A renewed sense of optimism has settled over the oil industry. Prices are rising and stockpiles falling, thanks to increased demand from North America, Europe and particularly China. The worst of a prolonged period of extreme belt-tightening appears to be over.
Optimism is addictive; however, downside price risks should give the industry some pause. The supply overhang from OPEC and North American shale has not yet been cleared and demand is still to catch up with pre-downturn levels. The broad consensus is that oil prices will now trade in a narrow pricing band whose ceiling is governed by US shale’s ability to respond to modest price increases.
With lingering risks on the downside, and little to look forward to on the upside, operators need to tread carefully as they move forwards.
Rethinking success
If the past few years have seen only the truly world-scale projects progress, it is not because of a lack of options. International oil companies still have plenty of projects in their portfolio that could be progressed, many of which were added before 2014 and then not sanctioned.
Most still remain on the books. And most remain undeveloped simply because they are out of the money. Higher-risk projects in particular – such as those in deep water or harsh environments, or those where the technical and political risks are too great – have largely been shelved. Many operators simply cannot find the funding, even for projects with attractive economic prospects.
In this straightened environment, it is the scarcity of capital, rather than lack of opportunity, that is still giving companies a headache. Discipline is still important when it comes to capital allocation, and portfolio managers have to ensure that investment criteria are strictly adhered to.
Higher-returning, but less-affordable projects are still more likely to be left on the shelf, while cheaper and less risky ventures take precedence. No one wants to see a return to irrational exuberance, and so the industry needs to recalibrate its expectations in this new reality.
As a result, the benchmarks for giving a new project the green light have changed subtly, moving away from simple measures of ‘value’, such as net present value, or ‘rates of return’ to place more emphasis on ‘affordability’ and ‘return on risk’.
For project managers, this requires a shift in thinking to give those existing opportunities the greatest chance of being progressed in this newly-cautious investment environment. This means simplifying and reworking projects to reduce overall costs and eliminate lingering uncertainties.
More significantly, it means that simply reheating previously-shelved projects is unlikely to succeed. Instead, original concepts need to be reworked to fit in with the new reality. Project managers should be prepared to curb their ambitions and look at less-lofty concepts in order to develop their projects. For example, downsizing or phasing the development of discovered resources can help increase affordability while putting less strain on the company’s balance sheet.
Familiarity breeds success
For ambitious project managers, the less easy option will be to repeat and recycle previous concepts. Engineers and project managers who have a natural tendency to go for the best possible version of each new project, should consider a less-optimal alternative that has been implemented before.
This kind of repetition helps to reduce risk and increase certainty around the costs, timing and ultimate operability of a project. As the US shale industry has proved, a large amount of repetition can reduce steep learning curves, which in turn leads to a dramatic reduction in cost and cycle time, and an improvement in overall project outcomes.
Similarly, modular approaches and standardisation can vastly improve the predictability of a project’s outcome. The oil industry has suffered greatly over the years by approaching every project as a ‘one-off’ that requires a unique solution. However, on projects where new technologies have been deployed, cost overruns, delays and poor operability are far more common.
“The ideal solution is to allow knowledge derived from extensive, practical experience to drive feasibility studies and pre-project analysis – rather than applying it as a layer to more abstract or theoretical work. There is wisdom and value in experience. The earlier in the project it is deployed, the more likely it is that investment will be directed into profitable channels and the more likely a commissioned project is to stay on track and deliver the expected value.” Tom Cuthbert, Regional Director – Hydrocarbons Concept & Feasibility, Advisian, Middle East.
Moving forwards
The pressure to fast track projects is obviously much lower than it was in the boom years. The upside is that it presents more opportunities to rework original project concepts to reduce costs and reduce risk. In doing so, more value can be identified, or a more affordable solution may emerge.
The argument for repetition is particularly applicable to national oil companies (NOCs), tasked with stewarding their nations’ oil and gas endowments. Fast tracking projects may be essential for generating a steady income for the state, and for providing secure supply to domestic energy markets. However, for an NOC whose balance sheets are, essentially, provided by its country’s government, affordability constraints are often a more important consideration than selection criteria based on value metrics.
In the current climate, NOCs tend to be the biggest beneficiaries of simplification, downsizing and project phasing. If affordability, rather than value, is the aim, then projects that consist of less ambitious but more manageable phases (and which can therefore be more easily approved) are more likely to keep the show on the road.
Nonetheless, in this new world, companies of all shapes and sizes need to recalibrate their success criteria to ensure they keep moving forwards. Right now, the security of steady but unspectacular progress beats the prospect of flashy failure every single time.
