Headwinds Still Ahead for Oil Markets
June 9, 2020

The oil price is staging a remarkable recovery thanks to a few factors: OPEC+ not only sticking to agreed production cuts but extending those cuts, the country is slowly returning to work and seeing early green shoots of a demand-led recovery across many of the G20 economies, led by China.

Looking out at the July futures, we could get a little carried away thinking that we may have seen the worst and oil prices are recovering. We believe there are more headwinds ahead, leading to more downward pressure, with political challenges in the US,  Geo-Political tensions, US-China trade war, COVID-19, high levels of debt/leverage amongst Shale Operators, to name just a few of the potential headwinds. Given the events of the past few months, Shale Operators will see more bankruptcies and consolidations. The other big unknown rapidly approaching on the horizon will be the potential outcome of the U.S. Presidential Election in November.

The last three years have clearly shown that U.S. oil companies do not operate in a bubble where U.S. energy policies have been able to create a competitive advantage. We saw significant elements of the regulatory framework removed and the lifting of environmental restrictions on emissions to help the industry improve its competitive cost position. During the same period, consumer trends have driven down the consumption of fossil fuels considerably amidst increasing public acceptance and awareness of environmental concerns. Deregulation aside, consumer trends will drive further reductions in the overall use of fossil fuels over the coming years. If anything, COVID-19 has elevated the need and pace of change. Organizations and employees have seen personal productivity benefits of remote working, resulting in more permanent changes to work patterns. Consumers are driving auto manufacturers to deliver increasing choice and production of EVs, in turn driving down the prices and making EVs more affordable for the average consumer. There is the potential impact of the second coming of COVID-19, or a change in the White House at year-end with Candidate Biden, more likely to reverse some of the deregulations of the past three years. These are some trends that will determine what the oil patch will look like in the U.S. over the coming years. Add the debt/leverage issue mentioned earlier, and the oil industry could be in for a tough time.

Given the challenges ahead, Operators are working hard to develop and rapidly execute strategies to ensure that they avoid the fate that has befallen too many companies already this year. Some companies have developed and implemented Robust Operations Excellence Playbooks, continuing to thrive in challenging environments. Scale is going to be important, aligned with rigorous management of cost (operational and overhead), and optimizing working capital to create force multipliers.

When it comes to managing costs, organizations will have to think out of the box. It will come down to how rapidly and effectively organizations can deploy and utilize technology, AI/IoT, to support and complement the workforce.

Organizations no longer have the luxury of piloting AI/IoT; it is about rapid and widescale deployment. Options are no longer limited, many AI platforms are battle-tried and tested, deployed delivering results in all different types of assets across the world. Even for organizations utilizing Remote Operations Centers, there is still considerable additional opportunity for further operational and cost performance improvements using AI.

The same is true for Operations Excellence playbooks. Many organizations developed playbooks but continue to struggle with implementation. The other critical point often missed is that to complement the playbooks fully, there must be a rigorous review of current organizational constructs, hierarchies, job definitions, role profiles, roles and responsibilities. None of these are easy but critical and must be addressed simultaneously.

Working capital, which is a measure of a company’s liquidity, operational efficiency, and short-term financial health, has always been an essential tool in an organization’s armory. Healthy working capital levels create the foundation for organizations to invest and grow, making it all the more crucial to optimize the three pillars of working capital: accounts payable, accounts receivable, and inventory. Organizations must optimize these levers to capture cash to the balance sheet. In this current climate, it will be the difference between those that thrive, and those that struggle.

A survey of over 300 North American Oil & Gas companies shows there have been improvements in Cash Conversion Cycles (CCC), but still estimates $170B that remains untapped. Other industry experts have estimated this value to be upwards of $300B. Both numbers are massive and represent a cheap source of financing for capital allocation strategies, providing additional opportunities to deploy to generate positive cash flow from operations. The most significant portion of working capital is usually tied up in inventory, followed closely by accounts payable and accounts receivable. The table below displays the key working capital numbers.

Irrespective of what is happening in the overall market and with oil prices, it is always crucial to develop and execute a solid strategy which focuses on conserving cash and converting the cash tied up in working capital, as well as strengthening the balance sheet.

Historically, the oil and gas industry has been slow to adopt working capital optimization leading practices like many other industries. Some of these activities include:

  • Greater emphasis on cash visibility by finance and treasury of cash generated by, and deployed in operations, with frequently monitored KPI’s
  • Review of all capital investments that consume a large proportion of cash and reevaluate non-core expenditures Implementation of an enhanced cash management program:
  • –  Tightening controls around contracts with all suppliers and identification of overly favorable or non-conforming payable terms

    –  Better procurement management and inventory levels aligned with updated supply chain requirements

    – Improved processes around receivables to expedite cash collections and update credit risk exposure

  • Greater collaboration between field operations and support services
  • Introduction of innovative supply chain financing

Audere Partners has a record of successful accomplishments in rapidly extracting idle cash from balance sheets and improving key processes to ensure long-term sustainability. We have developed proprietary tools to evaluate the operating and working capital performance of individual companies relative to their Industry Peers, Industry Median, Top Quartile, and their Best Demonstrated Performance over the past five years.

There are also specific tools to quickly identify the available cash that can be extracted from every component of working capital and the management operating system to capture it successfully. The chart below identifies the range of typical improvements that drive a rapid and significant return on our projects.

Our recommendation, as always, is to ensure that organizations are implementing strategies that optimize value from every aspect of their value chain, probably more crucial now than at any time in the past.

 

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