contracts with suppliers and vendors. A downbeat outlook shouldn’t prevent operators from deriving benefits out of low prices for goods and services that can result in foreseeable low cost exploration activities.

Written by Ajith Muralidharan, Vaangden Pte Ltd, Singapore.

As published in Energy - Global on 13th June 2016
Quoted from: http://www.energyglobal.com/upstream/drilling-and-production/13062016/Strategic-opportunities-in-the-oil-and-gas-industry-2608/

Reference

1. ‘Why Can Russia Compete with Saudi Arabia?’, Market Realist, http://marketrealist.com/2015/12/russia-can-compete-saudi-arabia/ (accessed 13 June 2016).