July 25, 2010

Anchoring Success: Effective Management of Energy Companies’ Shipping Interests

For decades, major energy companies have been at the forefront of the global shipping of hydrocarbons. Producers have played an instrumental role in the development of all aspects of the business, but shipping has often taken a subordinate role. As a result, energy company shipping assets have largely underperformed in commercial terms, according to a new study by Booz & Company. A systematic approach to strategy, operations, measurement, and organisation can position energy companies to reap major benefits from their shipping assets, ensuring efficiency, profits, and synergy with broader strategic goals.


The Growth of the Shipping Industry

The shipping industry has evolved in step with the development of the oil industry. Today, roughly two billion barrels of oil are transported annually by ship, and the biggest supertankers can carry more than three million barrels of oil in a single load. “Energy companies have been instrumental in the development of the industry. As it evolved, numerous independent shipping companies entered the market, offering a viable alternative to energy companies’ practice of owning and operating shipping assets,” said Ibrahim El-Husseini, a partner at Booz & Company. This maturity led to the natural commoditisation of crude and refined product tanker shipping.


Energy Producers Remain Invested in Shipping

Energy companies are committed to maintaining shipping capacity, although the degree of their involvement varies. Energy company rationales for involvement in the ownership and management of shipping assets are typically linked to a combination of five factors:

  • 1. Strategic coverage: Maintaining control over shipping capacity is important. Access to markets ensures business continuity and sustenance during periods of emergency.

  • 2. Volume commitments: National Oil Companies (NOCs) typically have a large volume commitment and base load shipping capacity requirement.

  • 3. National industry development: Shipping presents some producer corporations with an opportunity to expand and diversify their countries’ domestic economies, and provides an avenue to create employment and develop skills.

  • 4. HSEQ considerations: For International Oil Companies (IOCs) that face strict regulations and public pressure, control over shipping provides a greater ability to manage risks by adhering to health, safety, security, and environmental rules that protect the primary hydrocarbon business.

  • 5. Technological leadership: IOCs that are involved in highly specialised technological trades can use control of shipping to position themselves as end-to-end solutions providers.

Energy companies should develop their own priorities depending on their unique circumstances. This can be problematic. “Some strategic operations are explicitly recognised whereas others are not. As a result, there is often confusion throughout the organisation about the true goals of shipping and how to evaluate its subsequent performance,” noted Sean Wheeler, a principal at Booz & Company.


The Case for Focusing on Commercial Performance

The shipping divisions of energy companies often do poorly in terms of commercial performance: management often views shipping as a cost centre and the shipping company is relegated to an operational support area with limited autonomy in decision making. The lack of emphasis on commercial results also provides little incentive to innovate or improve efficiency from within.

Furthermore, the shipping industry’s financial dynamics can be unforgiving to halfhearted participants. There are two major sources of value creation (or destruction) in any shipping operation: assets and freight. Both can be extremely volatile and as a result, it is imperative to focus on maximising performance in the shipping arena. In doing so, energy company management must address and dispel three main concerns and misconceptions involving the shipping business.

Concern 1: The Pursuit of Commercial Performance Diverts Management from Its Core Purpose of Supporting the Strategic Aspirations of the Parent Company.
Executives may take the strategic considerations of their company not as directional aspirations but as firm mandates. The former approach lays out the boundary conditions that the shipping division must meet, while giving the division flexibility in how to meet them. The latter approach, lacking in adaptability, would not be responsive to fast-moving markets, whether in oil or shipping. Internal energy company criteria can rarely be defined so minutely as to dictate inflexible commercial decisions by the shipping divisions. “There is a significant element of subjectivity in all general decisions, enough to warrant a large degree of strategic flexibility for shipping divisions, and through it the pursuit of commercially viable performance,” said El-Husseini.

Concern 2: Energy Companies Cannot Do a Good Job of Commercially Managing Their Shipping Interests.
Energy companies should have an easier task and do a better job of managing their commercial performance than would an independent shipping company. This is because of the relative abundance of capital within the parent energy company; independent shipping companies, by contrast may have their hands tied owing to capital constraints. Two key components affect the profitability of shipping interests of energy companies: the first is capital decisions, including the timing of acquisitions and sales, decisions related to buying new or used vessels, and the selection of shipyards. The second is revenue; making sound freight market decisions and maximising vessel availability will ensure that companies realise the full revenue potential of their shipping assets.

“It is important to note that the biggest sources of value creation or destruction in shipping are minimally related to actual vessel operations and consequent health, safety, environment and quality (HSEQ) risks,” Wheeler commented. “Commercial performance can be easily achieved without any increased risk to the parent energy company.”

Concern 3: The Pursuit of Commercial Performance Does Not Contribute to the Achievement of Energy Companies’ Primary Strategic Goals.
The pursuit of commercial performance can be complementary to the achievement of the strategic goal on several fronts. For example, commercially well-managed shipping divisions are highly regarded by the parent company and find it easier to get support for initiatives that fit with the parent company’s strategic goals. “In addition, an energy company with shipping assets that consistently perform well in the market will feel little pressure to abandon its legitimate strategic interests in shipping—which might be the case if the parent company views shipping as a black hole in terms of its capital,” commented El-Husseini. Finally, a well-managed shipping operation finds it easier to attract the brightest talent from the industry and from the parent company, increasing the likelihood that its success will be sustainable.


Managing Performance

Management can operate shipping divisions efficiently and contribute to the parent company’s strategic goals by taking a systematic approach to addressing challenges in four major areas—strategy, operations, measurement, and organisation.


Analytic and Dynamic Strategy

In most cases, energy companies’ shipping divisions need to revisit their strategies to ensure overall coherence. The first step involves determining the explicit strategic considerations of the shipping division, which will also include institutionalising implicit strategic considerations. Once the organisation has defined its overall strategy, it should prioritise the timing, setting parameters for what needs to be accomplished and when. “Once these strategic goals are clearly defined and set, it is imperative that they be articulated in the mission, vision, and values statements of the organisation to ensure a common understanding throughout both the parent company and subsidiaries,” said Wheeler. Once the strategy is set, it must also be kept dynamic, by linking strategic actions to both the evolving strategy of the parent corporation, and the strategic responses required to an every changing shipping market.


Clear and Efficient Operating Model

There are two overarching objectives for shipping operating model clarity and efficiency. The first objective is to put the goals of the enterprise, or parent company, first. The second objective involves a fair recognition of the performance of the business, the transparency of costs, and returns on shipping assets. These twin objectives manifest themselves in several operational areas, such as the commercial arrangements between the parent company and the shipping arm for the use of shipping assets, decisions on the operational and office footprint of the shipping division and their associated cost implications, and the overall ship management approach.


Accurate and Effective Metrics

Performance management is critical, but it is often used by organisations as a mere reporting tool. A performance management system that is closely aligned with a company’s strategy provides leadership with the right level of detail and insight into the organisation to manage its performance actively and efficiently. “In turn, this drives the right balance of strategic and tactical behaviours across the organisation,” noted El-Husseini. A number of key principles can help management guide the business:

  1. Break down the strategy into measurable components.

  2. Identify performance indicators for each component.

  3. Ensure that these indicators form the basis of conversations between the leadership of the shipping division and the parent, and between the management and leadership of the shipping division.

  4. Tie the indicators to individual performance appraisals and rewards, strengthening effective consequence management.


Building Blocks of the Organisation

The final challenge for management concerns building an organisation that will achieve high performance, and includes five capabilities:

  • Organisational structure. The right structure will drive accountability and transparency throughout the organisation.

  • Process efficiency. Clearly mapped processes and clarity on decision rights for individuals and groups help smooth interfaces and increase organisational efficiency.

  • Human capabilities. Having the right quantity and quality of people, with a focus on employee development, is a key component of organisational sustainability.

  • Technology. Having appropriate fit-for-purpose technology platforms to aid the execution of the business improves organisational flexibility and responsiveness.

  • Key interfaces. “The shipping company should be organised in a way that provides clarity on the relationships with important constituents of the parent company, particularly those in supply and trading functions as well as special project coordinators and corporate strategic planning departments,” said Wheeler.


Conclusion

Shipping divisions have generally not played a central role in the corporate strategy of many IOCs and NOCs, but top commercial performance in the shipping divisions of energy majors is an imperative. Energy producers need to realise that shipping operations can enhance strategic goals and with a systematic approach to managing performance, energy companies can nurture top-quartile performance from their shipping operations while reaping the benefits for the parent corporation.