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Companies must change their strategy in the downturn

Upstream developments are often troubled by cost inflation and over-runs. SBC’s Eric Janvier* argues that as discoveries become more marginal and oil prices continue to fall, oil and gas companies must take a closer look at project management – and change the way they select and execute project

Megaprojects are intrinsically complex and tend to overrun in all industries. In the last decade, upstream projects have suffered more acutely. The first reason is structural: discoveries became more marginal, increasing the cost per barrel, and projects grew to cost tens of billions of dollars, increasing overruns. According to SBC’s annual Capital Projects survey, exploration and production companies multiplied their investment by four, and at the same time mega-projects over-runs quadrupled.

The second reason relates to markets: with a higher oil price, most companies expanded ambitiously, drawing many mid-sized companies into unfamiliar territory. The combination stretched both the supplier and talent pools, and amplified the inflation and over-runs. With lower oil prices now eating into profit margins, this trend has become unsustainable.

Challenging the status quo

Other sectors, such as the automotive and aerospace industries, have experienced a similar convergence of project over-runs with cash short-ages. To survive, companies in those industries had to transform both their engineering practices and project management, adopting leaner practices and deeper supplier collaborations. The trend is spreading: the space industry – launchers and satellites – is facing a similar transformation, as new entrants challenge traditional engineering methods. Major players in naval construction and the utilities sector are considering similar changes. Despite their differences, these industries applied similar principles to transform their project practices, and in doing so, achieved necessary cultural changes. These principles apply to the energy industry too, and companies who wish to continue to develop and operate large projects must consider adopting them.

There are four key principles to consider: first, to focus on leaner designs; second, to develop closer collaboration with suppliers; third, to adapt growth strategies to one’s true capabilities; and fourth, to create a robust system of central governance for large projects.

Producing hydrocarbons in deep waters and other extreme environments requires the application of sophisticated technology, yet many oil and gas projects suffer from over-engineering. This is where adopting the first principle is key. The industry has not been good at reusing past engineering efforts, and too many projects start with the assumption that a custom design is required. On top of this, the assiduous – and justified – attention to safety has encouraged an unchecked and costly inflation of engineering standards.

Adopting a leaner approach to design would go some way towards systematically eliminating that over-engineering, as well as any “waste” that consumes resources without generating value. Such an approach requires defining the functional specifications essential to a project as precisely as possible. Engineering efforts should concentrate on the elements that create the most value. The other elements are subjected to aggressive optimisation, usually through simplification and standardisation.

Cost reduction has a bad reputation in the oil and gas sector, hinting at compromises on safety, quality or recovery rates. When the oil price col-lapsed in the mid-1980s, the UK oil industry launched the “Cost Reduction Initiative for the New Era” (Crine). The initiative did reduce development costs substantially, but Crine remains a byword for substandard installations and unreliable performance.

Lean engineering

However, managed appropriately, leaner engineering does not imply indiscriminate cost-cutting or sub-standard performance. A lean design should operate better and more reliably than an over-engineered one: this is certainly the case for modern airplanes; and in the 1990s, Porsche demonstrated that lean engineering techniques can improve both costs and quality.

One important opportunity to increase simplicity is to “design one and build many”, at the installation or subsystem level. Some upstream companies recognise this already: Anadarko, for example, has focused on spar production platforms, dramatically reducing engineering costs and development cycles. Statoil has introduced “fast-track projects” for subsea tie-backs, Shell and Petrobras are – respectively – developing lines of floating liquefied natural gas (FLNG) and modular floating production, storage and off-loading (FPSO) vessels. Yet, examples abound in the energy industry where similar developments – often by the same company – are each designed from scratch. Many developments go through two or three FEEDs with competing engineering firms, a “design many, build one” strategy somewhat counterintuitive in a context of talent scarcity.

A leaner engineering approach means challenging functional specifications more aggressively, establishing realistic estimates of value versus full costs, including the pernicious costs of complexity; it means exerting tighter control over innovation, avoiding designs that incorporate too many, or immature, innovations; it means seeking systematically to reuse designs, or elements of designs, proved in previous projects; it means trading the fit that comes from bespoke designs for the cost and reliability that comes with repeated and continuously improved designs; and it means re-evaluating company standards to promote simplicity and proven supplier standards.

Two hurdles need to be overcome for this to work. First, some engineers will resist these principles, arguing that every project is different, that reusing concepts binds them to suppliers and stifles competition, or that innovation and quality will suffer. These arguments have been made in other industries which have adopted a leaner engineering approach, and successfully overcome. Second, this approach will only yield its full benefits if associated to deeper collaborations with selected engineering firms, which takes us to the next step.

However, over-run and cost inflation problems are amplified by the model of collaboration between operators and suppliers currently in use, a model which has become quite unproductive. This is where the second principle — developing closer collaboration with suppliers — is key. 

In many large projects, the process from conceptual studies to detailed design consists of a succession of tenders for engineering. This multi-plies hand-overs between contractors, and in some cases, may see work duplicated. New projects will usually be retendered, neglecting the value that can be created by strengthening existing relationships. These constant changes hamper efforts to improve performance across projects. It is arguable that in the energy industry, as with football, changing the team’s make-up for each game played makes it difficult – if not impossible – to win a championship.

An aggravating factor is that the industry outsources most of the design work, and therefore keeps fewer engineers on staff than other capital-intensive industries. Many mid-sized companies also struggle to assemble the in-house experience to match their ambitions. Believing, in this context that any “owner team” can effectively specify every technical choice, becomes a fallacy.

A new mindset

It is time for the upstream sector to explore the approach adopted by others: to develop longer-term collaborations with “tier-one” engineering firms covering a series of similar projects. In this model, tightly integrated teams collaborate on projects from concept generation to execution, and work together between projects to improve the performance of the next generation of installations. The tier-one contractors, in turn, develop their networks of tier-two and tier-three contractors, along similar principles, ensuring a cohesive supply chain.

This model will also enable the adoption of information systems that have, for a decade, enabled other industries to transform design, fabrication and assembly. Other industries now rely on full virtual models (digital mock-ups) and product lifecycle management systems (PLM) to speed up development, integrate hundreds of suppliers and improve the performance both of the project and of its end-product.

Finally, these changes in collaboration are necessary to develop an effective standardisation strategy. If every phase of every project and every new project is handed to new sets of contractors, it becomes difficult to maintain the consistency of design between projects, and nearly impossible to integrate processes and systems between collaborating parties and capture the expected performance gains.

Of course, such a medium-term strategy appears to contradict the more short-term strategy that multi-plies competitive tenders to squeeze suppliers’ margins. It is arguable, though, that the latter approach delivers limited cost reductions while increasing project risks. As the experience of other industries shows, with a few years of sustained effort, a strategy of deeper collaboration brings much larger benefits and remains compatible with healthy – although different – supplier competition.

This is where   the third principle – tailoring growth targets to a company’s true capabilities —  comes into play. Many medium-sized companies have pursued aggressive growth over the past decade, taking on complex projects in unfamiliar geographies or projects which require unfamiliar technical solutions. These companies now find themselves dangerously stretched.

Even the majors are not immune. Most of them strengthened their project management and engineering capabilities over the past decade. But, despite their scale, many of their portfolios remain too diverse to provide the repeatability they need to drive costs down via lean design strategies and deeper collaborations.

Many companies now find themselves facing unsustainable costs, especially in the context of low oil prices. In this situation, both the majors and their medium-sized peers will consider disengaging from projects plagued by uncontrolled project risks or disappointing economics.

As a consequence, it is likely that the next few years will see the industry restructure. Many companies should use this revision to develop a more realistic assessment of their project capabilities, and adopt more selective criteria to evaluate new opportunities. Once the storm is weathered, they will need new growth strategies and should avoid another unreasonable dispersion of their efforts.

Those who developed lean design strategies and strong collaborations will have a critical competitive edge. Clearer specialisation will deliver decisive performance improvements. If, for example, building a series of similar offshore platforms with the same EPC company and construction yard reduced construction times and costs by 30% and boosted early production by 20%, it is logical to play that strength in the selection of future opportunities.

Such specialisation is already occurring. Many US companies are selling overseas assets to focus on highly repeatable onshore domestic projects and build their competitive advantage on continuous improvement. Similarly, Petrobras is starting to see benefits from focusing on pre-salt resources. Companies that ignore the compelling benefits of specialisation will – eventually – lose their competitiveness.

But making this a reality requires significant cultural change for most companies — implementing central governance for large projects. As with all most ambitious transformations, success depends on the leadership of a strong central capital projects team. Left to their own devices, local business units will generate enough entropy to stall most lean design, collaboration and specialisation strategies.

Furthermore, organisations that delegate project leadership to local business units will struggle to develop the skills and practices required for mega-projects.

The question of a central leader-ship for large projects is still contentious. Most of the majors have built a central structure that provides strong capabilities and governance, but half of the medium-sized companies polled in a recent SBC capital projects survey maintain full project accountability to the business units.

For companies who develop mega-projects and seek to improve their performance, there is no real choice. To implement consistent practices, transfer experiences across projects, maintain a direct line from key projects to top management and manage a global pool of experienced staff, they need central leadership. Perhaps even more importantly, central leadership is needed to drive the transformation towards leaner designs and deeper collaborations.

There are many ways to transform and improve upstream project management. But meaningful change in performance will only happen if all four elements are brought together: lean design; deeper collaboration; clear specialisation; and central governance. This process will take time, typically two or three generations of projects.

Other industries have reaped the benefits from such transformations. Another rise in oil prices may tempt the energy industry back to a cycle of unfettered investment. A $50-a-barrel world may encourage a return to the old tendering techniques. But, as the lessons of 2008 prove, shaving a few percentage points off suppliers’ margins only brings a temporary respite.

The oil and gas industry must change its project strategy. Majors, independents and suppliers all have a role to play. All it takes is one or two visionary companies to take the lead, as Toyota did in the automotive industry. Once these pioneers prove the model, others will have to catch-up before their underperformance becomes obvious to their partners, shareholders and to resource owners.

Anadarko’s a case in point

Anadarko has a reputation for effective offshore developments. It based its strategy on long-term relationships with selected contractors, and maximum reuse of experience across projects. Don Vardeman, Anadarko’s vice-president for worldwide project management, explains how it was done.

Q: Anadarko has formed lasting collaborations with key suppliers. How successful has this been?

A: Trusting and empowering contractors is a significant part of our project-management success. The relationships we have built with vendors and contractors help us to establish and enhance efficiencies, mitigate risk and ensure on-time project delivery.

Seven spar hulls have been built in the Technip yard in Pori, Finland. This experience means individuals can transfer lessons learned from one project to the next, while maintaining excellent safety performance. A similar approach was applied to Heidelberg’s subsea trees, where we have worked with the same supplier for 20 years.

There is a relatively small group of providers that have the financial and technical expertise to design, fabricate or install deep-water structures and pipelines. We work to build good relationships with these contractors to assure that we can execute our programme plans. These relationships are key to our success in completing our projects on-time and within budget.

Competitive tenders still provide the best value in many projects. We follow all the providers, and perform concept selection studies when it adds value – for instance, for Shenandoah, our latest and possibly largest deep-water discovery in the Gulf of Mexico.

Q: You have used these relationships to standardise some of your concepts. What were the benefits?

A: In the case of the Heidelberg project, the spar was modelled on the Lucius design and the subsea architecture was inspired by our recent Caesar-Tonga development. The “design one, build two” approach helped reduce engineering man-hours in pre-front-end engineering and design (FEED) and FEED on the platform by more than 60%, with further benefits throughout the detailed design. The procurement cycle for the topsides equipment was reduced by 50%. Overall cost savings are estimated to more than $1bn.

Previously, Nansen and Boomvang, then Gunnison and Constitution shared their designs as well; although, Lucius and Heidelberg are the largest spars in terms of capacity that we’ve constructed to date.

We have standardised process equipment in our onshore developments too, introducing flexibility to respond to rapidly changing production rates.

Standardisation increases reliability, environmental and safety performance, and reduces costs and schedules. Independent benchmarking shows we remain in the top quartile of cost and schedule performance for megaprojects.

Q: What challenges did you face?

A: Replicating an existing design requires discipline in implementation, partner alignment, vendor consistency, open communication and a strong commercial focus. Controlling enthusiasm for change is key. These are traits that have remained central to Anadarko’s industry-leading project-management success.

Q: What implications does this have for the exploration and production sector?

A: Anadarko’s Lucius and Heidelberg projects demonstrate that by transferring knowledge, applying best practices from project to project and building relationship-based contracting, our industry can create tremendous value through simple innovation and enhance the deep-water opportunities in one of America’s most important producing regions – the Gulf of Mexico.

*Eric Janvier is a director at Schlumberger Business Consulting (SBC)

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