Mega Projects: Keeping On Track When Oil Price Is At Rock Bottom

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8over8 Ltd
07/15/2016

In June 2014, even when Brent prices were collapsing, the industry still did not believe that they could fall below US$50, but as the supply surplus grew, prices continued to drop.

Early in 2015, the unthinkable happened, with prices falling below the US$50 mark, lower than they had been at any time since April 2009. But this seems like a very long time ago now, as fears relating to sanctions being lifted on Iran and Iranian production adding to an already stark supply surplus drove the market below US$30 per barrel in mid-January 2016. That’s around a 70% drop in prices since the same time last year.

The current debate about the rationale for this price collapse centers on politics—OPEC and the West and the market economics of changing supply and demand in light of the surge in non-OPEC supply.

Despite falling prices, OPEC has stuck rigidly to its production quota of 30 million barrels a day, making it very difficult for smaller suppliers to compete. And the growth of US shale oil has contributed to a global surplus. While demand remains strong in some areas in the world, the slowing of China’s economy has had a significant impact in this major consumer’s buying capability, and then there is Iran. With promises of production levels of 500,000 barrels a day once sanctions are lifted, the gap between supply and demand seems set to widen even further.

With these price changes affecting all aspects of the upstream oil and gas sector, it’s now more important than ever to ensure that you run a tight ship, being creative in establishing ways of improving “value” to validate the business case for new and existing projects to continue.

Operators are looking to the supply chain for cost efficiencies, asking for discounts, and focusing onlower prices for services and goods supplied. However, there is a near-term opportunity to achieve higher value by improving contractual risk management in projects and operations which could lessen the risk of costly overruns. This can be accomplished by identifying new efficiencies in the management of contractor design and contractor construction interfaces, enforcing discipline in managing change orders and claims, improving the FEED definition, and streamlining contract execution.

Upstream oil and gas players can no longer afford to ignore their contractual risk management strategies as profit margins disappear. Significant sums were allowed to leak out from capital projects during the boom times as a higher priority was often placed on completing on time rather than onbudget. Now is time for a more watertight approach, one that engenders trust and confidence, as history is littered with poor capital discipline and significant cost overruns. And, if the statistics cited by EY, of almost two thirds (64%) of multibillion-dollar, technically and operationally demanding megaprojects exceeding budgets is accurate, then this cannot come soon enough.

McKinsey advised that managing the interface with your contractor is key to effective risk management in capital projects. This interface is the beating heart of oil and gas projects and disciplined management of the volume of communications, documents, change orders, and contractually significant authorizations that flow across this interface has been proven to create significant value. While a focus on capital discipline flows from the strategic level, it is in practice achieved through constant disciplined engagement with the contractor and enforcement and adherence to best practices.

Capital discipline is the new mantra as operators rush to cut costs and reduce capital investment levels. The cynics who assured us all that the oil price slides in 2014 would be short-lived are quiet now, as some analysts suggest that the price slide may well not be over yet.

There is no certainty at present as to how low prices will go, but enhanced contractual risk management is an assured value generator for all oil and gas projects in this new low price era.

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