There are plenty of opportunities out there - it is all about finding the right commercial model for your business
THOR MAGNUS ROVIK AND KENNETH FOSSØY, ROVIK AS, SANDNES, NORWAY
THE FIELD OF STRATEGY is broad in its reach and will offer both prescriptive solutions and philosophical perspectives on any organization's basis for its existence and development. Among oil companies, there is arguably relatively little variation in strategy and growth profiles, and the companies have a tendency to move in the same direction through cycles. They have done so for decades, and will continue to do so in decades to come. These unified behavioural tendencies are based on the industry's underlying characteristics.
OIL INDUSTRY DYNAMICS
The oil industry is both capital and tax intensive. Operations carry substantial risk, but also provide significant upsides. Governments throughout the world have different approaches to protecting people's entitlement to the value of the country's natural resources through taxation, production sharing agreements, license agreements, royalty systems, and other mechanisms for government take. Other critical functions of a meaningful fiscal regime are to facilitate for satisfactory activity through tax incentives, risk protection through depreciation and cash back solutions, and taxation of a significant share of the net cash flow.
Photo courtesy of DONG Energy
The combined effect of E&P risk, financing, and tax intensity is fundamental for any oil company's strategy. However, the way these components are perceived and managed through cycles, will vary. When oil prices are high, the focus tends to be on reaching first oil as soon as possible. Funding is easy, and risk is associated with operations and avoiding unplanned shut-downs. When oil prices are low, capital availability is more challenging. Risk is associated with corporate protection and efficient allocation of corporate resources.
Resource (as in all types of relevant resources - people, capital, competence, legitimacy, oil and gas prospects, resources and reserves, and more) dependency is a key strategy driver for any oil and gas company. Some oil and gas regimes provide lighter oil company models in which an oil company becomes merely an investor - an asset light model. However, most oil and gas capital is placed in asset-heavy companies.
STRATEGIC NAVIGATION IN TURBULENT ENVIRONMENTS
It is easy to argue that one cannot compare the general oil company strategy processes with the more funky, innovative, and cafeteria-based businesses that characterize the prototype entrepreneur profile of today. But, to a certain extent, this opinion is simply a result our own perception of what an oil company looks like. There are, however, some immediate characteristics that define an oil company, such as its capacity and knowledge to manage exploration and reservoir risk, its ability to plan and execute development projects, and its operational and marketing competence to commercialize the products.
Some companies are involved in everything from early exploration through to the end user of products. Others are more selective and are only involved in segments of the value chain - either exploration, development and production, late life production, transportation, refining, retail, or a combination of some of these.
In today's low-return environment, commercial flexibility is absolutely critical for any oil company strategy, and it is possible to be more dynamic and light-footed through selective value chain participation as opposed to the perception of the traditional oil company.
Do we need to be part of everything? Always? Can we be smarter in our resource allocation on a project-to-project basis? Can we rely on other value chain players to take over our non-strategic activities? Can we reduce our non-core participation? Do we need pipelines, platforms and retail positions in all countries and projects? Do we need to participate in the first well in a new basin, or could we buy in later? These are questions highly relevant to increasing commercial flexibility and strategic efficiency in these challenging times for the industry. Use the opportunities available to strengthen the strategy process for the longer term.
REALIZING THE COMMERCIAL OPTIONS AVAILABLE
An example of oil companies deciding to strengthen their focus on upstream development can be seen in the deals in Norway´s Gassled system where the sellers recognized that owning the pipelines is not critical to corporate success as long as capacity rights are secured.
Another example is Total's divestment of its positions in the FUKA & Sirge gas pipelines and the company's position in the St. Fergus Gas Terminal. One can argue that sellers will only increase their future tariff liabilities, but there is little doubt that companies are freeing up capital that can be allocated to higher return opportunities today, which provides more commercial flexibility.
In the US Gulf of Mexico, oil company LLOG and ArcLight Capital in December 2012 agreed to share responsibilities by ArcLight taking on investments for the midstream part of the Delta House operations, thus allowing LLOG to focus capital expenditures on its core competencies of exploration, production drilling, and upstream operations. This interaction between E&P and investment specialists has emerged in recent years as infrastructure capital is seeking investments in the E&P domain in addition to traditional infrastructure like water, sewage, roads, airports, and more.
We have also observed a tendency of infrastructure players to take more construction risk by moving from brownfield to greenfield, which further strengthens the commercial flexibility option and attraction for E&P companies. Still, E&P and infrastructure players are different as regards return expectations, so there is clear conceptual logic in working together. From time to time, we see seismic players providing data in exchange for corporate or oil license equity, enabling the counter-parties to continue development at low cost. The industry has seen examples of rig players developing models for E&P risk exposure in exchange for rig utilization and equivalent E&P upside potential.
Other models to improve industrial capital efficiency are consortium solutions that strengthen buying power and overall rig utilization in tight markets, and contractor consortiums facilitating project developments through increased contractor exposure towards first oil production resulting in higher risk and potentially higher reward for non-oilcos in otherwise tough markets. Recent trends demonstrate a closer collaboration between E&P companies and the supplier industry through alliances use of risk sharing contracts. The overall intent for the oil companies from these initiatives is to become strategically stronger through a more dynamic commercial involvement on a project-to-project basis, to increase financial flexibility, and to obtain a broader portfolio and properly focused organization.
EXPLORING THE OPPORTUNITY SPACE
Where there is a will, there is a way. For midcaps, large, and major oil companies, one project may only have an incremental impact on commercial flexibility. However, continuous increased awareness about the strategic criticality of particular value chain participation should continue to strengthening capital efficiency and commercial flexibility for the active oil and gas company's business development processes. There are certainly enough opportunities for collaboration out there - it is all about finding the right commercial model.
ABOUT THE AUTHORS
Thor Magnus Rovik ([email protected]) is managing partner of Rovik AG in Sandnes, Norway. He has 15 years of industry experience, including E&P management, investment and financial management, strategy and business development, international license portfolio management, and has an in-depth knowledge of funding and transaction processes. Rovik previously worked for Statoil and Rocksource.
Kenneth Fossøy is a partner with Rovik AG. He has 10 years of industry experience in oil service, gas infrastructure, and upstream. He also has significant experience from transactions on the NCS, as well as a background in commercial and financial management of an international portfolio of seismic new vessel build projects. Fossøy previously worked for Deloitte and Petroleum Geo-Services.
