Building a world class organization in a volatile oil price environment

Part 2 – The ability to maintain a highly competitive performance rate will be a necessity for oil companies in the 21st century

John de Wardt, de Wardt and Co. Inc., Steamboat Springs, Colorado

rude oil prices have taken a violent ride on the commodity exchange roller coaster, plunging from the $20/bbl range to $10 and then rising again, up beyond $20. This volatility is unlikely to disappear, as traders play the perceptions of supply / demand imbalances. Aggressive oil companies are now planning their futures on being profitable at potentially low oil prices – as low as $11/bbl. This means that they will demand low finding and producing costs.

Business Needs

Oil companies will need to meet a string of demands, if they are to be competitive in an aggressive environment. These demands include predictable costs, lower costs than competitors, excellent results from operations, short cycle times and a reduction in unused overhead.

Predictable costs are a must for managing any business in a competitive environment. Unfortunately, oil companies have become accustomed to forgiving cost overruns, as a result of their experiencing rising oil prices, increased productivity or extended reserves that mask economics from poor performance. In an aggressive price environment, this will lead to poor financial performance through an inability to accurately allocate capital – eventually, this will not be tolerated.

An ability to keep costs lower than those of rival firms is an obvious "must" for being competitive in an environment where supply may outstrip demand. The global oil industry is unforgiving in any comparison between high- and low-cost producing areas, because it is a liquid market. Consequently, high-cost producing areas will have to compete with low-cost producers, on a per-barrel basis, if they are to remain in business.

Operational results will have to deliver on the promises made to business leaders, in order for companies to compete. These results include production from development wells and data from exploration wells. The industry will not tolerate low-productivity wells, producers lost to operational errors or exploratory well data that are inadequate for decision-making purposes.

Short cycle times are the norm in highly competitive firms. The more aggressive oil companies are chasing these, as they attempt to bring their production revenue onstream as early as possible. Technical innovations, such as FPSOs, have improved cycle times on many projects. In the future, every possible method will be brought to bear, to reduce these cycle times in order to remain competitive. These schemes will include technical innovations and organizational methods, such as parallel engineering, design-to-construct and other organizational principles.

Unused overhead is pure waste to a firm. Oil companies traditionally have built up complete in-house abilities to perform their business. Highly competitive companies, in contrast, have developed relationships with service providers, who perform many of the functions at a far lower cost and with greater focus on core competencies. Some oil companies have outsourced their accounting / invoicing functions to the major accounting firms as a first step. These appear to have yielded higher process efficiencies than before. However, there are cases where the internal organization of the oil company grew to micro-manage this outsourced process.

Oil companies need to get serious about what is relevant overhead and what is not. Small aggressive independents that pick up and profitably operate old fields from the majors are extremely lean. The majors that relinquished these fields were burdened by oppressive overheads. In the future, oil companies will need to carefully decide where their advantages lie among insourced and outsourced work. This will require careful review of core competencies available internally and externally as part of a broader process. There will be no room for additional overhead or slash-and-burn reductions that are not based on business modeling logic.

Performance Measurement

Measurements made in oil industry operations often are not aligned to the projects’ real business objectives. Most measurements relate to rates of penetration that contribute to business objectives but may not be aligned with them. For example, a faster cheaper hole that does not produce at a good rate is possibly an economic loss to the oil company.

Many companies compare current performance to past performance – this leads to a mediocre attitude toward improving performance and is often associated with the lowest performing companies. Some firms have moved into the realm of comparing customers’ perceptions of performance to their own internal perceptions. This introduces the external element of performance review but is often subjective. Subjective performance reviews are difficult to measure and, therefore, often ineffective.

Benchmarking – comparing your own performance to the best competitor – has been introduced to the oil industry through regional surveys. These are useful but often treated as incomparable, since the challenges in wells differ. They often are used in a process of justification of current performance but underutilized to determine ways to really improve.

Non-oil field companies benchmark themselves against any relevant firms on a process basis. Initially, companies cross-compared their invoice payment processes, but they have advanced to more operational aspects. For example, Ford discovered that they had 425 people doing the same work that 5 people did in Mazda (a company in which they had an ownership share). Ford streamlined its process to reduce the number of people to 125 – an astounding 70% improvement.

World-class companies differentiate themselves by becoming the benchmark against which competitors compare themselves. These companies usually avoid benchmarking for establishing performance, since they view this as a process that limits them to current best achievement. They determine the performance level that they think is ultimately possible and reach for it through organizational alignment to stretch goals. These goals are viewed as being possible to reach, but the solution for achieving them is not known at the time that they are established. These firms do use benchmarking of parts of their business, to learn how to improve those portions performing at a lower rate than best-in-class.

"Technical limit" is a term that has been used recently to determine the best-expected performance in drilling operations. It is a useful benchmarking tool, however, it can become a limiting factor (glass ceiling) for performance. This is because it does not look for ways to improve beyond the historic best. It is simply a method of compiling the best performance for each drilling activity and creating a theoretical, maximum well performance.

Inefficient industries tie up a large amount of capital in inventory. Highly successful companies are often those that multiply turnover rates, thus minimizing the time that inventory is idle, or simply link the supply chain in such a manner that inventory is no longer a requirement for high performance.

These philosophies can be developed in the upstream oil and gas industry to create huge economic advantages. To date, these opportunities have been toyed with, at best. Learning and exploitation is the next step toward significant improvements in capital efficiency.

Boundaries Make Things Worse

Boundaries that exist between different parts of an organization are a significant part of the problem. These limits have grown up in the functional organizations that matured during the 1960s and 1970s. Some companies have attempted to break these barriers to information flow and cooperation by creating matrix organizations and co-locating different departments. These steps have brought only a small improvement, thus frustrating senior managers, who can see the potential benefits of broader cooperation across their companies.

Significant opening of boundaries that have then yielded business performance benefits has been achieved in organizations that were willing to re-create their organizational architecture through a process that involved the organization’s constituents. These organizations have been able to create valuable solutions, for example, through direct interaction of subsurface engineers with directional drilling engineers without the filtering often experienced through the traditional drilling engineer’s role.

Breaking The Barriers

World class performance can be defined as "doubling the productivity and improving the quality of results by at least 25% and, in many cases, more." A review of 3,160 development wells worldwide showed drilling performance at 10,000 ft reaches a limit of two days per 1,000 ft of well depth, from spudding until the final TD has been secured. This can be considered as the upper technical limit of the traditional drilling process.

In very few operations, a performance of one day per 1,000 ft of hole has been achieved repeatedly, when new organizational methods such as Lean Drilling have been employed. This latter result demonstrates that the technical limit can be breached in the same ratio as world class companies exceed the best-in-class performance in other industries.

Likewise, in exploration drilling, repeated best-in-class performance has been achieved through application of Lean Drilling, leading to superior organizational alignment, proper use of project management techniques and adoption of more aggressive target performance. In deepwater drilling offshore Norway, the best-in-class across the entire North Sea has been achieved repeatedly at 2.5 days/1,000 ft of hole (spud to final depth) with different rigs, service firms and oil companies, compared to a typical historical performance of five days/1,000 feet.

Simultaneously, the data acquisition performance has been improved to deliver all required data with no downtime. Post-well reviews of this performance indicate that rates of approximately 1.8 days/1,000 ft are possible, when all lost time and inefficiencies are removed. A true world class performance for exploration wells offshore is estimated to be 1.5 days/1,000 ft, at 10,000 feet. However, one operator’s performance declined to second-quartile status on its third project, as employees attempted to drive the change process themselves.

It will be possible to achieve world class performance through a step change and continuous improvement (on a repeatable basis) that exceeds the current, calculated technical limit. As with similar changes in other industries, dissemination across the oil industry will take understanding, drive and commitment from key managers, and knowledge from an expert who knows how to make it happen.

Since these improved performance times have been achieved repeatedly, they can become the normal performance level for companies that are willing to make the investment and see the opportunities. This improved performance level can transform the well drilling industry into a highly competitive business that is able to make profits in a low oil price environment.

Building The Bigger Picture

Traditionally, companies have focused on drilling as a stand-alone entity. It is not. It is, in fact, part of an interdependent set of systems that, together, generate overall project cost, the earliest date of production and the throughput of hydrocarbons from the reservoir. Smarter firms will realize that it is the optimization of the whole hydrocarbon development that will generate the best business results, not the usual factious fighting of the different oil company departments. To achieve this goal, companies need to differentiate between different areas of expertise and their interdependencies. A model is shown in Fig. 1.

Fig. 1. In this diagram of lean drilling / lean hydrocarbon development, a company must optimize the entire process, to generate the best business results.

The Future

The drilling industry can achieve significant improvement in financial results by combining the structural changes described in the first article of this series with the drilling performance gains described in this article. The next step is to redesign the contract, to deliver and reward added value; this will be outlined in the third article. These changes will become a necessity for companies that wish to remain profitable in a low, volatile, oil price environment.

Currently, many companies view the future oil price remaining close to $20/bbl, with periods of price volatility. More aggressive oil companies have said that they wish to structure their companies to be profitable at $11/bbl. Profitability at this low price, outside the low-cost producing areas, will require significant changes in an industry that has been created in a much higher price environment that forgave noncompetitive performance.

The author

John de Wardt is president and founder of de Wardt and Co. Inc., an international management consulting firm providing services to the worldwide E&P industry. He is a mechanical engineering graduate of University of Newcastle in England, where he focused on business studies. Mr. de Wardt has more than 23 years of experience in engineering, contracts, senior management and management consulting. Previously, he worked for an international oil company, international drilling contractor and major service company. He has developed proprietary programs for transforming E&P organizations to lean enterprises capable of achieving world class performance and developing strategies using scenario planning.

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