Strategic Roadmaps

International, economic and operational uncertainties are swirling, affecting every business and industry. That makes strategic planning an inherently challenging task in the highly volatile oil and gas industry, particularly in the upstream sector. Volatility has reached record peaks, creating new risks—as well as significant opportunity for companies that can plan and allocate capital resources intelligently and nimbly.

How can upstream organizations optimize their resource allocation and fine-tune their insight in the year ahead? What are smart market players doing to improve their accuracy and agility?

These companies face challenges and uncertainty on several fronts that they can expect to continue into 2013. For example, capital and operational costs continue to rise at a notable pace, driven by:

• increased rig activity due to higher oil prices,
• tightening supply chains for specialized services and equipment,
• higher day rates for deepwater rigs,
• an escalating skilled-labor shortage,
• increased technical complexity, and
• a heightened focus on capital-intensive frontier developments, which is becoming the new normal.

The IHS Capital Cost Index increased 5.3% in 2011 and in the first quarter of 2012 as the costs of building and operating upstream oil and gas facilities reached near- record highs. The IHS Upstream Capital Cost Index, which is based on a year-2000 benchmark, increased 2.3% during the first three months of 2012. The new index score of 227 means capital costs totaling $1 billion in 2000 would now be $2.27 billion.

Even as their need for capital grows, E&Ps find access remains tight in the wake of the most recent financial crisis. Companies continue to face greater investor scrutiny around capital planning as well as spend and return. This is the new financial reality.

Company executives need to be able to integrate financial management and project management data and functions, as well as reserve analysis, portfolio planning and financial planning functions.

Furthermore, the market expects to see high levels of volatility with continued economic uncertainty in Europe and what appears to be slowing growth in China, all of which can impact world energy demand and prices. The natural gas glut in North America and beyond is also expected to persist.

Time for a new approach

The confluence of these events—rising capital and operational costs, falling energy prices in some sectors and continued volatility—leaves many company executives struggling to make intelligent choices about the direction they should take and the best way to allocate capital.

Upstream operators often find themselves stuck in the status quo, even when they need to change direction and adjust capital allocation. Research strongly indicates that informed change can boost return and shareholder value.

A study referenced in the March 2012 McKin sey Quarterly shows that companies that reallocated more resources—in this case the top one-third of performers in the “How to Put Your Money Where Your Strategy Is” study (which shifted an average of 56% of capital across business units over a 15-year period)—earned, on average, 30% higher total returns to shareholders annually than companies in the bottom one-third of the sample. This was consistent across all the sectors of the economy.

Four keys for 2013 and beyond

It is increasingly clear that the status quo is no longer sustainable in the upstream sector. There are four new paradigms for successful planning for 2013 and beyond:

Optimize value across producing and facility portfolios. Traditionally, upstream operators have managed their production portfolio and corresponding infrastructure projects separately, which puts them at a great disadvantage because they cannot readily understand the relationships between these two critical cost centers. Integrating the management of well and infrastructure portfolios will provide unprecedented visibility that enables operators to optimize capital allocation, capitalize on synergies and increase value, while better managing risk.

Incorporate risk management and variability into the plan. Today’s producers also need the ability to incorporate risk and variability into their plans and to rapidly iterate on those plans. To optimize return on capital and shareholder value, they must understand how the volatility in the drivers, such as capital costs and commodity pricing, will impact the range of projected outcomes. Producers also know they can no longer simply set a plan and execute against it. Instead, with volatility rising, they require the ability to quickly model various scenarios and make adjustments to optimize return.

Silos must go to make way for integrated planning. A siloed approach to planning, long the de facto standard, precludes upstream operations from identifying interdependencies between portfolios. Working to balance conflicting stakeholder objectives, many upstream operations fell into compartmentalized planning practices, often completing separate exercises for regional and line of business planning.

This practice has led to a situation in which buckets of capital are allocated and optimized for a specific project or region—but, with little consideration of the impact of capital across the enterprise as a whole. As a result, companies cannot answer the critical planning question: “Am I spending each dollar in the best place for my organization?”

The answer is essential to optimizing return and value in today’s volatile market. To optimize capital allocation enterprisewide, organizations must first address their silo issues.

Gain agility in managing to capital constraints. Many organizations have limited ability to assess the sources and costs of capital as part of the decision on how and where to deploy the capital. If decision making is managed as independent processes in independent systems for access and allocation, problems can arise. In today’s environment, it is essential that producers understand variability around the cost of their capital, which may make a difference in terms of how and where it is deployed to optimize return.

How do we get there?

Modern planning solutions are the foundation for a successful strategic planning initiative. This should mean that company executives can integrate financial management and project management data and functions. Likewise, they should be able to integrate reserve analysis, portfolio planning and financial planning functions.

Here is a checklist for a holistic planning environment that will support the new industry paradigms. Does your current or planned environment enable you to perform these functions?

• Model various scenarios in reserves and pricing, rapidly and iteratively.
• Select capital portfolio by prioritizing investments and eliminating non-strategic and redundant investments across production and infrastructure investments.
• Analyze scenarios against corporate objectives for reserve growth, production and lifting costs.
• Determine optimal production and financial measures.
• Perform variability analysis and respond to changes.
• Integrate the optimized plan into the strategic financial plan.
• Perform model, scenario and risk analysis at every stage of the process.

Technology is an enabling tool. Used alone, it does not provide the complete answer to complex planning challenges. To go beyond that, to optimize capital and resource allocation, organizations must also be open to change, breaking free from established habits and traditions. Sophisticated modeling and planning tools can help facilitate this cultural change by delivering new levels of data visibility, accuracy and flexibility. Analyzing the data helps to instill confidence in taking a new path forward.

The ability to plan and optimize capital allocation can have a measurable impact on shareholder value and profitability. The status quo in the upstream sector will be increasingly difficult to sustain as costs escalate and energy prices remain volatile.

To prepare for these challenges, companies must embrace change in order to continue to optimize return on capital investment. Just as important, they need to put in place the right tools to incorporate variability and risk into their planning processes. In this way, they will find themselves able to efficiently manage across portfolios.

Charles P. Karren is director of energy industry strategy for Oracle and Judy Hamlin is industry principal, energy and resources. See oracle.com/us/industries/industry-scorecard-1683398.html for more information.