Oil companies took the crashes of 2008 and 2014-16 on the chin, but ultimately recovered. So, it’s hardly surprising they reached for the same playbook — slashing operating costs and capital investments, scaling back operations and acquiring smaller operators — to respond to this year's coronavirus crisis. However, despite decisive actions, 18 U.S. producers entered bankruptcy in the second quarter alone. More are expected, because this time it’s different.
This time, not only do oil producers face a crippling blend of decreased demand, supply wars, oversupply, and lack of storage capacity, but their ability to respond financially is far more constrained because of two factors. First, they are not as profitable as they were during the previous crash, with the price of a barrel of oil likely to hover around $40 (down from $60 in January) for the foreseeable future. Second, the industry’s ability to consolidate is limited. U.S. oil producers had already snapped up smaller, mostly shale producers during the 2014-16 downturn, and are now major shale producers at a time when investors are questioning the profitability of shale.
The stark reality is that producers that fail to secure their short-term survival while simultaneously evolving their core business will either be acquired, or slowly wind down their operations, just like the coal miners. This is why Marathon Petroleum is currently selling its distribution network for $21 billion in cash. And BP is investing $10 billion in renewables to accelerate its long-term shift toward decarbonization.
Procurement and supply-chain management (PSCM) response is to use the crisis to force suppliers to cut prices and lower the per unit cost of every item. The problem is, PSCM has already wrung most of the ‘dial for dollars’ savings out of its supply base during the 2014-16 downturn. Instead, here are the four novel strategies to make a meaningful and sustainable impact:
1. Leverage cash auctions in return for cost reductions. Cash auctions have proven their ability to provide the exact same benefit as early pay discounts from suppliers in other industries, such as tech and pharma. Instead of just leveraging a few days of cash arbitrage for a discount on one invoice, PSCM and treasury groups can make a larger cash pool available and auction it off to suppliers in return for long-term cost reductions. Cash auctions are an underused lever, especially today when producers are zealously guarding their cash, but it can generate significant value. Both parties benefit in the way that is most important to them right now: producers bolster their finances at a time when investor confidence is at an all-time low, especially in those overexposed to shale, and suppliers receive a cash injection that can be the difference between solvency and bankruptcy.
2. Reposition inventory. There is an eight-month window to effectively reposition inventory before it is no longer broadly applicable across the enterprise. If inventory is not repositioned by then, it leads to significant write-offs.
Non-hydrocarbon inventory repositioning — allocating inventory where there’s greater need and use of it, instead of letting it degrade on the shelves waiting to be written off — is a must-do. This lever is often overlooked because PSCM is reluctant to push operations to rely on a lower level of inventory because the business has become used to excess availability. But repositioning reduces inventory management costs, limits redundant ordering, frees up much-needed working capital, and helps minimize damaging future write-offs. During the last downturn, oil and gas producers released over $100 million in working capital by repositioning inventory for high-value non-hydrocarbon inventory, such as tubulars (OCTG).
While it seems an easy idea, repositioning requires PSCM to tag all capitalized assets and update inventory records in real time. Then engage the operations team to secure their buy-in and put a hard stop for all inventory purchases, while specialists assess repositioning opportunities before allowing purchases to be made.
3. Revisit capital expenditure contracts. During good years, oil and gas producers have more than 75% of their spend dedicated to capex. Even in the down years, this number can exceed 60%. Spending such a high volume of capital is a major risk during a downturn, because it comes with complex, long-term contracts encompassing cancellation clauses, payment guarantees, and remuneration and indemnification structures that require careful examination prior to voluntary termination of the contract. Failure to do so results in significant contractual penalties, or years of costly litigation.
PSCM must review existing capex contracts for cancellation penalties and delay payments, ancillary clauses impacted by or triggered during a delay period such as a hurricane shutdown, and punitive or exorbitant charges tied to non-value-generating activities. Determine whether to cancel the contract outright or to delay its performance. The key sub-decision is then whether to renegotiate contracts intended to be kept but delayed. This approach enables PSCM to head off potentially hundreds of millions of dollars in lawsuits and penalties, and support the retention of preferred suppliers.
4. Don’t just automate — eliminate processes. Following the codification of end-to-end business processes in the 1980s and 1990s by consulting firms, many procurement and supply-chain processes have become almost sacrosanct, and companies do them simply because that is what large companies do. A perfect example is the requisition-to-order sub-process. This process is at odds with oil and gas companies where remote workers request complex services at high speed and volume. Just as stopping drilling operations worth tens of thousands of dollars each hour to fill out a requisition form and wait for approval, transmission and acknowledgement of a PO undermines the company. Yet, instead of recognizing this fact and leaving requisition-to-order behind, many oil companies auto-create requisitions and orders upon receipt of invoice. This is the epitome of waste. Worse still, the license, maintenance, and personnel associated with these systems can run up to several million dollars annually.
So, rather than invest in process automation and outsourcing, the more fundamental question that this climate enables PSCM to ask is “should we do this process — what value does it provide?” Catalog existing processes to identify what should be retained and eliminated. Then work with operations to determine what else can be undertaken that is not currently part of the organization’s process. For example, few PSCM organizations actively track and manage the fulfilment of key bulk commodities like sand, water, fuel and cement, but this would add tremendous value.
While the petroleum industry keeps an uneasy eye on the emerging market parity of renewables, oil will continue to play a major role in the global economy for another half century, although it may never again soar to the heights of its past. If supply-chain and procurement leaders eschew the traditional playbook of cutting costs from the supply chain in favor of four strategies detailed above, they will strengthen their enterprise in the immediate and longer-term.
Patrick Heuer is director of consulting for oil and gas, and Ennio Senese is executive adviser, at GEP.
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