A “future-proof” strategy
Faced with the uncertainties of a potential supply crunch and the energy transition, what should companies do? The strategic principles laid out below will sustain your business, “future-proofing” it, regardless of short-term volatility.
Continue to manage the overall portfolio with a much lower break-even price, whatever actual oil prices are. Big players are already doing this. In May 2017, Shell divested the majority of its Athabasca oil sands business on the grounds of poor economics in a lower oil price world (and perhaps with an eye to the future, given the higher emissions produced by this unconventional source). In January 2018, BP announced it would only approve new projects that were profitable at less than $40/bbl. In order to maintain this type of portfolio, companies must undertake regular portfolio reviews to weed out assets that do not comply. This portfolio approach should resonate with companies of all sizes, including the smaller independents, some of whom focus too much on the technical challenge of discovering exciting new plays, rather than on commercial viability.
Hold on to the mantra of capital discipline. If the oil price rises, stay the course on cost reduction, standardization, and collaboration to make sure inefficiencies do not creep back in. Ensure all operational decisions — including new country entry, production optimization, and acquisitions and divestments — are reviewed under the lens of full-cycle project economics. All spending needs to reflect the focus of a company’s core and differentiated capabilities.
Supporting a high level of free cash flow will be critical for oil and gas operators. Capital will flow to companies that deliver positive returns in any type of commodity price environment. Since success in the market correlates with financial returns as opposed to production volume, the entire company will benefit.
Refocus investment and efforts on asset maintenance. As oil prices rise, operators may be tempted to push their equipment harder to produce more. But given the age of many assets, oil and gas companies need to ensure adequate funds are available to keep supply infrastructure in good repair. This is especially true for companies that deferred maintenance beginning in 2014. As rising levels of activity put stress on production equipment, unplanned outages will harm the industry. Thus, planned maintenance should account for the majority of activity going ahead.
Replace the “owner-operator” model with an “owner”-only approach where returns are the priority. Many oil exploration and production companies believe they need to build capabilities across the entire value chain, when in reality shareholders and the providers of capital simply want a return on their investment. In a dynamic market, the owner-operator model is a handicap; the costs incurred under this construct outweigh the value generated. Companies need to parlay their own exceptional capabilities into true partnerships with other best-in-class companies to stitch together an ecosystem of expertise. This shift away from operations will help them replace fixed costs with variable costs, and construct commercial terms that balance risk, reward, and roles. Companies in many other industries that went through similar downturns were forced to evolve and now are healthier, more agile, and more likely to win in volatile markets.
Double down on digitization. Now is the time to transform operations by leveraging advanced digital technology to drive efficiencies and to open up new opportunities. Doing so might involve so-called digital twins (virtual simulations of assets) that can improve the efficiency of predictive maintenance. It might also take the form of using drones to inspect offshore platforms, which reduces workers’ exposure to hazardous tasks; data analytics to optimize production and reserves; or other new processes and practices. Oil and gas companies need to drive this innovation across their businesses.
Develop talent for a new era of technology. The industry’s talent profile is changing. Traditional disciplines such as subsurface and surface engineering are still important, but they must be balanced against new demand for expertise in digital operations. As companies build their capabilities in software engineering and data science for example, senior executives in talent management will need to figure out the right weighting of technical (engineers) versus technological (data scientists and software engineers) staff and how the sector can attract the latter. Moreover, as companies become more efficient through the application of digital solutions and the likelihood of sustained lower oil prices, it is unclear if head counts return to pre-2014 levels.
Consider how the overall business should evolve. In the longer term, given the mega trends shaping the sector, companies must focus on finding and executing the most resilient future-proof strategy for their own unique capabilities. Entry into new types of energy operations may be one avenue. For example, Dong has used its legacy upstream oil and gas business to fund its growth segment in wind energy. In 2017, Dong exited the oil and gas business to focus on low-carbon plays, subsequently rebranding itself Orsted. Engie similarly divested its upstream assets to focus on power and renewables. Some of the European oil majors are also investing in low-carbon plays, which range from traditional renewable energy (such as wind and solar power generation) to more recent acquisitions involving electric vehicle infrastructure.
Shifting portfolios to further favor natural gas is another option. There is a growing school of thought in the market that oil-focused upstream companies have perhaps 10 to 15 years of potential growth opportunity. For producers who share this view, natural gas becomes the bridging fuel to a low-carbon economy .