Oil & gas companies that develop capital effectiveness will enjoy an advantage over their peers, says Michael Matthews, VP, (Strategy & Consulting), Enstoa.
In response to the collapse of oil prices in 2014 and the continuing low price environment for natural gas, leading US oil & gas companies have concentrated on improving their capital effectiveness and delivering more value with less investment.
How have these companies improved their capital effectiveness, and what can your company do to achieve similar results? This is a real challenge for many companies, as many projects fail to deliver their expected value with the majority exceeding budget and/or schedule. (i) This dubious performance leaves oil & gas CEOs and CFOs with limited confidence to pursue capital projects compared to other investment options.
A recent study of the upstream oil & gas sector found that the companies that evaluated and funded the right mix of projects that aligned to their strategy and then executed them faster and more cost effectively than their competition delivered two times (ii) the returns on capital employed (ROCE) than their peer average. Investing less capital and turning more profitable revenue from new oil & gas assets faster than your competition is Ã´capital effectivenessÃ¶ capability. As an asset intensive industry, capital effectiveness capability can be critical to your company’s success.
Capital effectiveness challenges present themselves in three primary scenarios that expose an organisation’s shortcomings delivering projects. These scenarios are the ‘Mega Project,’ the ‘Program,’ and the’Capital Intensive.’ Each presents unique challenges that often result in delays and overruns that erode confidence in investing in capital projects.
The Mega Project: This scenario is classically defined as a project exceeding $1 billion. But it applies when any company undertakes a project that is orders of magnitude larger than their typical project. In this scenario, it is the scale, complexity, and magnitude of risk that overwhelms the organisation.
The Program: This scenario is similar to the Mega Project in that it represents a marked increase in capital spend, but it is invested in a collection of projects versus a single Mega Project. In this scenario, the collection of inter-related projects exceeds the capacity of the company’s teams, processes and systems.
Capital Intensive: This scenario represents companies that maintain high levels of capital investment as normal business ranging from tens of millions to billions of dollars. The challenge presented by this scenario is large variability in project performance and consistent overruns and delays.
For oil & gas companies, developing and executing capital projects is not part of the core business. But those that develop capital effectiveness capability enjoy a distinctive competitive advantage by delivering more value through projects that realise twice the ROCE of their peer companies. The key is to determine what capabilities you must develop and maintain to secure that advantage. For each scenario described above, successfully executing a growth strategy can be accomplished by aligning the organisation’s capital effectiveness capabilities with the appropriate project delivery strategy.
Bridging the gap
Capital effectiveness capability is the combination of people, processes and technology that an organisation possesses to evaluate, fund, plan, and execute projects to deliver new assets. Most organisations do not possess the full capability to fulfil all of the design, engineering, procurement, construction, and manage-ment requirements necessary to develop and execute projects.
To bridge the capability gap, the company must define a project delivery strategy and execute contracts with engineering and construction companies. Projects typically fail when there is a disconnect between the organisational capability and the project delivery strategy selected to deliver the Mega Project, the Program, or the Capital Intensive scenario.
Research (iii) has found that project delays and overruns are overwhelmingly caused by management failures related to aligning capability and delivery strategy. A root cause of this failure is that delivering projects is not a core business function.
This leads to a critical question:
How do I align our capital effectiveness capability with our project delivery strategy to maximise ROCE and deliver two times the value of my competitors?
At its core, capital effectiveness is the act of managing risk, and capital projects are just inherently risky. When projects are funded, they typically have a confidence of 15 per cent for cost and schedule certainty, and there is a wide range of risk factors that can impact the project outcome. Recognising this inherent risk is central to establishing the capital effectiveness capability needed to deliver higher ROCE.
This can be accomplished in three straightforward steps:
1.Consistently follow project and portfolio management processes that span the complete project lifecycle and seamless turnover to operations, and that integrate with corporate back office functions (e.g., finance, procurement & supply chain, legal, and human resources);
2.Develop the project portfolio management skills required to execute the processes and oversee projects. People are the heart of capital effectiveness;
3.Maintain an enterprise project management system that enables the processes and organisation to manage both the project portfolio and individual projects.
Delivering Capital Effectiveness
Capital effectiveness capability is readily attainable for oil & gas companies that recognise its value and commit to developing and sustaining the capability as a part of any growth strategy. Realising twice the ROCE is a distinctive competitive advantage that is being pursued by the top oil & gas companies. Aligning your strategy, capital effectiveness capability, and project delivery is a proven approach to make your company distinctive and a leader in the oil & gas sector.
The Construction Productivity Imperative,’ McKinsey & Company, July 2015;’Correcting the Course of Capital Projects,’ PricewaterhouseCoopers, LLP, April 2013; Ã´How to boost capital project performance,’ Accenture – Outlook Journal, Issue No. 3, 2013; Construction Industry Institute research.
ii.’Driving Value in Upstream Oil & Gas,’ PricewaterhouseCoopers, LLP, November 2013.
iii.’Capital Efficiency: Making smart decisions during uncertain times,’ PwC Executive Webcast Series, April 2015.
About The Author
Michael Matthews is Vice President of Strategy & Consulting, Enstoa. The company’s offerings include business consulting, data analytics, technology deployment and training.