A Built-for-Purpose E&P Low-Cost Operating Model?

The following article is part two in a three part series discussing upstream operating models. View part one here.

Organizational capabilities are the lifeblood of an enterprise. In the E&P sector this includes positional assets, such as acreage. The portfolio of subsurface resources is a critical piece of the puzzle, but organizational capabilities go far beyond positional assets – they also include intangible assets, such as expertise. The case of Mitchell Energy and its commercial development of unconventional resources in the early days of the Barnett illustrates the importance of intangible capabilities.

The operating model of an enterprise shapes and directs these capabilities – including human expertise, technological capacity, and financial resources – to execute core functions, such as frontier exploration, subsurface interpretation, resource de-risking and development, upstream supply chain procurement and management, production operations and maintenance, EH&S, midstream logistics, commercial, etc. The precise list of an enterprise’s most critical capabilities, and their relative importance, is determined by its resource portfolio and other positional assets, strategy, and implementation of the strategy (i.e. as manifested by its operating model). This reconciliation of portfolio, strategy, and operating model, is the first step in the now essential transformation toward a sustainable, low-cost operation – a process to identify and strengthen key capabilities while cutting, revising or outsourcing others.

There is a growing body of organisational research that suggests operating model design has been more Darwinian than any conscious, rational effort toward optimization. Companies evolve their operating models subconsciously, on the basis of industry convention and the emulation of competitors. They use a limited number of different forms and operating models (e.g. functional, holding company, multi-product-division, country-division, split-business chain). These models are based (implicitly) on assumptions about the economic characteristics of resources, technology, institutional environment, human capital, scarcities in the economy, etc.

However, since these elements are changing, so too are the economic models, and so too must the operating models. But industry adaptation of operating models to new economic realities is often halfhearted.

The upstream oil and gas industry has undergone dramatic evolution and disruptive change; many aspects of its resources, technology, institutional environment, human capital, etc. are changing. Moreover, very few, or virtually no, operators have proven to be “world class” at unconventionals, and deep-water, and late-life assets, and oil sands, and arctic drilling, and international new frontier exploration, etc. Each of these resource types has its own requirements in terms of critical capabilities, and therefore requires unique accommodations in terms of operating models. The portfolios of many of the world’s largest oil and gas companies face a daunting task for new source production and a wide range of requisite capabilities. Not only has the prevailing industry operating model proven to be not successful across all plays, maturities, and resource types, but it is no longer consistent with the demands of prevailing prices, industry economics, technologies, talent, etc.

In many cases, circumstances call for a lower-cost operating model, with fewer layers, more agility and local control/adaptation by asset teams, and better collaboration with local vendors and operators. In a few cases, operators have implemented change to accommodate a tailored operating model, but historically, oil and gas companies only changed their operating models on an enterprise-wide basis in a post-merger integration, or in concert with a financial restructuring – such as the divestment of downstream refining and retail operations, corporate unbundlings like the disaggregation of Fletcher Challenge and Canadian Pacific, or the split of EnCana into Cenovus and EnCana.

However, other industries have more experience with operating model innovation in response to evolving industry economics and technologies.

• For example, when facing a chronic decline in drug discovery success rates, as well as a decline in “block buster” discoveries, many international pharmaceutical companies responded with operating models that supported licensing-in or acquiring their new drug pipelines, from smaller, independent biotechnology companies.
• And when “big pharma” industry regulation became increasingly unfavorable on issues such as patent protection and channel marketing, margins were eroded by competition from unbranded generics – some industry players countered with their own generic divisions, established as autonomous units with their own low-cost operating models. Novartis AG, the world’s largest biopharma company, owns Sandoz, which became the name it uses for its generics business.

It remains possible to design operating models for the new realities of an industry. And workflows can be streamlined more effectively through broad operating model redesign than just changes to the organizational design. As the E&P industry evolves, so too must E&P company strategic agendas, portfolios, organizational capabilities, and operating models.

Read more insightful analysis from Justin here