Category: Late Life Asset

Collaboration reduces costs?

There has been a lot of hand-wringing around collaboration recently. For instance Paul Goodfellow Manager of UK Upstream at Shell said companies working in the North Sea need to learn from other industries on how to work together [Link]. Quite which industries he is talking about I’m not sure, also I am not sure what type of collaboration he’s looking for.

Worryingly for me there seems to be a focus on input costs. For instance one quote in the article stands out: “work with the supply chain on how to collaborate and get common purpose whilst driving waste from the system and driving unit costs down”.

When I analyse situations like this with clients I encourage them to take a view on both industry and supply chain, and be clear about the distinction. In Shell’s case their industry consists of other oil and gas operators. MMO companies, Scaffolding providers, helicopter operators and a myriad of other companies are part of the supply chain. They belong their own set of industries. Of course many companies supply services in more than one industry – so I need to consider them both in relation to their “competitors” and their own internal structure.

Here are three ways that cost can be removed:

  1. Industry collaboration between operators – to increase standardisation or share resources
  2. Adoption of new technology and methods
  3. Drive new processes to reduce unnecessary steps

These actions can increase efficiency which I define as the ratio of units of output to units of input. Assuming that output remains constant then efficiency comes from reducing system costs by removing labour or materials. This will increase the profit available for distribution among companies within the supply chain.

Reducing costs within the supply chain does not necessarily mean that Shell will see their input prices reduce – the location in the value-chain where profits are captured is subject to other factors. One model to explain how profit is captured was described by Michael Porter [Link]. Supply chain collaboration is, of course, important to organisations such as Achilles backed by my friends at Hg Capital [Link]. They set out some of their views on the issue here [Link].

In a commodity industry – like crude Oil and Gas production – there is little that producers such as Shell can do to change the selling price of their product (of course OPEC might have a different opinion [Link]). To protect profits producers need to reduce cost. At the moment operators seem to be forming committees to squeeze the supply chain. They are also laying off employees to cut overhead. I don’t see any action from Operators to collaborate with each other to reduce their own structural costs. Claims that they are seem to be a joint-ganging-up to encourage the supply chain to collaborate and reduce prices. That’s different.

Oil and Gas UK have stated that the North Sea needs to reduce costs by 40% within 5 Years or face very tough times indeed. Stephen Marcos Jones, Oil & Gas UK’s business development director, said: “Companies are having to make tough decisions on their capacity during the downturn and are individually taking measures to improve efficiency. However, co-operative working across the industry … can also help deliver the cost and efficiency improvements required to secure a long-term future for the UKCS.” [Link]

This quote from the Shell article highlights the inefficiency in buying within a single operator:

“One very enterprising supplier came forward and said we’ve got a great piece of quick erecting scaffolding, but we don’t understand why you haven’t been picking it up. The reason was because they were trying to work at various front-line levels of the organisation and it wasn’t important to one individual, because they didn’t know the totality of what we were spending on that service. When they came in through the strategic contracting team and demonstrated to the facility managers and made the decision there and then and we’re in the process of deploying it across every facility and rig we have in the UK sector.”

I feel this is an example of an operator missing new technologies due to their internal bureaucracy and inefficiency. My clients can tell me about literally hundreds of examples of this type of behaviour. The reality of course is more complex. When I ran the technology investment process at a major operator I found that the cost (and risk) of scaled change was such that it can easily outweigh the demonstrable benefits delivered from a new technology. Therefore this type of change can be slow and the results can be counter intuitive.

So in summary to drive out costs we must answer the following:

  1. What time scale and magnitude do we need to work to (some are long-term structural and will take many years to deliver, other are tactical and can reduce Op-Costs quickly)
  2. What can we do to reduce the cost within the supply chain, and how will we ensure that those costs flow to the prices we are charged?
  3. What can we do to reduce costs within our industry by collaboration and standardisation
  4. What can we do to reduce our individual costs by simplifying what we do, eliminate unneeded activity and increase work-rates?

Of course, as you would expect, the professional services firms have opinions on this. Their approach and advice is nuanced and reflects many of the same themes. Some of what they are thinking can be found here: PWC [Link], Deloitte [Link] and [Link], EY [Link], Bain [Link] and KPMG [Link].

Incidentally the word-cloud image at the top of this post contains many of the words I’d expect to elicit from a group of oil executives. It comes from VOTE – an organisation based in New Orleans – the Voice of the Ex-Offender. It is a grassroots, membership based organization founded and run by Formerly Incarcerated Persons (FIPs) in partnership with allies dedicated to ending the disenfranchisement and discrimination against of FIPs. [Link]. Goes to show that many of the issues that surround collaboration are human ones and not things specific to our industry.

Private Equity Buying O&G Assets

With the INEOS deal completing I cast my mind back to 2014. It was rumoured then that over 75% of North Sea assets were for sale, but questions around ability to shoulder decommissioning liabilities and inability to agree on an oil price stifled deal making. Prices are depressed but major operators wish to raise cash and stifle outflows the interest for private equity investment is increasing. Managers such as Bluewater Energy [Link], Riverstone[Link] and many others are said to be considering deals.

The Financial times reports that this month’s redetermination of reserves in relation to asset-based lending is unlikely to cause havoc [Link] but it may accelerate deal making.

I recently asked a senior partner at a well-known advisory firm what he thought would be different with private equity arriving. He pointed out that the PE players backed management teams – such as Siccar Point, Fairfield and others. He thought that these management teams might be surprised about the amount of data and “proof-points” that the PE backers would require, he also reflected that some management teams would be used to working within large corporates with in-house teams they can mobilise. They will now have to find providers they can trust and who are credible in-front of investors.

The known model of exploration and farm-down during development is now giving way to a new world where valuations are determined using a DCF model and a decommissioning cost. There are no proven rules-of-thumb here now. This means that investors are more cautious doing deals in this context than before. It does appear odd that in a business known for taking investment risk on exploration there is almost no appetite for assuming risk or unknown in this investment stage.

Another advisor at a large accountancy firm noted that very few companies operating in the North Sea were likely to make a profit any time soon (not only because of tough trading conditions, but also because they have various offsets and other tax-shields). This means that decommissioning offsets and other tax-carry forwards are of little interest to them – this might suggest that either a change in the rules is required or that sale to a profitable entity could provide differential value and hence facilitate win-win deals.

Shell recently announced its opinion that oil prices may spike upwards soon [Link], that may be music to the ears of financial buyers. If this is the start of deal-making season it will be interesting to see who the players looking at acquiring assets are. Will it be PE backed new Co’s, will it be established late-life operators like Enquest, or will assets be acquired into existing profitable entities to enable tax optimisation.

INEOS, Small Fields, Politics and Tie-backs

Political intervention can swing both ways.  Political intervention in the L1 acquisition of DEA assets has enabled the INEOS deal announced today [Link]. This sees Jim Ratcliffe enter into the Upstream business with an opportunistic deal to buy assets reluctantly removed from the DEA portfolio [Link]. INEOS previously looked to be moving into shale developments in Scotland [Link] – the logic of vertical integration to supply his other assets is compelling. The shale move was stalled by the Scottish Government [Link]. Plus Ca Change, Plus C’est la meme chose as they say in the French Speaking regions around Lake Geneva where Jim’s HQ is located.

Perhaps Jim may consider lending his political influence to influence the debate over offshore developments – an area which is controlled by the UK goverment not the whims of the Scottish Parliament.

Perhaps he will point out the difficulty faced by new developments of  a small offshore oil-field which must find a way to process and transport the fluids to where they can be used. One way is to hook up to old platforms – many of which are now operating below their design capacity. As fields age production rates decline and this means platforms and pipelines built to support them become underutilised.

However, oil price declines means pressure has mounted to decommission the infrastructure that supports some of this production in the North Sea. For example Alex Mitchel [Link] says that he believes that the current fundamentals will lead to significant growth in decommissioning activity on the UKCS. He adds that operators are under increasing pressure to reduce exposure to high-cost regions, and remove decommissioning liabilities from balance sheets. Without traditional sale routes, operators will increasingly make strategic decisions to push forward with asset decommissioning. Advantages for first movers are evident, with the opportunity to avoid constraints in the supply chain, and take advantage of suppressed rig rates for P&A.

I asked a member of the Bestem Network who negotiated the commercial terms of some of the recent marginal developments what he thought. He told me that an FPSO option is often chosen not because it’s best, but because it increases control and reduces uncertainty. Tie-backs would be better but the modest initial tariffs can quickly change to become uncontrollable cost-sharing agreements.

FPSO’s require a certain volume to work effectively so they will inevitably not drain fields as fully as other options. Other fields will never produce enough to make an FPSO a viable option.

Once key infrastructure is gone, it is gone for ever. It will never be replaced. We have to act now if we are going to save this national asset.

Tax relief is not the answer – subsidy might be

As I was driving to Aberdeen last week I wondered what would happen if I considered the export and processing infrastructure in the North Sea was a road network on land.

Why would anyone build a factory in a remote area if they did not have access to roads? The same could be said of remote field developments that hook back into export and distribution systems.

Taking the analogy further, what if there was a road outside your proposed factory but it only led to the M6 Toll Motorway. What if that toll booth could raise its prices whenever it liked and there’s nothing you could do? What if sometimes when you turned up at the toll-booth it was broken, and no-one knew how long it would take to fix. What if, one day, you received a letter to say that they were digging up the motorway and restoring the land back to farming?

As a business man, I would find that unacceptable. I’d be a fool to build my factory at that location. And that, friends, is the situation we have currently have in the UK North Sea.

Not only is that the situation but – because oil prices are down – the probability of bad things happening has increased. Despite this Oil voice reports that MPs do not favour support of the oil and gas industry [Link] their report says that:

‘Tax reliefs and allowances can never fully offset the operational challenges posed by the falling oil price […] Whilst the majority of Government MPs appear to have made up their mind about their position, the latest developments could prompt a rethink. There is a potential opportunity for the industry to engage with undecided Labour MPs to make the case for additional support at this challenging time.’

I agree with the position that this is not about Tax relief. To address this will require restructuring the way that the industry operates. If not outright nationalisation of parts of the network, this – at least – requires more control and probably limited subsidies. For goodness sake – we subsidise the tracks that our trains run on, I can’t see any argument for the creation of economic value there that does not apply to our North Sea processing and export network.

When I talked about this at a networking event, an experienced member of the Bestem Network informed me that decommissioning must be sanctioned by the government. So, in a sense, because you need to apply for permission the assets are indirectly controlled by the government. But, as he then said, there are really no sanctions if you fail to operate assets productively or if they’re closed for maintenance. And, apparently, declaring a safety critical event before shutting in is something no-one has the balls to question. Apparently there is a voluntary “infrastructure code of conduct” [Link] that defines principles for access to other companies infrastructure but how effective this is in practice is something some members of the Bestem Network question.

The oil industry is in a down cycle – now is the time to be investing as a nation to maintain the capability to produce.

I am sure there are macro-economic arguments regarding the value of extracting assets under our control for any price (including opportunity costs for displaced workers and spending within the economy) vs. the export of national treasure in exchange for the import of similar from overseas. I am not qualified to make those arguments – if you are, please comment.

Cross-company integrated planning

A while back I was talking to the CEO of a North Sea operator. He was telling me a tale of one of his assets – it had been off-line for a large proportion of the last year. He was beyond annoyed and had become “resigned” to the situation.

At first the he was off-line because the gas it imported from a nearby platform to power his water injectors was not available due to that operator’s maintenance schedule. Almost as soon as this came on-line his export route into CATS was suspended – again due to maintenance. (Here’s another example of an operator affected by CATS maintenance [Link]). Well blow-me if – when that came on-line – he didn’t face a gas-turbine maintenance problem on his own platform.

This interlinking of assets and reliance on others’ actions is becoming more common – for example here is what Enquest say about the Heather installation: “The Heather installation is designed to accept production fluids from Heather field and Broom field via subsea tieback. The production fluids are processed and separated into oil, gas and water. The processed oil is exported to the Sullom Voe Terminal via Ninian Central platform, while the gas is routed through compression trains for lift gas purpose.” [Link]

For years operators have battled to schedule maintenance on their own platforms so that work can be conducted in the most economic sequence. They aim to maximise capacity, up-time and utilisation. In this new interconnected world of small fields and infrastructure operating beyond its design life, companies must take into account the maintenance schedules of others.

One way is to be ready to work when the unexpected windows occur – that’s true even when you are a lone operator – but planned maintenance is a different matter.

Bob Spence, founder of Capital Project Partners, and member of the Bestem Network says that among the things he would consider are to: establish a common vocabulary across the supply chains of all operators; develop common definitions of how plans are communicated and progress measured and reported; find ways to deliver real-time reporting; and use predictive analytics to generate insight.

Lars Sandbakk, a leading light at Safran Software Solutions and expert in project planning tells me that from a technology perspective the issue boils down to: different software and their embedded methods; different project management philosophies; different terminology; and the lack of sensible data that can be easily exchanged without exposing more about your operation than you want.

He tells me that there is a cross-company initiative called ILAP (Integrated Lifecycle Asset Planning Standard) is being worked on and has been submitted as an ISO Standard.

Of course, while information and technology may be part of the solution, to make this work will require changes to commercial agreements and changes in the ways people actually work. These things are difficult to achieve and, without properly aligned incentives or new regulation and enforcement they are unlikely to take hold.

Learn to share nicely!

I had a number of responses to my comments about the main export pipelines from the North Sea – such as CATS – and the tariffs that are charged. A member of the network (senior SPE member who would rather not be named) pointed out that the “arteries” such as CATS are not such an issue as the “capillaries” – smaller interconnections – used in the gathering networks. Things like pooling of processing capacity (to remove water), compression (to build gas pressure up to enable it to be injected into the export pipes) and power (needed to run equipment) require a series of bi-lateral agreements. Smaller operators are heavily dependent on the reliability of big-players’ infrastructure. Sometimes alignment of incentives to operate effectively are missing and are, apart from oil price forecasts, the biggest economic blockers for marginal development.

The chairman of a large service company, and member of the Bestem Network, pointed me to a story by Robin Pagnamenta of The Times newspaper [Link] (Sept 9th 2015) explaining how the “great and the good” were meeting to discuss a proposal to pool infrastructure including, warehouses, subsea equipment, support vessels and other facilities. What I found interesting was, that while there was agreement that cost could be saved by pooling (non-core) operations, there was no talk about how to share the offshore installations and associated processing capacity.

Sharing bases and logistics will make things more efficient but won’t address the issues surrounding reliance on infrastructure operated by others. I can see how this will delay the inevitable slow down but not how it will facilitate drainage of marginal areas. It will not tackle the thorny area of non-common interest involved in sharing primary core assets nor maintaining shared operational schedules.

Further I can see that implementing shared arrangements for support logistics will take time to sort out, give the impression of progress but ultimately fail to unlock the opportunities that are present. Of course, go ahead and do it, but don’t think that this is all (or even the best) that can be done. Fundamental changes to the operator processes and license management in the UK sector is required, pretending that there is no problem with operator behaviour and narrow commercial interests as the JOA level cannot be avoided if we are to save this opportunity for the nation.

What do you think?

Infrastructure sharing in troubled times

I didn’t go to OE this year. I don’t think I was alone. From the reports I’ve heard things were quite subdued, except there were many people looking for work, apparently we are approaching 70,000 lay-offs in the UK Oil and Gas industry since 2014. Reports in yesterday’s guardian suggest that there is still more job cuts to come. This report in CITY AM – shows how the perception in London is being shaped and the urgency of the situation is being lost. CITY AM quoted job losses of only 5,500, and for many of the casual money men down here, that is all they will read.

The oil price is low. I remember when it was less than 25% of the current price– this report from the independent reminds us of $9 oil. In 1998 we also had the Asian currency crisis which started in 1997, what could a 75% drop in price do? With the recent wobbles in the China market, and talk of the commodity super cycle that wasn’t in the FT, is market perception changing, and perhaps there is further to fall?

I was pleased to see that Andy Samuel was quoted welcoming the efficiency task force – but I fear that these cross-company committees will be slow and ponderous. I also fear that operators will see this as a way to try to squeeze supplier prices and hurt the value chain. In my opinion, urgent structural change will be required to enable us to extract the resources that lie under the North Sea. Urgent because we need to maintain the infrastructure that will enable the extraction. This is a national opportunity and one that requires a national regulated response.

Andy was quoted as saying “The ETF is taking a three pronged approach to drive greater efficiency under the themes: Business Process; Standardisation; and Cooperation, Culture and Behaviours.” – Well frankly I don’t think this will be enough. I think the OGA must act, and use the powers it has (or obtain the ones it needs) to enable this. Of course, action like this is for the brave. Look at the trouble the control of access tariffs had in Norway, with investors suing the state. There must be questions about this with the recent private equity stakes being taken in CATS , FUKA and SIRGE – in one way this simplifies the access rights and can serve the needs of the customer better, but in another it centralises power in a way that only quick regulatory intervention can balance.

Can we get the last drop?

North Sea Oil and Gas is the property of the people from the countries that surround it – UK, Norway, Denmark, Holland, Germany. As a citizen of the UK I don’t want any more of my country’s wealth to be transferred to the citizens of other countries than is necessary. I think that this means extracting every last drop from this resource that we economically can.

There seems to be a number of issues that will stop this from happening. I hear many reasons that might account for it including:

  • High cost of production in the basin;
  • Inability for companies to co-operate on problem solving;
  • Individual companies optimising for their goals;
  • Lack of access to shared infrastructure;
  • Environmental impact; and
  • Decommissioning liabilities

I sense that if action is not taken soon, access will be lost to critical shared infrastructure. Should we get the last drops out of the North Sea? What do we need to do to make this happen?