Weathering the weak O&G market conditions

Weathering the weak O&G market conditions
-A +A

To help oil and gas (O&G) players plan their resources and investments better, Petroliam Nasional Bhd (PETRONAS) has released to the public its second Petronas Activity Outlook (PAO), which outlines the local O&G activities between 2018 and 2020.

On top of giving O&G companies a heads-up about potential job opportunities during the period, the effort is also aimed at encouraging supporting sectors such as banking to participate in the sector. After all, the prolonged period of low oil prices since 2014 has changed the behaviour of stakeholders in the industry.

Oil producers around the world have been cutting costs, diversifying their operations and innovating to tackle the challenge. Shale producers in the US, meanwhile, have remained competitive by maintaining leaner operations, even in a US$50 a barrel environment, which is far from the days of US$100 a barrel oil.

For the oil majors, diversification is also a practical strategy to maintain their position in the energy market. According to Bloomberg, Royal Dutch Shell Plc expects to spend as much as US$1 billion annually in renewable energy by the end of the decade. Meanwhile, Total SA had made the shift earlier — it spent £800 million (RM4.39 billion) to acquire a 60% stake in SunPower Corp, the second largest solar panel manufacturer in the US, in 2011.

In both senses — cost optimisation and portfolio diversification — Petronas, too, has done well to continue maximising the returns of its integrated O&G value chain, including expanding to participate in the complete cycle of the industry.

In 2008, it acquired FL Selenia SpA — Europe’s largest independent producer of automotive lubricant and other functional fluids — and consolidated it with its own lubricant business, forming Petronas Lubricants International. PLI is now among the top 10 global lubricant companies, with markets in over 100 countries.

Petronas also found a cost-effective solution to simultaneously improve its global branding and technical capabilities in the global downstream arena with its participation in automotive sports, namely Formula One.

The continuous efforts put into this venture — beginning with sponsorship in 1995 — has led to the O&G firm becoming the technical partner of the Mercedes-AMG Petronas Motorsport F1 Team, which clinched first place in both the driver and constructor categories for the fourth consecutive year in 2017.

It has been a conscious effort by Petronas to expand its footprint in the right direction. In recent years, the company has further increased its exposure to the downstream segment, in a bid to balance its portfolios along the O&G supply chain.

The development of the US$27 billion (RM113.2 billion) Pengerang Integrated Petroleum Complex in Johor, for one, will provide a “natural hedge” against the prolonged low oil price environment, according to Petronas president and group CEO Tan Sri Wan Zulkiflee Wan Ariffin.

“We may also be looking at other businesses other than O&G, such as renewables and new energy,” he told reporters during the company’s results briefing for the first half of 2017 back in August.

The way Petronas presents itself as an integrated O&G company will consequently set an example to local oil and gas services and equipment (OGSE) companies.

The call for transformation had been made by Petronas as far back as when Tan Sri Shamsul Azhar Abbas was its CEO. While the market has seen hurdles in the process — such as the unsuccessful merger between UMW Oil & Gas Corp Bhd, Orkim Sdn Bhd and Icon Offshore Bhd — they have become the catalysts for growth for others, such as Seamog Group Sdn Bhd.

Group managing director Sofiyan Yahya said Seamog, despite being a new company, is a great example of industry consolidation, having grown to integrate four companies of different expertise. These range from project management to integrated operations and even Internet-of-Things (IoT) solutions.

Seamog’s consistency in searching for new opportunities and business innovation has been the key to its success, said Sofiyan. “From the example of my own company’s growth, the experience from the projects won locally, we have now worked in the Philippines, Brunei, Sudan, UAE, South Korea and Iraq.”

The push for OGSE to be competitive is also relevant for another reason, he added.

“In many countries, the tendency is to end up with a few large local players monopolising the industry at the expense of smaller players.

“One key contribution from Petronas is the governance of how the licences are issued, thus contributing to the growth of local players — there is room for small and large players as they serve strategically across the value chain, and Petronas has managed it excellently,” said Sofiyan.

One way Petronas has done so, he continued, is through its decision to make its latest activity outlook publicly available. He opined that information from the 2018-2020 PAO — combined with industry dialogue sessions — gives “genuine players” a chance to formulate a sustainable plan, and to “tweak where necessary”.

“[This is] especially when the activity outlook is not as upbeat as the industry had hoped, though not unexpected,” Sofiyan said, adding that companies can decide on the redeployment of their staff and assets, determine the direction of their business, expand in new focus areas identified in the PAO, and seize opportunities for consolidation.

“In the past, there was little look-ahead to help steer and encourage such decisions among potential strategic partners,” he said.

Another big step being undertaken by Petronas is the extension of its Cost Reduction Alliance (CORAL), the first stage of which was implemented from 1994 to 2005. CORAL 2.0, which commenced in 2015, is a demonstration of the seriousness of the company and other O&G companies involved to weather the downturn.

The five-year upstream cost reduction programme has 11 core initiatives to reduce cost and increase revenue, including the optimisation of maturing fields and reduction in drilling costs. Wan Zul said it should be the “standard way of how the O&G industry in Malaysia operates”, irrespective of the oil price levels in the future.

Through the initiative, Petronas also adopted a higher degree of digital implementation, such as in its sourcing and procurement processes. This can be seen in substantial savings during cost benchmarking and technology replication, to name but a few, according to Accenture Strategy.

Petronas has set a target of at least RM4 billion in annual financial returns from CORAL 2.0 by 2019. The targets are high but the results have been very encouraging — it has cut costs by RM5 billion in three years between 2015 and 2017.

From the three-year total, RM2.6 billion was from initiatives in 2016 alone, of which 15% or RM411 million was gained from technology replication that ties back to the digital approach.

“In CORAL 2.0, Petronas worked with PACs and service providers to create a collaborative environment that drives optimisation in the Malaysian upstream O&G industry,” said Accenture Strategy managing director Sven Ruytinx.

The partnership, said Ruytinx, allowed Petronas to consistently introduce structural changes from a digital perspective. “More importantly, it has also changed the mindset of the industry to be more cost-conscious and transparent in its way of working,” he added.

Navigating uncertain waters ahead

During the good times in 2012, Petronas reportedly awarded RM52.48 billion worth of contracts to companies that are majority owned by bumiputeras — almost double the RM29.35 billion given out the year before.

But as upstream investments have yet to recover to their pre-glut levels, some local OGSE companies have taken the cue from their international peers and Petronas to stay resilient.

Serba Dinamik Sdn Bhd, for example, has chosen to adopt an asset-owner business model to remain sustainable. Leveraging its capabilities, the group has invested in a compressed natural gas (CNG) plant in Indonesia, three hydropower plants in Sabah and a water works project in Terengganu, to name but a few.

Coupled with the recent stabilising oil prices, the higher transparency of the local O&G market — as advocated by Petronas — should allow local OGSE companies to better prepare themselves for the opportunities or challenges ahead.

But with 4,000 companies in the sector registered with Petronas, there are challenges in terms of competition and job availability. Even if only 2,000 remain in operation, the figure would still be far from ideal.

Norway, for example, had only 700 firms at the end of last year. This is despite the country having proven oil reserves that were 1.83 times the Malaysian oil reserves of 3.6 billion barrels as at the start of this year, according to data from the US Energy Information Administration.

“Industry transformations and reforms are never easy and straightforward — you will have winners and losers in the process,” said Boston Consulting Group Sdn Bhd managing director Rick Ramli, who is also a core member of Energy and Public Sector practices in the consulting firm.

For the diverse Malaysian OGSE sector, Rick said it is critical to ensure that any reform approach does not end up as a “one size fits all” model, but rather one with a clear appreciation of the distinctions between individual segments.

“Adjustment also takes time. It is important to stay the course, even if in the short term we hear more from those negatively impacted by the reform measures than those positively impacted.

“In the end, we will have a much stronger, competitive and vibrant OGSE industry,” said Rick.

The international market has seen a number of mergers, prompted by the low oil price environment and the need to be more efficient. In May last year, there was a US$13 billion merger between US equipment manufacturer FMC Technologies Inc and offshore drilling installation expert Technip SA. The merged entity, TechnipFMC plc, expects to shed US$200 million in annual costs as early as next year, and a further US$400 million in 2019.

Could local firms emulate this success? Analysts said local players are still valuing their assets based on their peak prices, and are holding out for better value. This strategy is not likely to pay off as time is not on their side.