Growing Champions: Staying on top of tumbling oil prices

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MALAYSIANS may be celebrating lower petrol prices at the pump, but what do falling prices mean for the industry and its players? One thing for sure is that the oil companies need to revise and implement winning strategies to stay on top of tumbling oil prices.

The industry’s immediate response to falling oil prices has been to cut costs out of its supply chain. This means falling wages and margins, companies in debt crumbling under pressure, and investors feeling the domino effect. Already, global players such as Total SA and ConocoPhillips plan to cut costs and investments by 10% to 20%. At home, national oil corporation Petronas plans to cut operating and capital expenditure by 30% and 15% respectively.

Over the last 10 years, production at some of Malaysia’s major oilfields has declined. Nearly all of the country’s oil comes from offshore fields and the pressure of lower prices would be mostly on upcoming production. To extend the production life of some of the oldest oilfields, the government had encouraged investment in several enhanced oil recovery projects, such as the Tapis oilfield, where ExxonMobil and Petronas are working together.

Also in the works are the development of small/marginal and deepwater fields, such as Shell’s and Petronas’ investments off Sabah and Sarawak. The current low oil prices mean that globally, 65% of projects such as these could become unviable. Investors fear that they may not even reach the breakeven price of oil, necessary for a project to produce reasonable returns.

A sustainable long-term price for oil can help mitigate these circumstances but it is tricky to predict. The drop in prices to the US$70 to US$80 per barrel level was supply driven, but the plunge to the US$45 to US$50 range was due very much to a weakness in demand.

Spurred by the sky-high oil prices early last year, US and Canadian companies decided to drill for more crude from shale formations, which became commercially viable, while weakening economies and regulatory changes meant lower demand from Europe and Asia. By early 2015, overall supply worldwide was significantly higher than demand.

It is possible that prices will rise at the first sign of growth in demand and move back to the “old normal” of US$90 to US$100 per barrel. Most oil-producing countries need this in order to balance their budgets but if the current cost-cutting is sustained and leads to a 15% to 20% cost disinflation in the industry, a US$70 to US$80 a barrel range looks the more sustainable long-term price.

Until prices reach these sustainable levels, companies need to do more than just cut costs. They have to adapt, increase efficiency and be ready for the future. This is the time to review portfolio investments and accelerate savings across the board.

BP recently highlighted 60 “simplification” measures, including a cut in capex of roughly a fifth and writing down US$3.6 billion in assets. In parallel, companies must closely monitor supplier health and evaluate the risks of failure.

Petronas , for example, has decided to stop awarding contracts for small/marginal fields to third parties and is even looking to renegotiate existing vendor contracts to further reduce costs. While these measures will certainly help in the short term, it is important to monitor the long-term effects of such measures.

Large players like ExxonMobil, BP and Chevron have all announced plans to divest assets and non-core operations to re-balance their portfolios. Some companies are also rethinking their business model. ConocoPhillips recently spun off its refining, transport and chemicals business into a separate entity while BP established a separate entity to manage its US Lower-48 operations.

On a strategic level, times like these also provide the perfect opportunity to acquire potential targets at better prices. Companies with strong balance sheets operating in low-cost basins can scoop up assets from those with less liquidity.

For service or consumer companies, it’s key to identify pricing opportunities with suppliers as well as customers. Decode what lower prices mean for demand and then target the segments where lower oil prices have boosted demand. It is also important to reorganise talent according to efficiency, which will ultimately increase productivity.

High levels of storage and continuing overproduction could mean that oil prices may not rise anytime soon. On the other hand, efficiency measures and increasing shale production could force a lower “new normal” price for the next four to five years. Either way, this is not the time to batten down the hatches and wait for the storm to blow over. This is an opportunity — to adapt, to reinvent and to emerge stronger.

Rick Ramli is a partner and managing director at The Boston Consulting Group, Kuala Lumpur

This article first appeared in Forum, The Edge Malaysia Weekly, on April 13 - 19, 2015.