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Keeping a tight belt

Upstream companies must make cost savings structural and permanent in 2017, not short-term and reactionary

Upstream oil and gas costs fell in 2016 and many in the industry expect further reductions in 2017. But less than half of the savings projected for 2017 can be sustained in the longer term and the industry must reshape its approach to cost management if it is to make recent cost-reduction efforts stick for the duration of their projects.

A survey of the global oil and gas industry by Wood Mackenzie - based on responses from a wide range of company types and regions - shows average costs fell by around 17% in the past year, with larger reductions detected among supply-chain companies than operators. Overall, it is reported, the industry expects a further 5% decline in costs in 2017, but there will be significant variations across company types and regions and as much as a quarter of respondents are actually readying themselves for cost rises in 2017.

Sustainability in cost reductions is far from assured. Wood Mackenzie's survey shows that less than 50% of the savings expected between 2015 and the end of 2017 can be kept in the longer term.

That view tallies with the survey results. Asked to rate the importance of 14 approaches to reducing supply-chain costs, respondents indicated a continued focus on tactics, such as the renegotiation and re-tendering of contracts. While more emphasis was placed on structural approaches to cost management, such as standardisation, than in the 2015 survey, tactical responses predominated.

Responses to the question of whether recent cost reductions are structural and sustainable or cyclical and temporary were varied. After two years of low oil prices, many respondents noted a more mature approach to re-basing the industry's costs, with signs of greater collaboration between operators and suppliers, and more use of new technologies. Yet fewer than 45% of respondents believe that recent changes are structural.

Making cost reductions stick permanently is hard for several reasons. Many businesses lack the detailed financial, operational and headcount data to understand where to target reductions - this is especially problematic if an organisation is responding rapidly to external market conditions, like an oil-price slump. And driving cost efficiency requires real change in culture and behaviour, which in turn depends on consistent leadership focus.

Upstream companies face their own peculiar set of problems. As commodity prices are in a constant state of flux, sustainable cost reduction demands more than just pushing the pain back along the supply chain. Upstream assets undergo continuous change too. The weighting of costs towards projects means companies can be tempted to scale down an activity to meet cost-reduction targets. In some instances, a shortage of detailed information on operational and financial performance creates uncertainty about whether or not cost-cutting measures can be sustained for the duration of an asset's use.

But upstream companies can make lasting cost reductions in several ways in 2017. For one thing, they can make cost efficiency a strategic priority and hardwire it into performance management. Cost leaders in many sectors say it is essential that cost efficiency become a clear strategic priority. The leadership of a company sets the tone, but this must be reinforced with performance indicators, targets and incentives.

They can also break the single-operator development plan. Operators optimise development plans for their own assets, but, given the high concentration of operators in many basins, plenty of opportunity for collaboration on existing or planned infrastructure exists. This could bring down life-cycle asset costs. Another method is to optimise the procurement and supply chain process during the commodity-price cycle. Collaboration is key here too.

Firms should also review their basic operating model.

Many have seen low-margin assets (either high-cost or mature assets) as a portfolio-management question. In a period of lingering weakness in the oil price, operators need a strategy to keep these low-margin assets viable.

Also, operators must understand the component parts of their project, and their risks, to make sure it is all sustainable. This demands a thorough grasp of the scope and approach of projects and a forensic approach to the cost base; the commercial model of the projects; and each project's targets.

In short, the industry must implement a shift in focus from tactical cost cutting to sustainable cost management as a matter of urgency; 2017 would be a good time to start.

This article is part of Outlook 2017, our annual book looking at energy market trends for the year ahead. To purchase a copy, click here

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