Topic: Intervention

Maintaining momentum: ensuring cost improvements are truly sustainable for both operators and the supply chain

Region: North Sea
Content Types: Analysis
Date: Jan, 2017

Cutting costs is imperative, but total life-cycle costs and sustainability are critical

Prolonged challenging market conditions have posed existential threats to operators, contractors and in the case of the North Sea, arguably, an entire basin. The severity and rate of market deterioration has made deep blanket cost reductions an imperative of survival, with little scope to consider more surgical approaches. However, as an impending potential market recovery, performance improvement and efficiency gains begin to appear, it is critical that measures taken to-date are carefully evaluated to ensure gains are sustainable and present a sound basis for long-term value creation for all stakeholders – operators, contractors and investors alike. For example, in February, Statoil said extensive cost cuts had brought the breakeven cost of projects set to start production by 2022 down to $41 per barrel from the $70 seen in 2013. There are initiatives in place to further improve this, but the question remains how much is attributable to margin pressure and how much is truly sustainable, structural, cost and performance improvement.

Operators: focus must now shift firmly towards structural cost savings

Despite the ongoing oversupply across much of the depth and breadth of the supply chain, the temptation to excessively leverage this to further reduce costs should be resisted. Any additional short-term benefits of this approach are far outweighed by the potential long-term damage this may do to the supply chain and ultimate impact on future supply and total life-cycle costs. Instead, by focusing on establishing more meaningful partnerships with contractors where risks and rewards can be shared, opportunities exist to develop sustainable structural cost savings through a collective focus on operational excellence and efficiency. By taking more integrated approaches to working and aligning the incentives of operators and contractors, the full benefits of standardisation, cross-functional optimisation and decision streamlining can be realised.

In more practical terms, to ensure cost savings can be sustained in the longer-term and real value is created for shareholders, operators must:

  • Clearly identify key suppliers that can help deliver essential operational performance improvements and work closely with them to identify and prioritise areas that can have the greatest impact on reducing costs, saving time and creating net savings.
  • Recognise the need for contracts to be financially viable for both parties, so that contractors can retain the necessary capability, competence and flexibility to fully support operators’ initiatives throughout the downturn and eventual market recovery without creating conditions that ultimately underpin rapid cost inflation and erosion of cost and performance improvements.
  • Develop consistent working processes and templates that allow best practices and efficiency gains to be quickly captured and widely deployed across all operations.

Supply chain: focus on delivering sustainable value to operators by bridging gaps in understanding

At OFS Partners, a particular focus of our work with oilfield management teams (and oilfield service sector investors) is to help them better understand the needs of operators, improve their chances of success in procurement processes, and ensure products, services and precious R&D spend best positions them to deliver value to operators and create sustainable competitive advantages. Through this work, we consistently discover significant disconnects between what operators’ requirements, objectives and preferences are and how the supply chain in general is seeking to provide solutions. Resolving such misalignments in understanding is crucial to developing long-term sustainable cost improvements, and determining the winners and losers in the downturn.

To increase the likelihood of being a beneficiary of understanding gaps and current market disruption, contractors should:

  • Engage early and often with operators to understand their needs and invest time and resources into building relationships rather than making grand assumptions based on static information or analysts’ assertions as to what is required, when and where.
  • Efficiently deploy R&D capital to provide specific solutions for specific, well known, understood and actionable operator needs. This will ensure maximum value is created, captured by contractors and delivered to operators, while also avoiding the risk of innovations being scoped out by operators choosing to take alternative approaches.
  • Seek strategic alliances, JVs or Mergers & Acquisitions that can truly enhance propositions and deliver real and immediate value to specific operator challenges. It’s essential such ventures are as closely linked to operational execution as possible and not simply tenuous thought leadership around collaboration.

Investors: look beyond the macro to unlock significant value creation opportunities

Macro market uncertainty and difficulties identifying attractive actionable investment opportunities has led many investors to either de-prioritise oil and gas as an investment theme altogether or take an approach of waiting until there are clear signs of a sustainable recovery in progress. Nonetheless, significant opportunities exist, particularly in market segments where the focus on cost reduction and performance improvement by some businesses is creating substantial market disruption by challenging conventional thinking with alternative solutions. Investors can best position themselves to create considerable value by leveraging a deep understanding of structural industry changes and how micro-market recovery expectations vary across the sector. In this regard, OFS Partners are actively working with investors to make timely and intelligent investment in new opportunities or building cases to deploy growth capital to safeguard the market positions of existing investments.