Beating volatility in exploration and production
July 26, 2019
RESEARCH REPORT
In brief
In brief
- Exploration and production players in Oil & Gas must deliver better investor returns while retaining asset optionality and agility.
- The sector’s current portfolio management approaches—generating returns of 2-3 percent—aren’t up to the task.
- A balanced approach that considers the potential returns, risks and volatility of each asset can boost both ROIC and competitive agility.
- Dynamic portfolio management—through advanced analytics and frictionless transfer of assets—sets E&P companies apart with veracity and velocity.
It’s a challenging time for exploration and production (E&P) operators in the oil and gas industry. Crude supplies are plentiful. But demand growth is uncertain. Oil prices are low and volatile. And shareholder returns have taken a hit.
Understandably, investors have grown skittish. They’re turning their backs on long-cycle assets that once delivered accretive returns―demanding greater exposure to assets with lower risks, more predictable returns and limited downside potential. In response, E&P companies have shifted more of their portfolios to short-cycle holdings. But, as many of them are now learning, this strategy has significant limitations.
E&P companies’ return on invested capital is now hovering at about 2-3% with no improvement in sight.
Short-term solutions don’t solve long-term problems
Returns on short-cycle investments usually start flowing in a matter of months. But payback times for deepwater projects are decreasing, thereby chipping away at unconventional assets’ advantage. Additionally, new shale acreage is hard to find and costs associated with developing short-cycle assets are quite high.
The bottom line? While diversifying portfolio holdings to include more short-cycle assets made sense from a risk-mitigation perspective, it hasn’t had much effect on the industry’s US$500 billion in annual capex spending. This puts E&P companies in a bind. If they don’t get their portfolios in order and generate better returns over time, investors will not be inclined to make the investments the industry needs to maintain operations over the next 25 years.
The case for veracity + velocity
E&P companies need asset portfolios that enable the production of energy from the best asset class in a given moment. These portfolios must be highly flexible, since retaining asset optionality will be critical as these companies navigate the ongoing disruption in the industry. Moving forward, the best asset management approaches will be characterized by two things:
- Discipline: A more balanced approach to portfolio management—akin to approaches used by bank’s wealth managers—will enable E&P companies to consider not only the potential returns, but also the risks and volatility of each asset in their portfolio. The Sharpe ratio, which calculates an asset’s returns in light of the risks that accompany them, can introduce order and rigor into a process that has long been ruled by instinct and gut feelings. Importantly, advanced analytics can help E&P companies measure risks and rewards associated not only with finding new oil, but with developing the oil they have found.
- Speed: Digital technologies and cloud computing make it possible for E&P companies to evaluate multiple data sets, from multiple teams, simultaneously. With this capability, linear decision making by a few engineers and geologists gives way to fluid, real-time strategy discussions that involve multiple stakeholders. Accelerated decision making makes near-real-time and frictionless asset moves possible.
This combination of veracity and velocity enables E&P companies to shape a dynamic portfolio management strategy that not only boosts ROIC, but also retains the optionality and agility needed to jump in as opportunities arise.
Regaining balance
A combination of veracity and velocity enables E&P companies to shape a dynamic portfolio management strategy that not only boosts ROIC, but also retains the optionality and agility the ongoing disruption in the industry calls for. Winning companies will:
Bring balance to portfolio decisions
Forward-thinking E&P companies will extend their risk/return analyses to development and production. This means adopting a new mindset, a data-driven asset allocation strategy and a risk/reward culture that covers the entire E&P lifecycle.
Supercharge the analytical underpinnings
Pulling the right risk/reward levers across exploration, development and production will require new analytical capabilities—along with intuition and creative thinking.
Analyze and act in real time
Winning E&P companies will monitor the economic impact of their decisions, rapidly reallocating capital, making nimble portfolio decisions and re-prioritizing technology investments as needed.
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