Commodity price volatility has thrust cost management to the top of the boardroom agenda as global oil and gas companies have grappled with how to improve margins in a low-price environment. In fact, EY’s recent Capital Confidence Barometer revealed a more than threefold increase over the last two years in the number of oil and gas respondents with a primary focus on cost reductions and improving operational efficiencies. For many, that effort focused on portfolio optimization. News of project deferrals and even cancellations soon followed.
Capital projects are a particular sore spot for the industry. EY analysis of 365 projects found that 64% faced cost overruns and 73% reported schedule delays. And, as if that’s not bad enough, the average cost escalation sits at 59%. Such overruns were damaging during the period of high oil prices; now they’re fatal. Companies can’t afford to leave that kind of cash on the table.
But portfolio optimization alone is not enough. Planning effectively for the future is increasingly difficult. A portfolio optimized for a high oil-price environment is unlikely to be optimized for a US$50/barrel oil-price world. Compensating for uncertainty requires companies to evolve their approach to portfolio management and embed optionality.
Optionality, or flexibility, enables companies to quickly and efficiently shift their focus from underperforming assets or projects to better-performing ones. Embedding flexibility is not as easy, however. Assets are often inflexible, with significant lead times and decades-long capital commitments. Optionality is even more challenging when you consider the short-term investment horizon of investors. But that doesn’t mean it is impossible.
The third report in EY’s Capital Project Series, Portfolio management in oil and gas: building and preserving optionality, shows how companies can embed optionality into their organizations at the corporate, portfolio and project level. At the corporate level, it involves creating an adaptable legal and capital structure, a strong balance sheet and access to a wide range of financing options. At the portfolio level, companies can enhance optionality by ensuring decisions on projects, and assets are considered in both absolute and relative terms against criteria (hurdles) and each other (ranking). And optionality at the project level depends on a commercial and capital structure that allows for flexibility from the beginning.
Having optionality at each of these levels gives companies the flexibility they need to respond to sudden market events. That translates into better returns and, ultimately, satisfied stakeholders. It can also mean the difference between surviving and thriving amid uncertainty. After all, volatility is the one thing we can be sure to expect in the future.
Andy Brogan is the Global Oil & Gas Transactions Advisory Services Leader for Ernst & Young LLP. He is based in London. For more information and to access EY’s report, Portfolio management in oil and gas, visit ey.com/oilandgas/capitalprojects.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.
