The long slide in oil prices since the summer of 2014 has transformed the business landscape for energy producers, as easily seen in the 2015 Grant Thornton LLP Survey of U.S. Oil and Gas Companies
. Asked about their biggest operational infrastructure challenges, last year 45% of respondents cited finding and retaining the right people
. This year, nearly three in 10 respondents chose the opposite answer, necessary downsizing of personnel
But industry veterans are long accustomed to working through hard times. They are making the tactical business decisions — introducing operating efficiencies, adopting innovative technologies and employing tax-saving techniques — that will help get them through the recession and make themselves more attractive to capital suppliers. In previous downturns, companies that have done those things have emerged from slumps stronger than before. The current cycle should be no different.
Energy companies dive deeper into uncertain territory
2015 has been a difficult year for the oil and gas business. The price of West Texas Intermediate crude, after briefly stabilizing at around $60 per barrel in spring, was around $45 at the end of October. U.S. oil production stands at 9 million barrels per day (bpd), significantly below the 9.6 million bpd peak in April; for the first time in years, U.S. oil imports are rising
have accelerated and now surpass 200,000. The number of working rigs is down 60% year over year, causing operators to resort to cannibalism
: They don’t buy replacement parts for their rigs — they simply pinch them from idle ones
“Early this year, producers began cutting back by taking the usual steps — i.e., reducing capital budgets, cutting rigs and introducing typical cost reductions,” says Kevin Schroeder
, who leads Grant Thornton’s Energy practice
. “In the spring, when it looked like the oil price would stabilize at around $60, most companies believed that would be the new norm and were looking to gain efficiencies to operate in that environment for an extended period. But prices have since retreated back into the $40s and companies are operating under further stress.”
Even for an industry accustomed to uncertainty, the outlook for the oil and gas business is hazy. “Everyone is struggling to find even a short-term crystal ball,” says Gerrad Heep
, a Grant Thornton Audit Services partner specializing in the energy industry. “If companies had a handle on conditions for over just the next three to six months, it would help tremendously — but they don’t. People are trying simply to maintain their operations until they get a better sense of direction.”
Operational efficiencies, key to most energy companies
In the face of such business conditions, all companies need to take a hard look at the way they do business — but that doesn’t mean they have to discard their entire business model. Companies need to ask what tactical changes they can make that will steer them in a new direction and make them more desirable to external suppliers of capital.
, partner in Grant Thornton’s Transaction Advisory Services
practice and Advisory Services leader for the Energy practice, addresses this question. “Companies have gone to great lengths to reduce costs, including reducing rig count and headcount,” he says. “But in addition to these measures, there are ways companies can fundamentally change the way they conduct their operations for improved profitability and cost containment.” Benoit cites these actions: (1) manage the cash conversion cycle, including an in-depth review of accounts and errors; (2) examine and audit joint ventures; and (3) make sure external vendors are operating correctly under contract terms. Accounting details matter.
Benoit says that, in practice, doing any one of these things individually may not seem significant, but our experience is that, when done holistically throughout the business enterprise, there may often be material benefits: “First, you properly set expectations with companies you’re doing business with at a granular level. Second, you reduce costs from leakages in contract management. And third, over time these processes often result in renegotiation of agreements with vendors — what you’re going to pay them for, and under what terms.”
Benoit identifies several specific areas where companies can find cost savings:
Waste water hauling — overcharging
Oil field service companies — incorrect quantities and incorrect pricing, specifically in fracking, cementing and wireline charges
Maintenance, repair and operations supplies — incorrect pricing, poorly managed buyouts, pipe and oil country tubular goods
Leases and equipment rentals
Another avenue companies should consider is getting their records in order. For example, Schroeder comments: “As companies rapidly grow and complete acquisitions, their land and lease records can often become a mess. Even if they did want to approach the M&A market, their records aren’t in order to do that or it may cost them in a transaction. Companies need to ready themselves for the next move.”
The consequent improvements from these actions make companies more attractive to outsiders, whether they are potential lenders, investors or buyers. External parties are going to have a much higher level of confidence in the company for whatever transaction is contemplated.
Introducing transformative technologies
Another tactic in steadying operations is the use of new technologies that enable producers to continually cut required resources, including the number of working rigs. “The technology in the industry continues to advance so quickly,” says Schroeder. “Companies are finding that they’re doing their work completely differently now than they were even a year ago.”
Among the innovations companies have utilized are:
Drilling several wells at a time, which reduces the time it takes to drill each well.
Using fiber-optic sensors to find out how far a fracturing job is penetrating hard rock, allowing better planning of the spacing of wells.
Technologies that allow companies to use less or no water in hydraulic fracturing.
Adopting choking — i.e., controlling the rate of flow — which limits initial well production but helps maintain well integrity and structure for greater output over the long term.
Using more sand to increase the amount of fractures that stay open and hence boost output.
Much attention has focused on refracking, where companies revisit older wells and apply new technology
to raise production. It can be an economical means of producing oil and gas, but refracking also has its downside
, earning it the moniker pump and pray
in some circles. Refracking aims at only parts of the well that have not been fractured, a technically difficult process that can be expensive; moreover, done improperly, it can ruin
a reservoir. There are several refracking methods
, each with its advantages and drawbacks.
When we asked respondents to our survey about refracking, less than 10% said they were actively engaged in a refracking effort.
The next downturn: Can it be avoided?
Cycles of boom and bust have been part and parcel of the oil business. But the advances in data analytics and IT that are having powerful effects in other sectors raise the question: Does it have to be that way? Are there ways the industry can plan and structure its operations to avoid the sharp peaks and valleys that have marked its history?
Certainly the energy business has features — some inherent, some cultural — that stand in the way of less jagged earnings. Oil prices are an important example. Grant Thornton’s Gerrad Heep says: “On the revenue end, producers are confined by their strong dependency on energy prices. They can hedge, of course, but there are limits here too — pricing often runs in several-year cycles, while hedges go out at most a couple of years. Moreover, oilmen don’t like to hedge 100%, even at the expense of predictability. They like to have some upside, because they know they can make a lot of money if prices go up. What you might see happen in the current environment is that their capital suppliers — the banks, private equity — will demand they hedge as much as, say, 70–80%, where they were hedging just 60%. But when more buoyant prices return, they’re likely to go back to fewer hedges.”
Still, the possibility remains that, with the continuing improvement in analytic capabilities (our survey found that today only 33% of respondents rely on data analytics), such obstacles can be overcome. Grant Thornton’s Kevin Schroeder remarks: “In the oil industry, we operate in a go-go-go, stop-stop-stop mentality. But what if the industry employed the techniques of big data and analytics that other industries are using? Can the industry adopt a more sustained, more systematic approach that’s less sensitive to the ups and downs of the oil market? Companies can develop strategies for different oil price levels — and stick to them — to help prevent overpaying for assets; manage volatility; and maintain liquidity, capital and resources throughout the cycles, while realizing sustained success.”Adopting tax strategies
SALT is another area where tactical business decisions can pay immediate cash dividends, as well as demonstrate operational efficiency to external audiences. To spur economic development and job creation, many energy-producing states offer tax credit and incentive programs. Oil and gas companies have used these provisions successfully during times of expansion — and they are still worth pursuing during downturns
“A lot of companies think they can’t qualify for these programs if they’re not adding significant numbers of employees, or building, say, a large manufacturing plant,” says John LaBorde, practice leader for Grant Thornton’s SALT practice in Houston. “But for some programs, you can qualify on the employment end just by maintaining headcount. And you don’t necessarily have to be investing in something like a greenfield factory — it could be buying a new computer system or the like.”
A less positive development on the tax front, however, is that states are working to limit revenue falloff from lower payments by energy companies. In Texas
, for example, the state is looking very hard at well reclassifications in an attempt to limit falloff associated with the high-cost gas and marginal gas well incentives. These incentives can be lucrative for gas wells in the current environment; as a result, producers are working to reclassify wells from oil wells to gas wells. The state is giving these reclassifications an additional level of scrutiny. Finally, the state of Texas has decided to increase their audit staff for severance tax audits, and will be working diligently toward increased audit and enforcement in this area.
Moreover, Texas and other oil-producing states are adding money to state budgets for audits of oil and gas producers. “States are getting serious about doing audits,” says LaBorde. “Their efforts underscore, first, the importance of doing your taxes correctly and, second, if you do get audited, having the resources — or acquiring them — to deal with it.”
At the same time, companies may view state taxes with an urgency they formerly lacked. “Faced with a stunning, sustained decline in oil prices, companies are looking for any cost savings they can find,” says Heep. “In boom times, a state audit might not have attracted much attention. Now the company may spend a lot more time on a state tax audit, especially if they have the resources to handle it.” Clearly, SALT presents both opportunities and risks that energy companies can no longer afford to ignore.
Sustained low prices have presented energy producers with enormous challenges. But the industry is long-accustomed to dealing with downturns and emerging from them stronger than ever. Those companies that adopt tactical business decisions to stabilize their operations and burnish their financial statements will be best positioned to attract capital and succeed when prices recover.