Three Ways to Create Value in a Flat Commodities Market

26_--shutterstock_244384327In a press release from late July of this year, John Baffes, Senior Economist and lead author of the Commodities Markets Outlook said, “We expect slightly higher oil prices for the second half of 2016 as oil market oversupply diminishes. However, inventories remain very large and will take some time to be drawn down.” The behavior of commodities over the past several quarters (and the related commentary by market watchers) makes us appreciate Harry Truman’s oft-quoted desire for a ‘one-handed economist’ – so that there can be no equivocating “…but on the other hand…”

Drivers of the commodities downturn in fact remain either flat or at the very least uncertain – weakness in China’s economy, the Fed’s interest rate policy, and even monetary and trade policy (regardless of who wins the presidential election) are consistent in providing murky projections.

Given this uncertainty, how do we think about responding and implementing enterprise strategy? From cutting costs to planning for the next rise, here are three things you can do now:

1. Cut costs disproportionately

If you’ve survived long enough to be reading this, you’ve undoubtedly gone through multiple rounds of successive reductions in drilling plans and other capital programs. Some of our clients cut budgets equally across departments, or reduce headcount by seniority; this is not something we recommend. Laying rigs down was certainly an imperative, and we have seen budget cuts in infrastructure as well – IT, Regulatory, etc. How do you know which functional areas should be reduced and which should be preserved?

Our goal for clients is helping them build a resilient organization, not merely how to survive the siege. We advise reducing capacity in some functional areas where service providers can be flexibly deployed, but also re-designing the organization to operate cross-functionally. For an E&P organization, think of the development process from Land through Production. Define product lines by customer and process similarities, measure your process capacity (supply) to profitably balance with demand, and appropriately size each horizontal. This will result in cutting expenditures differently in different departments.

2. Retool

We believe in not letting a crisis go to waste; along with cutting expenditures in strategic ways, some investment must be made. We are advising our clients to invest in time – specifically, Time-to-Value. By defining the end-to-end process for, say, bringing a well to production, cycle times can be captured and handoffs documented. Tools typically used in other production-type industries such as manufacturing, can be employed to reduce the lead time to completion.

In our work with client supply chains, we have helped capture significant reductions in cycle time and queue time by simplifying pad development utilizing a product family approach. We take similarities in development, which may include ownership structure, regulatory requirements, geography, production volume, etc. and divide them along these lines into groups. The groups with common key characteristics become our product families, with a defined process for bringing each type into production.

This method of standardizing equipment configurations has the added benefit of facilitating pre-fabrication. Construction of pad equipment is done off-site on a skid, which is then trucked to the site. Not only is this method more cost-effective, but by fabricating in a controlled environment, we have been able to design piping with more welded connections, reducing flanges and the resulting fugitive emissions.

By defining the overall process, new ways of standardizing structures, equipment configurations and grouping procedures can lower costs and reduce time to market. And by using a down market to restructure processes, your organization will be poised for growth in an upturn.

3. Know your strike price

Just as divestitures were pegged to commodity prices on the way down, some of our clients have contingency plans in place for how and where to invest, given different scenarios of per barrel prices and recoveries in the price of oil vs. gas, etc.

Extending the metaphor of product lines and product families, which of them will be cost-effective at different price points? If we know our costs, our cycle time and our capacity, we can calculate when and how to re-engage our operations.

At our clients, we have documented end-to-end processes and then made them as visible as possible. This can be as simple as a wall poster of the process, overlayed with projects planned or underway. The pipeline of projects in various stages of development are prioritized in part by the market price for that commodity. The annotated project graphic serves as a visual contingency plan for operations and infrastructure investments.

Though the commodities market often seems subject to more than Adam Smith’s ‘invisible hand’, we can still develop plans for future growth. Our focus should be squarely on where we want to be when the next opportunity arises.

 

This article was written by Scott Zimmerman, a Manager at RAS & Associates. Since joining the RAS team in September 2014, Scott’s focus has primarily been Supply Chain Process Improvement. Most recently, Scott implemented a new contract bidding process for field store procurement at a leading organization in the O&G industry.