Oil companies seek lasting cost cuts after crude price plunge

08:29 28 April in Latest News

As oil companies grapple with the consequences of the plunge in the value of crude over the past nine months, some are coming to a paradoxical conclusion: they may be better off when prices are low than when they are high.

This response to a 45 per cent drop in the price of their principal product might sound delusional. Oil has always been a business for optimists, but there are genuine reasons for the leaders of large international oil companies such as ExxonMobil, Total and BP to feel positive about the outlook.

The crude price crash has unleashed a concerted push by oil companies to reconfigure their own organisations, and reset relationships with suppliers and governments.

Above all else, there is a new found vigour to cut companies’ costs. When oil prices were high and rising, being cost-effective became less of a priority than making sure that the oil would keep flowing. Not any more. “The industry was chasing barrels; now it’s chasing efficiency,” says Daniel Yergin, vice-chairman of IHS, the research group.

If oil rebounds to, say, $80 per barrel, the companies could be more profitable than they were when it was $110.

Even when crude was at those higher levels the financial performance of the large international oil companies was unimpressive.

The average return on capital of the largest European and US oil companies dropped from 21 per cent in 2000 to 11 per cent in 2013, even though the average price of benchmark Brent crude rose from $29 to $109 per barrel over that period. Cost increases more than offset the rise in revenues.

Under pressure from dissatisfied investors, big oil companies had begun to take steps to tighten capital discipline and improve returns even before last summer. The collapse in oil prices has galvanised those efforts.

Patrick Pouyanné, chief executive of France’s Total, told the IHS CeraWeek oil industry conference in Houston last week: “We have to take this challenging period as an opportunity to clean up our industry.”

In Total’s case, that means lowering the price level at which revenue covers costs from $110 to $70 a barrel.

Mr Pouyanné says the whole company understands the importance of what they are doing. “It’s much easier, I can tell you, to mobilise at $50 per barrel than it was last year at $100 per barrel,” he adds. “Sometimes the executive committee had the impression we were not totally listened [to]. Today I am.”

Other companies are undertaking similar exercises. Stephen Chazen, chief executive of Occidental Petroleum, told the same conference: “You’ve got to be able to survive not just at $60, but maybe less.”

The simplest way for oil production companies to cut their costs is paying less to their suppliers. The large companies have been calling in all their suppliers, demanding cuts in rates, and the pressure on service companies is being reflected in large job cuts, with 20,000 going from Schlumberger, 10,500 from Baker Hughes and 9,000 from Halliburton.

More fundamentally, companies are changing the way they design and run their projects to make them more efficient.

Project costs can be significantly reduced by measures such as maximising the use of standardised designs, says Christian Brown, president of oil and gas at SNC-Lavalin, the Canadian engineering group.

Eldar Saetre, Statoil’s chief executive, says the company is working with its suppliers to develop standardised equipment for use on the seabed, which could be put down like modular blocks.

Total says that in its case the focus on costs has already started to pay off. Last year it planned a project called Kaombo in the deep water off the coast of Angola, budgeted at about $12bn to $13bn. When the bids came in from contractors, the cost had soared to $20bn, but following an “intensive optimisation exercise”, Total managed to get that back to $16bn. That was more than it had originally hoped, but low enough to give the project the go-ahead.

Other companies have also been “recycling” projects, in the industry jargon: delaying them for reappraisal and seeing if they can be delivered at a lower cost.

BP last month won some of the regulatory approvals it needs for a revised lower-cost version of its planned Mad Dog 2 development in the Gulf of Mexico, a joint venture with BHP Billiton and Chevron.

Another shift in oil companies’ favour is that some countries are offering them better treatment to attract investment.

The UK government last month announced a sharp cut in taxation on North Sea oil and gas profit, reversing a rise introduced in 2011. Iraq’s government has said it plans to revise its contracts with foreign oil companies to make the terms more attractive.

There will be lags, lasting years in some cases, before the effects of all these changes work through. They will not last for ever, either, says Kaam Sahely of Vinson & Elkins, the law firm. “You lock in rates for a period, and then as the market recovers there will be creep,” he says.

Even so, the opportunity to increase profits as the oil price recovers is real, executives and analysts say.

“These lower costs could give oil companies a chance of regaining the higher returns that they enjoyed 15 years ago, before the price run-up of the past decade,” says Jamie Webster, also of IHS.

The shock treatment of lower oil prices may turn out to be just the therapy the industry needed.

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