It’s pretty simple: Radically innovate or die!
In our business, the levers are price, volume and expenses. Over the past 15 years, price has been very kind, rising to average $92/bbl in 2014. This year is a very different story, averaging $50 and recently dipping below $40. The past year has been like hitting your hand with a hammer—it hurts. Some 37 North American E&P companies have decided, or rather their banks have decided, that they need to quit hitting themselves with negative margins, and have filed for Chapter 11 bankruptcy.
Exxon Mobil recorded a $442-million net loss versus a $1.3-billion net income in the year-ago quarter. Even the world’s lowest-cost producers are hurting, with Saudi Arabia’s credit rating lowered, due to a deficit that will hit 16% of GDP. The Saudi Arabian Monetary Agency reported a drop in the Kingdom’s foreign holdings of $83 billion.
Chesapeake’s CEO stated, “Why would one maintain 10 MMbopd at $50, rather than cut 1 MMbopd and earn $80 on 9 MMbopd? I can do the math, and it doesn’t make sense.” But the oil continues to flow. IMF estimates that the Kingdom has fiscal reserves to survive for five years at $50. Can you wait them out?
How are companies addressing the new reality? Individual companies sell into the market and are unable to control the price. That leaves volumes and expenses. While producing more out of a specific zone may help wellbore economics, in aggregate, more volume continues to put downward pressure on price. When you are in negative territory, you can’t make up in volume what you lose in margins!
So, to a large extent, the response has been to hammer expenses. Ask anyone on the service/supply side, and they will surely tell you about the pain there is in cutting costs. Forbes recently quoted BP Chief Executive Bob Dudley as stating that the $60 level is a price point that the company is gearing up to face over the next three years. Whiting Petroleum Corporation CEO James Volker explained in a recent publication how his firm is “retooling to prosper with $50 oil.” His strategy is start first with a good liquidity basis, then divest non-core assets, cut expenses (headquarters and field), and then innovate with new technology. At this point, most executives realize that the pace of cost reductions is unsustainable, and they are now looking for the next big thing. What will it take to survive?
Radical innovation is what it will take! In our business, we are comfortable with evolution and continuous improvement, and have policies and procedures to support such activities, but not revolutionary ideas. We are good at incrementing small tweaks and twists to aggregate to an improved product or service. Industry players from the operating and service sectors have inventories, spare parts, procedures, technical authorities, and operational prefaces that drive multiple standards, even with the same corporations, organizational processes, and consensus-driven decision-making. If your balance sheet can wait for price recovery, carry on. If not, then something completely different should be examined.
One of the first steps is to consider who in your organization should be leading the effort to source radical improvement ideas/implementation, and ensure that their performance metrics are aligned with your objectives. It is unlikely that the same technical authorities that acted as gate-keepers, to ensure only risk-free technologies were embedded in new projects, will be the best champions for this new effort.
The person/small team leading this new effort will need support at the highest levels, and probably someone from outside the organization to support the effort. And yes, a budget. Not confusing innovation with R&D, it was still interesting to read in a recent publication that Saudi Aramco—arguably one of the lowest-cost producers with a half-dozen research centers, including one opened up late last year in Houston that focuses totally upstream—has increased its R&D funding five-fold.
With the right leader and a budget, where to start? Looking outside oil and gas, where technologies have been de-risked by use in other industry segments, can be a great start. The Offshore Technology Conference launched a new initiative this year to help leaders “connect the dots” at the highest levels. D-5, the Next Big Thing (http://2015.otcnet.org/d5), brought together world-class innovators from within, as well as outside, the industry to jump-start the creative process. A similar program will be held on May 6, 2016, in Houston at Rice University.
SPE’s R&D technical section highlighted, during the recent Annual Technical Conference and Exhibition, one such company that helps facilitate this process; the Oil and Gas Innovation Center. In Houston, the SPE Gulf Coast Section formed a study group that explores innovative companies and ideas. Rice Alliance for Technology Entrepreneurship is a center within Rice University that has identified and mentored more than 1,400 companies. It has assisted in launching more than 300+ new technology companies, which have raised more than $1.3 billion in early-stage funding. And there are many more. Understand that radical change is necessary to survive, and then happy hunting!
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