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Enhanced profit recovery Sustaining the gains with capital efficiency

In today’s oil and gas markets we have seen both offshore and onshore capital investment strategies shift focus from reserve replacement and production volume growth to lowering their breakeven points through capital efficiency. As a result, leading companies have improved their ability to profitably develop assets in a wider variety of price scenarios. Sustaining this level of performance will require maintaining discipline even as prices recover above $50. We will outline key activities that can help companies avoid backsliding and continue growing their competitive advantage.

The rapid deflation in the price of crude oil from the 2014 highs of US$100+, through the lows of early 2016, to today’s levels above $50 resulted in major decreases in capital budgets and projects. This reduced volume of activity allowed for increased focus on cost transparency, productivity, and performance. For some mature E&P’s, the deceleration of capital projects in 2014 was accompanied by greater selectivity and capital discipline, resulting Many E&P’s that were able to survive at in the capital efficiency needed to survive $50 oil have reached the conclusion of throughout 2015 and 2016. Industry efficiently allocating resources to capitalize veterans who have lived through previous on opportunities as volume/activity oil slumps feel that the need for ruthless increases and maximize the return on selectivity and capital efficiency has never capital employed. These companies have been greater to sustain the gains that have doubled down on capital discipline in been made while activity and the volume 2016 and 2017 due to today’s “leaner for of work increases. longer” environment. Containing inflation in 2018 will require active portfolio With today’s market volatility comes management, demand management and the demand to adhere to stricter capital capital efficiency tenets, enhanced by and allocation policies, monitoring of capital embedding process and tools into standard investments, and more frequent capital operating models. allocation and reprioritization decisions. Large mega-projects, facilities, and drilling What is Capital Efficiency? programs were deferred or cancelled following the steep oil price decline. With From a capital project perspective, the ongoing uncertainty in price recovery, capital efficiency requires defining a clear Oil and Gas investors are looking for more corporate capital investment strategy; accuracy in project estimates and historic optimizing an organization’s portfolio cost information, to avoid deviations from to align with that strategy; developing the original budgets and business cases. In internal processes, procedures, and addition, these investors desire a higher capabilities to execute projects that degree of project monitoring, visibility align contract strategies; establishing of suppliers and 3rd party costs, and ‘bit how “value” is measured; and enabling to boardroom’ management reporting to technology with an organization’s measure capital productivity. capabilities and risk appetite.

PwC : Enhanced profit recovery The twelve elements of capital efficiency

Capital efficiency is required throughout organizations to better integrate strategy the entire asset lifecycle from strategy with planning and execution—through through execution. Benchmarking your measurement, feedback, and lessons organization against a standard framework learned—to better inform capital (see figure below) helps to determine blind allocation. spots where you can capture value and achieve the most benefit from your capital As an example, the ability to quantify the allocation strategy, selection, and project benefits of a capital project through value execution. measurement creates a more holistic basis to define how to measure value Understanding the unique dependencies and strengthen corporate strategy and between these twelve elements allows shareholder value.

Capital Efficiency is defined as the This enhances your ability to not only measure of a company’s ability to select, deliver projects on time and on budget, deploy, and manage capital investments but ensures you optimize your return on that maximize shareholder value. capital employed. Capital efficiency also requires the courage to abandon, suspend, or divest under-performing projects that no longer align with your portfolio or corporate strategy.

Containing inflation in 2018 will require active portfolio management, demand management, and capital efficiency tenets.

PwC : Enhanced profit recovery The challenges

What does capital efficiency Enhancing value and free cash flow look like? Capital efficiency is tailored by each oil and For an organization to achieve a high gas organization in terms of compatibility level of capital efficiency, it will need to with enterprise value, strategy and asset establish and implement a robust capital mix. To be more productive, capital decision and project lifecycle framework. projects and operations must be pushed to superior cash flow recovery. The ability A holistic approach manages projects in to influence cost reduction through a dynamic sense: they can be initiated, continuous improvement and lessons altered, maintained, suspended, learned depends on early intervention in and terminated based upon market, the well-field lifecycle. Efficiencies that competitive and internal environments. drive both cost and schedule reduction will By establishing these processes, optimize free cash flow and drive field, pad methodologies, and tools, your capital or wellhead profitability. investments are more likely to hit budget, schedule, scope and strategic targets. Capital efficiency in play Capital efficiency is driven by selectivity, From bit to boardroom not velocity. A key element of measuring capital project performance at the field, pad, well, Given today’s market conditions and infrastructure project, or portfolio level is the need for dynamic capital allocation, having sufficient granularity of data (cost, competitive pressures are forcing schedule, safety, quantity, quality) and management to improve productivity and integrated reporting and analysis tools. efficiency to drive and sustain profits. Removing subjectivity in the chain of Capital efficiency helps maximize returns custody, progress, and financial reporting on highly productive assets during periods ensures capital allocation or redeployment of reduced volume/activity. Capital decisions are informed with accurate real- efficiency is the result of cross-functional time data.

PwC : Enhanced profit recovery collaboration—in most companies there How do you stack up? is no single function which “owns” capital efficiency. When E&Ps attempt to scale Benchmarking internally, and among these benefits on an enterprise-wide peers is critical. level, integration of front- and back- office resource and cost systems becomes Capital efficiency is driven by continuous essential to enable bit-to-boardroom improvement initiatives as well as the use decision support to sustain these gains of external benchmarks. long-term. Ongoing measurement of value from In order to accomplish capital efficiency capital investment is standard practice. at this enterprise-wide level, leading This return fluctuates with commodity companies have been exploring the use price, resulting in inconsistent and of dynamic capital allocation, portfolio unpredictable revenue forecasts. optimization, predictive analytics and Successful E&Ps will differentiate emerging technology. Efficiency gains themselves from their competitors by have been achieved partially through optimizing the return from each capital enhanced oversight, decreased volume, dollar invested. allowing increased transparency and granularity of actual cost and production While each organization may measure data. Sustaining those gains will require capital efficiency in a different manner, sustaining the focus on optimizing the baselines have been developed in order to portfolio through techniques such as those compare organizations’ capital spending mentioned above. effectiveness. Other measures provide qualitative insight into an organization’s ability to manage its portfolio to better achieve capital efficiency.

The PwC capital efficiency framework provides a common framework for companies to to see where their strengths and weaknesses lie while establishing a fit for purpose operating model that drives capital efficiency.

PwC : Enhanced profit recovery Conclusion

Those in the oil and gas sector can of deploying capital to its highest and best safely assume there will be continued use. Capital efficiency is not “one size fits need for capital efficiency and increased all” and requires breaking down barriers productivity. Top performers will be in organizations to fully enable cross- measured by their ability to ride out the functional initiatives required to drive “leaner for longer” storm, while competitive improved performance, to sustain the gains forces and oil prices will challenge achieved during the recent downturn. companies to find new and innovative ways

Stay tuned for the next paper in our Enhanced Profit Recovery series

Contact

Anthony Caletka Reid Morrison CP&I Energy Leader US Energy Advisory Partner Partner (347) 574-2285 (713) 356-4132 [email protected] [email protected]

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