The landscape in which companies execute major capital investment oil&gas projects has changed since the 1960s North Sea and Gulf of Mexico booms.
In the 21st century, mega-projects, volatile oil prices, access to financing, shortage of labour, rig rates, equipment lead times/costs and the emergence of national oil companies (NOCs) provide a backdrop of uncertainty which is dominating discussions from tearooms to boardrooms across the industry.
Despite these factors, demand for global energy continues to drive substantial capital investment within the sector, with the 2008 combined capital expenditure forecast for five of the leading international oil companies (IOCs) being $114.7billion, with some individual projects exceeding “mega” values of $10billion.
With the expenditure on projects surpassing the annual gross domestic product (GDP) of some countries, small schedule delays or cost increases, coupled with fluctuating oil prices, can severely impact project financials.
Moreover, project out-turn results and the success (or otherwise) of delivery can materially impact the financial performance of some organisations involved in their execution.
Significant capital expenditure and the demand for materials and equipment has resulted in the Upstream Capital Cost Index, which measures inflation of upstream oil&gas projects, increasing by 79% since 2000, with the greatest rise occurring in the last two years.
In addition to these challenges, projects are increasingly unconventional and are typically being undertaken in complex markets such as Africa, the Middle East and the Former Soviet Union, all of which may not be fully open to foreign investment and/or have unstable fiscal and operating regimes.
With these uncertainties and potential corporate exposure, projects must be treated as companies. No longer can project leadership teams focus solely on operational threats (such as resource requirements); instead, they must robustly consider sector-specific threats that are reshaping the industry – in addition to macro-economic threats within the general geopolitical and macro-economic environment.
In 2008, Ernst and Young consulted industry analysts and produced the Strategic Business Risk Survey. The survey identified the top 10 operational sector and macro strategic risks likely to severely impact financial performance of companies within the sector. Four salient examples of how these business risks can impact project performance are discussed below.
Perhaps one of the greatest risks impacting the sector identified in the survey is the deficit of skilled human capital. Research by the Society of Petroleum Engineers suggests that almost 20% of the industry has less than five years’ industry experience (Brett, 2007).
However, the greatest talent void is among experienced staff as a result of an ageing resource pool now approaching retirement, and the middle-management ranks, which would have stepped up to fill this gap, stripped out during the last industry downturn.
By 2010, this deficit (between supply and demand) is expected to be between 10% and 15% and be sufficient to impact project delivery schedules (Weirauch, October, 2007).
Further complications are arising from competition for reserves from NOCs as a result of rising energy nationalism and political constraints impacting access to reserves. With NOCs owned and controlled by local governments, they are typically incentivised to maximise returns for their local communities and economies (CSR Report for Congress, 2007) as opposed to IOCs, which tend to maximise shareholder value.
Intensifying NOC competition and the desire of resource-rich countries for a greater share of the oil&gas wealth is creating a paradigm shift with respect to production sharing agreements (PSAs) and contracting terms and conditions.
Contract requirements including minimum “local content” stipulations are designed to provide NOCs (together with their governments and economies) with financial benefits and a long-term competitive advantage.
Inflationary pressures, shortage of resources and more rigid contracting terms create increased cost-control challenges during project execution.
One area where cost control is critical is within the supply chain. The recent rise of oil&gas capital expenditure has also resulted in increased lead time and associated costs for materials and equipment, with the cost of large fabricated pipework alone increasing by 50% between 2002 and 2006 (Merrow, IPA; 2006).
Companies, therefore, will need to leverage not just procedures and processes (to control procurement activities), but consider unique approaches to extending their value chain into their supplier network (Porter, 1985) in order to provide some protection against supply-side volatility.
In the context of this changing landscape and intensifying risks, companies that achieve successful project out-turn results are likely to display the following attributes:
Have an effective risk management process whereby there is a clear line of sight between project, portfolio and strategic risk management such that strategic objectives are supported by appropriate tactics that address operational, sector-specific and macro-economic threats. Companies need to view risk management as more than a spreadsheet and a monthly meeting. Risk management must be in the DNA of the business and be a fundamental part of how projects are won and delivered, receiving the appropriate level of senior management commitment.
Undertake rigorous portfolio management and greater scrutiny around not only project selection, but providing greater certainty during the feasibility phase regarding project out-turn costs and supporting human resource requirements. Notwithstanding the impact the current credit crunch may have on access to capital, organisations need to increasingly consider where best to allocate their finite human resources to projects within this challenging environment.
Twenty-first-century project demands and the emergence of “mega” projects result in massive barriers to entry for organisations seeking to achieve business success through project delivery. This may result in a global “super-league” of delivery organisations, but to achieve “super-league” status, organisations will need to appropriately invest in enabling technology, processes and systems to deliver a seamless and effective global operation and knowledge transfer.
Standardised processes and systems to underpin greater governance and enhanced oversight, enabling improved transparency and allowing strategic hubs to control worldwide teams without jeopardising quality, cost and/or schedule. And organisations will also have active stakeholder management plans – at the highest level, these will address relationships with emerging NOCs and influence how they effectively interact with governments, local communities, joint-venture partners and the supply chain in a manner that not only supports successful project execution, but promotes a responsible corporate brand image.
Whether it be operators, contractors or suppliers, most organisations do have the technical know-how to execute major capital investment projects.
However, many fail to consistently demonstrate the required attributes to be successful within this new environment.
While well considered corporate strategies may address this changing landscape, implementation of these strategies commonly falls short, preventing organisations from realising the opportunity to manage risk away and achieve greater certainty of outcome.
Loretta Hudson is the oil&gas sector leader within Ernst and Young’s programme advisory services practice
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