The conventional wisdom in the oil and gas industry is that the price collapse of 2014–15 spurred significant structural improvements in efficiency, enabling operators to reduce their per-barrel costs and remain competitive at a much lower break-even point.
But, while some efficiency enhancements were made, the heavy lifting was achieved through downsizing and cyclical cost reductions.
In other words, these were not permanent efficiencies. Some studies show, for example, that as much as 60% of the wellhead breakeven decline in the US shale production during 2014–16 was due to oilfield service (OFS) cost deflation.
To achieve those reductions, OFS firms laid off large numbers of skilled and experienced people from their workforces and scrapped older equipment. When demand rises, OFS companies will be forced to address those gaps and rates for equipment will raise accordingly — once again leaving operators with lower margins on each barrel produced.
Complicating this new environment is a shift in the strategy operators use to buy services. Increasingly, operators want one-stop shops and integrated packages that enable them to drive down the total cost per barrel, rather than seeking to achieve the lowest cost in each service category.
At the same time, operators are more open to collaboration and risk-sharing, and are seeking to align interests across the value chain. Creative approaches to supply chain–operator partnerships are growing in popularity.
Go-to-market strategies that work
These trends will eventually force OFS companies to take drastic measures to remain competitive — transforming their value propositions to meet operator needs. Companies that take bold steps today will create a significant competitive advantage in the years ahead.
There are many ways by which OFS companies can achieve better alignment across the value chain and create a compelling offering for their customers. One of them is to design and implement alternative commercial models. These include:
- Investing with the customer: OFS companies can take an equity stake in projects by deploying capital in the form of products, services, technologies or finances. The company’s returns are then linked to the project’s success in the form of profit-sharing or a percentage of actual oil and gas production. This strategy offers multiple benefits. It lowers development risk for the customer, improves the project’s sanctioning attractiveness, enables the customer to retain asset ownership and accelerates learning by ensuring that operators and suppliers work together to achieve the best possible results.
- OPEX-based pricing models: By renting out assets — while being responsible for maintenance, performance and uptime — the OFS company can better align its offerings with the operator’s needs. This approach helps the customer reduce the upfront capital investment, lowers operating expenses (since there is no payment for downtime), improves performance on return on investment (ROI) ratios (such as return on capital employed or return on assets) and incentivizes the OFS company to improve performance to maximize its return.
- Outcome-based pricing models: In this approach, OFS companies provide products and services with payments linked to specific performance metrics, such as equipment uptime or total production. This model can reduce upfront costs for customers, transfer some project risk to the OFS company and incentivize it to improve performance, reduce hidden costs and time (since performance is the focus, not adherence to service-level agreements), and improve overall execution.
OFS companies can also create a competitive advantage by changing the way they provide products and services, such as:
- Integrated solutions: By providing multiple services through a single contractual structure, OFS companies can simplify the procurement process and reduce the number of interfaces for customers. Greater project coordination can be achieved by better alignment between the OFS company and operator. As OFS companies gain a deeper understanding of the development concept and how various components are linked, the project design also sees significant development. Enhanced performance, as a result of the better alignment between the OFS company and operator results in stronger financial prospects and greater accountability, including faster response and reduced downtime. OFS companies and their customers who have adopted this approach are seeing significant improvements in production and length of field life, as well as improved efficiencies and reduced capex costs.
- Standardized and modular solutions: By collaborating with customers to standardize specifications for equipment and packages, OFS companies can easily replicate previous designs, saving time and money. This strategy can reduce project costs by as much as 20% — streamlining decision-making, enhancing collaboration between contractors and the project team, fostering cross-functional integration and information sharing, and improving overall sanctioning economics.
Recognizing and overcoming challenges
Innovating and problem-solving together with partnership can deliver substantial benefits. In fact, we are beginning to see OFS companies and their customers achieve positive results with these strategies. But a key element of this approach is customer intimacy — knowing and understanding the customer’s goals, objectives and challenges overall, and for each project.
This level of engagement requires OFS companies to have much deeper commercial and organizational capabilities. It’s a shift from a “sales” model to a more collaborative relationship — that is, “partner” versus “customer.” That’s a structure and mindset that OFS companies will need to develop in the years ahead.
This will be a significant challenge, and at times, even more difficult for OFS companies partnering on a tender or project, where they offer clients a one-stop-shop and outcome-based pricing — such as a fixed fee for products, including installation. In such a case, providing a competitive bid, price risk contingencies and agreeing on which company pays penalties in case of delays or other issues can be complicated, given the number of dependencies. This requires building the relevant commercial capabilities as well as developing integrated teams, as opposed to two organizations operating in silos.
At the same time, the emergence of digital technology can help OFS companies reduce the risk of these types of business models and achieve better performance gains. Creating digital ecosystems across the value chain — linking operators, drillers, well servicers, logistics companies and OEMs — can drive performance by capturing equipment data to predict failures, well data to create standardized designs and forward-looking drilling data to forecast logistics requirements.
However, companies must be willing to invest in technology to support digital capture and data analytics — and just as important, be comfortable giving up proprietary control of that data. That will require a change in thought process for many in the industry.
Another challenge is that these models require OFS companies to take on new risk. Risks increase as OFS companies move from a fee-for-service model, to fee-for-service plus KPIs, to partnerships, to turnkey solutions and finally to equity positions. OFS companies that are ready to accept these risks must have the opportunity for significant upside. Creating operating structures and associated contracts that benefit both OFS companies and operators should be the overarching goal. Sustainable, long-term “win-wins” will create maximum value for everyone over time. This is even more important as shifts in business models potentially erodes revenue for OFS companies across a number of contracts. Therefore, they must obtain significantly high cost savings.
It’s important to note that these strategies are not suitable for every region or play, due to the unique characteristics of each market. OFS companies must carefully study the value chain characteristics, risk profile and financial feasibility of projects before deciding which model might be best applied. In general, markets at opposite ends of the spectrum offer the best opportunities for creative approaches — these include mature markets with geopolitical stability and a competent supply chain, or immature markets with limited infrastructure and capabilities. OFS companies must conduct due diligence before moving forward!