Partnerships

Source: Presentation by Paal Kibsgaard at the Scotia Howard Weil 2016 Energy Conference, 21 March 2016.

Following my theme for the year on risk and reward, this month’s column looks at how partnerships affect the risk/reward balance. Our industry is full of partnerships—it’s how we share the risk in a very risky business. But when times are hard, the partnerships can be strained—as they are today. Can we adjust the business models and partnership alliances so that both operators and service providers can survive and thrive going forward? Can partnerships be adjusted to benefit both parties? Is it time for some new business models?

Whenever I speak to students and SPE’s Young Professionals, I remind them this is the oil business. As engineers and SPE members, we love to focus on technology, but ultimately oil companies thrive on dollars and barrels. Generally, international oil companies (IOCs) make money from very long-term investments while national oil companies (NOCs) are more focused on developing long-term, sustainable oil and gas fields within their borders. NOCs also nurture their own citizens’ job skills and support local industries.

The past 2 years for the service side of our business have been a matter of survival. Or, in some cases, not. Everyone agrees that the service sector has taken the strongest hit during this downturn. Operators still have cash flow because of the underlying producing assets. But when the operators stop investing, the service companies’ cash flow stops. The operators’ cash flow may be down by half, but at least they still have cash flow. Many service companies’ cash flow has gone to almost zero. These service companies have few options other than to retire or mothball equipment, cut their staffs, and “hold our breath and hope for better times soon.” See Schlumberger CEO Paal Kibsgaard’s presentation at the Scotia Howard Weil 2016 Energy Conference, 21 March 2016 at http://www.slb.com/news/presentations/2016/2016_0321_pkibsgaard_scotia_­howard_weil.aspx.

So, what’s at stake? Operators (both NOCs and IOCs) are completely dependent on the service sector to execute our projects. They drill our wells, build our production and refining facilities, and, most importantly, provide us with innovative new products. IOCs provide integration capability, the full value chain, and usually a very long-term view for asset management. IOCs have the capability and incentive to actually apply the new technologies developed by the service companies—for cost ­reduction, increased production and recovery, and long-term asset management.

How did this symbiosis with service companies develop? First, a little history. Early in the 20th century, IOCs expanded into frontier areas and the concession agreements were tilted strongly in their favor. These agreements were often characterized by a long concession time frame and big scale, limited oversight by the host government, and not much revenue flowing back to the host government. These were bonanza times for Big Oil. After WWII, oil demand increased in newly expanding economies, and independence movements by many former colonies created new governments. Domestic political pressures forced the new host governments to look at the IOCs differently. Some countries, such as Iran, nationalized their oil industry. Most negotiated new, often joint venture agreements where the profits were shared more equally between the IOC and the host government. But most countries still lacked the human capital to exploit their oil resources themselves. So, the IOCs became one-stop shops for all aspects of development—company-owned rigs, large R&D centers, and full-service technical staff. More revenue went to the host government, but not much was accomplished for local human or industry development. Technologies were developed in IOC com­pany laboratories, and service companies stuck to their usual product lines.

In the 1970s, the oil embargoes and price increases changed the partnership power structure yet again. Existing NOCs began to push back and started looking and acting more like the IOCs. NOCs, such as Saudi Aramco, wanted more than just a check from the IOCs—they wanted to be full and equal partners. Other countries that had never had an NOC, such as Thailand and Malaysia, formed new enterprises to better manage their national resources. The partnership power shifted as the NOCs demanded more from the IOCs, including sourcing and developing both local human talent and service industries and suppliers. NOCs began bringing in technology directly, including setting up their own technology centers, and they began raising their own capital in markets. The NOCs became more sophisticated and continue to do so.

The long downward price cycle of the 1980s and 1990s caused big changes in the IOC community. The late 1990s was an era of big mergers; many of the smaller majors were absorbed by the larger ones. More importantly for the partnership discussion, the IOCs reduced or eliminated their ability to develop new technologies on their own by shutting down long-standing US-based E&P research and development facilities: Amoco in Tulsa, Oklahoma; Marathon in Littleton, Colorado; ARCO in Plano, Texas; and Chevron in La Habra, California, to name a few still-missed research centers. It may not have been deliberate, but IOCs effectively outsourced technology development to the service providers.

As projects became more complex, with rising costs and stakes, both IOCs and NOCs needed more from the service companies. The service sector, including the engineering, procurement, and construction (EPC) community, created sophisticated supply chain organizations, sourcing not only commodities like pipe and sand, but also sophisticated technology and software, often with mixed results.

So, here we are. Not very good partners, yet dependent on each other for survival. Operators are squeezing cost concessions from service and EPC companies, while the service sector is madly slashing capacity. NOCs are unhappy at losing market share to the technology-driven US shale revolution. Host governments are shell-shocked at the dramatic reduction in revenue, which supports the entire government for most of them. Fragile local companies have seen their business ebb away.

Yet, if the service sector is crippled, operators will not be able to execute their plans. We are partners because we have to be—we cannot survive without each other. At the November 2016 IPTC conference in Bangkok, John McCreery of Bain and Company led a plenary session on partnership in a new (lower for longer) paradigm. How can IOCs, NOCs, and service companies work better together so all can survive in a volatile market that is healthy and sustainable for all?

Is there something we can do differently? In Bangkok, the panelists all agreed that for new project sanctions, costs must continue to reduce. This requires all parties to work together on the right type of technology solutions for each project. The key to unlocking these sustainable reductions is the willingness to change behaviors and mindsets to work together in a different way.

In this recent downturn, some service companies, especially Schlumberger, have advocated for a move away from the current procurement-led relationship between service and operating companies to a more collaborative relationship. Both risk and reward would be shared, where the service providers would share in upside if their solutions yield results. If operators could plan their work on a longer time horizon, service companies could staff and equip to meet their needs. I think long-term, collaborative relationships are more likely to emerge with NOCs, which (by definition) take a long-term view of their own resource developments. IOCs are too often driven by market analysts and quarterly or annual shareholder demands. But there is hope for a different partnership equation.

Of course, if it were easy, we would already have done it. Operators and service companies should be more collaborative in technology development and place less emphasis on low-bid, procurement-driven solutions. These solutions work for pure commodities such as pipe or sand but are not so applicable for technology-driven solutions such as subsea kits or complex completions. Operators could level-set their spending to lock in long-term service contracts and avoid swings in costs and availability. Can we bring both sides to the table? Can we be more open? Will the E&P industry learn the lesson that the laws of economics still apply?

As we cut slack out of our system, the business cycles will produce more big winners and big losers. Cutting capacity during downturns leads to cost inflation during high oil prices and ­activity upturns.

Always.

Partnerships

Janeen Judah, 2017 SPE President

01 February 2017

Volume: 69 | Issue: 2