Compensation trends

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Year-end business performance is the single most important contributing factor to funding employee bonus pools and other discretionary spending for oil and gas firms. While the industry continues to respond to fluctuations in global and domestic benchmark commodity prices, approximately 75% of organizations were able to forecast their year-end business results in relation to their financial goals. Among those organizations that chose to forecast year-end results, approximately 32% performed below target, 34% performed at target, and 34% performed above target financial performance year. As expected, oilfield services and equipment providers were the most pessimistic about meeting financial objectives, with 66% of participants indicating below target performance. However, upstream producers were more upbeat, with approximately 60% of organizations indicating expected financial performance to be above target levels for the year.

While most companies did not resort to such drastic measures as reducing base salaries in 2016 (97%), actual base pay increase budgets have been reduced over the past two years, with 44% of firms reporting a salary freeze in place during 2016, including 75% of upstream producers. Most companies (94%) did not report plans to freeze base salaries in 2017. However, companies did indicate that reduced base pay increase budgets are likely to be spread across fewer employees, focusing dollars on high performers, field populations in highly productive geographic areas and key contributors to company success.

Across all participants, projected base pay increase budgets average 2.7% to 2.8% of current base salary payroll, with executives and field employees slightly higher than corporate staff. However, projected base pay increase budgets do vary by industry segment. Midstream organizations maintain a median budget of 3.0%, but upstream producers fall closer to 2.0% at the median. Most oilfield service and equipment providers indicated plans to freeze base pay levels in 2017.

VARIABLE PAY

Despite the downturn in commodity prices, the oil and gas industry continues to outpace general industry in projected spending on variable pay for their non-executive population, reflecting the importance of aligning industry employees with the company's financial success to drive individual and team performance. According to research collected by Aon, oil and gas companies are projected to spend an average of 18.6% of payroll annually for non-executive variable pay salaried exempt employees, which mainly consists of annual bonuses.

However, the average company across general industry spends 12.8% of payroll on variable pay for salaried-exempt employees. The higher spend on variable pay among oil and gas companies is mainly driven by the larger proportion of salaried-exempt employees in the petroleum business with deep technical expertise and the impact of these employees on business results compared to general industry.

It is important to note that while 27% of all participants were unsure of their financial performance for the year, 40% of upstream producers remained unsure at the time of our research, indicating many firms are taking a wait-and-see approach to finalizing funding for their employee bonus pools and other discretionary spending in 2017, with several firms indicating an expectation of delaying base pay increases for at least a few months from the previous year.

LONG-TERM INCENTIVES

A long-term incentive, or equity compensation, is highly prevalent throughout the oil and gas industry beyond solely executives in the board room. While executives will receive a significant portion of their total direct compensation in equity, even at lesser values, it continues to serve as a retention device that aligns employees with the financial success of the company.

Most companies began planning for their 2017 long-term incentive grants in the fourth quarter of 2016. Long-term incentive practices vary significant by company due to corporate structure, share availability and company culture; however, the following trends exist:

• Upstream producers often grant long term incentives to employees below the management level to key contributors in technical disciplines, with half the sector granting shares to employees at all levels in the organization.
• Privately held companies generally will restrict access to long-term incentives higher in the organization than publicly traded companies, as vehicles are either more complex or cash-based.
• For publicly traded companies, the predominant form of equity compensation is a mix of time-based restricted stock and performance-based restricted stock, with executive compensation more heavily aligned with performance-based restricted stock.
• Since many performance-based restricted stock grants vest based on performance relative to peer organizations, executives of companies with better relative performance may see significant value delivered despite depressed market values for investors.
• Vesting periods for time-based vehicles will vary between three and five years from the date of grant, generally vesting in equal tranches throughout the vesting period.
• Performance-based grants generally will vest on a cliff date, where performance is assessed through a lookback period.

During 2016, many upstream producers, mainly due to their historic granting practices, ran into the conundrum of insufficient shares or a dilution rate that may alert investor watchdog organizations to sustain historic granting practices. According to our research, in the fourth quarter of 2016, upstream producers were significantly more likely to adjust their methodology for determining long-term incentive grant values for employees in 2016, with 41% employing some alternative methodology to reduce the number of shares required.

Most organizations employed some discretion by managers on who should receive grants, while others chose more quantitative ways of using fewer shares, while some organizations chose to utilize an alternative cash-based vehicle, despite not knowing how long prices would stay depressed and knowing three years from now, these grants will come due.

Other adjustments that upstream producers deployed in their grant valuations included:

• Maintaining the same level of dilution from outstanding shares as the previous year
• Reducing eligibility for grants
• Using a historical or average stock price from an earlier period
• Reducing prevalence of grants
• Fixed dollars budget

Long-term incentive compensation continues to be an important element in the overall rewards for employees in the oil and gas industry. As equity valuations improve with the global landscape, companies have to remember the impact of these awards on employees nearing retirement and key successors to their roles.

Organizations throughout the industry have to remain nimble and focused on the timing of execution. Much of this timing requires talent to be engaged in the process, understanding how each organization can maximize on movements in the market and capitalizing at the right time. Rewards programs are just one lever to use to engage employees, and with budgets more constrained, organizations often need to find different tools to help them achieve their results.

Developing stretch roles for high-performing employees to further their knowledge and capabilities; investing in employee development and mentorship programs; and employee recognition can all have as great, or even greater, impact than monetary rewards on employees' overall satisfaction and engagement.

ABOUT THE AUTHOR

Joshua Ross is an associate partner in Aon Hewitt's Talent, Reward & Performance practice and is responsible for Aon's Southwest Region and North American Energy Vertical. With more than 14 years of consulting experience on compensation-related projects, he works primarily with organizations in the energy industry. He has led and served as a senior contributor on several large global and domestic integration projects. Ross completed the business/economics program at the University of Texas with a concentration in quantitative methods. He is based in Houston.