The underlying economics of the upstream Exploration and Production (E&P) industry have fundamentally altered. It has become a margin business, with relentless pressure on unit cost performance and global competition for capital.
To adapt to this new economic reality, companies have to go further than recent tactical responses to the downturn. Instead we believe that for those players prepared to challenge conventional perceptions of ‘best-in-class’ and look outside of the sector for inspiration, exciting opportunities exist to deliver a step change - including bringing new technologies to the fore. We believe there are five key sources of long-term value:
Delivering the prize in E&P calls for targeted execution of high-value opportunities to complement continuous improvement efforts, along with a new entrepreneurial approach of ‘start small, fail fast, scale fast’.
Whilst oil and gas consumption is forecast to grow by 25 percent between 2015 and 2035 , the growth rate is slowing significantly, with a further drag from decreasing energy intensity. Significant US unconventional capacity continues to be brought on stream at constantly falling unit costs, while new renewable energy capacity is being added at pace, with spectacular improvements in costefficiency. In addition, increased regulation in Europe and elsewhere is speeding the transition to non-hydrocarbon fuel sources. These are long-term pressures that are likely to carry on squeezing E&P firms.
At the same time, greenfield capital expenditure (Capex) has reduced dramatically, from US$200bn per annum (p.a.) between 2011 and 2013 to US$65bn in 2017 . The majority of production-adding projects approved in 2016 were either brownfield expansions or tiebacks that made use of existing infrastructure. As a result, many E&P capex portfolios have shifted emphasis from high-risk, high-cost mega-projects towards a longer tail of smaller, incremental development opportunities, driving complexity into many business units.
As reduced investment translates into lower production, many conventional E&P business units are likely to experience additional pressure from rising unit costs. In order to offset declining returns, companies increasingly need to drive efficiencies from complex portfolios of smaller, more diverse assets and maintain a relentless focus on break-even costs.
To date, most responses have revolved around short-term initiatives, such as aggressive supplier rate reductions, organizational downsizing and deferral of project and maintenance spend. KPMG member firms have also observed a second wave of improvements, focused on operational efficiencies such as reliability and turnaround performance. We believe these efforts do not go far enough and will be difficult to maintain. This is consistent with a recent Wood Mackenzie survey in the North Sea which suggests that only 14 percent of the cost reductions achieved between 2015 and 2017 are sustainable.
Structural economic pressures have transformed upstream into a margin business. The urgent search for further sources of long-term value is revealing a number of exciting opportunities with the potential to reduce unit costs by a further 30 percent. This is not about another transformation program – those leadership teams that move fastest are likely to gain competitive advantage.