Big Oil’s Great Migration: Survivability to Sustainability
April 29, 2022
April 29, 2022
The term “Big Oil” was initially coined to represent the seven supermajors and the economic power they wielded. Soon it became synonymous with the broader oil industry. Big Oil impact on the global economy, national security, politics and society at large was hard to ignore. That’s still the case. However, over the past decade, the industry has confronted complex challenges and existential threats that called its fundamental role in our daily lives into question.
The recent pandemic-induced demand shock, followed by a supply shock during the faster-than-expected economic recovery have given energy transition proponents a strong argument for companies to re-think their survival strategies. Old ways of working no longer apply. This is evident in the industry’s general inability to respond quickly to changing market dynamics. Case in point: The industry’s average operating expense grew at a CAGR of 1% as oil prices plummeted by 7% over the last 10 years.1 Today’s commodity price spike will only exacerbate the cost challenge moving forward.
We estimate that there is between $500 billion and $1 trillion in trapped value from inefficiencies in the oil and gas industry. Until recently, the industry adhered to a “cost-plus” mindset driven by the cost of the marginal barrel of oil. Efforts to manage the cyclical nature of the industry have typically involved countless ad-hoc cost take-out programs. It’s no surprise that such kneejerk reactions to market forces were unsustainable. Costs inevitably grow back as fast as they were taken out. And that spelled big trouble for many industry players. The number of Chapter 11 bankruptcy filings for exploration and production (E&P) companies came down from 70 in 2016 to 24 in 2017; but they rose to 46 during the most recent crisis in 2020.2
In nature, many species exhibit the same behavior to endure feast and famine cycles. That is, they make hay while the sun shines and turn to hibernation when winter removes their sources of food. Fortunately, nature offers other examples for an industry looking to move from survival mode in times of feast and famine to a sustainable existence, regardless of external (and economic) circumstances. Every year millions of Arctic Terns set out on an epic journey to secure food and bask in warmer weather. They push the limits of endurance to migrate from pole to pole. They start their migration when the seasons begin to change. That way, they always live where it's summer.
While a number of mechanisms come into play to enable this journey, three stand out:
1. The ability to migrate: The Arctic Terns are made for migration. Every year, they travel from the Arctic Circle to the Antarctic Circle—a round-trip of about 30,000 kilometers (18,641 miles). Their migration is one of the longest of any animal on Earth. They eat and sleep “on the wing.” Their bodies are large enough to carry adequate energy reserves to get them through their long trek, but not so big as to overtax their systems during flight.
2. The ability to adapt their plans in mid-flight: The Arctic Terns use a variety of cues—such as the magnetic field of the earth, changing concentrations of minerals in the ocean water, or polarized light—to find their way. They adapt the route and timing based on these factors, and they use the collective's aggregated information (or “swarm intelligence”) to decide the best way forward. They may fly thousands of miles out of their way to take advantage of the best weather and get the best food. They can bounce around every continent instead of flying in a straight line to the poles.
3. The ability to sustain the journey—and their very existence—year after year: The Arctic Terns’ lightweight body structure allows them to use the ocean breeze to carry them long distances, without having to expend a lot of energy flapping their wings. Sustaining the species is a matter of working smarter, not harder.
Big Oil can pick up a thing or two from the birds that defy all odds to keep their species alive. But will they? With oil prices skyrocketing to $100 and beyond, it will be easy to forget the lessons they’ve learned over the last two years. But they must remember. Now is the time that they, like the Arctic Tern, move from immediate survival to long-term survivability.
How? The energy industry must shift its mindset from cost resilience to margin management. This will empower organizations to adapt to fast-changing commodity cycles and make better, sustainable portfolio decisions. Shifting focus from production to profitability requires a carefully calibrated three-phase approach.
1. Build cost-resilience: In the new world, cost management is not just about managing the cost base through a crisis, but about ensuring its resilience going forward. Oil and gas operators have traditionally shied away from pushing the boundaries on optimizing fixed cost elements. Similarly, they are less likely to keep pressure on non-working money in good times, since these actions risk undermining opportunities to maximize production. With the competitive advantage shifting to those that can thrive in a variable economic environment, this must change. Like the Arctic Terns, oil and gas companies must cut the fat by identifying and re-allocating non-working money so they can withstand headwinds. They must build agility and variabilize their cost structures in the right places to enable quicker financial reactions to changing conditions. And they must build up their muscle memory and “swarm intelligence” to allow them to respond quickly and as a cohesive unit.
2. Build short-term optimization capabilities: For an industry whose fortunes are linked to the price of the commodity, there have been 30 instances in the last 21 years in which oil prices fell by 10% month on month—including seven instances of a more than 20% drop.3 This type of fluctuation calls for quick and surgical responses. Unfortunately, such responses are in short supply. The reason is that large organizations tend to make big decisions infrequently. This stymies their ability to respond to market conditions in the most efficient and effective manner.
Margin optimization is not a new concept. But optimizing margins can be an enormously complex endeavor, given the number of factors that oil and gas leaders need to consider (e.g., market forecasts, long-term reservoir performance, maintenance plans, secondary and tertiary recovery impacts, staffing consequences, etc.). These considerations slow the typical decision cycle, which involves collating information, analyzing and synthesizing data, and generating insights. That’s why, for example, a steam-assisted gravity drainage (SAGD) operator may only evaluate which wells to operate on a quarterly basis or even less frequently.
Operators must emulate the Arctic Terns and adapt to changing conditions more often. Given the rich data and system integration that is possible now, operators can have a single source of trusted data and a semi-closed process to make decisions daily, if needed. As with swarm intelligence, operators should have the agility to adapt their operational strategy on the fly and maximize their margins. This is not just about deciding which wells to operate or shut down. This is about determining where to choke back, which wells to prioritize, and how to manage the impact of such actions on chemicals, energy and even maintenance plans. It stretches beyond operational costs and into capital expenditures. Being able to dynamically change capital allocation decisions and continuously rebalance at speed ensures that they’ll be seizing the most advantageous opportunities.
3. Build the right structure: Thinking longer term, it’s worth recognizing that the Arctic Tern did not become the long-distance champion overnight. Evolution had to follow its course. Oil and gas operators must also evolve. But they can accelerate the changes to their own portfolio to build even greater resilience more quickly.
Every operator ideally wants assets that operate below the marginal barrel in any environment. Keeping a keen eye on costs, through the good and the bad, is critical to developing more and more assets in this camp. For those assets that remain around the marginal barrel, the ability to flex costs quickly is key. In this scenario, even as production drops, profitability is maintained. But operators must look beyond the here and now. They also need a firm understanding of an asset’s future potential—and future costs that may be incurred by, for example, changing environmental liabilities. In addition, operators should look to maximize their assets’ returns and diversify their revenue streams. One way to do this is by not just relying on hydrocarbons, but also looking for other innovative opportunities, such as leasing out land to solar farms, selling data, or subleasing or sharing infrastructure.
The transition from survivability to sustainability is not easy to execute. It requires the whole organization to think and act differently and maintain this change through good times and bad. Operators may start big or small, but what is important is that they start. After all, one thing is certain: winter will come again!
Special thanks to Varun Unnikrishnan and Vishvesh Bhardjwaj for their contributions to this blog.
Disclaimer: The views and opinions expressed in this document are meant to stimulate thought and discussion. As each business has unique requirements and objectives, these ideas should not be viewed as professional advice with respect to the business.
1 Accenture analysis
2 Haynes Boone Oil Patch Bankruptcy Monitor 2022