Chevron CEO John Watson recently lamented that “$100 a barrel is becoming the new $20 a barrel,” while Total CEO Christophe de Margerie said flatly, “We cannot continue to swallow this huge inflation.”
Operating cost inflation, which Ziff Energy’s analysis puts at 10% annually, is impacting the industry in several significant ways. As profit margins are squeezed, some projects become more marginal economically. Large operators have increasingly focused on fewer, higher value properties. Finally, a shift has begun from the outward focus of opportunity capture toward a more inward focus on efficiency and cost control.
If the oil and gas business is to maintain its historical 10% to 12% returns, operators will have to get a handle on retaining margin and controlling costs. The ability to achieve these returns depends not on revolutionary change but on achieving incremental improvements.
Oil industry in transition
Watson’s comment about $20/bbl oil came at the recent 2014 IHS CERAWeek summit, where an organizer said, “I don’t think I anticipated just how much cost was on people’s minds. There’s this idea of an oil industry in transition, from really boom times to a more sustainable pace.”
This search for a more sustainable pace comes after a post-2008 economic downturn and post-Macondo period during which oil prices have recovered and activity has dramatically increased. In pursuit of higher production and facing competition for supply and services, companies have paid less attention to negotiating lower cost arrangements. For some time there has been a seller’s market, a fact not ignored by the services community, which has worked to recover some of the profitability it lost during the previous decade. These upward cost pressures have continued, so it’s only natural that there is added emphasis on getting more control of supply costs.
Gaining control begins with an evaluation of personnel-related costs. Many companies rapidly grew their staffing with the upturn in business post-2008, throwing significant personnel resources at key activities. Now the focus is shifting from staffing up to more effectively and efficiently executing and pursuing existing opportunities.
In the interest of preserving capacity utilization at individual facilities, a number of operators are looking for opportunities to develop satellite fields and processing nearby production from other operators. Subsea completions and subsea field development technology will continue to be focus areas.
A few operators have announced wide-ranging restructurings, selling nonstrategic assets as they transition from unbridled opportunity capture and growth to focus more on efficiency with their core assets. One operator that was pursuing growth opportunities in more than two dozen basins is now concentrating its capital spending on just five separate plays, all liquids-related. Other large operators have announced sizable layoffs and spinoffs of lower margin businesses.
While some operators have tried various methods to gain control of this cost inflation, benchmarking is seen as a beneficial pathway to improvement. This back-to-basics approach emphasizes efficiency, more specifically the identification of incremental improvement opportunities that can be exploited to improve efficiency.
Ziff Energy’s approach to benchmarking uses a two-phase (diagnostic and improvement) process with five key steps in each. In the diagnostic phase, it collects, analyzes and compares data to objectively identify and measure performance gaps. Because companies organize cost and production data in a variety of formats and with different levels of detail, data must be standardized and compared on a consistent basis. The methodology encompasses the following steps to create a meaningful “apples-to-apples” comparison:
- Standardize and organize cost categories and production data;
- Standardize measurement procedures and performance indicators;
- Identify a group of peer fields for comparison;
- Measure performance, cost and efficiency metrics; and
- Identify performance gaps against peer and leader (best-in-class) averages.
In the improvement phase, an operations team reviews and analyzes measured performance gaps, then develops and implements action plans with performance tracking to narrow targeted performance gaps. This effort is typically accomplished in the following steps:
- Analyze performance gaps to determine why they exist and establish priorities for closing them;
- Communicate an understanding of the gaps within the organization;
- Design action plans to close identified gaps;
- Implement the plans to harvest the benefits of cost savings and incremental production and measure progress; and
- Learn from the action plan results and make adjustments as needed for continuous improvement.
Applicable deepwater lessons learned
In reviewing data and trends from benchmark studies of deepwater facilities, some key lessons have emerged:
- Many facilities are under-utilized, with oil and gas production rates 50% or more below design capacity;
- Facility complexity impacts overall operating cost;
- Improving fuel efficiency and reducing the use of fuel gas has a double benefit of reducing operating cost and increasing the revenue from gas sales (plus reduced emissions);
- Facility staffing practices vary widely for similar facilities;
- Areas with lower cost labor tend to have more staff, negating their low labor cost advantage;
- Unit cost is not necessarily directly correlated to facility age; and
- Production efficiency and reliability are key to managing production losses.
Looking ahead, Ziff is developing a biennial worldwide offshore study that will provide operators with consistent benchmarking results across their offshore portfolios. The company will be introducing a regression analysis-based normalization approach to help assess differences within each of the groups.
Wise operators open to ideas
Going forward, the industry will continue to search for opportunities in new growth areas and within existing development basins. There will be continued focus on exploration and development in frontier offshore basins.
With improvements in technology, distances are less of a challenge. So some locations where 15 or 20 years ago there was little or no development, such as offshore West Africa, are having significant ongoing development activity.
The challenges facing operators are many and well-established:
- State of the world’s largest economies;
- Political environment in the U.S.;
- Coming change in employee demographics known as the “Big Crew Change”;
- Increase in North American supplies from shale resource development;
- More rigorous regulatory demands (post-Macondo); and
- Reduced influence on world markets of some producing countries (OPEC).
In the midst of all of these challenges, the bottom line is this: Operators must get a handle on retaining margins and controlling costs. Doing so does not require revolutionary change; it requires identifying and achieving incremental improvements that can be found when operators compare their performance to peers.
Wise operators are open to ideas and approaches that are successfully being used by others. They understand “our way” may not be the best way.