The inherent volatility in the oil and gas industry came into full force in 2014, with the culmination of increasing complexity, rising operating costs, and a rapid fall in oil prices. Getting through this latest downturn will require a balancing act between short-term measures to reduce costs while maintaining a long-term perspective on growth.
While the cyclical rise and fall of the oil price hardly comes as a surprise, there is an obvious correlation between confidence in the industry and the price of a barrel of oil. In tandem with identifying the priorities and strategies for the year ahead, this was very much demonstrated in the findings of our fifth annual industry benchmark study, A Balancing Act: The Outlook for the Oil and Gas Industry in 2015.*
Unlike in previous years, we felt the need to carry out the survey on industry confidence twice, three months apart, as we believed that the rapid drop in oil price at the end of 2014 may have skewed the results. We did indeed see a sharp drop in confidence between October 2014 and January 2015, from 62% being confident to hit their revenue targets down to 32%. The sharpest drop in confidence was seen in Asia, which dropped from 72% to 33%. The research not only compared results across a quarter of the year, but also from DNV GL’s 2014 industry outlook report, providing a snapshot of sentiment and a look ahead.
A Test of Confidence
Ongoing rises in operating costs colliding with a dramatic fall in oil prices made operators across the industry respond with further cutbacks in their capital expenditure plans and cost-cutting measures across their operations.
Overall, 28% of respondents remain confident about the oil and gas industry going forward, down from 88% in 2014 and a high of 89% in 2013. The speed of the downturn inevitably hit home in several key areas: far fewer are confident of their capacity to meet revenue and profit targets this year. Less than one-third predict they will hit their revenue (32%) and profit goals (30%), and these percentages have more than halved from last year (70% on both). Low oil prices are now the biggest barrier to growth in 2015, cited by 68% of respondents, followed by weak global economy (35%), and uneconomic gas prices (20%) as well as tougher competition. The industry’s skills shortage, which has been the largest barrier to growth for the past 2 years, has fallen to 10th place (14%), jointly with geopolitical instability in key markets.
It is concerning for the long-term health of the industry to see behavior so tightly bound to oil-price fluctuations. We essentially need to heed lessons learned from previous downturns and avoid repeating mistakes.
Split Strategies
All of this poses a downturn dilemma for oil and gas leaders in 2015 and this is reflected in the survey findings, which show that the industry is split over cost-management strategies. Indeed, companies that are confident in hitting their profit targets are showing signs of counter-cyclical behavior. Those who are most confident about reaching their profit targets take a long-term approach, while those pessimistic about hitting profit targets are more likely to take short-term cost-cutting measures, such as reducing headcount and pulling back on investment. Almost seven out of 10 “profit confidents” (67%) expect capital investment to be increased or maintained compared with 29% among “profit pessimists,” and 70% intend to bolster R&D spending compared with 40% of the pessimists.
Only 15% of the profit confidents see reduced headcount as a measure for stricter cost control compared with 35% of their more pessimistic peers. Profit confidents also have a greater focus than profit pessimists on improving workflow/work processes (45% vs. 35%), greater use of automation (11% vs. 1%), and the adoption of new information technology (13% vs. 4%).
Standardizing for Smarter Cost Cutting
Both profit optimists and pessimists place standardization high up on the list of cost-control measures. Nearly a quarter (24%) of all respondents say they will increasingly push to standardize their tools and processes in order to control costs. In its various forms, the advantages of pursuing this approach are significant.
For example, a new “Standard for Certification of Subsea Equipment and Components” has recently been launched by DNV GL. For operators, the aim is to reduce costs without sacrificing quality, innovation, or safety. For suppliers, it will increase predictability and enable the strategic stocking of long-lead items. Overall, the standard could potentially reduce project lead time by 6 months.
Speaking at a forum in Stavanger in 2013, Norwegian Oil and Energy Minister Tord Lien said that too much paperwork was killing the profitability of the industry. In the subsea industry, for instance, a typical project can involve more than 10,000 documents (with up to 80,000 in a complex project) over a life cycle of 30 years.
Operators, contractors, and suppliers will often spend millions of dollars on document management, technical review, and information management systems to develop, maintain, and verify the quality, security, accuracy, and availability of documentation. The lack of standardization in this documentation process increases the risk of misunderstandings and makes handling approvals more cumbersome. This subsequently leads to increasing project lead times and costs for both operators and suppliers.
A joint industry project has resulted in the first draft of a recommended practice to establish industry guidelines and recommendations to streamline documentation requirements for subsea operations. Statoil is now operationalizing the draft recommended practice in a pilot scheme with Aker Solutions as part of the requirement for the development of the Johan Sverdrup field on the Norwegian Continental Shelf.
Automation may also present opportunities to reduce costs. Statoil and its partners have chosen an unmanned wellhead platform to be remotely controlled from the Oseberg field center in the North Sea as a concept for Oseberg’s further development. The investment decision is expected in several months. The alternative was to place wells on the seabed, but the cost of such wells has tripled in the past decade. The decision was therefore taken to use platform wells on a steel frame, which reduces costs by several hundred million kroner, according to Anders Opedal, director of projects at Statoil.
Preparing for a New Normal
The low-margin reality brings both opportunities and challenges. Industry leaders will have difficult choices to make about financial solidity, cost control, and growth strategies, but at the same time, new possibilities will open up. There will be short-term opportunities to refocus on core projects, ease up on talent pressures, and explore more affordable acquisitions or consolidations.
More importantly, the low-margin environment creates momentum for enforcing and speeding up much needed long-term measures to reduce the overall cost base in the oil and gas industry. By taking a broader view to reduce complexity, and by standardizing processes, materials, and documentation, industry players can develop a long-term sustainable cost base, rather than a knee-jerk, short-term reaction to oil price fluctuations.
*A complimentary copy of A Balancing Act: The Outlook for the Oil and Gas Industry in 2015 is available at www.dnvgl.com/balancingact.
