Value-Added Engineering: A Solution to a Down Market
Welcome to the new domestic energy market.
Oil and gas prices are falling in the US because of a range of larger economic forces such as product oversupply and fluctuating demand, leaving many producers with some hard choices to make in the event of further revenue reductions. Oil prices fell by 60% from June 2014 to January and ranged from more than USD 100/bbl to less than USD 45/bbl in recent months, according to the US Energy Information Administration.
For consumers, this news has largely been welcome, delivering savings at the pump nationwide and helping the US economy continue its march back from the brink of the 2008 recession. Retail prices for automotive gasoline have dropped significantly. Consumers, not surprisingly, are happy with this development, which is making a difference in the monthly household budgets of millions of Americans.
But the good mood does not extend to domestic oil and gas firms for whom the challenges of doing business in this environment are clear. Lower prices mean lower revenues and lower profits, which are stressing business models, forcing cutbacks to operations and investment budgets, and raising new questions for midstream and upstream firms. Among other risks in this changing market, operators now face a reality of lost profits, delayed exploration and development efforts, and changes to their long-term site and growth plans.
In the short term, oil and gas firms need to find ways to cut costs and optimize their existing production efforts and debottleneck their systems to maximize available revenues from what they are already producing to maintain profitability until the market returns, all with an eye on future needs. Prices are falling now, but are expected to rise again in the future. Operators need to know that they can make adjustments to expenditures now without sacrificing future opportunities down the road.
It is a delicate balance. It might be tempting to trim the operating costs at a given site, especially if the cost to keep the facility running exceeds the amount of revenue it is generating, but that can be a rash decision. The real question should be: How do I maximize my production against the needed cuts in capital and operating expenditures to maintain profitability in this market? Where is the “sweet spot” between costs and revenue? To what degree should I cut costs now to hit the sweet spot?
Consider, for example, an operator that decides to lay down a rig on one of its well pads to scale back its operating costs. Rather than building out facilities to support the one remaining wellhead (in this example), the company might want to build out capacity so that it would be able to add onto the site in the future when it is again able to invest in new rigs and assets. Cutting operating expenses and capital expenditures now might require a decrease in exploration and drilling activities, but the operator should still think about the future need for surface facilities to avoid having to make up ground when a return to growth occurs.
In the long term, the risks associated with lower oil and gas prices could be even more significant. If prices linger at today’s low levels for an extended period, operators could be faced with some difficult decisions about their existing and future assets. Today’s oil and gas sites may eventually become uneconomic, meaning that the cost to operate them could exceed the amount of revenue they generate. Operators may even be tempted to abandon their longer-term plans in favor of quick savings and cost cuts.
When will domestic operations stop making economic sense? When will oil and gas firms be forced to pull the plug rather than lose money on their investments? What will reduced domestic production, as a result of the low prices, mean for global energy prices or the US’ growing role in this market?
So far, no one has all the answers. What this could mean for the long-term health of the US energy market remains to be seen.
How are operators addressing these challenges? So far, they have been using a mix of mid-term planning and short-term cutbacks.
Firms are generally finding savings by cutting staff, consolidating resources, delaying exploration and drilling, and even holding off on the completion of existing wells without making fundamental changes to their business models. These efforts are helping to keep them solvent and their investments in place in hopes of a quick turnaround in oil prices.
Examples of the efforts are as follows:
- Cost savings. As revenues have been falling, many operators have begun to cut costs, both in terms of operating expenses and development expenditures, to remain profitable in this environment. Many producers are delaying exploration efforts and trimming their capital expenditures.
- Diversification. Some operators are introducing new products to their offering mixes such as the extraction of helium from natural gas in parts of Colorado, while others are adding processes such as fractionation to their facilities to access products such as butane, propane, and hexane. This puts them at a strategic advantage by allowing them to go to market with new revenue streams in which there is more demand and stronger pricing.
These steps have helped many firms adapt to the changing pricing climate for oil and gas products, but they may be insufficient to weather the industry against a protracted and widespread market downturn. In the face of potential long-term revenue reductions and profit losses, the industry needs a carefully planned, well thought-out approach to solving these challenges.
Toward an Engineered Solution
Fortunately, value-added engineering can be part of the solution.
How? By helping energy operators cut costs and raise revenues in innovative ways. By leveraging proven approaches in midstream engineering to help with pricing challenges, operators can retrofit existing facilities, better plan new installations, and ensure economic operation of sites in both current and future market conditions.
Carefully planned facilities engineering can do the following for operators:
- Cost reductions through process optimization. Existing oil and gas collection and delivery systems may be improved by focusing on efficiency improvements, addressing product quality needs, and eliminating redundancies. The overall goal of process optimization is to reduce the cost of production at existing sites and reduce long-term maintenance needs. Where can these improvements be made? What redundancies can be addressed? What maintenance can be eliminated or streamlined? Can any existing process be done differently to remove waste from the system?
- Revenue generation through debottlenecking. By bringing more products to the market, operators may increase their potential revenues from existing sites by both increasing production and adding new products to the mix. Often, this revenue stream is being constrained by improper or less than optimal site designs. Where is production currently being held back? Done right, engineered debottlenecking of oil and gas sites may allow operators to make more money with their existing resources at minimal cost, thus offering the best of both worlds.
- Strategic site planning. Would shifting to prefabricated or modular facilities help the operator with overall system efficiency and cost? Can their installations be better planned and organized to take advantage of shared labor, resources, and economies of scale? Engineers can develop plans for retrofit applications and newbuilds, thus minimizing the cost of construction and ongoing maintenance and upgrade costs.
- Pre-engineering to prepare for the eventual upturn. Given that oil prices are lower now, but will most likely rise again in the future, operators need to take careful steps to cut capital expenditures and operating costs today with an eye toward returning to investment mode in the future. This also extends to site planning and asset acquisition. By taking the market dynamics into account, operators can become more strategic with their investments when building new sites, preparing both for a changing market and a changing regulatory environment. Well thought-out preparations made now can and will pay dividends down the road.
By considering these value-added options, engineering firms are well positioned to provide these services with better efficiency, streamlining, and cost-saving innovations. The firms provide optimized facilities design solutions that are fit-for-purpose and will prepare clients to return to the market more productively. Exposure to a myriad of facilities and processing challenges enables engineers in knowing how to solve the unique, complicated problems that face each individual operator and how to use their tools to maximize site efficiency, profits, and resiliency in the face of fluctuating returns.
Oil and gas firms cannot give up on existing assets as a result of market pressures because it will cost more to get back into production mode later if they do. Maintaining a readiness to return to the market at higher production levels is key. Now is the time to work more effectively to extract maximum productivity from existing facilities by building value, maintaining flexibility, and improving efficiency.
|Travis Hutchinson is the vice president of operations at Halker Consulting. He joined the company in 2009 and has previously worked as the process department manager and director of projects. He has experience in upstream and midstream natural gas and crude oil processing and coal gasification. He holds a BS in chemical engineering from the Colorado School of Mines. He may be reached at email@example.com.|
|Peter Dickey is the vice president of business development at Halker Consulting. He has more than 35 years of experience in the refining, oil and gas, petrochemical, industrial gas, and minerals processing industries. He holds a bachelor’s degree in chemical engineering from Carnegie Mellon University. He may be reached at firstname.lastname@example.org.|
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