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Lower-for-Longer Oil Prices and Oil Patch Budgets: Four Strategies to Cope

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by Hack Heyward

Oil and gas companies have been predicting lower-for-longer pricing scenarios for months now, and OPEC’s recent decision not to curb oil production resulted in crude oil futures contracts trading at the lowest levels since 2008. This effectively drove a stake through the heart of any near-term hopes for an oil price recovery. Oversupply has already sent the price of Brent Crude to a six-year low, and the anticipated hike in interest rates in the U.S. is likely to generate more bad news for commodity prices in general, including crude oil. Even if the U.S. lifted its 40-year-old ban on the export of oil, which would create upward pressure on oil prices, global oversupply would still exist.

In an interview with Bloomberg TV in early 2015, oil historian Daniel Yergin predicted that major oil companies would face budget cuts of 10-25 percent, while independent producers in North America could face cuts of 30 percent or more. In many cases, Yergin’s numbers turned out to be optimistic.

And early 2015 predictions about bankruptcies among the weaker players and merger and acquisition activity among the stronger ones are only accelerating. Nothing drives aggressive back-office budget reduction like a recent merger or acquisition.

Many companies have begun cost-reduction projects that can quickly deliver savings and help cope with necessary budget reductions. To quote one oil patch CEO: “We can’t take costs out fast enough.” Here are four low-risk strategies to reduce costs right away and make a difference in 2016:

  1. Outsource facilities management. Facilities management spend is often widely distributed and not easily visible to the CFO. First-generation facilities management outsourcing projects reliably return a net 10-15 percent savings on facilities operations and maintenance and—at the same time—bring a new level of transparency to the function. These projects are quick to execute and do not require new capital investment. Because many site-specific services, such as cleaning, catering and security, are already sourced, a shift to a new facility manager is barely noticeable to the organization. Including transition expenses, a net savings of four to eight percent is typically achieved in the first year of the contract.
  2. Outsource the indirect procurement spend your procurement staff doesn’t have time for. Management consultants and service providers love to talk about how they can manage the strategic sourcing for an organization more effectively than the organization’s own buyers. And it does happen, but very rarely for oil and gas companies with significant scale. The far greater opportunity lies with spot-buying, which can amount to hundreds of millions of dollars in purchases that have not been strategically sourced. A large portion of spot-buy spend is not managed by professional buyers because the organization’s limited number of buyers are rightfully focused on the highest-value procurements. For this reason, large enterprises often delegate procurement authority to their end users for purchases that fall below an established limit per individual purchase, a limit that often exceeds $100,000. In aggregate, this type of uncontrolled spending can easily approach two percent of an oil and gas company’s revenue. The good news is that procurement service providers with thousands of buyers in low-cost locations are very good at this type of spot buying. They are known to save eight to ten percent of the amount an organization’s end users spend.
  3. Still doing enterprise document printing in-house? Enterprises that combine outsourcing with comprehensive process improvement initiatives and automation of key print functions can achieve savings that range from 25 to 35 percent. Most print operations today involve expensive equipment and staffing costs and are managed using labor-intensive processes and outdated technology. The majority have yet to automate ordering processes or move them online, which means the function suffers from the double whammy of high costs and low performance. A lack of end-to-end ownership and visibility into total costs means it often falls below the radar of cost-reduction initiatives. Automation is the savings driver here. On average, a print production job in a large business organization requires 45 to 65 human touches while innovative large-scale print shops that use automation average only 15 to 20.
  4. Tighten the management of existing outsourced services. Thirty-six percent of oil and gas companies in the Forbes Global 2000 currently use outsourcing to a significant degree. The low-hanging fruit for reducing costs in currently outsourced services lies in managing the service providers more effectively to ensure that the value contracted for is actually delivered. Typical areas of value leakage include: 1) invoicing errors due to inadequate invoice validation, which are almost always in the service provider’s favor, 2) contractual obligations that are not delivered and are forgotten unless the client knows they have been missed and insists on delivery, and 3) poorly managed inventory or capacity, which means clients are charged for services they do not actually use (such as unreturned laptops, unused active network ports and storage or processing capacity that exceeds requirements).

Tightening service provider management using in-house staff would be very difficult to do quickly and effectively enough to make much difference in 2016, but these governance services can be successfully outsourced to experts. For example, with ISG’s help, clients can take advantage of an onshore/offshore model at a lower cost than their internal staff and realize as much as 10 percent of their Annual Contract Value (ACV) in hard dollar savings and another 5 percent in soft savings.

ISG can help you deliver meaningful cost savings in 2016. Contact me to discuss further.

About the author

With extensive senior management experience in shared services, outsourcing and negotiating major contracts, Hack helps clients develop strategies for designing and executing multi-process shared services and sourcing solutions, including finance and accounting, procurement, IT infrastructure, application development and maintenance (ADM) and ERP software negotiation. Hack has worked with clients around the world and across a broad range of industries including oil and gas, utilities, pharmaceuticals, financial services, transportation, high tech and manufacturing. Hack joined ISG in 2005.