KPMG UK explains how alternative cost management models can deliver more sustainable budgeting for the Upstream Oil and Gas industry.
Whilst the Upstream Oil and Gas industry reaps the gains from its efforts to drive improvements in efficiency and productivity, the lessons of the downturn remain fresh in the mind. Despite a healthier oil price, finding more sustainable ways to manage costs remains a top priority, and at a time when assets need to be competitive within global portfolios, effective ways to reduce unit costs with a longer-term view is becoming increasingly challenging.
As we enter a new tax year, Exploration and Production (E&P) companies are taking the opportunity to review their business models and assess current financial processes. More than ever, we are seeing companies opting for a Zero-Based Budgeting approach, which focuses on allocating resources based on efficiency, necessity and value, rather than any historic budgeting.
Whilst this cost management approach is well established in sectors such as Consumer Goods, it is yet to make a significant impact in Upstream Oil and Gas. However, with the ongoing focus on unit cost performance, Zero-Based Budgeting represents an attractive proposition for E&P players with the potential to provide a competitive advantage.
With this in mind, zero basing is starting to gain traction in the oil and gas sector. This interest in alternative cost management methods is also being driven by rapidly changing business models, a drive for more radical and creative approaches to delivering value, advances in smart data analytics and the need for agile and smart deployment of resources.
Fundamentally, this is where the true value of zero based cost management lies. It is about driving trade-offs between risk and value – sending resources quickly to where they have the greatest strategic impact. For example, reducing time spent on providing low value-adding services, can free up capacity of technical staff to focus on strategic development projects.
Done well, zero basing can help to drive the most granular level of cost transparency, introduce new levels of cost conscious behaviour and aggressively reallocate both funds and resources. Whilst this all sounds highly appealing, zero basing, which was first introduced over 40-years ago, quickly fell out of favour with executives, who viewed it as unwieldy, labour intensive, highly disruptive and ultimately not delivering to the bottom line. A potentially powerful process had fallen foul, it seemed, of basic failings in application.
For E&P companies, history might repeat itself. However, like any other new approach many mistakes in application can easily be mitigated if companies take the necessary steps to prepare properly. In addition, with the rapid growth of data analytics and digitalisation, applying this approach in today’s business is likely to be more achievable and much less painful.
Whilst the scale of the challenge often makes it difficult to know where to start, effective zero basing must begin with a laser-like focus on where the material value opportunity sits. Companies should avoid attempting to zero base everything and risk delivering nothing. Prioritising areas based on a combination of size, the level of discretionary activity, risk and importance, will deliver greater ‘bang for the buck’.
At the heart of the process is the tension of balancing value and the risk of stopping activity or changing service levels. The highest standards of objectivity are required to make these trade-offs, supported by financial rigour and governance to ensure decisions are unencumbered by established politics, historical decisions and cultural constraints. However, it must be remembered that zero basing means zero basing. Start with the legal and regulatory minimum and work from there, then you will create the right tension rather than negotiated compromises away from today’s position.
In addition to balancing value and risk, managing shifting risk profiles is also key. Embedding robust, fit-for-purpose governance, and a clear, data-led approach is essential to avoid value-creating ideas being blocked lower down the organisation. Taking the tough decisions at management team level, such as choosing to streamline the permitting process, can liberate lower levels of the organisation to become more radical in their ideas, avoiding the natural tendency for a more cautious, conservative approach.
Whilst many business leaders have been attracted by value/ risk trade-offs and affordability thresholds as a way of injecting a one-off ‘shot in the arm’ to their businesses, few appear to be casting their gaze further out to acknowledge its long-term value. Continuous, staggered ‘waves’ of zero basing focused on ‘hot spot’ areas can minimise disruption whilst creating a constantly refreshed portfolio of cost initiatives. For example, focusing initially on a review of discretionary maintenance, engineering and turnaround work-scopes can provide immediate benefit, whilst a second wave might target service levels from the support functions.
This long-term perspective is the most difficult to crack, yet the most important. The pace at which long-established business models are now changing demands far greater agility, not only in predicting these shifts, but in rapidly reallocating resources in response. Furthermore, the frequency of these changes creates a state of constant disruption as executives seek to realign, and realign again.
Gone are the times when an annual cycle of budgeting using zero basing was adequate to reboot the internal cost management machine. For the E&P companies, the requirement for new levels of commercial and organisational agility has put an ongoing, long-term, continuous process of challenging resource allocation at the heart of true competitive advantage.
James Albert, Associate Director, KPMG, leads KPMG’s Upstream Oil and Gas strategy practice in the UK.
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