Oil and gas companies in the GCC are benefiting from improved supply chain operations, but far more can be done, says Vinodkumar Raghothamarao, customer engagement manager, Epicor Software Corporation
Oil and gas companies operate in dynamic and complex environments, facing constant challenges especially in terms of supply and demand. Companies need to focus not only on their product supply chains, but also on the non-hydrocarbon supply chains that handle the parts, materials and services required to run the business.
The non-hydrocarbon supply chain is critical to delivering the equipment and services required to find, extract, refine and finally market the oil and gas. Procurement and supply chain strategies are among the most critical issues facing oil and gas producers.
In addition, factors such as energy prices, industry capital spending amongst others are rapidly changing the oil and gas landscape.
It means that international and national oil companies need to reassess the effectiveness of their procurement and supply chain. They will require new robust strategies that can deal with the complexity of this mid-term business environment.
Oil and gas supply chain practices lag behind (in certain geographies) those of some other industries that use advanced techniques, such as optimised inventory management and collaborative supplier relationship management. There are a number of opportunities and areas where supply chain practices can be improved amongst the IOCs or NOCs.
According to Harvard Business School Review, purchased products and services account for more than 50% of the average oil and gas producers’ total costs. Even a 5% reduction in purchase costs can result in a significant increase of companies’ profit margins.
There are a number of areas that firms can target to achieve this, including: supply chain market intelligence; demand planning; materials, supplier relationship management; supply chain technology; and supply chain talent.
‘Supply Chain Market Intelligence’ is the process of acquiring and analysing information in order to understand the present and future market; support current and future sourcing and market sector strategy execution; and enable the business to better anticipate changes in the external marketplace and react before others do.
Effective supply chain market intelligence helps oil and gas companies deal with strategic supply chain challenges such as constrained capacity, infrastructure and volatile markets. It also helps companies make the right decisions about which markets to buy from, how to determine the right price to pay and what benchmarks and targets will provide a competitive edge.
Effective demand planning is the next step to improving supply chain. It is a key factor to determining future requirements, which in turn helps to step up or step down supply, and leverage demand based on scalability. Many of the oil and gas supply chain and procurement executives across the globe agree that challenges arise when their demand-planning measures do not match their forecast expectations. The main reason for this is because it is only being used in selective areas.
For example, oil and gas companies may use demand planning in limited areas such as long lead time capital equipment, but not for other areas of the project, which can cause cost overrun. Beyond that, many oil and gas companies do not use demand planning at all, leading to a situation where internal customers are not linked to any structured planning process.
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The oil and gas industry is heavily dependent on suppliers to provide complex services and technical equipment to support ongoing projects and operations. However, contract management and supplier relationship management are not usually at an acceptable level, and as a consequence, the oil and gas companies take on supplier risks.
To improve supplier relationship management, companies should adopt a method of supplier benchmarking. Firms need to measure the robustness and performance of different contractors for various spend categories, and constantly seek dialogue with them so that the suppliers are in unison with the necessary obligations in terms of safety, training, equipment and staffing requirements. For contract management, we have seen some oil and gas companies with non-efficient processes, such as non-compliance of contracts, with established suppliers.
Another method that can help producers with pricing negotiations is the use of the ‘Should-Cost’ model and the ‘Total Cost of Ownership’ (TCO) model.
In the former, the total acquisition cost for a particular equipment or service is arrived at by taking into account the design cost, supplier operating cost, supplier margin, and transaction and acquisition costs. The Should-Cost model for different spend categories should enable companies to effectively negotiate contract terms and conditions with the suppliers.
In the case of the TCO approach (more suitable for long lead and critical capital intensive equipment), the different costs including the acquisition, and operation and maintenance are arrived at before choosing the right supplier at the competitive price. Some IOCs have adopted measures such as the Should-Cost and TCO models but these are yet to be adapted by other regional and local players in the oil and gas market.
This area of supplier relationship management – especially in the GCC – will need deeper analysis and a smarter approach given that local content plays a part in determining the right contracting and procurement strategy.
It is also true that materials management is lower down the priority list in oil and gas, compared with the healthcare supply chain, for example. But the supply chain function is still evaluated on the turnaround and delivery of materials and services being available at the right time and the right place.
Excess inventory based on historical usage and inventory levels by stock keeping units that do not match the service level requirements are some of the typical bad practices that companies should avoid. Oil and gas companies should adopt practices where there is high level of availability with minimised inventory.
Another area of materials management where best supply chain practice can be improved is the movement of materials to the project site. Most oil and gas firms deploy the services of third-party logistics (3PL) providers for transportation. Good tracking visibility, alternative material procurement, cross-docking and direct delivery are some of the measures that can be deployed to tackle challenges faced by using 3PL providers.
While the advent of technology has helped companies to find and extract more oil, there remains a need to seriously consider supply chain and procurement systems that provide additional real value. Modern enterprise resource planning (ERP) systems help to address concerns already outlined. These ERP systems should cater for inventory management, demand forecasting, contractor management, master data management and e-procurement.
Demand forecasting and planning coupled with inventory management and e-procurement form an effective oil and gas supply chain strategy. Oil and gas focused ERP systems have changed the way enterprise resource planning is being carried out in different industries. There has been a shift that has seen oil and gas companies take e-procurement far more seriously.
E-procurement is the new paradigm in procurement, acting as an information hub to support business planning and decision-making. It improves the performance of routine tasks like transaction processing, monitoring and enforcement of regulatory compliance. Used properly, it can increase transparency, eliminate middlemen overhead costs, improve competition amongst suppliers and ease management reporting.
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The main benefits of e-procurement as part of its contracting and procurement strategy in oil and gas are myriad, and include the potential to: transform procurement organisation by automating workflow, redeploy people for more value added strategic tasks and create additional value in procurement; improve sourcing and transaction cycle time; establish tighter integration with suppliers and customers; provide accurate inventory information, complete spend information and supplier performance metrics; minimise manual intervention and errors; and decrease internal procurement cost by having less maverick spend and hence greater volume with approved suppliers thereby leading to higher volume discounts.
Even with the best in class supply chain processes and systems, without the right people, best supply chain practice cannot be sustained, nor can the full benefits of supply chain really be achieved. As with any other industry, oil and gas has to grapple with the shortage of supply chain and procurement talent due to an ageing workforce and growing skill shortages.
Some of the measures that can be effectively adopted are training and grooming of talent in critical supply chain functions, establishment of supply chain centre of excellence and industry-academia collaboration to nurture talent.
Supply chain practice has improved in oil and gas, but there is always scope for improvement. Better demand planning and optimised inventory management will help companies maintain equipment uptime and benefit from improved productivity.
Improved spend category management and collaborative supplier relationship management coupled with increased automation of transaction processing, will lead to sourcing savings and identification of secondary saving opportunities.
The deployment of supply chain best practices, coupled with the implementation of a strong software, is the way forward for the oil and gas companies to reduce costs and to focus on oil and gas production and exploration in the most effective way.
There are a number of ways for IOCs and NOCs to improve the effectiveness of their supply chain operations
• Understand the ‘total value’ of major spend categories. This requires thoroughly identifying costs and options across the supply chain for each category and determining appropriate interventions (e.g., seeking new supplier, changing specifications, altering contract terms).
• Build custom fit procurement processes that provide better clarity, engage suppliers early in the process. Moreover follow through to execution and into operations.
• Manage risks across the entire spending portfolio — not just within individual projects or commodities, or splitting capital from operations spend.
• Proactively manage the supply base, select relevant suppliers, focus on alignment and sustainability (i.e., dynamic relationships), and ensure company ownership and accountability is clear to suppliers.
• Institutionalise the capabilities required for supporting procurement and supply chain activities. Today, these scarce skills are at a premium. In the next few years, it will be just as important to cultivate the right talent here as it will in the most critical technical and operational areas.
