By Vinodkumar Raghothamarao, Director Consulting, Energy Wide Perspectives & Strategy, IHS Markit EMEA
Oil and Gas companies operate in dynamic and complex environments, where they face constant supply and demand challenges. Now with Brent oil prices hovering at 50$ range, the need of the hour is to evaluate the supply chain and procurement techniques and costs. Sector companies need to focus on the non-hydrocarbon supply chains that handle the parts, materials and services required to run the business.
The non-hydrocarbon supply chain is very critical to deliver the equipment and services required to find, extract, refine and finally market the oil and gas. Procurement and supply chain strategies are set to be in the forefront of critical issues plaguing oil and gas companies especially in the current era of low oil prices.
We have found that oil and gas supply chain practices clearly lag behind (in certain geographies) those of some other industries that use advanced techniques such as optimised inventory management, collaborative supplier relationship management and so on. In this article, we provide a brief insight about the opportunities and areas where supply chain practices can be improved amongst the IOCs/NOCs, and highlights other industries that companies in the oil and gas space can learn from, including improved service to internal customers and reduced costs.
According to Harvard Business School Review, purchased products and services account for more than 50% of the average oil and gas company’s total costs. Thus, even a 5% reduction in purchase costs can result in a significant increase in the profit margin for oil and gas companies. To achieve this, sector companies should look at the following opportunities in order to deliver better supply chain value: Supply Chain Market Intelligence; Materials/Supplier Relationship Management; and Supply Chain Talent & Technology.
Supply Chain Market Intelligence is the process of acquiring and analysing information in order to understand the present and future market; support current and future sourcing and market sector strategy execution; and enable the business to better anticipate changes in the external marketplace and react before others do. Supply Chain Market Intelligence is key to any industry and more so for the dynamic oil and gas industry. Effective supply chain market intelligence helps oil and gas companies deal with strategic supply chain challenges such as constrained capacity, infrastructure and volatile markets. It also helps companies make the right decisions about which markets to buy from, how to determine the right price to pay and what benchmarks and targets will provide the right competitive edge.
The hydrocarbon industry is heavily dependent on suppliers to provide complex services and critical equipment to support on-going projects and operations. More than often, contract management and supplier relationship management are not up to the mark, and as a consequence, the oil and gas companies take on supplier risks. To improve supplier relationship management, the companies should adopt a method of supplier benchmarking. Oil and gas companies need to measure the robustness and performance of different contractors for various spend categories, and constantly seek dialogue with them so that the suppliers are in unison with the necessary obligations in terms of safety, training, equipment and staffing requirements. For contract management, we have seen some oil and gas companies with non-efficient processes such as non-compliance of contracts with established suppliers.
Another method that can help the oil and gas company in pricing negotiations is the use of the Should-Cost model, and in addition, the Total Cost of Ownership (TCO) model. In the former, the total acquisition cost for a particular equipment or service is arrived at by taking into account the design cost, supplier operating cost, supplier margin, and transaction and acquisition costs. The Should-Cost model for different spend categories will empower oil and gas companies to effectively negotiate contract terms and conditions with the suppliers. In the case of the TCO approach (more suitable for long lead and critical capital intensive equipment), the different costs including the acquisition costs, and operation and maintenance costs are arrived at before choosing the right supplier at the competitive price. Some of the IOCs have adopted measures such as the Should-Cost and TCO models but these are yet to be adapted by other regional and local players in the oil and gas industry.
Even though the advent of technology has helped oil and gas companies to find and extract more oil, there is a need to seriously consider supply chain and procurement systems which provide additional real value. Needless to say, modern supply chain solutions and systems really helpful to address the above mentioned concerns. These supply chain solutions should cater for inventory management; demand forecasting, contractor management, master data management and e-procurement. Demand forecasting/planning coupled with inventory management and e-procurement form the crux of the oil and gas supply chain strategy. Oil and gas focused supply chain technology solutions have completely revolutionized the way supply chain planning is being carried out in different industries. There has been a paradigm shift in the way oil and gas companies have embraced e-procurement or shown interest in e-procurement systems.
Even with the best in class supply chain processes and systems, without the right people, the best in class supply chain practice cannot be sustained nor can the full benefits of supply chain really be enjoyed. As with any other industry, the oil and gas industry also has to grapple with the shortage of supply chain and procurement talent due to an aging workforce and growing skill shortages. Some of the measures that can be effectively adopted are training and grooming of talent in critical supply chain functions, establishment of supply chain centre of excellence and industry-academia collaboration to nurture supply chain talent.
Operating companies can improve and deploy the best in class supply chain practices through the implementation of some of the following measures: Firstly, to understand the “total value” of major spend categories. This requires thoroughly identifying costs and options across the supply chain for each category and determining appropriate interventions (e.g., seeking new supplier, changing specifications, altering contract terms). Secondly, to build custom fit procurement processes that provide better clarity, engage suppliers early in the process. Moreover follow through to execution and into operations. Thirdly, to manage risks across the entire spending portfolio—not just within individual projects or commodities, or splitting capital from operations spend. Fourth, to proactively manage the supply base, select relevant suppliers, focus on alignment and sustainability (i.e., dynamic relationships), and ensure company ownership and accountability is clear to suppliers. And finally, to institutionalize the capabilities required for supporting procurement and supply chain activities. Today, these scarce skills are at a premium. In the next few years, it will be just as important to cultivate the right talent here as it will in the most critical technical and operational areas.
Going forward, we realize that even though some of the supply chain best practices have trickled through the oil and gas industry, there is always still scope for further improvement. Better demand planning and optimized inventory management will help oil and gas companies maintain oil and gas equipment uptime and hence benefit from improved productivity. Improved spend category management and collaborative supplier relationship management coupled with increased automation of transaction processing, will lead to sourcing savings and identification of secondary saving opportunities. Effective deployment of supply chain best practices is the way forward for the oil and gas companies to reduce costs in this era of low oil prices and to focus on oil and gas production and exploration in the most optimized way. It will be really interesting to see how oil and gas companies can effectively manage local content sourcing coupled with the adoption of best in class supply chain practice in 2017.
About the Author
Vinod Raghothamarao is a strategy and management consulting professional with 15+ years of work experience in oil and gas, power, refining and petrochemicals, mining and heavy industries. Worked on strategy, market intelligence, investment advisory, supply chain & operations, technology, Capex/Opex advisory, HSE and risk management consulting assignments for energy and mining clients across USA, Latin America, Europe, Middle East, Africa and Asia Pacific. Consulted for clients such as Saudi Aramco, ADNOC, Shell, BP, Exxon Mobil, Petrobras, DNO, Petro Masila, Oman PDO, KNPC (Kuwait), First Solar, Qatar Petroleum, Vale (Brazil), Alcoa and Rio Tinto and also for few energy related PE firms.
Currently, Director of Energy Wide Perspectives (EWP) at IHS Markit. As director of EWP, work across Upstream, Mid-Stream, Downstream and Power, Gas, Coal and Renewables. EWP provides advisory, research and consulting related to Upstream, Downstream, Mid-Stream, Integrated Energy View, Inter-fuel competition, Long-term Energy Scenarios, Corporate Strategy, Country Energy Planning, Climate and Carbon and integrated energy market understanding for finance and service sectors.