Cost optimisation strategy as a panacea for the oil & gas industry – A supply chain perspective

Typical of every shock interject in an ecosystem, COVID-19 has spurred our thinking to re-evaluate how we work, live and interact with each other. It bears similarity to how geological dykes can sometimes affect an entire body of sedimentary strata, subsequently allowing for systemic metamorphism. The sharp intrusion of the molten magma creates a metamorphic reaction, thus changing the chemical component of the intruded rock and forming the inevitable – a dyke.

The oil industry has perhaps, among all industries, taken the greatest hit as a result of this “biological dyke” called COVID-19; reflected by a period of low Energy pricing, low Energy demand, deferred projects and low revenue generation, and as such has altered the most fundamental reasoning of how oil is produced.

This systemic metamorphism as a result of COVID-19 means that the oil and gas industry needs to start thinking of innovative ways of staying afloat, reinvent and sustain itself against both natural and unnatural existential and sudden threats. For Nigeria, the critical path to managing this metamorphism is delineated in three strata: Project prioritisation – Project economics, Cost structure and contracting process and Supply chain optimisation and Fiscal reform.

Regarding project economics and management and Fiscal reforms, it’s imperative that the industry players and its bloc assess what projects to bring on stream, and what to defer to a time of boom. Issues revolving around cash flow management and risk management of assets must be thoroughly assessed. The Nigeria Petroleum Industry Bill being the critical element needed for fiscal reforms and investment development industry should be passed. A phased reformation approach should be adopted.

With deference to Cost structure and Supply chain, the systemic metamorphism due to COVID-19 has opened our eyes as to the intrinsic cost of the “oil per barrel”. In 2016, the Wall Street Journal reported that the United Kingdom, Brazil, Nigeria, Venezuela, and Canada had recorded the costliest production while Saudi Arabia, Iran, and Iraq were attributed with the cheapest production costs. Nigeria’s projection as at 2016 was circa $29 per barrel while countries like Saudi and Iran estimated costs that hovered around $10 per barrel. From all indications, it seems the cost price projection by the Group Managing Director may have been driven primarily by the cost structure implemented in Saudi Arabia, the Republic of Iran and Iraq. Nonetheless, I rather would recommend a cost optimisation strategy rather than a cost reduction strategy for one crucial reasoning. In optimising cost, you are perceived to be more agile and progressive rather than reactive and offensive.

While many clamours that some of the biggest estimations of the cost per barrel of crude oil are largely driven by Human resources, analysis have shown that the actual supply chain cost per barrel for Nigerian Brent crude accounts for over 70 percent of the total cost, which is inclusive of capital cost, production cost and administrative cost. It’s now pertinent that to effectively impact the cost price we need to optimise what drives the cost. Thus, a spend analysis by category management needs to be assessed by all.

To address this, we need to know the elements of the cost structure; such as the exploration cost, drilling cost, production cost, Transportation and other ancillary services attached to the aforementioned categories. Today, drilling costs seem to account for the largest portion of the cost per barrel, and as such, this is one major area of the total spend that needs thorough addressing. Currently, the Nigeria Rig count as at March 2020 reveals one (1) Drill-ship, several Jack-up rigs and Land Barges/Rig.

Are we getting the best competitive international pricing for our rigs? Are there alternate investment models for the Drilling business worth the time and attention of the NNPC? Can we set up a JV structure that the NNPC or its Upstream Subsidiary and International drilling Rigs Company can syndicate with a view for a long term strategic alliance. Such alliance will ensure joint interest for a long term acquisition of a new Asset (Jack -up or Drillship alike)  that could be translated to a model similar to BOT, but with some tweak that allows the technical partner to continue to operate whilst ownership is transferred to NNPC after payback period of initial investment.

we must recognise that cost reduction isn’t a sustainable approach as it’s largely influenced by the oil price. The era of a cyclical cost nature must be considered obsolete and intentionally eradicated. Cost optimisation, however, perhaps is a rather slow process, however, it sure brings long-term solutions and provides the necessary sustainability the industry requires

As at 2019, the cost of a new build Jack-up was circa $150 million, and it’s worth noting that a 49 percent interest in such an investment would amount to a circa four-year day rate of today’s Jack-up drilling rate. It typically means that for circa ten years, the total cost of the rig would have been fully paid, and it can thus become not only a money-spinner for the government but translate into a rig supply security for the country. Imagine what Nigeria would gain if we invest in three units of such assets from three different international partners just for risk management.

This is just one of the many optimisation strategies which the NNPC can review for its cost optimisation. To take this conversation further, I have coined what I called the 3C’s on cost optimisation that works and could be used by the NNPC in sustainably reducing the cost per barrel. They are Coordination, Cooperation, and Collaboration.

While the first C largely reflects supply chain internalisation and optimisation, the other two C’s tend to extend to Suppliers, development partners and other stakeholders at large. The three C’s encapsulate most of the elements of a sustainable supply chain practice which has become the going trend.

I believe that the first form of cost optimisation should start from the local E&P companies within the NNPC portfolio. Supply chain coordination means that NNPC can strategically and effectively understand and know the cost of each activity in its supply chain, hence extract the optimisation value therein.  For example, aside from drilling costs, what other cost category accounts for the top 20 spend in the NNPC operations. What quickly comes to mind are Catering, Logistics (Yard and Transportation), OCTG, and HSE spend, and that’s all great. However, are there other subtle spends but that are likewise salient by implication such as Fuel Cost and multiple offices – therefore, a complete spend analysis review needs to be urgently done to take account of every variable and effectively manage the process.

Are there opportunities for logistics optimisation (streamlining yard location from multiple to one or two locations, Freight)? Another area of optimisation is Inventory management; currently, what is the total cost of inventory for NNPC’s upstream operations? Are we carrying obsolete items and implying them as real inventory? How do we best optimise our contracting process to ensure we reduce significant waste and trim off cost escalations due to lead times for execution and payment terms? Have we invested enough in the supply chain team in a way as to drive the optimisation process?

Essentially, Coordination encapsulates what strategy to execute in our stakeholder engagement for cost optimisation. Just asking a supplier or development partner to reduce cost isn’t the best strategy to adopt at this time. We must engage from the position of knowledge and infer the incumbent value thereof.

Secondly, “Cooperation” requires that we engage other stakeholders in the value chain in optimising cost. Having strategically coordinated what we spend, and how we can optimise the different cost structures, the first level of stakeholder engagement must be harnessed. The approach to negotiating the best deals must come from a perspective of data analysis. Where are we? What can we achieve, and at what point in the deal structure does a development partner or supplier come in? To effectively get in the best result, a strategy for cooperation must hinge on internalising supplier relationship models rather than coercion.

Cooperation models should be implemented in bottlenecks and non-strategic service and procurement services. We must harness the use of some items interchangeably by development partners; OCTGs should be procured for Project A, and if not in use can as well be used for a Project B with a separate development partner. Instrument Exchange Portal through a cost unitisation model can be explored by development partners for the procurement of relevant materials. This can be achieved when we know the actual size of the inventory we have in-country by the development partners and National E&P company. Germane ideas of cooperation can also be heard from the stakeholders’ industry, analysed and implemented via an Industry Stakeholder Engagement.

Furthermore, “Collaboration” requires that we translate ideas centred on cooperation into real actions. Critical items and critical services in Drilling and Production and Transport operations are areas that can be raised by pillars of intentional collaboration. We must, therefore, seek to work with development partners and relevant service operators in the industry.

One major area the NNPC should look at is the rising cost of Logistics because it’s a potential area of collaboration between Ports Authorities, concessionaires and the State Government. We should synergise possible double tax structures and excess rent-seeking from Logistic operators. As earlier mentioned, we must seek alternative ways of providing drilling services and production services with a mindset of facilitating long-term investment that translate to lower cost of operation overtime. The industry must find a way to collaborate with local content partners in providing sustainable pricing for its services.

Lastly, we must recognise that cost reduction isn’t a sustainable approach as it’s largely influenced by the oil price. The era of a cyclical cost nature must be considered obsolete and intentionally eradicated. Cost optimisation, however, perhaps is a rather slow process, however, it sure brings long-term solutions and provides the necessary sustainability the industry requires. We must also do this with the mindset of creating sustainable development by ensuring that our people, the environment and other stakeholders are epitomised in our cost optimisation model.

Eboagwu is a Supply Chain Consultant for the Oil & Gas Industry and writes from Lagos and could be reached via Twitter @mekzyking01, email: [email protected]

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