Economist's Corner

Issues With Opex Forecasting in Economic Evaluation

Historically robust demand and hydrocarbon prices in the past have conditioned the industry to regard operating expenditure (opex) as a minor element compared with capital expenditure (capex).

The industry’s downstream sector, which has had more traditional competition, has been assessed on world-league tables of refinery performance. Downstream has used whole-of-life costing for many years, which includes both capex and opex. In contrast, the upstream sector has tended to focus on capital costs, making rigorous assessments of them, for example, when delivering a facility with which to exploit a hydrocarbon reservoir. As a result, the scope, dimensions, and impacts of the potential risks during a venture’s production phase often have been grossly understated and poorly defined. Failure to achieve expected financial performance has been an inevitable consequence. This experience, together with the continually changing global business environment faced by operating and service companies, is now resulting in changing attitudes toward managing opex and business strategies for maximizing economic returns on developing, developed, and mature fields.

Diminishing business performance and high costs have been linked to numerous causes, including excessive levels of plant unavailability because of lack of fit-for-purpose equipment to meet process demands; a poor initial capex/opex balance, resulting in operating-cost levels that erode margins; operations personnel who lack certain competencies; regulatory and fiscal regime changes; currency movements; and changes in market demand.

To understand and mitigate the risks of the operational phase, it is essential to model the key assets linked to business results. Through modeling, one can examine major opex issues such as

  • Effect of capex on opex
  • Effect of engineering change on asset status and performance
  • Forecast of expenditures

A key enabler of this whole-life solution is the implementation of activity-based costing (ABC). Historically, operating costs have been very difficult to model. ABC provides a framework that allows costs to be tied directly to assets. The principle of ABC is that all costs can be described by the activities performed on a company’s assets and the resources these activities consume. In detail:

  • An asset can be anything that has value to the company. (This means functional assets such as pipelines or separators.)
  • Activity describes the tasks that take place on the asset—for example, inspection and maintenance.
  • Resource describes everything needed to undertake an activity (i.e., manpower, equipment, materials, and services).

Through this concept, because costs are now applied to the physical asset, it becomes much easier to analyze the impact of a change on that asset—for example, the addition of a compressor.

The creation of a model consists of a number of stages, including building an asset register, defining activities/resources on assets, and applying tariffs. This approach can be used at all stages of the life cycle, and it can be simplified by discriminating between greenfield (new project) and brownfield (ongoing project) phases.

In the case of a greenfield, the asset register is based on equipment lists derived from basis-of-design information. For activities during the early phases of a project, it is important to model multiple scenarios rapidly and understand quickly the impact of capex decisions on opex.

Not all costs can be represented by the activity/resource relationship; some need to be allocated to the asset through tariffing. A typical example is tariffs associated with access to a multiuser pipeline. The key to this process is to achieve a fair and equitable distribution of costs—for example, by allocating regional pigging costs to the total length of pipeline traversed in each asset.

The main advantages of this approach are an interaction between capex and opex; the facilitation of capital-phase decision analysis, such as equipment type, training, sparing, and manning; the ability to rank opportunities on a more rigorous net-present-value basis; and enhanced visibility of the annual budget requirements with the ability to assess the impact of different options.

Life-cycle costing has been around for many years but has not been used widely in the upstream sector for activity/asset-based planning and asset business planning. The processes used to develop the latter are the real key to achieving business success because they

  • Systematically address the primary business attributes: assets, activities, and resources
  • Identify the key risks that may threaten the business
  • Help to identify options for managing those risks successfully.

Terry Hancocks is Support Services manager for Agip KCO, London. He has spent more than 20 years in the oil industry, primarily with Shell in operations and maintenance. Hancocks has also been manager for IHS Energy Group and general manager of that company’s Aberdeen office.


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