1. Introduction
Cutting cost has become a priority for many oil companies in recent years. The discussion covers the reason why oil companies are cutting cost and the means that management in oil companies are employing to cut cost.
2. Why oil companies are cutting cost?
Oil companies are cutting cost in response to the radical drop in oil prices in the last two years. From 2011 to 2013, the price of crude oil was above $100 per barrel. In 2014, prices dropped to below $100 per barrel but above $90 per barrel. By 2015, crude oil price fell to $49.49 per barrel. Average crude oil price for 2016 was $39.69 per barrel. (“Average Annual OPEC Crude Oil Prices”)
Supply of crude oil in excess of demand is the dominant explanation for the radical decrease in oil price in 2015 and 2016 (Addison 7). Shale oil production contributed to the increase in oil supply in the past years. Shale oil extraction peaked in 2013 to 2014. Increased levels of shale oil production allowed the United States to lessen its importation and engage in the exportation of oil. Oil producers in OPEC countries decided to increase oil production in order to compete with the United States. As a result, the supply of oil in the global market increased further. OPEC meetings failed to result to an agreement over controls in oil production. More intense competition among oil suppliers to the global market, especially the Asian market, drove oil prices down. Sudden increase in oil supply without any corresponding increase in demand resulted to the radical decrease in oil price. (Sebastian) Oil prices may shift further down or slowly increase depending on the impact of political and economic factors on the global supply of and demand for oil (Addison 8).
Drop in oil prices due to supply exceeding demand meant decline in revenue and profit for all oil companies. Intense competition limited revenue generation. Cutting cost was the way to increase and sustain profit.
3. What management in oil companies are doing to cut cost?
Management in oil companies are implementing similar measures to cut cost. Cutting cost cannot address the challenge of low oil prices on its own. It is also not sustainable, with only 10 percent of cost cutting programs causing long-term results (Agrawal et al.). Cost cutting has to form part of an integrated or comprehensive strategy that addresses short and long-term strategic goals even with limited resources (Duey).
An initial measure commonly adopted by oil companies to cut cost is outright reduction in labor and capital expenditures. Cutting labor expenditures involves letting go of personnel. Cutting capital expenditures means cancellation and/or postponement of purchases of land, buildings or equipment. Oil companies expect to cut around 10 to 15 percent of total cost through the reduction in labor and capital expenditures (Donati). In the case of British Petroleum, the company reduced its workforce by 10 percent and contractors by 42 percent in order to decrease total cost by $3 billion in 2015. A further decrease in capital expenditures by 25 percent should result to a reduction in total cost by $6 billion in 2017. (Addison 7)
Cutting labor and capital expenditures may reduce cost and increase profit. It also creates complications for oil companies by increasing risks. Risks involve costs. For example, oil companies in the North Sea that are facing aging assets and environmental challenges have reported declines in operational efficiency. Cutting labor and capital expenditures affected personal and plant safety. Cost-cutting measures implemented in 2014, when oil prices were still above $90 per barrel, resulted to an increase in maintenance backlogs for safety-critical equipment to 4,000 man-hours per installation in 2014 from 1,000 man-hours per installation in 2009 and backlogs for corrective maintenance to 2,500 man-hours per installation in 2014 from 500 man-hours per installation in 2009. (Murray) Further decreases in labor and capital spending, when oil prices range from $30 to $40/barrel, would exponentially increase the equipment and corrective maintenance backlogs. Backlogs mean operational inefficiency and higher safety risks that translate into costs. Cutting costs could backfire and cause more spending if this measure causes or worsens operational inefficiency and heightens safety risks.
In addition to cutting labor and capital expenditures, the management of oil companies also needed to adopt measures for operational efficiency and risk management. Operational excellence involves the management of risk in relation to productivity and efficiency. Achieving operational excellence can result to 29 percent increase in productivity, $30 billion savings over five years, 43 percent decrease in cost, and 43 percent decrease in safety events (Murray).
Standardization, industrialization and collaboration are interconnected strategies for achieving operational excellence. Standardization and industrialization usher cost savings by allowing better access to information, techniques and tools. Collaboration ensures continuous innovation even with reduction in expenditures. (Donati) Collaboration involves partnerships among different oil companies or between oil companies and firms in the services sector. Collaboration may range from bundled services to integrated services that allow oil companies to acquire the expertise and skills they lost during cost cutting and technological tools at lower cost and shared risk. (Addison 9) For example, engineered oil wells that result from collaboration can increase productivity by 36 percent to 82 percent. Another example is SBM Offshore’s engagement in collaborative tendering or tendering as a group that helped the company meet its production target at 30 percent cost savings. (Duey) As interrelated strategies, standardization and industrialization allow oil companies to benefit more from joint activities. Collaboration facilitates standardization and industrialization through the emergence of techniques and tools based on the collective experiences of oil companies. (Donati)
Failure to achieve operational excellence is often due to the inability to translate theory into practice. Technological tools can address this difficulty by facilitating cross management silos to make sure that operational data goes to everyone in the company. Information and inter-departmental linkages should lead to better, safer and more informed operational decisions within the context of organization-wide cost cutting. (Murray) Investments in digital field technology optimizes production, improves efficiency, reduces cost, and raises savings (Donati).
Electronic communication technology can enhance operational excellence. Oil companies in Oman invested in electronic communication technologies, among other measures, due to the decrease in oil prices that resulted to the reduction in government subsidies for the oil industry and imposition of higher taxes for oil and gas companies (“Cutting Costs”).
Analytics are also technological tools for reducing downtime and optimizing production. Analytics allows oil companies to manage, track, report and analyze levels of production loss and downtime in real time to determine the root cause of these problems. In effect, oil companies can determine priority responses and timing of implementation. Actionable data can result to cost savings of $100 million per year. (Sebastian) Analytics on production and profitability also facilitate the monitoring of performance measures and identification of areas for immediate improvement. Ordinarily, analytics occur every year or twice a year. Customization of analytics can result to daily analytics for distribution to all decision makers. Customized analytics can enhance performance by 1 to 2 percent, which may translate into millions in revenue. A delivery management software is an example of a tool that provides analytics on different tasks performed by various departments, including resource development, land, geology, project development, drilling, completions, regulatory compliance and production. The software provides information needed by the departments to speed-up decision making on and implementation of decisions on drilling by around 5 percent. Improvements in rig scheduling and use can save the oil company about $30,000 to $100,000 per rig. (Sebastian) Analytics provide managers with unit-level information to determine specific areas for cutting cost and assign accountability for spending mismanagement (Agrawal et al.). Use of analytics is an investment, which adds to expenditures. Cost savings can offset this expenditure. Gains from this investment extends to the long-term.
Another technology that may be worth the investment is the fixed-cutter bit designed for tangent, curve and lateral drilling in a single run. Ordinarily, drilling these three sections involves changes in motor, bits and other components that take about 18 hours. With this technology, adjustments to the same motor, bit and components allows the drilling of one section to another. Eagle Ford in Texas has invested in this technology. (Anderson and Drews)
4. Conclusion
Oil companies cut cost due to the radical drop in oil prices caused by oil supply exceeding demand in the last two years. Management in oil companies cut cost by reducing labor and capital expenditures. Standardization, industrialization and collaboration allowed oil companies to gain lost expertise and skills, save on cost, share risk, and achieve operational excellence. Investment in technologies ensured innovation to offset lost expertise and skills.
Works Cited
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