years for solar to replace the electricity currently obtained from nuclear plants).3 Even with the tailwinds of government support at federal, state, and municipal levels, including regulations, tax credits, and direct subsidy, the US Energy Information Administration (EIA) expects “fossil fuels” will provide more than three‐quarters of US primary energy in 2040.
Figure 1.1 World Primary Energy, by Fuel (million tonnes oil equivalent)
Source: BP Energy Outlook 2035
WHAT NOW?
Oil and gas companies have been focused on cost and productivity since before the 2014 collapse in oil prices. Upstream operators have made enormous efforts through massive vendor concessions, capital project deferrals, reductions in force, and “high‐grading” drilling and completion activity to the most productive acreage.
For example, in 2016, one dollar of US onshore capital yielded twice the output (i.e., BOE/D) that it did in 2014, due to lower costs and higher productivity.
WHAT NOW?
For those asking, “Are we there yet?” sadly, the answer is no. For most in the industry, free cash flow is inadequate or even negative. The question to be asking is, “What now?”
The industry has experienced tremendous evolution in terms of our understanding of the underlying global resource base, the nature of its ownership and principal stakeholders, and the methods and technologies for resource development. And business models have evolved considerably with these changes, including the adoption and growth in usage of “drilling promotes” with a carried interest, farm‐outs, and other nonoperated ventures (NOVs), an industry supply chain with a wide array of field services companies, many forms of collaborative ownership and operation through joint ventures (JVs), state ownership and control of natural resources through national oil companies (NOCs), the adoption of corporate shared services models, experimentation with business processes offshoring and/or outsourcing, and much greater use of big‐data analytics and digital solutions within the core operations.
But beyond direct accommodations in response to each of these changes, there has been very little effort to redesign and transform internal enterprise operating models. Moreover, unlike other industries that have undertaken operating model transformations in response to disruptive industry forces (e.g., retail), the upstream rarely undertakes operating model change on a systematic or enterprisewide basis. The notable exception has been event‐driven situations, such as post‐merger integration (PMI) programs where promises of synergies may trigger fundamental reviews of upstream operating models, and major divestitures such as a sale or carve‐out/spin‐off, and initial public offering (IPO) preparation.
Upstream operators were already struggling to earn adequate returns before prices fell, but now face difficulties generating sufficient cash flow even to cover their basic needs – they do not generate enough cash flow to cover operating costs, capital projects, overhead expenses, debt service, dividends, and so on. With oil and gas prices remaining low, hedges rolling off, and sources of cash falling short of uses for cash, the upstream requires fundamental gains in cost and productivity. Many of the largest (and easiest) cuts, like vendor concessions, will not be sustainable over a full cycle. Furthermore, some of the biggest gains thus far are not scalable. And the future supply gap beyond 2020 requires a significant investment to find, develop, and produce resources that are very likely to be relatively expensive barrels.
There must be considerably more work, and more difficult work, to reduce upstream costs. The industry has made great strides for sure, but now the more difficult (but more valuable) task is to sort through:
1. What different to do (i.e., setting the strategic agenda)
2. What to do differently (i.e., defining the operating model)
The first question (i.e., the “what”) establishes a strategic agenda, and relates to choices in terms of the corporate and business unit strategies, asset portfolios, and business models. Setting the strategic agenda demands choices about what businesses to be in and what assets to own. Perhaps more importantly, the strategic agenda must establish in which “key capabilities” to invest and which activities to “in‐source.” It is impossible to be “world‐class” in every capability – every aspect of activity of the business and therefore critical choices must be made.
The choices about what not to do are often more important than the choices about what to do. Most upstream oil and gas enterprises have a portfolio of too many businesses, too many assets, too many geographies, too many resource types, and too many opportunities, all of which are competing for too little capital, not enough expertise, and too limited a talent pool. Therefore, the most important strategic choices are what not to do. Moreover, these choices require an iterative process to “reconcile” between the following three critical elements of the upstream enterprise:
1. Aspirations, goals, and objectives for the business
2. Opportunities and needs of the underlying resource portfolio
3. Organizational capabilities of the enterprise internal operating model and talent pool
The second question (i.e., the “how”) sets the enterprise operating model, and relates to the internal architecture of the company, its operation, and its governance. Defining the operating model – choices regarding the internal architecture, performance metrics, systems, processes, and culture has a profound impact on the performance of an enterprise. An operating model is effectively the “blueprint” for the internal architecture of an enterprise, its operation, and oversight.
Now, most research and experience with low‐cost operations tends to focus on innovation in business models (rather than enterprise internal operating models) to lower the costs of acquiring and serving customers and enhance the customer experience, often with digital platforms.4–5 Where there is research and experience with low‐cost operating models, it tends to be in consumer‐facing industries, with examples such as Costco, Dell, Southwest Airlines, Walgreens, Wal‐Mart, E*Trade, and IKEA rather than “B2B” industries, or specifically, the upstream oil and gas industry.6,7
INDUSTRY EVOLUTION
Over the past century, the oil and gas industry has experienced a significant evolution in terms of our understanding of the underlying global resource base, the methods and technologies involved in its development, and the nature of its ownership and principal stakeholders. In conjunction with this change, there has been considerable evolution in business models – but so far, the accommodations made to enterprise internal operating models have been largely incremental (see Figure 1.2).
Figure 1.2 Upstream Evolution
Source: IHS Energy
What began in the early days of the twentieth century as a largely entrepreneurial effort quickly evolved into big business, in part due to the scale of its requirements, in terms of capital and expertise – in the 1960s, oil supply was safe and abundant and not a constraint on economic growth, with excess capacity exceeding demand by about 20 percent of the free world's consumption.8 This fueled the corporatization and professionalization of the industry and facilitated tremendous growth in functional expertise, especially geological and geophysical roles, engineering, and other technical functions. The growth era of 1972–1981 drove large‐scale expansion. While the 1980s were characterized by low prices, layoffs, and consolidation, they also gave rise to innovations in 3D seismic, commercial beginnings for both horizontal and logging while drilling, and many new technologies and service companies.