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Back to basics: to do what everyone is doing…but better

guillermo bilbao | petroleo & energia | 1 april 2016

Variations in oil prices are making necessary for E&P companies to implement some transformations that will meet the challenges of the changing energy scenario. The business as usual approach is not enough to cope with these changes as the complexity of the E&P projects is growing and requires more specialized suppliers and a better understanding of each project’s field.

We must assume that oil is a commodity and must be understood like that. It is a valuable and undifferentiated asset. Commodity is all that is underlying a futures contract, according to their legal definitions. The most immediate implication is that prices are determined, not by supply and demand, but by their current forecasts. Capital markets and speculation are the pillars of this definition.

Capital markets make great efforts to estimate its forecasts and future demand-supply relations. On one hand, regarding supply production, there is a general fear for the half a million barrels that Iran will add to the market. Regarding the demand, the International Energy Agency forecasted a growth on the demand to up to 600,000 barrels per day driven by a slowdown (not decrease) in the Chinese demand. The IMF changed its growth forecast for China from an estimated 8.6% in 2013 to an estimated 6.3% at the end of 2015.

The balance on forecasts of the supply and demand was not always a bad omen. For example, in 2005 a boom in the demand was predicted, and after a short period in 2008, due to the global economic downturn, it transformed into the euphoria of high expectations we had anticipated. By the way, at that time, reviewing the literature, one of the most plausible explanations which can explain the price hike was the changing expectation of China’s growth.

Without a doubt, the variations that capital markets implement on its forecasts, affect supply and demand breakeven of future oil, and therefore, its price. Today the forecasts have several signs of demand deceleration and supply expansion. Those forecasts are used for making short term decisions and the companies from this sector perform actions based on income forecasts for the coming months.

In this situation, the business as usual recommendations for a price contraction as the one we are experiencing today, have historically been the same: from the outside in.

It starts by lowering external spending, for example, providers are asked to "make an effort". Also, movements of centralized purchasing and scale search are generated. These movements are presented aside expectations of savings from 10 to 20 percent on purchases under the previous model. The cuts in the operation are the next step. Method and time workshops in platform maintenance, analysis to eliminate rework, and productivity search facilities from platforms to pumping stations promise 10% savings. Finally, it goes to overheads and staff. Normally, this is the most painful and controversial step. At this point, the main operational needs are so urgent that in many cases, they are easily solved with a quick negotiation.

The problem is that E&P projects complexity is growing and requires more specialized suppliers and a better understanding in the field of the project. Deepwater projects and heavy crudes require high expertise and knowledge and today it is not clear that centralizing purchases needs to be accompanied by productivity. Similarly, the programs to improve operations have limitations. Improvements are often based on the established process, and rarely offer transformations that involve large productivities. Finally, the changes in the structure and personnel are made based on a reduction of immediate cost objective, and not in profitability.

A company may implement the traditional changes with a more or less urgency depending on the speculative conjunctures or can make efficient and long-term plans. Business as usual may be followed to seize the challenge to do unusual things.

Talking about providers, local businesses can be developed. Local businesses should not only aim to cheapen what is already done, but they can intent to be innovative: doing things differently. For improving operations, innovation can also play an important role. Digitalization and system dynamics for decision making may give an understanding of the processes that will improve them from the root; moreover, the structures can be improved by new management models based on shared services.

Innovation plays a fundamental role for the development of the whole process, and it must be inserted from the start of the management process to evolve apace with the strategies to implement. That is the ideal path that should be followed.

Guillermo Bilbao is an energy expert and Director for Mexico at PA Consulting Group

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