Oil and gas companies operate in dynamic and complex environments where they face constant challenges, especially in terms of supply and demand. Now, with oil prices at historic lows, it is time to evaluate the supply chain, and procurement techniques and costs. Oil and gas companies need to focus not only on their product supply chains, but also on the non-hydrocarbon supply chains that handle the parts, materials and services required to run the business. The non-hydrocarbon supply chain is critical to deliver the equipment and services required to find, extract, refine, and finally market the oil and gas. Procurement and supply chain strategies are set to be in the forefront of critical issues plaguing oil and gas companies, especially with the current downward spiral of oil prices.
We have found that oil and gas supply chain practices (in certain geographies) clearly lag behind those of some other industries that use advanced techniques, such as optimized inventory management, collaborative supplier relationship management and so on. In this article, we provide a brief insight about the opportunities and areas in which supply chain practices can be improved amongst international and national oil companies (IOCs/NOCs), including improving service to internal customers and reducing costs, and highlight other industries from which companies in the oil and gas space can learn.
According to the Harvard Business Review, purchased products and services account for more than 50 percent of the average oil and gas company’s total costs. Thus, even a 5 percent reduction in purchase costs can result in a significant increase in the profit margin for oil and gas companies. To achieve this, oil and gas companies should look at the following opportunities in order to deliver better supply chain value:
- Supply chain market intelligence.
- Materials/supplier relationship management.
- Supply chain talent and technology.
Supply chain market intelligence is the process of acquiring and analyzing information in order to understand the present and future market; support current and future sourcing and market sector strategy execution; and enable the business to better anticipate changes in the external marketplace and react before others do. Supply chain market intelligence is key to any industry, and more so for the dynamic oil and gas industry. Effective supply chain market intelligence helps oil and gas companies deal with strategic supply chain challenges, such as constrained capacity, infrastructure and volatile markets. It also helps companies make the right decisions about which markets to buy from, how to determine the right price to pay, and what benchmarks and targets provide the right competitive edge.
The oil and gas industry is heavily dependent on suppliers to provide complex services and critical equipment to support ongoing projects and operations. More than often, contract management and supplier relationship management are not up to the mark, and as a consequence, the oil and gas companies take on supplier risks. To improve supplier relationship management, companies should adopt a method of supplier benchmarking. Oil and gas companies need to measure the robustness and performance of different contractors for various spend categories, and constantly seek dialog with them so that the suppliers are in unison with the necessary obligations in terms of safety, training, equipment and staffing requirements.
Another method that can help the oil and gas company in pricing negotiations is the use of the should-cost model, as well as the total-cost-of-ownership (TCO) model. In the former, the total acquisition cost for a particular piece of equipment or service is arrived at by taking into account the design cost, supplier operating cost, supplier margin, and transaction and acquisition costs. The should-cost model for different spend categories can empower oil and gas companies to effectively negotiate contract terms and conditions with suppliers. In the case of the TCO approach (more suitable for long lead times and critical capital-intensive equipment), the different costs, including the acquisition costs, and operation and maintenance costs, are arrived at before choosing the right supplier at the competitive price.
Some IOCs have adopted measures such as the should-cost and TCO models, but these are yet to be adopted by other regional and local players in the oil and gas industry. We realize that this area of supplier relationship management needs a deeper analysis and smart approach given that local content plays a part in determining the right contracting and procurement strategy.
Even though technology is helping oil and gas companies to find and extract more oil, there is a need to seriously consider supply chain and procurement systems that provide additional real value. Needless to say, modern enterprise resource planning (ERP) systems are really helpful to address the above-mentioned concerns. These ERP systems should cater to inventory management, demand forecasting, contractor management, master data management and e-procurement. Demand forecasting/planning coupled with inventory management and e-procurement form the crux of the oil and gas supply chain strategy. Oil and gas-focused ERP systems have completely revolutionized the way enterprise resource planning is being carried out in different industries. There has been a paradigm shift in the way oil and gas companies have embraced e-procurement or shown interest in e-procurement systems.
Even with best-in-class supply chain processes and systems, we strongly believe that, without the right people, the best-in-class supply chain practice cannot be sustained, nor can the full benefits of supply chain really be enjoyed. As with any other industry, the oil and gas industry also has to grapple with the shortage of supply chain and procurement talent due to an aging workforce and growing skill shortages. Some of the measures that can be effectively adopted are training and grooming of talent in critical supply chain functions, establishment of a supply chain center of excellence and industry/academia collaboration to nurture supply chain talent.
To improve and deploy best-in-class supply chain practices, IOCs/NOCs can adapt and/or implement some of the practical measures listed below:
- Understand the total value of major spend categories. This requires thoroughly identifying costs and options across the supply chain for each category and determining appropriate interventions (e.g., seeking new supplier, changing specifications, altering contract terms).
- Build custom-fit procurement processes that provide better clarity and engage suppliers early in the process. Moreover, follow through to execution and into operations.
- Manage risks across the entire spending portfolio—not just within individual projects or commodities, or splitting capital from operations spend.
- Proactively manage the supply base, select relevant suppliers, focus on alignment and sustainability (i.e., dynamic relationships), and ensure company ownership and accountability is clear to suppliers.
- Institutionalize the capabilities required for supporting procurement and supply chain activities. Today, these scarce skills are at a premium. In the next few years, it is going to be just as important to cultivate the right talent here as it is in the most critical technical and operational areas.
Going forward, we realize that, even though some of the supply chain best practices have trickled through the oil and gas industry, there is always scope for further improvement. Better demand planning and optimized inventory management can help oil and gas companies maintain oil and gas equipment uptime, and hence benefit from improved productivity. Improved spend category management and collaborative supplier relationship management, coupled with increased automation of transaction processing, leads to sourcing savings and identification of secondary saving opportunities.
We believe that the deployment of supply chain best practices, coupled with the implementation of a strong software solution, is the way forward for oil and gas companies to reduce costs, and focus on oil and gas production and exploration in the most optimized way. It is going to be really interesting to see how oil and gas companies can effectively manage local content sourcing combined with the adoption of best-in-class supply chain practices in 2016.
Vinodkumar Raghothamarao works in professional services for the Middle East, Africa and India (MEAI) at Epicor Software Corporation.