Drastic Measures in the Oil Patch Helped Survival – But Can They Translate into a Sustainable Cost Management Program?

Tyler Chase, Managing Director Energy and Utilities Industry Global Leader
Christopher Monk, Managing Director Business Performance Improvement

The oil bust, which began shortly after prices peaked at nearly $108 per barrel in June 2014, has pummeled U.S. producers. According to the U.S. Energy Information Administration, oil and gas production jobs declined 26 percent and rig count plunged 78 percent from October 2014 through May 2016. Meanwhile, global oil and gas capital spending dropped 40 percent over 2014 and 2016. Leading producers swiftly responded, by extending payment terms with suppliers, aggressively renegotiating contracts seeking price concessions, and deferring or cancelling projects, among other cost avoidance or cost savings actions. These drastic measures managed to slash well costs by at least 30 percent and, in some cases, upwards of 50 percent. However, in today’s “pay me now or pay me later” mentality, producers and suppliers both recognize that the price concessions were temporary to weather the storm, and once crude prices rebounded, suppliers would come looking to make up for lost profits. This is, of course, unless producers have the ability to aggressively manage the potential increase in costs.

After hitting a low of $27 per barrel in January 2016, oil prices have rebounded to a range of $45 to $58 per barrel, albeit with moderate volatility. Yet prices are still a far cry from their highs a few years ago, and it doesn’t appear they will rise materially anytime soon. Barring a regional conflict or some other unforeseen cataclysmic event, they may never reach previous levels. The International Monetary Fund is projecting a West Texas Intermediate crude oil price of 53.40 per barrel in 2022, for example, and December 2025 crude oil futures contracts were recently trading a dollar less than that. Against that backdrop, plentiful oil supply, flat demand, increasing oil production, and rising business costs paint a discouraging outlook for any significant increase in oil prices, and thus revenues, over the next several years.

That kind of operating environment demands that organizations become more efficient, find ways to reduce and sustain cost savings, and drive the realized savings to the bottom line. The question for energy companies is whether they can transform their emergency cost-reduction strategies into long-term programs that not only sustain the benefits thus far derived, but also effectively manage and track costs over the long haul. This is becoming particularly critical as suppliers try to reverse some of the concessions they made during the oil market’s collapse.

Unfortunately, findings from Protiviti’s 2017 Procurement Survey, Bridging the Gap Between Finance and Procurement, indicate that procurement functions across all industries need to beef up their operations to generate greater value and take advantage of the potential value they uncover. Even with the severe measures employed during the oil market crash, the energy industry is not immune to procurement shortcomings. In fact, it scored worse than other business sectors in a handful of categories.

For example, only 27 percent of energy organizations in the survey said that they were recognizing absolute savings from their procurement functions, versus 35 percent of respondents in other industries. Two-thirds of energy respondents also said that they either did not track their spending or did not feel confident in their savings numbers. The survey revealed that the energy companies were lagging behind organizations in other industries in their deployment of spending analytics.

What’s more, very few energy organizations thought that a substantial portion of procurement-driven savings ever made it to the bottom line. Energy companies cited the following as the top reasons that savings failed to contribute to earnings:

  • Loosely controlled budgets that permit savings to be spent elsewhere
  • Changes to commodity prices, inflation and other variable expenses or simply a wrong assumption about their cost trajectory
  • Advancements in operational specifications that resulted in more expensive equipment, materials, labor and services

The good news is that the survey also provided some answers on how to brighten that picture. Answers from finance and procurement functions, while often diverging on their opinion of procurement’s performance and value, have helped define what steps procurement personnel need to take to build a sustainable cost reduction and management platform to maintain long-term savings. In broad terms, these are:

  • Evolve from sourcing to category management – Value from sourcing activities erodes over time as resources are redeployed to support other commercial sourcing efforts. Shifting to a more comprehensive category management program not only sustains sourcing benefits, but it also provides additional cost reduction and value improvements.
  • Increase supplier relationship management – Supplier relationship management has evolved from a discipline of simply managing spend and finding the lowest-priced supplier to a process in which procurement functions work more closely with suppliers to identify weaknesses, mitigate risk, measure risk performance and assess other operating variables.
  • Drive savings to the bottom line with a centralized structure – The centralization of the finance and procurement functions is key to meeting this goal. Our survey indicated that seven in 10 organizations that had such a structure were able to drive more than 60 percent of their procurement savings to the bottom line. Fewer than 20 percent of respondents lacking centralization were able to match that.
  • Invest in more robust spend analysis tools – A formal and robust spend analysis is perhaps the most essential building block of the procurement success – this was a key finding in our survey confirming what we knew informally. The survey results indicated that tools supported by third parties are frequently the most effective.
  • Increase focus on working capital management – Organizations that drill down on processes in the inventory, receivables and payables departments stand a better chance of boosting the bottom line with savings. Strategies include decreasing the time between ordering goods and paying for them, managing inventory to reduce the time that goods sit in storage, and increasing the number of days before suppliers are paid and/or maximizing discounts and rebates.

Oil producers could certainly benefit from carefully considering the above findings. Internally, oil and gas companies should continue to enhance collaboration between procurement and finance. (This is where the energy industry has an edge: 91 percent of energy respondents in our survey said that procurement and finance were aligned, versus 80 percent of respondents in other industries.) Externally, energy companies need to move from a price to a cost focus to sustain previous savings. Rethinking opportunities to leverage technology for internal operations is also important, such as implementing innovations like robotic process automation to help provide a competitive advantage in managing costs and growth.

Price booms and busts are nothing new in the oil patch, and producers have adroitly addressed the most recent bout with effective cost-cutting strategies that helped them survive. With the industry facing years of flat oil prices, those organizations would be wise to turn those emergency strategies into formalized standard programs for the long term.

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