Oil and commodity markets have already taken massive knocks as the spread of Covid-19 accelerates globally. The full impact of the pandemic and reversal of OPEC+ production cuts are yet to crystallise, but it is clear that the upstream sector is in for a tough and challenging period.
Operators and supplier are facing difficult decisions regarding investments, dividends and day-to-day spend with little certainty as to when things will improve. Unexpected external events like this are a fundamental feature of the oil and gas industry. The breakdown in the OPEC+ production cuts rams home the point that operators and investors cannot solely rely on the oil price to deliver sustainable returns.
Operators need to continue to focus on cost discipline for some time but now, more than ever, they must set their sights higher.
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Over the past few years, the global upstream sector has had a bumpy ride. Since prices collapsed in mid-2014, the sector has been on a robust cost reduction drive. This has largely been a success. Unit development costs came down by as much as 50% and the industry proved it could make big gains in productivity by embracing new technology with a relentless focus on costs.
The flip side has been that the service sector supplying to the oil operators is still on its knees financially. Margins have been compressed and investment in new capacity scaled back.
Respondents to our global upstream cost survey showed us their thoughts as they were at the end of 2019.
Operators and suppliers that we surveyed expected gradual cost growth for the next 12 to 18 months. And that view was supported by our data. Underlying cost drivers for the major inputs to upstream equipment were projected to increase, broadly in line with general inflation.
Of course, this view has been made redundant by recent market events and the prevailing market uncertainties. Not least a sub-$35 oil price. The focus for all industry players must be not just on controlling costs, but in getting leaner in order to at least be sustainable at or close to these price levels.
Opportunity remains to reduce costs if you know where to look. Some operators have only belatedly taken up rigorous cost reduction. This now becomes more essential than ever. The challenge for all operators is to look forensically and rapidly across the cost base to identify and deliver sustainable cost reductions.
The step down in commodity prices will create opportunities to rebase prices, but this time round the supply base is unlikely to have the margin cushion to be able to absorb blunt price cuts.
All the signals are that cost management is going to be at the top of the agenda for some time to come.
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