“Lower for longer” has been a well-worn phrase in the oil and gas industry since the latter part of 2014. Not only does it describe the fact that crude oil prices have been significantly depressed since then, but it also signifies the change of mindset the industry and its supply chain has had to wrestle with in that time. This is an industry used to oil price fluctuations, but this time it’s been taken by surprise.
Between 1970 and 1974 global demand for hydrocarbon products rocketed, pushing Brent crude (an industry benchmark) from $11 to $55. As crude prices continued to rise and fall over the following decades, rising demand across an increasingly global market coupled with the theory of “peak oil” (i.e. supply reserves would dry up sooner rather than later) meant that average prices remained historically high and the focus was on volume – and at (almost) any cost. Managing the supply chain in a truly cost-effective way was secondary to generating vast annual revenues.
Today, however, the economic fundamentals for the industry have shifted significantly. “Peak oil” no longer describes the anticipated lack of supply, but rather a lack of demand. A significant factor in the long-term decline in demand is the strong and increasingly rapid emergence of renewable sources of energy, improved vehicle fuel efficiency and the development of electric vehicles. BP, in its 2016 Energy Outlook states “Looking out further to 2050, under most scenarios, cumulative global oil demand amounts to less than half of today’s technically recoverable oil resources”.
This problem for the oil and gas industry is compounded by a significant over capacity (particularly in North America and Europe) of refining and exploration operations, which are hugely expensive to operate and maintain. Operations have historically been labour intensive and input costs high, resulting in an industry facing major cost challenges to remain profitable, enhance cash flow and maintain the all-important dividend to shareholders.
The exploration of opportunities
Given the economic pressures on the sector and the state of the industry, there is no better time for oil and gas companies to take advantage of the procurement function to facilitate the transformation of an industry that has spent so much for so long and can no longer afford to do so. So, what can procurement do to show value and create more cost-efficient operations?
Project work is where vast sums of money are spent, so early involvement of procurement is essential to ensure cost effectiveness. The procurement process can often be perceived as the administrative burden at the end of the process that places the order and often becomes the scapegoat if equipment is not delivered correctly or a service isn’t up to scratch. Developing project procurement strategies that are agreed at the start of the project can not only help procurement perform an effective role as the project progresses, but it can also demonstrate to the project that it needs all parties to work together with procurement to deliver a successful outcome.
The use of Engineering Procurement Contractors (EPCs) is a common place across the industry. Like any service provider, these EPCs need to be managed closely. There are a number of remuneration models, but providers can be contracted on a “time and materials” basis, where specifications are largely undefined, through to “turnkey” or “lump sum” contracts. The closer a project moves towards “turnkey” projects, the greater the cost control. Procurement can help in processes, such as defining the contract type, facilitating the timely development of specifications and managing the performance of the EPC.
Day-to-day operations, which include regulatory “turnaround” events, are hugely costly and a large part of this cost is made up of employing sub-contractors. Typically, employing maintenance sub-contractors represents around 70% of the asset’s third party spend, equating to tens of millions of dollars per year. So the way these individuals are managed from the moment they arrive at the gate each morning to how their time is spent during the day can result in significant savings.
I could also discuss the use of e-procurement tools, equipment standardisation and the use of state-of-the-art mobile technology to provide information to an engineer at his or her fingertips, for example, but what is clear is that there is a myriad of areas that procurement can focus on delivering value. At the end of the day, it’s a two-way street: a successful business will allow procurement to lead many of these cost challenges, but procurement needs to be capable of meeting the challenges; it will struggle to be accepted unless it does.
The crude reality
The oil industry has been awash with cash for decades with little incentive to scrutinise its supply chain costs, but those days may have come to an end for good. There is much more procurement can achieve and bring to this industry, but it needs to work more rapidly than ever to achieve greater value delivery – all in an environment where safety is the number one priority.
Even if the oil price were to return to three-figures, for the oil industry to remain sustainable in the long term, good procurement should be at the heart of it.