Procurement in the Oil and Gas Sector – Is Collaboration Key for Supply Chain Survival?
28th January 2021
Our Service Offerings & Thought Leadership team are working closely with the University Of Bath and the students of the MSc in Operations, Logistics and Supply Chain management to investigate the trends driving changes and the common ways organisations are tackling them. Next up, we looked at procurement in the oil and gas sector.
The Oil and Gas industry has been severely affected by the Covid-19 pandemic with falling demand and price wars between OPEC and Russia leading to a collapse in oil prices debilitating operations. Additionally, global lockdowns and border closures have caused significant challenges that have prevented oilfield services and equipment (OFSE) suppliers from delivering on time and on budget. Due to the significant oil price drop and the logistical, supply chain, and manufacturing issues that global lockdowns have posed, widespread supplier distress is a reality and large operators are confronted with a large number of force majeure incidents and bankruptcies in the industry.
Forcing these suppliers to reduce their prices puts them in serious jeopardy of going bust if appropriate action is not taken. In the short–term, operators must take steps to ensure suppliers stay afloat so the supply chain can continue to function. Industry commentators predict that if support is not provided from operators to OFSE suppliers, then nearly half of all OFSE companies could face bankruptcy or forced to lower pricing – leading to damages to the industry. Even if they survive, the operators also fail to understand the long-term impact that their adversarial reaction to falling oil prices and aggressive short-term cost reduction has on the supply market.
Operators must perform a far more in-depth financial analysis of suppliers to ensure they are protected throughout the pandemic. Previously operators would look at financial metrics such as liquidity, debt-to–equity, and interest coverage ratios, credit ratings, and Altman Z bankruptcy scores. These metrics are no longer adequate when assessing the financial health of the suppliers, especially when the primary aim in a pandemic scenario must be to ensure supply chain resilience.
By examining how oil price changes have impacted demand for various supplier services in the past, operators can analyse the vulnerability of individual suppliers’ revenues in the current crisis. Operators can assess the likelihood of revenue losses for different OFSE categories. By examining market concentration for suppliers in different categories, operators can determine any supplier’s ability to absorb revenue declines and protect margins. This level of analysis is imperative to ensure that suppliers have the financial means to survive, resulting in operators having the ability to source the equipment they desperately need to continue running.
Furthermore, the pandemic has provided an opportunity for operators and suppliers to develop strategic partnerships to create holistic value. It is estimated that such collaboration can deliver a value of 30% to 50% in operators’ upstream operations.
To make strategic supplier partnerships a success and maximise the benefits they offer, as well as understanding the true financial health of suppliers, operators should identify two or three suppliers across key categories, where large pools of potential value could be unlocked, and pilot strategic supplier partnerships with them. Long-term performance-based contracts, to help build trust between operators and suppliers should also be utilised.
Creating these strategic partnerships and operators having a strong interest in the financial health of their suppliers is crucial for the long-term survival of the supply network. Without this essential collaboration, it is likely suppliers will collapse under the strain of the pandemic and operators would be severely pressured when attempting to source the services and equipment that are critical for their operations.
Our fear, however, is that many operators will simply react to the very low oil price and use the same ‘reactive’ sourcing strategies based on aggressive short-term cost reduction that will have significant consequences for future supplier management in the industry, just as it has in the past.
If the Oil & Gas companies do repeat themselves as the price of oil falls, it will be a very great pity and a testament to the wasted opportunity in the industry during the ‘good’ years when oil prices were high. In this period the opportunity existed to segment categories to identify when it is sensible to work with suppliers to create continuous improvement in value for money using proactive and collaborative sourcing techniques.
However, our concern is that the industry may once again ‘miss the boat’.