For the past five years, companies working in shales have been living and breathing that age-old mantra, “Drill, baby, drill.” But as this downturn lingers and uncertainty settles in, the time has come to think. Strategy is the name of the game right now.
Organizations are going to have to make some tough decisions to ride out the low oil prices, but those that use this time wisely to analyze their costs, goals and action plans will not only survive but be set up to thrive once the action picks up again.
Looking End To End
Many companies will be making budget cuts, but the ones that will come out on top when prices recover are those that hone in on what they can accomplish through cuts and how each cut affects the organization as a whole rather than cutting costs as a reactionary, quick-fix approach to financial struggles.
“There’s a lot of cost-cutting going on, and it’s very easy to fall in the trap of just taking a siloed approach—looking at one department or one function at a time,” Linda Castaneda, EY U.S. Oil and Gas advisory leader, said. “The organizations that are really looking end to end at how they cut costs are going to avoid some of the unintended consequences.” For example, if a company curtails drilling, it should look at how that impacts indirect drilling costs and taxes down the line.
Though spend may be smaller, it’s likely to be more targeted to a company’s sweet spot—which could lead to some exciting acquisition and divestiture (A&D) activity. “We haven’t seen as much the first half of the year, but second half of the year we’ll see a lot more mergers and acquisitions,” Castaneda said. “It’s a great way for companies that have a strong balance sheet to get into the market and grow their footprint.”
A rig works in the Duvernay. The Duvernay in Canada is one of four assets where Encana will spend most of its capex this year. (Source: Encana)
Encana—which implemented a new, fine-tuned strategy in late 2013—works as an example of how a focused plan can play out over time and improve a company’s position, both geographically and financially.
While divestitures and workforce reductions may seem like negative reactions to the downturn, for Encana these actions were and are part of its strategy going forward to be more profitable in the future. The company restructured and resized in late 2013 and early 2014, cutting 25% of its workforce and capturing about $150 million of enduring operating, administrative and capital cost savings. Encana has looked to narrow its focus and rid itself of noncore assets as part of its “value over volume” strategy. The company cut its investment to its 28 previously funded areas and focused investment on seven growth assets in 2014, generating about $400 million of free cash flow, according to Encana CEO Doug Suttles in the company’s year-end earnings call. In 2015 the company will spend most of its capex on just four assets with strong liquids margins and competitive supply costs: the Montney and the Duvernay in Canada and the Eagle Ford and Permian Basin in the U.S.
With this asset strategy in place, Encana is making deals. In September 2014, Encana acquired Athlon Energy’s Midland Basin assets, adding 168,000 gross acres to its Permian portfolio. In January Encana completed the sale of about 1.2 million net acres of land from its Clearwater assets in Alberta, Canada, to Ember Resources Inc. for $542 million. And according to a Bloomberg report in late April, Encana is looking to sell its Haynesville Shale gas assets, which are valued at up to $1 billion.
“Today we are clearly better positioned than a year ago to weather the current weak oil and gas price environment,” Suttles said in the earnings call. “The cornerstone of our strategy is to sustainably grow cash flow per share and maintain a strong balance sheet.”
The company has also been able to improve efficiencies and sees room for even more improvements given the current environment.
“We see opportunity to deliver efficiencies through our supply chain and our administrative costs as well as all aspects of our operations,” Encana spokesperson Doug McIntyre told E&P. “With this in mind, we are budgeting a further 15% improvement in capital cost efficiencies in 2015. Our focus on base optimization should also generate approximately $75 million of direct operating cost savings. We also see an opportunity to make further improvements in our corporate cost structure.”
Encana went from investing in 28 funded areas to focusing on seven growth assets in 2014. (Source: Encana)
This effort has put the company in a good place to move forward with any deals that open up in line with its strategy. “In my experience and knowledge of the history of the industry, it’s the low points in the commodity cycle that are usually the most exciting times,” Suttles said. “And I can tell you we are prepared to respond if the right opportunities come along.”
Land assets aren’t the only consideration up for grabs in this downturn. One of the most important assets companies should be considering is talent. Layoffs may be part of a disciplined approach, but it’s important to have a good talent strategy in place, both in terms of analyzing where to make the reductions and, if the opportunity is there, gaining some very valuable employees, Castaneda said.
“Some of the companies that are really smart know there’s good talent in the market right now,” she said. “Some of the oilfield services companies, because they’re the first to react, have had some very significant layoffs of some very talented people, so if you’re able to be smart about it and understand where you’ve got some gaps, we’ll see some hiring going on.”
The slowdown in activity also provides the opportunity to take a look at a company’s processes—land, marketing, financial, etc.—and how those integrate with production and drilling. Data processes in particular could have a huge impact on the bottom line and future success of a company.
“In this space there’s a plethora of data that organizations have, but there’s always a challenge of ‘What are the right metrics that I should be tracking? How do I get the best data that I need to make decisions?’” Castaneda said. “Over the past five years or more, everything’s moved so quickly that a lot of companies have not had time to keep up with the pace of the drilling. If you can use this time to put those more efficient processes in place, you’ll really be well positioned as things start to improve.”
The effects of the downturn on service companies have been seen in the waves of layoffs these companies have gone through already—almost 40,000 at the three biggest service companies alone. While service companies have fewer opportunities than operators during a downturn as the purse strings tighten, they still have the chance to position themselves for success in the recovery.
“The oilfield services companies are going to continue to see their prices get driven down, and they’ll have to work with those producers a little more closely,” Castaneda said. It’s those partnerships that will have an impact. “At the end of the day [if service companies foster those relationships], they will be better off when things start to turn around.”
Some service companies are taking this time to improve in ways that might give them an edge over the competition. Fortis Energy Services Inc. is focusing on setting itself apart through its growth strategy, which includes three “pillars of differentiation”—FortiSafe Certified, Designed Solutions and lean methodologies.
The second and third pillars concentrate on identifying and eliminating inefficiencies, while the first pillar, FortiSafe Certified, focuses on safety with a program that exceeds all regulatory and customer requirements. “Our crews must earn the certification, and they are incentivized to do so,” Edward Shelton, vice president of business development, said. “Our entire fleet will also display the certification so anyone working with and around the equipment knows it was inspected prior to arriving on location.”