Managing Decline with a Swiss Army Knife, not a Machete
In case you have not noticed, it is campaign season. Hyperbole is flying high these days. Donald Trump stumps with statements that the US is going to hell in a hand basket because of bad deals being made. The other side is railing on the 1% destroying the country. Politics aside (certainly don’t want to go there), many folks do agree with this view and you cannot blame them, especially if they not only have seen few real income increases over the last decade but even more so if they just lost their fairly secure job in bell-weather industries, such as oil and gas.
A number of sectors are currently in a declining or at least restructuring phase (see coal industry). Case and point also: petrochemical. With the Paris climate accords, China coming down to below 7% annual growth, stagnating European markets, the Brazilian economy in free fall, Saudi Arabia pumping profitable at below $20 cost/bbl and Iranian oil coming online, executives are scratching their heads if they should set themselves up for a controlled shut(slow)down or pure panic moves. A panic move like divesting leases with multiple bores or even completions, which could produce within a quarter when the markets turn positive, cutting 30% of the workforce or selling the OpCos outright may be detrimental to long term company health.
Last week, I asked my Uber driver in Houston if he felt the contracting oil and gas industry in his pockets. His answer was, “Absolutely!” “Of course, you feel twenty or thirty thousand folks being layed off across the region”, he added.
So what does history teach us about a controlled decrease in business operations? Are the first movers getting exponentially punished? Are the ones cutting the deepest keeping their executive staff and ensure an above industry-average valuation? Are the ones looking for equity over debt getting the short end of the stick? How about firms, which are using their data more wisely before ridding themselves of assets?
The Baby with the Bath Water?
Well, the picture is mixed if you ask me, as it often depends on the organization’s financial and operational structure, (in)ability forecast long term demand as well as execution. Sensibly leveraged firms with a decent, predictable recurring cash flow from operations and fairly organic growth via sensible new product development (or E&P activity in O&G terminology) are likely to remain the darlings of the markets. Once firms spend 60%+ of their cash servicing debt, the vultures start to circle above. So if you were one of the large operators taking on debt right before or at the very beginning of the dip and most of your assets are in fairly un(der)developed reservoirs, e.g. Permian basin, you should be in a more enviable position for the rebound.
The Financial Times reported last week (4/13/16) that Marathon Oil sold $1B in assets, getting a 9% bump in stock valuation on the day the price per barrel went over $50, while many analysts were already forecasting a production freeze. Was this too much, too late?
Divestiture of un- or underdeveloped reservoirs with high (often complex horizontal) exploration and transportation cost may be an avenue to explore at this point. However, it may be prudent to cap and keep wells, especially in patches with a high degree of completion and extensive survey data and stash them for the day the price moves beyond $60. Maybe it would be advantageous to first look at renegotiating service contracts, joint venture cost/revenue allocations and resource actions in the affected projects and even back office support staff.
But hold on! Why do all this scenario planning and horse trading before you have even taken all the “virtual fat” out of your current physical operations? Where are your competitive strengths located, how are your data assets or vice versa?
If you lose your job, you don’t immediately sell your car, your house, your TV or take the kid’s out of private school. You gradually degrade the products and services associated with these fixed assets down to the point of when it becomes noticeable, meaning painful. First, you move to a basic cable package, get rid of the HD DVR receiver in the house, start pumping 87 octane gas, delay the next school uniform upgrade, new car purchase and upcoming oil change by a month. You start taking 10 minute showers, eating out less and cancel the gym membership.
What is Thy Purpose?
If these are fair assumptions, why not look at the existing “virtual assets” first. This means your applications and their data. Do you need to upgrade to the newest version of Petrel or your analytics app? Conversely, what can you upgrade with the data these applications already generate(ed)? Can you move some applications into the cloud, particularly those, which are highly commoditized like payroll, expense and benefits management, accounting, CRM and potentially even some more business-specific ones around work order management? Can you string together seismic, geophysical , GIS, drilling and production accounting data around a central concept to allow for more appropriate cost reduction strategies at the enterprise level? Such a concept is typically the core asset, i.e. the well.
But what is a well? Is it the surface location, is it the well set, is it the bore and if so, which one? Is it the completion? Once you figured this out, tying standardized attributes from multiple systems together for a 50-150 attribute-wide well profile, will suddenly allow operations and finance heads to see, which service partners, reservoirs, drill strategies and wells can actually be run productively at certain price levels. Diversification into new business areas, e.g. logistics, consulting, data management services, and aiming for marginal gains in key operations instead of hunting the elusive white elephant project, may serve operators well.
On top of this, this cleaner view ensures regulatory fines and insurance premium overpayments can be quickly identified and eliminated. While these were considered cost-of-doing-business and “noise” during good times, they certainly deserve a second look in today’s economic environment.
Ultimately, the viability and success of this strategy versus the classic cost-cutting measures will only be visible when things rebound. But beware; analysts, consultants and research across industries has proven that deep staff cuts, (re)hiring cheaper staff and divesting out of competitively differentiating assets (Peabody chapter 11) will not allow for a quick recovery. Leading companies expect downturns, prepare for them and use existing (virtual) assets as a weapon, not just a balance sheet item and in case of data, just overhead. They use increasingly different tools to make surgical changes to address problems.
I would love it if you could share with me any research or personal experiences you have on how certain companies or industries deal with downturns.