People First: People KPI

Abdul-Jaleel Al-Khalifa, 2007 SPE President • president@spe.org

Our industry leverages talent and technology to extract the maximum benefit of hydrocarbon resources. The ultimate objective, of course, is to enhance the socio-economic development and well-being of human kind. Our industry business model towards achieving this noble objective has over the years resulted in corporations that follow a market economy. Is this the best and most efficient business model? Are we maximizing the benefit of hydrocarbon resources—that is, are we finding and recovering the highest volume of hydrocarbons in the most cost-effective way? The answer, unfortunately, is no. For example, the current ultimate oil recovery averages 35%. This is very low compared to the maximum physically allowable recovery of 70 to 80%. The current finding success ratio is only 20 to 30%, which can be improved to 50%.

Can we enhance our business model to achieve these objectives? The answer, fortunately, is yes. So, why do not we do it? I believe that both our current financial model and corporate cultures require a fresh look and major reforms. Last month, I emphasized the role of leaders in changing corporate cultures, such as setting fair policies and living the values of fairness and excellence in their day-to-day actions.¹ Corporate leaders can walk this talk and start assessing and reporting a people key performance indicator (KPI) that reflects their sincere desire to support their people and to boost the performance of our industry.

I will explain the proposed people KPI, and then will continue last month’s analysis of our current financial model.

People KPI

I strongly believe that a frequent company-wide assessment of workforce engagement is essential. Results can be reported as a people KPI and shared with all stakeholders. This KPI will complement other reported indicators, such as quarterly earnings, cost per barrel, and reserve replacement ratio. This KPI is essential for two reasons: it promotes the value of people, which is the right thing to do; and it will improve the performance and extend the life of our industry.

A people KPI is extremely important for all stakeholders:

Corporate boards can monitor the performance of their executives in relation to people issues. Similarly, executives can assess the performance of middle management and institute immediate changes when needed,
Employees will communicate their concerns, remain engaged, and continue to be innovative,
Investors and market analysts can utilize the people KPI to assess a company’s long-term viability. This will complement the quarterly earnings data that reflect short-term performance.

Survey Focus and Results. Healthy organizations tap the hearts and minds of their people, and help them draw on their utmost potential in a happy and engaging environment. These organizations enjoy the brightest innovations and the most cost-effective performance.²

People are engaged if (1) they are happy and (2) they utilize their full potential. These are the two pillars of my proposed people KPI. They have to be measured as they reflect the true engagement of our human resources. Any shortfall of full potential is a big loss to our industry.

With the help of SPE Research Manager Paul Gerber, we conducted a survey in October 2006 to help establish a base line for the industry and to encourage corporations to conduct similar surveys. Survey invitations were sent to 40,405 SPE members (excluding SPE staff, self-employed/consultants, and students). A total of 9,448 responses were received, for a response rate of 23.4%. Results are therefore statistically representative at the 99% confidence level with a ±1.16 margin of error. Respondents included executives, managers, superintendents/foremen, engineers, geologists/geophysicists, and others.

Figs. 1 and 2 show the results for the people KPI elements proposed here. (Additional survey results will be published in the March 2007 Talent & Technology, which members will receive with the March JPT.) The percentages reflect the “strongly agree” and “agree” groups and leave out the “neutral,” “disagree,” and “strongly disagree” groups.

Fig. 1—57% of the respondents strongly agree or agree that their job utilizes their full potential.

Fig. 2—68% of the respondents strongly agree or agree that they are happy in their jobs.

These results highlight the importance of the people KPI. At the time that projects are deferred because of scarce talent, the industry is leaving a significant portion of its human resources disengaged. This emphasizes the critical need to enhance the current corporate cultures and industry financial model.

I strongly encourage corporations to measure and report on these two components of the people KPI frequently. These surveys can have second- and third-level details for internal analysis to help design changes in the work environment. Follow-up surveys after 6 months or 1 year will help assess the merit of the strategies implemented and need to be publicly reported.

Current Financial Model (Capital First)

Our industry is very capital intensive. We focus on how to find, develop, process, and market hydrocarbons in the optimum way. Profit margin is affected by the quality of reservoir rocks and fluids, application of talent and technology, stages of field depletion, and fiscal conditions. As the market price of hydrocarbons fluctuates, a company has to readjust its expenditure to maintain a healthy profit margin.

In today’s financial market, capital can earn a secure interest rate that is normally higher than the rate of inflation. A company can attract capital only if it can yield earnings that are higher than the secure interest rate. The expected return on capital (normally double digit) is proportional to the risks involved and the time value of the capital (i.e., a dollar today is worth a dollar plus its accrued interest rate after one year). When evaluating projects, companies normally apply a factor of 10 to 15% to discount future revenues to present value. Any project with a positive net present value (NPV) is considered profitable and can then be ranked against other opportunities.

What are the flaws of this model?

Since the financial market offers risk-free interest earnings, companies must yield higher earnings to counter the perceived risk of unpredictable crisis. There is a school of thought that affirms that risk-free interest should be banned and that capital should take a risk to generate earnings. According to them, their approach can generate more economic activity and ensure a fair distribution of wealth.
The high expected return and thus the high discount factor kills many potential projects that can generate lower return.
Capital exerts unbearable pressure on management to ensure a double-digit return. This sometimes happens at the expense of ultimate hydrocarbon recovery, talent, and technology.
Discounting future revenues to estimate NPV overvalues short-term and severely undercuts long-term revenues. This has intensified industry’s focus on short-term objectives.
In addition to the high expected return, capital “owns” the industry and normally benefits from historical upsides.

Currently, there is a flush of capital awaiting industry opportunities. Therefore, it is time to change the rules of the game.

Quick Financial Returns vs. Ultimate Recovery. The practice of discounting future revenues intensifies our industry’s short-term focus. This can be very detrimental to long-term ultimate recovery. A higher production at minimum cost, now, is more attractive than incurring higher development cost now to maximize recovery in 20 to 30 years. This is further exacerbated in time-constrained concession and production-sharing projects. It is therefore not surprising that field development is mostly optimized in light of financial earnings and not in terms of ultimate recovery. Although this is commercially prudent, it defeats the objective of maximizing the benefits of limited hydrocarbon resources.

Quick Financial Returns vs. Talent and Technology. Stock analysts and fund managers exert extremely powerful market pressure. They use reported quarterly earnings to measure corporate performance as well as signals of future growth. Corporate management constantly strives to ensure a positive drive in stock prices.

This scenario can severely impact talent and technology in a cyclic industry like ours. Declining oil prices generates a series of mergers, restructures, and downsizing of talent and technology spending. When the low cycle of the mid-1980s and mid-1990s reversed a few years ago, we realized that the earlier downsizing was not optimal for the long term. Our industry today lacks the critical mass to run the day-to-day operations.³ Therefore, it is imperative that our industry and the financial community embrace a new paradigm of people first, which will significantly improve our performance (Fig. 3) because both corporate and people interests are aligned.1 But how do we introduce people first in the financial model?

Fig. 3—A people-first paradigm will extend the life cycle of our industry.

Taming the Capital

Companies leverage people, capital, and technology to develop natural hydrocarbon resources. Both capital and technology result from the work of talented people—capital is the earnings of people and technology is their innovations accumulated over time. This implies that the two main assets of our industry are people and natural resources, while capital and technology take second priority.
Let’s try to see how people can be placed ahead of capital in the business model:

A group of people started their own company.
They secured a contract to develop an oil field for a service fee of $X/bbl, or a Y% share of the production stream.
They decided that instead of getting investors to raise capital (i.e., shareholders to own the company), they would convince investors to own the facilities. Their company would then rent to buy the facilities over a number of years. This secure rent can be equivalent to the return on capital expected from other opportunities.

This model entails that the talent owns the company and therefore enjoys the future upsides. The capital will earn a risk-free rent but does not benefit from the upsides. This model helps minimize the aggressive power of the capital, as it:

Reduces the risk for the capital, and therefore lowers its expected return.
Prevents the capital from owning the industry and benefiting from the upsides.
Protects the industry from shareholders’ and stock analysts’ mounting pressure.

This is food for thought. I strongly recommend that our industry engage a group of financial experts to study this fundamental issue and develop better alternatives to the current financial model. The alternative model needs to tame capital and ensure a healthy outcome that promotes the value of people and does not jeopardize the long-term interests of our industry.

References

Al-Khalifa, Abdul Jaleel: “People First: Excellence and Fairness—Part 2,” JPT (January 2007) 10.
Al-Khalifa, Abdul Jaleel: “People First: Full Engagement,” JPT (November 2006) 10.
Al-Khalifa, Abdul Jaleel: “People First,” JPT (October 2006) 12.