There are two routes to efficiency in the oil and gas business, each having to do with scale. Efficiency can come from mass or, for lack of a better term, maneuverability. These paths used to run in parallel. But $16/bbl oil and $1.50/Mcf natural gas, by placing efficiency at the core of competition, have changed the map.
Mass provides scale economies, in which the cost of each new unit of output falls as total output rises. Maneuverability uses low scale to match costs with related output and keep total costs low.
Seldom both routes
In times past, a company followed one or the other of those routes but seldom both. Companies with lots of capital favored mass, others maneuverability. Major companies pursued the scale economies that come with size, independent companies the high maneuverability of low scale. The industry developed around this economic topography.
The oil market followed a similar course. Thanks to scale economies, big reserves and big production capacities mean low per-barrel costs. Scale is, of course, the competitive advantage of producers in the Middle East.
But scale isn't what it used to be in either oil business structure or the crude market. Technological developments of the past few years have provided impressive new ways for enterprises to be efficient regardless of scale. Nature, meanwhile, sets limits on the number of new ways to be big.
The market effects of this are dramatic. The scale producers, most of them members of the Organization of Petroleum Exporting Countries, are losing share to new or enhanced production from resource bases much less grand than their own. Dealing with this is OPEC's central problem, whether or not ministers address it at their meeting next month.
And scale's eclipse as a guiding light of management has produced equally dramatic effects in the behavior of companies. The most obvious example of this is the eternal "downsizing" of major companies. But large companies' pursuits of nonscale efficiencies are producing new wrinkles that should gratify and perhaps worry independents and keep OPEC ministers awake at night.
In a move that combines downsizing with such other current business tactics as "partnering" and organizing around "core assets," Amoco Corp. and Shell Oil Co. have agreed to form a jointly owned company to explore for and produce hydrocarbons in the Permian basin. The deal is historically significant because it's the first such merger involving major companies across an entire U.S. basin. It's strategically significant because an express aim is to create a venture that will act not as a miniature version of either parent but as an independent. The strategy is one of maneuverability rather than mass, focus and expertise rather than scale.
This is both flattery and threat to independent producers, who suddenly have a new--and, if Amoco and Shell do it right, highly maneuverable--competitor. It also promises more ultimate production from the Permian basin--and lower U.S. purchases of OPEC crude--than there would have been in the absence of the merger.
This is not to suggest that scale is dead as a business strategy. It is for the sake of scale advantages, for example, that U.S. independent gas producers propose to form cooperatives to help market production. And OPEC producers would be much more formidable competitors than they are now if they augmented their scale advantages with marketing and technical efficiencies that many of them now avoid.
Scale still important
So, although it seems to be yielding for the moment to maneuverability as a business strategy, scale remains very important. Present trends simply suggest that the once-parallel approaches to efficiency now overlap.
Big producers can't rely solely on scale and must find ways to act small. To remain competitive, small producers will have to find ways to act big. In this manner, $16/bbl oil and $1.50/Mcf natural gas reshape an industry. Copyright 1995 Oil & Gas Journal. All Rights Reserved.
