Local content in oil and gas: Recasting the conversation
As local governments demand more than a share of royalties from oil and gas projects within their borders, companies need to develop collaborative, comprehensive local content programs that spread economic benefits more widely in the countries where they operate.
Local content in oil and gas Recasting the conversation
About the authors
Beirut Georges Chehade Partner +961-1-985-655 georges.chehade @strategyand.pwc.com Dubai David Branson Executive Advisor +971-4-390-0260 david.branson @strategyand.pwc.com
Houston Juan Trebino Partner +1-713-650-4151 juan.trebino @strategyand.pwc.com London Viren Doshi Senior Partner +44-20-7393-3572 viren.doshi @strategyand.pwc.com Melbourne Malcolm Garrow Partner +61-3-9221-1928 malcolm.garrow @strategyand.pwc.com
Milan Giorgio Biscardini Partner +39-02-72-50-92-05 giorgio.biscardini @strategyand.pwc.com Paris Douwe Tideman Partner +33-1-44-34-3127 douwe.tideman @strategyand.pwc.com São Paulo Arthur Ramos Partner +55-11-5501-6229 arthur.ramos @strategyand.pwc.com
Douwe Tideman is a partner with Strategy& based in Paris. He has 25 years of consulting and industry experience in the upstream energy sector in Europe, the Middle East, and Asia, with expertise in performance improvement, strategy and business development, and transformational change programs. Arthur Ramos is a partner with Strategy& based in São Paulo. He has worked extensively with companies in the oil and gas, utilities, and infrastructure industries on issues involving strategy review and growth, mergers and restructuring, and governance and organization. Georges Chehade is a partner with Strategy& based in Beirut, and the leader of the firm’s energy, chemicals, and utilities practice in the Middle East. He has extensive experience in energy, including midstream and downstream oil and gas, and has led numerous transformation programs for large international and national oil companies, including corporate and business unit strategies, restructurings, and operating model redesigns. Rose Landau is a senior associate with Strategy& based in Melbourne. She has extensive experience in upstream oil and gas, including developing government-facing strategies and designing local content strategies.
Countries around the world are tightening the requirements they impose on international oil and gas companies regarding their use of local content, in hopes of encouraging companies to participate more actively in the local economy, train and hire workers, and build local supplier ecosystems for goods and services. In response, companies must rethink their approach to local content if they are to maintain and improve their relationships with host governments. The proper approach demands, first, that companies gain a clear understanding of the countries they are operating in — both locally and, more broadly, nationally, including such aspects as local capabilities, national development agendas, and nongovernmental stakeholders. Then companies and countries must work together to define success — the skills, capabilities, and economic activities to be developed — and the country’s wider ambitions for developing its energy resources. An analysis of where the capability gaps are will enable companies to find opportunities to boost local content. Finally, frequent reviews and an agreed-on way to measure progress will let both parties make adjustments to the program when necessary. Ultimately, the key to a successful collaboration between companies and host countries is flexibility, transparency, and good faith. Otherwise, neither is likely to reach its local content goals, or its long-term agenda.
The virtues of local content
An old issue is taking on new urgency for oil and gas companies operating in developing countries: local content. Governments in host countries have been raising the ante for access to their natural resources, demanding increased participation from international oil companies in the local economy, to spread the benefits of their activities beyond rents and taxes. That in turn will require oil and gas companies to refine their approach to the issue if they are to maintain good relations with host governments and reap the business benefits that such relationships can bring. Oil and gas companies have traditionally approached the issue of local content with a compliance mind-set — doing the minimum necessary to meet local requirements while limiting as much as possible the impact on core business operations. This fundamentally reactive approach assumes that local content is a negative effect to be reduced, rather than a potential business benefit to be earned. That makes it harder for companies to build effective and productive relationships with host governments because those governments don’t see any real commitment on the part of companies to improve local capabilities and conditions. Moreover, the old approach is risky, and will only become more so in the future if the rate of contractual and legislative changes continues or even increases. Those changes, we believe, are inevitable, as governments try to generate greater benefits from companies they feel are not delivering what has been agreed on or is expected. And even though many companies have adopted increasingly sophisticated approaches to the issue, the gulf between how oil and gas companies operate globally and the expectations of local governments remains substantial. Pushed to the extreme, governments may strike back at noncompliant companies, imposing financial penalties, making it more difficult for them to recover costs, refusing to extend contracts, and even kicking them out of the country altogether. Under such circumstances, neither the host government nor the company wins.
To prevent any further widening of the gap between host governments and oil and gas companies, now is the time for them to recast the conversation to better align their collective interests and to develop a more flexible, collaborative approach to the issue of local content. Improving their relationships with host governments can also bring further benefits to companies, including lower costs, greater access to new projects, and the potential to develop a sustainable, long-term partnership.
A changing environment
The urge on the part of host governments to demand more from the oil and gas companies operating in their countries is understandable. In some cases, it is a result of disappointment and frustration with past experience — both Nigeria and Kazakhstan, for example, have wellestablished oil and gas industries, but they have yet to reap the broader benefits expected from the industries’ activities. That’s why many countries, including Brazil and Uganda, as well as Kazakhstan, are already strengthening their local content regulations, expecting higher local procurement and staffing targets, lower limits on expatriate staff, and higher training requirements. And new entrants to the extraction industry such as Ghana and Tanzania are looking to learn from the successes and failures of other countries in order to implement a more effective local content regime of their own. For their part, meanwhile, some leading oil and gas companies have been developing and implementing more standardized frameworks and approaches to the issue of local content. And they are pushing efforts to get involved early on, through programs like supplier training and the financing of local initiatives. Many companies have reorganized local content activities, shifting them from corporate social responsibility and sustainable development teams to “core” business functions such as logistics, field development planning, and human resources. The shift puts local content issues at the heart of their international exploration, development, and production operations. Africa, with its recent discoveries and tremendous oil and gas potential, poses its own set of challenges. Many countries on the continent — particularly those that have only begun to develop their resources — face high unemployment, large youth populations, and severe capability shortages. These countries are taking an aggressive approach to local content as they look to the industry to aid significantly in their overall economic development. Companies hoping to operate in such countries must be especially mindful of local conditions and local requirements. Moreover, many countries, in Africa and elsewhere, are pushing toward greater transparency in terms of financial reporting and governance,
including better compliance with regulations such as the U.S.’s Dodd– Frank Act, which requires companies to report financial information on capital projects, and voluntary programs like the Extractive Industries Transparency Initiative. This puts further pressure on companies to improve their performance and to communicate better to shareholders, governments, and local communities alike. It also underlines the need for companies to clearly understand and communicate to government the costs and benefits associated with specific local content activities, which will vary depending on the environment in which they are operating.
A new approach
Our approach to local content is derived from the critical factors we see as lacking in most local content activities today. First and foremost, it’s about collaboration: Governments and companies must jointly agree on overall program objectives and how they will be achieved. It is also dynamic: Effective feedback loops must be designed to measure progress and adjust plans accordingly. The approach is pragmatic: Companies must tailor solutions to the specific needs and capabilities of the country, rather than imposing on it an “ideal” but ultimately unworkable vision. Finally, it must be founded on a degree of “good faith” between governments and companies; too often, these interactions are fraught with suspicion and mistrust from the outset, undermining any chance of finding common ground. Thus, flexibility is critical. Governments need to be willing to take advantage of the industry’s extensive experience in order to design better cooperative development programs and to secure full buy-in and commitment to the results of such programs. In turn, oil and gas companies must work closely with governments to create these programs and generate greater goodwill in regions where they do business. Those that succeed in doing so can generate real business value as well as a positive impact on the company’s reputation locally. Companies can lower staffing costs through the use of local workers rather than their own expatriate workforce, and potentially lower the cost of goods and services by developing more competitive local supplier ecosystems and lower international shipping and import costs. More broadly, a successful local content program can improve relations with local governments, leading to a smoother cost recovery process, preferential access to additional licenses and projects, and a reduced risk of industrial or social unrest. Finally, it can promote the development of a sustainable relationship with the country, enabling the company to plan for the long term. And companies new to a country can leverage a successful program to differentiate themselves from others operating there (see Exhibit 1, next page).
First and foremost, it’s about collaboration.
Exhibit 1 A collaborative approach to the development of local content
4a Detail and plan initiatives 2a Deﬁne and agree what success looks like, including the requisite trade-offs 4b 3 Deﬁne the opportunity areas Perform detailed gap analysis (supply/ demand) 4c Deﬁne program ownership, governance, and resourcing Execution Create performance metrics and management system
Build detailed and comprehensive understanding of local context
Structure communications and engagement
Do – Learn – Improve Regularly review progress, extract learnings, and adjust program as required
Source: Strategy& analysis
Understanding the context. Countries need to define clearly their options for the development of local content, including employment opportunities and the availability of local suppliers. In turn, companies should analyze how such options might benefit their activities locally and globally. This will involve a realization on the part of companies that the host government is in effect a customer. A full understanding of local conditions should include considerations of the country’s national agenda and priorities, how that agenda might conflict with regional and local issues, how the country approaches the local content issue, and the risks and uncertainties involved in operating there. Companies also need to analyze the broader national operating environment, including institutional strengths and weaknesses, policies and legislative issues, local infrastructure, and nongovernmental stakeholders and their own agendas. To build this understanding, companies will most likely need to be supported by a competent and credible local partner.
Defining success. Both countries and companies need to determine clear objectives in their efforts to develop oil and gas resources. They should be specific, measurable, and — most important — achievable. Both the U.K. and Norway succeeded in developing their local oil and gas industries in large part by tailoring their vision for the industry to their existing capabilities, the skills they hoped to develop, and their economic agenda. When oil was discovered off the coast of Norway, for example, the country decided to develop the resource slowly, and invested a great deal in ensuring that Statoil, its national oil company, and its ecosystem of suppliers built considerable expertise in advanced technology. That has enabled Norway’s industry to become a leading provider of highly technical oil services to other companies and countries. By contrast, the U.K. discovered its own oil in the North Sea during the 1960s, when the country was facing a difficult economic situation, with high unemployment and challenging state finances. So the government decided to focus on accelerating production and creating jobs locally, while leveraging traditional skills and resources in its iron and steel manufacturing, shipbuilding, and construction industries, rather than spending the money to create a high-tech services sector of its own. Every country, in defining its ambitions regarding the extractive industries, must accept that some activities will develop more slowly, or not at all, and adjust its local content policies accordingly. Such trade-offs will vary from country to country — Iraq and Kazakhstan, for example, may focus on boosting employment, while Brazil seeks to build higher value-add, industry-specific capabilities such as research and development. Host governments and companies must agree up front on the cost/benefit trade-offs of local content activities — understanding that sourcing certain goods locally may mean project delays as those capabilities are developed, for example, or, on the other hand, accepting that an aggressive project time line may require a higher proportion of expatriate technical staff. In codifying their specific vision for leveraging local content, countries should conduct a realistic assessment of their existing capabilities. This assessment must be data-driven, and coordinated across the different parts of government — not just the agencies overseeing the oil and gas industry, but also education, employment, industrial development, and regional and local governments. This effort needs to be supported by the oil and gas companies operating in the country, since there are often a wide variety of capabilities required, depending on the nature of each project, and the companies are clearly best equipped to understand the capabilities they need, and how to fill in any gaps. If countries and companies can’t align on such issues, there is little chance that they will agree on local content targets or time lines.
Trade-offs will vary from country to country.
The definition of success also needs to be agreed on within the host government itself, even before it works to align its targets with the oil and gas companies. In our experience, this internal government alignment is often missing. Ultimately, there is no such thing as a single government view; instead, multiple stakeholders will no doubt have competing agendas. Still, some consensus as to the overall goal in developing oil and gas resources, and how success is defined and measured, must be settled on among all the relevant agencies and ministries. Gauging the gaps. Companies operating locally must judge the gaps between the desired local content goals and the country’s currently available capabilities. While the gap will necessarily evolve over time as individual project plans change, there needs to be a single view across different projects as to capabilities such as total shipyard capacity and the availability of local talent, including petroleum engineers, drilling operators, health, safety, and environment specialists, and the like. Companies must ensure that host governments buy into the results of the gap analysis — ideally, governments should participate in conducting the analysis as well. In addition to identifying and prioritizing areas for further development, this gap analysis can serve several other purposes. It can help make sure that the local content program is conducted in a timely but reasonable fashion — high local staffing targets in skilled technical roles, for instance, may be feasible only once a new generation or several generations have received the relevant training. The gap analysis can also determine whether the right stakeholders are involved in the development and implementation of the program; they might include primary and secondary education officials as well as those at relevant universities and technical colleges. Program ownership. Countries need to distinguish between ownership of their local content program, which should reside within a single government entity to ensure clear accountability, and who governs the program, which should be a broader and more inclusive body, involving key stakeholders throughout the government. From a resourcing perspective, the government representatives developing and overseeing the country’s local content program need to be credible to their industry counterparts, with the technical knowledge needed to understand fully any issues the operators may face. Companies, too, must clearly detail their own positions, including their overall objectives and boundary conditions. For example, there may be certain activities, such as the financing of local suppliers, that companies are not prepared to undertake for reasons of reputational or financial risk. This is also an opportunity for companies to think through the value proposition they can make to their host governments.
Are there specific areas of expertise — perhaps technical skills such as welding or university programs they have established elsewhere — that they can offer, or capabilities they have developed while working in other countries that they can call on? In our experience, companies tend to approach each new national local content program as a clean slate, often failing to build on their experiences elsewhere. Finding the opportunities. How companies can find opportunities for developing local content will depend on their “customer” country’s priorities, the local gap analysis undertaken, the company’s own objectives and constraints, and the relative degree of development of the country’s oil and gas industry. In countries with a fair degree of industrial development, a local content program might focus on how to ensure that local suppliers are given access to contracts, or the development of higher-value-added activities such as research and development. In less sophisticated countries, however, more early-stage intervention may be required, such as training suppliers on standard contracting and procurement processes, supporting the financing of suppliers, or education and training in technical skills (see Exhibit 2, next page). This focus on basic development is often a source of tension with host governments, many of which are impatient to move directly to more sophisticated activities, which they perceive to be dominated by the company’s expatriate staff and international suppliers. Reducing that tension will require working closely with host governments to educate them about their capabilities and needs. Putting programs in place to demonstrate that local suppliers will be able to move up the skills curve will help, as will developing technology transfer arrangements and setting up local joint-venture deals. Though a standardized approach to local content developed through projects in other countries is likely to be of limited value in defining opportunities in new countries, companies should develop a common framework for boosting local content wherever they operate. This should include a consistent way to assess the value such programs can offer host countries and the financial and strategic benefits they can bring to the company. The framework should also establish methodologies for analyzing associated costs and potential impacts on the company’s project schedule, and determining each local content program’s feasibility, sustainability, and reputational and financial risks. Furthermore, oil and gas companies should share as much of their analysis of the local content situation with host governments as possible. Doing so will enable them to provide input on how governments might best define their own local content policies, and reassure governments as
Develop a common framework for boosting local content where you operate.
Exhibit 2 Selected examples of global local content efforts
Augmenting the training programs BG has already set up there, the company began construction on a Global Technology Center at the Federal University of Rio de Janeiro’s Technology Park in 2013. Expected to open in 2014, the center will become BG's primary research and development facility.
In 2012, Tullow opened an enterprise center in Uganda to provide business skills training, mentoring and networking, and information on opportunities within Tullow's supply chain to local entrepreneurs and small to medium-sized enterprises. That year, the company also launched its Tullow Group Scholarship Scheme, which has already brought more than 180 African students to Europe for postgraduate studies in a variety of industries.
In 2013, Petrofac committed US$120 million to operate three training facilities to support the workforce capability program it had established with Petronas, Malaysia’s national oil company. The centers of excellence will have the capacity to train 500 people annually, in a variety of upstream and downstream skills.
In 2002, BP launched the Enterprise Center, which provided services to local small and medium-sized enterprises, including business and technical training, assistance in ﬁnding future opportunities, and information on local content requirements. Since 2009, its role has been ﬁlled by the Enterprise E-Center, also sponsored by BP, which continues to aid local businesses in developing opportunities in conjunction with the country’s oil and gas industry.
Source: Press releases and annual reports
to the degree of effort and analysis the companies have made to define opportunities to leverage local content. Moreover, it will promote agreement between companies and governments as to the current status of local content use, and how to move forward. If host governments don’t buy into the proposed program from the outset, the risk of problems further down the road will only rise. Measuring performance. Many oil and gas projects around the world face a fundamental mismatch between the scale of government ambitions for local content and the scope and time line of individual
projects, creating considerable tension between countries and companies. It is essential for governments to orchestrate and coordinate their overall local content programs, as only they can take the long-term view of their specific needs and ensure that each individual project makes its contribution. Furthermore, governments and companies must be aligned at the outset on what success looks like and on the program targets and performance metrics used to define it. These metrics should be aligned to the project’s phases and milestones, and include “early warnings” to address any problems before they escalate. The performance management system should also include mechanisms for the oil and gas company to communicate the local content program’s progress to the host government, demonstrate its value, and celebrate its success. The goals and metrics for the program should be determined in the early stages of the project, and structured so that progress can be measured in a rigorous, quantitative way, such as by the number of graduates with target skill sets, or the number of local contractors supplying a specific good or service. The role of primary contractors here is crucial — their own efforts must be fully tied in to the performance management system if they are to be fully accountable for their role in helping to deliver progress. Demonstrating value should also include making clear the full set of tax payments that companies make across all areas, including environmental, property, production, people, profits, and the like. Therefore, every oil and gas project must include frequent reviews in collaboration with host governments to confirm that the local content program stays on the right path, and to agree to adjustments where necessary. This “do-learn-improve” program requires a clearly defined process, and considerable discipline will be needed to follow it, as well as adequate resourcing and strong governance mechanisms. The review process must also be transparent — any problems that arise must be acknowledged and addressed as quickly as possible, in cooperation with host governments. How companies perform in leveraging local content will largely be driven by the caliber of the people responsible for designing and executing the local content program. All too often, oil and gas projects don’t have local content teams with the credibility or capabilities needed to oversee such programs. Properly resourcing local content is not just a question of having enough people, but also ensuring that those people have the expertise and the background necessary to take on the role.
Local content is an increasingly critical issue for the oil and gas industry, and there is great potential for both companies and host governments to attain better outcomes. Aside from the further development of their resources, countries can benefit through increased employment, higher levels of skills and capabilities, and greater local economic activity. And companies can achieve lower costs, access to further development programs, and a strong long-term relationship with the host country. Ensuring success will involve tailoring the local content program to the company’s and the country’s specific needs and capabilities, close collaboration between the partners from the outset, an understanding of each other’s priorities and goals, and the willingness to remain flexible as to how to meet them.
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