Mitigating energy risks leads to strong opportunities
Energy supply chain challenges are top-of-mind for leaders in the industry. Whether they’ve faced a radical decrease in demand based on pandemic shutdowns or a sudden drop in supply caused by sanctions against Russia — or encountered the supply chain and workforce issues that have been pervasive now for years — energy leaders have kept their organizations strong while transforming them for even better results in the future.
Grant Thornton’s CFO survey for the fourth quarter of 2023 showed supply chain concerns receding dramatically across all industries, but the volatile political situation in the Middle East precipitated by the Israel-Hamas crisis threatens to create challenges in energy supply chains until a peaceful resolution is reached.
Houthi attacks in the Red Sea have caused significant disruptions in shipping and threatened energy supply chain security for many companies. Although it’s possible to travel around the Cape of Good Hope instead for some deliveries, this increases shipping costs and causes delays.
So although many of the issues related to the COVID-19 pandemic have been solved, supply chain challenges remain prominent for energy companies. Here’s how energy supply chain issues are affecting various sectors of the industry and how effective energy supply chain management can lead to improved results.
Downstream, midstream, upstream: Common ground
Workforce, regulation are constant energy issues
Downstream, midstream and upstream energy companies have a number of issues in common:
- They have difficulty securing workers in a specialized and competitive talent market.
- Managing regulation, coupled with new ESG demands, can be challenging.
- Cybersecurity and physical security require significant funding as companies constantly face the threat of attacks.
The solutions to these concerns can be elusive, but top companies are finding a way to stay on top of them.
Getting creative to attract workers
Although workforce challenges have eased somewhat, energy companies are still struggling to find workers to fill transportation and storage roles.
Companies have often used temporary agencies to fill jobs, paying them guaranteed fees to send dozens of workers to the job site. However, they have frequently found that many of those temporary workers have quit before completing the training because the work is difficult.
Now, energy companies are getting creative with their pay structures and creating financial incentives for longevity and attendance. They’re also developing relationships with vocational trade schools to meet some of their specialized labor needs.
Companies may even consider following the lead of a company in another industry that Grant Thornton Growth Advisory Principal Jonathan Eaton is familiar with. The company began recruiting nonviolent offenders who are reintegrating into society. They represent a labor pool that’s eager for work but having trouble finding employment.
After conducting a thorough background check to make sure that the offenders are drug-free and haven’t been charged with financial crimes, the company is giving them opportunities. “The company is finding now that these are some of their most reliable employees,” Eaton said.
Employers that conduct background checks need to be sure to follow all applicable laws and regulations related to drug screening, credit checks and other processes.
Monitoring regulatory and ESG issues
Downstream, midstream and upstream companies can experience a sort of regulatory whiplash depending on who’s in power in the federal government and even in state governments.
After the Trump administration worked to eliminate barriers for fossil fuels, the Biden administration has put significant incentives in place to help renewables grow as an answer to energy needs in the United States. The changes in the regulatory environment can make long-term forecasting difficult for companies in all stages of the energy stream.
Upstream energy providers have additional regulatory concerns, as regulators often have a say in where they can operate or whether they can use technology such as fracking to get access to product.
Although renewables are growing their market share, Eaton expects the need for oil and gas to remain.
“The U.S. will continue to need to source energy from both renewables and fossil fuels as it works toward an energy transition,” he said.
Meanwhile, the growing emphasis on the environmental, social and governance (ESG) movement among regulators and consumers creates challenges for companies throughout the oil and gas energy stream, but it also creates opportunities. Refinery processes, for example, are always going to create carbon emissions that have a negative impact on the environment.
“Be thoughtful about the commitments you are going to make, state the importance, and be responsible by reporting progress.”
However, downstream, midstream and upstream companies can work to at least decrease their carbon emissions without setting goals for eliminating them. Capturing a baseline of their current emissions for reporting purposes is the first step. Meanwhile, these companies can differentiate themselves by focusing on the social and governance factors in ESG. For instance, meeting diversity, equity and inclusion metrics and engaging in community outreach can help these companies show they are serious about being good corporate citizens.
“Be thoughtful about the commitments you are going to make, state the importance, and be responsible by reporting progress,” Eaton said. “That’s an area of improvement that these companies can focus on.”
Prioritizing cybersecurity
The Colonial Pipeline cyberattack, which caused havoc for fuel supplies in May 2021, was a wake-up call for cybersecurity in the energy industry, particularly for midstream companies.
By now, most company leaders understand the basics of cybersecurity. It’s necessary to have:
- A tone at the top of the company that prioritizes cybersecurity
- Strong IT controls
- A training protocol for personnel
- A well-rehearsed plan for how to handle an attack, if it does occur
“Supply chain resilience is essential and taking proactive steps to understand the threat landscape is table stakes. Risk mitigation strategies are a must-have, and a well-thought-out business continuity plan needs to be ready for immediate activation,” Eaton said. “Prioritizing cybersecurity and taking the proactive measures to secure the IT infrastructure and applications is a no-brainer.”
Maintaining energy supply chain security
Electrical substation attacks that were carried out early in 2023 in North Carolina, Oregon and the state of Washington have highlighted the importance of physical security in the energy industry.
Power plants, refineries and chemical plants with a fixed location typically have very strong security on their premises. But pump stations, compressor stations and especially pipelines are more difficult to guard. There has been discussion of using drones and satellites to help secure these assets against attack, but Eaton said the security response time — particularly for attacks in remote areas — combined with the lead time for new transformers and equipment can make these solutions problematic.
Nonetheless, some energy companies are making substantial investments in physical security, with enhancements such as security fencing and concrete barriers. Technological solutions such as video surveillance and key-coded access control are also growing in popularity.
Regulators at the state and federal level also are enacting policies to strengthen the protections of energy assets, and leaders of downstream, midstream and upstream companies are closely monitoring and evaluating these risks.
Midstream companies turn to technology
Asset tracking delivers critical improvements
Operational efficiency is critically important in the midstream sector, and leading companies are finding that technology for asset management and asset tracking helps them operate as profitably as possible and deliver effectively for their downstream clients.
“If companies want to differentiate, they certainly need to invest in asset tracking.”
“If companies want to differentiate, they certainly need to invest in asset tracking,” Eaton said. “Asset tracking is essential for understanding flow and the efficiency of assets. These assets operate nonstop and require timely maintenance, calibrations, etc. IoT sensors and sophisticated data models that monitor performance and failure can be used for predictive maintenance planning. The result is improved performance and higher return on assets.”
Technology and artificial intelligence can deliver substantial improvements in the management of fleets and pipelines. The combination of historical volumes, flow rates, asset uptimes, storage capacity, the proximity of storage capacity to wellheads, etc., combined with forecasting models that integrate machine learning, are absolutely essential for long-term capacity planning and knowing, geographically, where the storage capacity is needed, Eaton said.
Understanding third-party risks
Third parties, such as oil field services providers, can present unintended and significant risks to midstream providers, in addition to companies providing upstream exploration.
Failure to conduct due diligence on third parties could cause leadership to miss the risk of a provider:
- Using questionable sources of materials and labor.
- Having liquidity issues or working with other third parties that have such issues.
- Being under scrutiny from the EPA or experiencing other regulatory issues.
In all cases, avoiding harmful outcomes from working with third parties requires obtaining a deeper understanding of them.
“There has to be traceability that satisfies the ESG commitments and policies of the third-party company, operational execution needs, risk mitigation and the actions they take for maintain a safe and resilient supply chain,” Eaton said.
Managing contracts and pricing
The large number of variables associated with midstream costs makes pricing extremely difficult. Eaton said that companies in the sector often either overcharge or undercharge their clients and are left to deal with the consequences of either action.
That’s why companies are investing in software and contract management capabilities to help them price their services competitively while also maintaining profitability. Pricing can be tiered based on volume, and gross margins can fluctuate. Being able to track the contracted pricing and actually execute on changes in pricing models is essential.
“The pricing models are dynamic, and midstream companies should utilize technology that allows them to fully understand margins so they can price effectively by linking execution to the tiered pricing models they may utilize,” Eaton said.
Upstream energy: Innovation is the key
Data analytics can lead to more precise management
Upstream energy companies face substantial obstacles as they attempt to drive growth:
- Prices are expected to remain volatile for the carbon steel and stainless steel materials that upstream companies need.
- Midstream and storage capacity may be limited, so it doesn’t make sense to extract products that they can’t deliver.
Technology and innovation present potential answers for materials issues as well as for workplace issues.
“Oil and gas companies are always investing in innovation and trying to find new ways to be more efficient and lower cost, and I think the focus on innovation will always be there,” Eaton said.
Companies are investing in technology that uses data from throughout the supply chain to enable more precise management. This technology can be used to monitor productivity and efficiency, help manage the servicing of equipment and even locate materials when necessary.
Downstream energy: Focus on capacity management
Forecasting and budgeting are critical
Capacity management with an eye toward cost containment and building efficiency is a priority for downstream energy companies.
Forecasting, budgeting and scenario planning help downstream companies make the most of the workforce and materials they have.
“These facilities run nonstop,” Eaton said. “So the easiest way to control cost is to maximize the use of the capacity. And you need to have scenario planning based on budgeting, forecasting and enterprise business planning capabilities to identify potential issues and plan for them.”
Solar energy supply chain issues
Utilities work to deliver on promises
Even as tax credits and incentives in the Inflation Reduction Act (IRA) provide an impetus for solar energy in the United States, leaders in the industry face solar supply chain issues because of materials sources that are almost completely based in China.
China’s share in all the key manufacturing stages of solar panels exceeds 80%, and its share for key elements including polysilicon and wafers is set to rise to more than 95%, according to an International Energy Agency report issued in July 2022.
Although China’s investment and innovation in this area have significantly reduced the costs of photovoltaic solar production, this geographic concentration of the supply chain is a constraint in a sector that is rapidly expanding. There is also geopolitical concern about the solar supply chain’s exposure to the Xinjiang region of China, a key polysilicon production area. These concerns have led companies to invest in production facilities elsewhere throughout the world, including building solar production facilities in the United States.
The desires of political and regulatory leaders to create geographic diversity in the solar supply chain, as well as the tax incentives in the IRA, can provide opportunities for U.S. participants in solar energy and other renewables.
Throughout the renewable energy sector, Sections 45X and 48C of the IRA were designed to strengthen the U.S. domestic supply chain with novel credit concepts. These IRA credits provide a direct benefit to manufacturers and producers of various components and property in the energy supply chain, incentivizing investment in renewables. Sections 45 and 48 also contain a 10% domestic content credit for renewable energy projects that is meant specifically to encourage domestic suppliers. At the same time, rising interest rates have diminished investor enthusiasm for solar project financing. This development has eased some of the pressure on the solar supply chain.
In solar energy, utilities play a major role in shaping the supply chain throughout the United States. Twenty-nine states and the District of Columbia have renewable energy portfolio standards that require companies selling electricity to generate or purchase a specific percentage of their energy from renewable sources, according to the State Power Project run by Harvard Law School’s Electricity Policy Initiative.
When utilities fail to meet their benchmarks, states can typically either assess fines or withhold incentives that have been put in place. For many of them, the first milestone is 2030, which isn’t far off.
Capacity is expanding
After the installation of 20 gigawatts of solar photovoltaic capacity in 2022, U.S. capacity reached 142 gigawatts, enough to power 25 million homes, according to the Solar Energy Industries Association. By 2033, the agency projects, capacity will grow by a multiple of five to more than 700 gigawatts.
As utilities work to expand their capacity and meet their benchmarks, they are taking advantage of tax credits and incentives enacted or amended by the IRA, including investment tax credits under Section 48 or production tax credits under Section 45. Both sections support incentives for investments in facilities that generate clean energy. As producers and distributors of solar energy, utilities have an interest in developing a more robust supply chain for solar manufacturing while focusing on domestic sourcing considerations.
Utilities are partnering with companies in the United States and abroad on various projects. In some cases, silicon foundry companies are working with local utilities to convert shuttered coal plants to produce wafers for solar cell production.
When rolled out correctly, there is an opportunity for utilities and their partners to develop a supply chain that is more stable, closer to the consumer and creates a superior product. Solar modules produced in China may be less efficient than those from South Korea, Japan, Taiwan and Malaysia. Utilities that can partner with producers in those countries and use joint ventures to ramp up U.S. production are likely to be rewarded.
Sourcing solar-skilled labor will also likely require utilities to create partnerships with nearby trade schools that can train the workers needed to staff the budding industry.
While it may seem odd for utilities, long a distributor of solar power, to add a focus on the solar manufacturing supply chain, it can make sense. The utilities have promises to keep and benchmarks to meet. As global demand for solar increases, utilities can partner with manufacturers to enable the development of solar panels that will be used by solar collection facilities and residential collectors who will also add capacity to the grid.
In some cases, certain energy and chemical manufacturing facilities are installing solar panels for company use. This provides an opportunity for businesses to improve energy efficiency and their ESG performance and control a portion of their own power, enhancing their reputations for clean energy use and reducing their dependence on the grid.
Although private investment in the sector has been tepid, the IRA tax incentives may provide the boost needed to encourage public-private partnerships.
Maintaining resilience
A promising future
Solar energy interests appear to have a promising future, even as upstream, midstream and downstream companies have proven their resilience over the past few years.
In almost all cases, energy companies are finding that technology transformation is delivering excellent results related to productivity and efficiency. And as they manage the workforce, regulation, cybersecurity and other key issues, leaders are maintaining resilience throughout their operations, which positions them for success on the road ahead.
Contacts:
Tracey Baird
Principal, Tax Services
Grant Thornton Advisors LLC
Tracey Baird is a Managing Director in Grant Thornton’s Strategic Federal Tax Services (SFTS) practice, a dedicated team of experienced tax professionals who focus on certain areas of federal tax law where appropriate planning can help clients achieve significant savings.
Houston, Texas
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Dan Mueller
Senior Manager, Renewable Energy Team
Grant Thornton Advisors LLC
Kansas City, Missouri
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