The oil and gas industry is a cyclical business. For every top there is a bottom—it’s the length and depth of the bottom that keeps us up at night.
At the lowest points of the cycle, industry veterans often spend time comparing current challenges with those of past downturns in an effort to avoid mistakes and find a road map for survival—or, better yet, position themselves for when markets turn upward. This thinking is referred to as normalcy bias, a mental state people enter into when facing a disaster. Unfortunately, it causes people to underestimate both the potential for disaster as well as the extent of damage should one occur.
The current recession is a reminder of just how vital high-performing teams are to an organization’s long-term success and sustainability. After all, people’s value-added contributions are what help companies avoid or mitigate unforeseen negatives, overcome obstacles and solve the problems faced in today’s trying times.
The hurdles posed today are as daunting as at any previous time. Many observers believe this is or will prove to be the worst energy downturn to date. Those who have been in the industry for more than three decades, as we have, benefit from having lived through the major downturns of the mid-1980s, 2008-2009 and, of course, the current slump. Each cycle has unique characteristics but all require that individuals stay focused, both challenging the status quo and preparing for the eventual upturn.
Lessons from ’86-’87
In the mid-1980s, the industry had large E&P operators like Mobil, Texaco, Unocal, Amoco, Arco, Kerr-McGee, Diamond Shamrock, Santa Fe Energy, Oryx Energy and others. Conoco and Phillips were not yet combined. When the price shock of falling crude prices overwhelmed the industry in 1986, the response was the largest personnel cutback in its history. Companies lopped off large portions of their organizations. Some estimate the total jobs lost at between 1 million and 1.2 million. When compared to current cutbacks, this seems like a staggering number of layoffs, but there were more than 400 oil and gas companies of size back then. Today, due to consolidation and bankruptcies, there are fewer than half that number, and current downsizing is easily as devastating, if not worse, on a relative basis.
After the drastic reduction in personnel in the 1980s, activity—from exploration to drilling to completions—was frozen for a prolonged period of time. High-level executive searches that had been pledged to firms a year in advance were cancelled. What people had no way of knowing, however, was that the choices they were making based on the data in front of them at the time, e.g., low crude oil prices, would create a hangover lasting 30 years.
Reducing head count became the standard playbook in the oil and gas industry, because it is the quickest way to address bloated cost structures. But many senior level engineers, geologists, corporate and field personnel left the industry never to return. Years later, energy companies are still playing catch-up to fill the gap in the workforce created by sweeping layoffs and the lack of talent coming out of universities from 1987 until 2010.
For perspective, in 1984, 32 universities offered petroleum engineering degrees. But when oil fell to $10 in the late 1980s, energy curriculum enrollment dried up. As late as 2008, only 17 universities offered degrees in petroleum engineering, and the total number of undergraduate degrees conferred that year was only 600.
What this means for recruitment at the executive, board and senior levels is that companies need to be cognizant that upper-level professionals in their mid-30s to age 50 have never seen a downturn as severe as this one. Finding employees with the appropriate experience and/or strategic mindset is difficult. While technology and consolidation have helped to alleviate the gap in knowledge and experience, the gap remains, and it makes knowing how to identify and recruit talent that much more critical.
Lessons from ’08-’09
Unlike the mid-1980s cycles, the 2008-2009 energy recovery was V-shaped. Companies were stunned by the sudden drop in oil and gas prices caused by the global economic slowdown, but they recovered relatively quickly. As the saying goes, the harder the fall, the stronger the bounce. The industry paused for about six months to get its bearings, but the downturn wasn’t long enough to warrant big cuts in personnel.
We learned a lot from the “Great Recession” downturn. Oil and gas companies, if structured correctly, were nimble. Crude prices improved by 2009, but natural gas prices never rebounded, forcing natural gas-weighted companies to seek oil and liquids exposure in older, developed basins or emerging tight oil plays. Leadership teams took the strategic steps needed to achieve their organizations’ growth targets and, as a result, were able to capitalize on the upturn.
This one is different
Today’s industry contraction has distinct differences from the downcycles of the past. Perhaps most apparent are companies’ debt- burdened balance sheets and the first wave of bankruptcies. More than 40 companies filed for Chapter 11 bankruptcy in 2015, according to EnerCom Analytics. Their combined debt is $17.85 billion, approximately 50% secured, 50% unsecured. Additionally, even though there were more large companies operating in the mid-1980s than now, there is a new phenomenon to deal with this time around—private equity and alternative investment firms.
What this means for entrepreneurs and others is that there are still many companies in the sector, albeit with a different business model, looking for high-quality talent. Estimates are that more than $100 billion is on the sidelines waiting to fund new management teams. Private equity funds are seeking highly experienced managers who can build successful organizations and create value, often quickly. They want teams who can manage a balance sheet, identify and acquire core acreage in premier oil and gas plays and, more importantly, rapidly challenge the status quo to find innovative ways to create stakeholder value.
Hiring for tomorrow
Supply and demand responses are inevitable, although the timing is not easy to forecast. In this cycle, the seeds of a commodity price recovery were planted more than 16 months after OPEC refrained from curtailing production quotas on Thanksgiving Day 2014. This February, Saudi Arabia, Venezuela, Qatar and Russia began pushing OPEC nations to keep production flat in an effort to persuade Iraq and Iran to follow suit. The recovery may not come as quickly as the industry might hope, and the agreement may not hold, but eventually, global demand will overtake supply. Robert Dudley, BP’s CEO, may have said it best: “Lower for longer but not forever.”
Today’s market only has room for excellence. From the boardroom to the C-suite to corporate and field offices, excellence is what drives today’s top performers. A look inside some of the industry’s most successful companies reveals technical and procedural superiority in all areas of the business. These companies do not operate in silos. For example, a lower-level financial analyst has direct access to field and operations personnel, meaning data and information are shared between divisions. The leaders of these organizations foster this type of environment.
The top-quartile companies can generate more than $1.50 of cash flow for every dollar invested. This form of total corporate excellence, where financial strategies are intertwined with operations so that growth is calculated and not just pursued at any price, provides a blueprint for the industry’s future. Declines in the commodity price deck demand that companies adapt to the market or risk extinction, like the dinosaurs that are the source of the oil and gas produced today. Those that remain profitable did not overleverage their balance sheets when times were good. Some are electing to pay down debt even though they don’t need to, freeing up additional lending capacity for when the industry turns around.
Now is the time for introspection. Using a top-down approach, directors should look at each individual to decide whether their board is made up of the right people, with the necessary skill sets and expertise. Balance and experience are crucial, as boards need seasoned technical talent, skillful financial experts, knowledgeable industry executives—and the unique perspectives of a few authorities from outside the industry to help the organization thrive. Companies that can develop and leverage the combined, diverse experiences of the board will more effectively and efficiently develop assets and outperform their peers.
Once an analysis and proper moves have been made at the board level, the board of directors should look inside the organization to analyze its current strategy and assess whether the right people are in the right positions. Tough questions should be asked of the CEO and his or her executive team. The go-ahead approach is to have integrated financial and operational processes leading to sustainability, scalability and, importantly, profitability through the cycles. When about 30% of the industry’s 2016 production is hedged at $67/bbl and $3.65/Mcf, thinking strategically about the team is the right course of action.
Survival and preparation for the future are parallel themes in this downturn. Tough choices need to be thought through and acted upon quickly. The desired outcome for any company is to retain sufficient core talent to build on when the turn comes.
There are no simple answers or silver bullets, but leadership teams should consider the following factors:
Layoffs. If deemed necessary, these should be strategic rather than tactical. A company should know the desired or optimal composition of its workforce and, if it has been diligent in managing the workforce, “who should go” should be readily identifiable. Those targeted for a layoff should not put at risk the company’s ability to achieve its long-term goals. The exiting employees should be treated with dignity and respect, as their departure is likely not their fault, and the company’s reputation is important. Additionally, remaining employees will take notice and react to the way others are treated.
A last point on layoffs: Follow the adage, “more is better.” Do reductions all at once rather than multiple times, even if it means cutting too much. Keep in mind that the remaining employees are impacted as well, and if they think another axe will fall, their productivity and loyalty will be affected. Also consider outsourcing functionality through a severance package that helps fund a start-up business. Then buy back the services as needed. When things turn, these people will most likely return and be in step with the company’s activities.
Compensation. This is the most fundamental and sacred aspect of the employment relationship. Any changes in the design need thorough consideration prior to implementation. Be careful when considering reductions, especially base pay. Remember, base pay is what many employees live on from check to check. They are more likely to understand a reduction in bonus amounts during these times. If you decide to cut the short-term bonus, and it is possible to offer a greater equity component as an offset, then do so. This can have a positive, bonding effect, as it says, “We will all be better off after it turns.”
Communication. This is imperative to surviving downturns. You cannot over-communicate. Leaders must treat employees as adults and let them know what is going on and why. If you do not, the rumor mill will take over. It is important for the remaining employees to understand events and not be left looking over their shoulders. Leaders must communicate a consistent view of the goals, strategies, plans and objectives so that all are pulling in the same direction. Employees know times are tough, but if they believe “we are in it together,” it is amazing what can be achieved. Tough decisions made by good leadership with the right vision and emotional quotient will help the company reach the end of the rainbow.
David Preng (713-266-2600) is founder and president of Preng & Associates, a global executive search firm dedicated to the energy industry and based in Houston. Celebrating its 36th anniversary this year, the company has assisted nearly 700 management teams and boards.