Profit and loss (P&L) analysis on each asset creates opportunities for higher profits.

The financial performance of many energy companies during 2000 shows they achieved record profits and returns on investment. One major, for example, reported the highest net income in its 121-year history. These impressive industry gains were attributed largely to strong market demand, unusually high crude oil and natural gas prices, superior refining margins and solid operating performance.
Unfortunately, financial results like these have a way of masking fundamental business problems that can threaten long-term industry profitability if they are not addressed. For example, in the wake of the industry's ongoing mergers and acquisitions, the number of underperforming oil and gas properties can be "lost" easily within many, if not most, corporate portfolios. Another, perhaps more urgent, challenge is the acute and growing shortage of technical professionals needed to resource the industry's producing assets.
What's more, energy companies face a completely new set of uncertainties following the events of Sept. 11. Potential oil supply disruptions, fears of a worldwide recession, greater geopolitical instability, heightened security issues (and costs), global oil demand uncertainty, a growing surplus of gas in the United States and significant fluctuations in commodity prices suggest the need for continued vigilance and a sustained focus on profitability, despite previous record results.
Corporate and industry profitability can be optimized using an emerging asset P&L model. In brief, the model suggests each producing asset should generate a separate P&L statement, and that operator and partner resources used to support a particular asset - people, processes, data, applications and computing infrastructure - should function as if they were parts of a single entity.
This approach would "flag" unprofitable assets in a company's portfolio and, by eliminating redundancies inherent in most joint ventures, could dramatically lower information technology (IT) costs and solve the problem of staff shortages anticipated in the upstream industry.
Assets and profitability
Oil and gas assets - not companies - are the fundamental building blocks of the energy industry's financial universe. As such, the profitability of a producing asset has a fundamental impact on the aggregate profitability of a particular company's portfolio. Furthermore, the profitability of publicly traded oil and gas companies has a positive or negative effect on the industry's profitability - as well as the company's image in the eyes of potential investors.
While an individual energy company's financial performance tends to be compared with its peers, outsiders view the market as a whole and wonder if the upstream oil and gas industry is a smart investment option at all. Despite recent stronger-than-usual returns on shareholder equity, many investors remain wary of the boom-and-bust cycles that historically have characterized this industry. Just 3 years ago crude oil prices fell through the floor, triggering a wave of unprecedented consolidations and cost-cutting initiatives. Without an immediate reversal, 2002 could bring similar market upheaval.
Although Wall Street tends to award larger companies with higher price/earning multiples, the jury is still out on whether these consolidations and cost-cutting initiatives are creating real value in the marketplace. Certainly they are removing expenses from the system, but investors want more than top-tier cost reductions.
In any case, ongoing mergers underscore the assertion that assets, not companies, are the coin of the realm. Why? Because companies come and go - forming and reforming around a relatively fixed number of producing properties. Assets, therefore - like atoms to the molecule - remain the fundamental building blocks of industry profitability.
Yet P&L statements are reported only for corporations, not for individual assets. Unfortunately, aggregating assets under a single regional or corporate P&L statement can hide the poor performers while diluting the profitability of top performers. Until recently, few but the most innovative companies even tracked the P&Ls of individual assets internally. Although the practice of generating internal asset P&Ls seems to be growing - especially for some of the largest and most strategically vital assets in some portfolios - it is far from universal or consistent, even within a single energy company. Many assets still are managed by engineers who focus on total production or reserves rather than profitability. Complicating matters, many decision-makers in multinational corporations have great difficulty consistently comparing the business performance of their assets in one region or business unit with those of another.
In this context, the term asset refers to a set of geologically or geographically related hydrocarbon traps - basically oil and gas properties or fields - and the capital infrastructure necessary to produce them. Detailed P&L statements should be generated - at least internally - for every producing asset, no matter its size or corporate priority. It is impossible to optimize something you cannot see.
Of course, optimizing an unprofitable asset could entail scaling operations down to a more appropriate level, shutting in reservoirs or divesting properties altogether.
Several inertial forces inhibit asset managers from dealing rationally with poor performers in their portfolios. One is an unwillingness to reduce the size of one's kingdom. Another is the fear of overlooking something big and suffering embarrassment when the next owner or operator finds it. As an old oilfield saying goes: "It is one thing to drill a dry hole. It is another to farm out a discovery." In some cases, at least for short periods, companies may not divest unprofitable assets in regions where they wish to maintain a strategic presence. Finally, when energy prices are low, certain assets are retained due to an entrenched belief that prices will come back someday. Often, they do. At other times, having a grasp of the actual costs and profits associated with an asset would dictate swift divestiture under any price scenario.
Joint venture redundancies
Complicating the challenge of asset optimization is the energy industry's low tolerance for risk, at least in the development and production stages of the oilfield life cycle. This means few, if any, producing properties are owned 100% by a single company; most are organized and operated as joint ventures. These business relationships are a common occurrence resulting in the sharing of risks and high capital costs. In some countries, the government decides whom the partners will be, throwing together companies that possibly compete with one another elsewhere in the world. Whether self-chosen or imposed, upstream joint ventures are characterized by a lack of trust that may represent one of the most costly problems in the industry.
Oil companies normally seek independence rather than interdependence or collaboration, often to their own detriment. Due to lack of trust, for example, most joint ventures deliberately create costly redundancies in human and technical resources. Typically, the field operator dedicates considerably more technology and team members to the effort (gaining, of course, greater control over key decisions and costs), while other interest owners implement shadow teams to audit the other team member's work. Joint operating companies, in which partners build one team and share resources in proportion to their working interest, are extremely rare. Even where they exist, each parent company usually maintains a certain amount of shadowing.
In the worst case scenario, each partner duplicates the entire system dedicated to an asset - exploration and production professionals, IT and other support staff, project database systems, hardware, applications and computing infrastructure (Figure 1). Vendors and service companies working on the project have been known to do the same. Not only is this approach unnecessarily expensive, impacting the long-term profitability of the asset and each joint venture partner, but other assets become critically underresourced.
Partners also engage in competitive technical interpretations, using proprietary tools and techniques they are unwilling to share with one another, even though their economic success is intertwined. This practice is based largely on a sort of technical arrogance - a widespread belief that one or more proprietary technologies are, in the end, materially differentiating. The truth is, most energy companies today have, or have access to, roughly the same technological capabilities.
When joint venture partners do not share knowledge and resources, decision-making processes inevitably suffer from redundancies, inefficiencies and long cycle times that impact everyone's bottom line. For example, the operator of one mature, onshore US asset said its partner routinely takes 6 months or more to approve wells in the field's deeper, more complex section. Both companies have separate teams, and one team does not trust the other's interpretations or economic models. As a result, they engage in considerable dialogue and numerous iterations before reaching agreement. In another prolific offshore basin, different joint venture partners once had literally hundreds of reservoir engineers doing the same analyses, using different data and generating different answers.
Given today's demographics, oil and gas companies no longer can afford the human and technical duplications built into traditional asset management by joint ventures. The upstream industry already has fewer technical professionals than it needs and more assets than it can resource. Companies must get more output from fewer people (Figure 2).
Demographic time bomb
Remarkably, despite the drain of intellectual capital over the past few decades, the industry has managed to sustain hydrocarbon production by continually improving productivity. This was accomplished first through acquisition of new types of data (for example, 2-D and 3-D seismic), later through new information technologies and integrated workflows. Recently, the industry has begun to reap the benefits of better knowledge management.
Dramatic improvements in technical analysis, data and information management systems and business processes would further raise the productivity of existing exploration and production professionals - enabling companies to do the same amount of work with fewer people, or more work with the same number. Nevertheless, young college graduates with even greater productivity than today's workforce will have to be recruited as well.
In the past year, published articles and research studies have made the demographic problem acute enough and visible enough to raise serious questions about the usual ways joint ventures continue deploying scarce resources to manage producing assets. Moving to an asset P&L model would optimize productivity and profitability.
The asset P&L model
Only a few of the larger energy companies manage individual assets as P&L centers. If assets are the building blocks of financial performance, then optimizing the profitability of any portfolio depends first on tracking and knowing the P&L of each asset, improving comparisons of key performance indicators (KPIs) among assets worldwide and dealing decisively with poor performers. If every asset was treated as a separate company - and had to compete for investors the way companies do - capital naturally would migrate toward the top performers. That cannot happen, of course, unless the actual costs associated with an asset are transparent to all parties involved with its management. Today, by rolling numerous assets into a single P&L, those costs are largely hidden from public scrutiny as well as internal decision-makers.
The first component, therefore, of the asset P&L model is simply to develop P&L statements for every producing property, however daunting that might be initially (Figure 3). The Web is an ideal way of making all the costs and KPIs associated with an asset visible in real time. To maximize profitability, however, exploration and production technologies used to model assets should be integrated with enterprise resource planning systems, and executives should use modern portfolio management approaches that accurately assess risks and uncertainties.
As a veteran member of several large oil company boards observed: "Everything in the oil business is beset with uncertainty. The big problem in this industry is not just that people still don't know how to deal with uncertainty; they do not even recognize the need. By the time investment options reach the board level, most of the uncertainties have been expunged. All you get is a 'most likely case' with a few sensitivities. No company I have ever seen displays the full spectrum of uncertainty to its decision-makers. Yet it is precisely those unrecognized uncertainties that come back to bite you later on."
While creating asset P&L statements, posting costs and KPIs online and integrating those costs with risk and portfolio analysis tools are necessary first steps, they are not sufficient in themselves. Another key component of the model is to begin operating the joint venture as if it were a single company, tasked not just with modeling reservoir geology and fluid flow, but with asset profitability as well.
What would operating the joint venture as a single company entail? First, it would mean eliminating the shadow efforts and redundancies in the system. No company would commit three teams to a single asset. So why should joint ventures do so? Instead, one - and only one - multidisciplinary team should be formed to manage all business and technical aspects of the asset. Membership would be open to all partners. Ideally, exploration and production professionals would be selected from each company based on a particular set of core competencies needed on the team, not just on their percentage interest.
Building a single joint-venture asset team could reduce the need for headcount by 50% or more, effectively solving the demographic dilemma. For example, if an operator previously dedicated 12 professionals to an asset and its two partners committed six each (for a total of 24 people), it is possible the joint venture could get by with just 12, if they trusted each other and worked together. This benefit alone could provide sufficient motivation for hard-pressed oil companies to adopt the asset P&L model.
The second way joint venture partners could function as if they were parts of one company would be to stop building multiple IT infrastructures and supporting them with expensive in-house staff. Instead, outsource the data, applications, hardware, network and technical support to a commercial e-workspace service provider, and connect all authorized team members and third parties (independent consultants, vendors) via the Internet. By doing so, the virtual asset P&L team would have secure, online access to a single, quality-controlled database, one set of high-end technical software licenses and almost unlimited computing horsepower.
Outsourcing the computing infrastructure would dramatically lower IT costs associated with the asset because they are shared rather than duplicated by every partner. It also would enable remote, real-time collaboration among team members not in a single office. The ability to review asset data and interpretations online would allow decision-makers to stay up to date, and partners to reduce approval cycles by several orders of magnitude.
The asset P&L model may be more important internationally than in North America. Most large discoveries take place in the international arena, yet obtaining certain types of equipment overseas can take years of advance notice. So reducing time to first oil is critical to financial success. Bringing government agencies into the virtual team could reduce cycle times dramatically. Governments are, after all, members of every joint venture team, especially outside the United States, simply because they own the mineral rights and are responsible for regulating energy industry activities within their borders. As noted earlier, they may even choose the joint venture partners. Unfortunately, serious goal misalignments often occur between international oil companies (IOCs) and national oil companies (NOCs), due - again - to lack of trust and cooperation.
Publicly traded IOCs are motivated largely by the need for short-term profits, while NOCs may be more interested in ensuring maximum reserve life and long-term production. Both can waste enormous amounts of time trying to convince the other that their goals for an asset are more appropriate. Implementing an asset P&L model within an NOC, or between an IOC and NOC, could alleviate much of the problem. Through the sharing of common Web-based IT infrastructures and building joint asset teams, IOCs could enhance technology transfer and improve their relationships with NOCs. By obtaining real-time asset performance data - not just production rates - from IOCs operating in-country, government agencies could better compare assets and optimize investments in their own national portfolios.
Integrating the value chain
In a mature vertical market striving to keep investors interested while continually downsizing and consolidating, perhaps beating the competition no longer makes sense. It simply costs too much, both in people and in capital, to duplicate so many parts of the system. The time has arrived to integrate the upstream value chain more than ever before.
Trust, not technology, may be the biggest barrier to implementing the asset P&L model. Only by changing all three pillars of integration - people and culture, business processes and technology - will financial outcomes be optimal for all partners (Figure 4). To develop trust and re-engineer joint venture governance in an industry characterized by win-lose business relationships, substantial commitment on the part of corporate leaders and intentional change management processes will be necessary. For companies still working in functional silos, the challenge will be even greater. They may need to implement multifunctional teams in-house before attempting to integrate more seamlessly with their partners.
Change will take time. The right time, therefore, to make the move to an asset P&L model is today. Many of the best oil companies already have implemented parts of this model. Those who wish to hone their collaborative edge will look for ways to accelerate the change process.

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