COOPERATION AMONG COM- panies became a cornerstone of oil and gas industry management in the 1990s.
Pressure to control costs forced managers to reduce efficiency wherever they found it. And they found much inefficiency in the proprietary redundancy that characterized operations through most of the industry`s history.
Under old practices, companies conducted their own research, maintained their own data bases, and sustained their own staffs to conduct every operation in the field, plant, and office. The result was great duplication of effort across the industry and even in specific projects with more than one company involved.
After oil and gas prices stagnated in the late 1980s, companies began to ask whether they could afford the redundancy. Many began to say no. They began to ask why, for example, in a drilling joint venture involving five partners, every partner should separately collect and interpret project data on its own. There was only one project. Four sets of data were theoretically unnecessary.
So companies began to jointly collect and share data that they traditionally guarded as confidential. The result: one shared set of data for a single project-and savings represented by costs not incurred for four sets of data no longer collected and maintained.
And sharing of data in a drilling venture was far from the only form of cooperation to take shape in the 1990s. Operators pooled assets in regions where they once had worked as competitors. Vendors and operators formed strategic alliances. Downstream companies joined hands in a variety of ways.
Cooperative operation received credit for helping the industry cut costs and return to profitability. But it didn`t come about easily.
Companies had to discard habitual tendencies to treat everything as proprietary without surrendering managerial discipline. They had to learn to share resources without giving away core assets. The new practices called for major changes in most companies` approach to management.
By 1997, experience with these new forms of cooperation was yielding guidelines for management of cooperative ventures. The guidelines had their foundations in basic reasons for the trend.
Old vs. new
In an October 1997 presentation at the annual meeting of the Society of Petroleum Engineers, John H. Pinkerton, president and chief executive officer of Lomak Petroleum Inc., contrasted the old pattern of uncooperative operation with the new way of cooperation.
Short term effects of the old way, Pinkerton said, included the view by every company that it alone could do things correctly, a large number of operating companies, and what he called a "reactive workforce."
Long term consequences of the old way were fragmented property groups, high operating costs, duplication of overhead structures, inefficient marketing, limited technical exchange, restricted exploitation activities, and reduced operator influence with service companies.
The new, cooperative approach to business, Pinkerton said, encourages companies to look for a better way of accomplishing tasks. And it fosters a "proactive workforce."
Cooperative operations lower finding and operating costs and reduce duplication of effort and expense. They enhance technical expertise through exchanges of information. They also accelerate application of technology, improve ultimate recovery, and provide for more-efficient marketing of products.
Pinkerton noted that companies turned to cooperation in response to the oil and gas price declines of the 1980s and consequent pressure to reduce costs. The maturity of basins also encouraged companies to share information and work together.
The growing importance of risk management and technological advancement further strengthened the trend toward cooperation. Other contributors were the tightening of oil field service markets, deregulation, and investor demands.
Pinkerton pointed out that cooperation has long been part of oil industry practice. Traditionally, cooperation took the form of property acquisitions, property swaps, and company mergers.
More recently, cooperation has taken many new forms. One general form is the exploration and production alliance, which can involve joint property operation, property contributions to existing companies, and property contributions to new companies.
Pinkerton`s company, Lomak Petroleum, formed an E&P alliance with Venus Exploration through a property contribution for stock.
The Lomak president also cited service company alliances formed to conduct geological and geophysical, drilling and exploitation, and production activities.
Downstream cooperative ventures, he noted, have formed around marketing, pipeline and transmission, and refining and distribution functions.
Another recent type of cooperative venture is the full-service energy provider, often formed to combine natural gas and power companies and take advantage of convergence of the markets for gas and electricity.
Cooperation and shareholders
In a 1997 article in McKinsey Quarterly, published by management consultants McKinsey & Co. Inc., David Ernst and Andrew M.J. Steinhubl estimated that alliances could unlock $40 billion in shareholder value in North America alone.
Of that total, $25 billion could come from consolidation, $10 billion from partnerships between major companies and specialists, and $5 billion from outsourcing, the McKinsey consultants wrote.
In a survey by the consulting firm, 84% of senior managers from leading U.S. and Canadian oil companies said they expected alliances rather than internal operations to be the main source of future performance improvement.
Ernst and Steinhubl pointed out that managers often prefer alliances to acquisitions and divestitures because they avoid or reduce the valuation, tax, and regulatory issues that accompany total changes in control. Alliances also allow the parent companies to retain oil reserves as a hedge against price increases.
The McKinsey survey revealed, however, that oil company executives were wary about their abilities to make alliances work. Only 20% of the companies in the survey said they considered themselves skilled at matching the different types of alliance to specific objectives. Less than half believed they had tailored their alliance approaches to particular oil field assets or geographic business units.
"This is bad news," Ernst and Steinhubl wrote, "because these are exactly the skills oil companies need to harness the shareholder value at stake."
Alliance types
The consultants identified five emerging types of alliance within the upstream oil industry: consolidation joint ventures, alliances with specialists, enhanced supplier relationships and outsourcing alliances, advantaged networks of producers and suppliers, and new operated-by-others (OBO) relationships (Table 1).
Consolidation joint ventures, which combine parent companies` assets across a range of activities, are best suited to areas where production has peaked and ownership and operating structures are fragmented, according to Ernst and Steinhubl. They can provide efficiency in use of equipment and infrastructure, lower labor costs, extend lives of oil fields, increase recoveries, enhance bargaining power with suppliers, and allow for sharing of best operating practices. At their best, they can help majors maintain or reclaim structural advantages over specialist companies with lower costs or distinctive skills.
In consolidations, partners can merge all operations, assets, and reserves, or they can form above-the-ground joint venture service companies, retaining ownership of reserves, licenses, and capital equipment. Full consolidation can offer greater value but presents more complication. The management challenges are similar to those of a merger, calling for the creation of a single culture for the new venture.
Ernst and Steinhubl said that of the $25 billion in shareholder value that consolidation offered in North America, $10 billion would come directly from lower costs and the rest from adoption of best operating practices and more-intensive exploitation of properties.
Specialist alliances, typically between a major and smaller specialized operator, combine complementary capabilities such as low-cost operational skills, geographic experience, and large asset positions. Opportunities for such alliances exist across North America because many specialist operators want to expand their reach but find that majors control large areas of attractive land.
For a major entering such an alliance, the McKinsey consultants wrote, the management challenge is to preserve the culture, skills, and approach of the specialist partner. The larger company should control critical areas such as environmental compliance and major capital expenditure but not day-to-day operations. It also should try to secure key talent, specifying which of the specialist company`s people will operate its assets.
As examples of enhanced supplier relationships, Ernst and Steinhubl cited agreements between Schlumberger and Amoco in Northwest Hutton field in the North Sea, and between Mobil and Halliburton in Parks Devonian field in West Texas.
At Northwest Hutton, which Amoco had considered abandoning, Schlumberger and the operator both invested in production enhancement. Schlumberger participated through a gainsharing arrangement.
In the Parks Devonian project, Halliburton was to invest $10 million to drill five horizontal wells in return for a share of production. Acting as project manager, it provided drilling and completion rigs, wellsite facilities, and subsurface products and services. Mobil provided assets, knowledge of the field, wellsite supervision, and wellbore construction engineering.
Outsourcing, Ernst and Steinhubl noted, had moved beyond accounting and finance into areas such as logistics, well operations, and field development planning.
In advantaged networks, an oil company or service company acts as a systems integrator to manage a set of alliances and contracts involving suppliers, service providers, and other operating companies. Managed successfully, such a network reduces overall system costs and cycle times and ensures access to technology and inputs. The McKinsey consultants said networks are most relevant in technologically complex frontier regions.
Elements of success for advantaged networks include strong partners, clear objectives and decision-making powers, and common financial incentives-the same as for bilateral alliances. Challenges include managing communications, tailoring financial arrangements to reflect each partner`s contribution and ability to absorb risk, and managing the risk of inadvertent transfer of proprietary capability.
New OBO relationships build on traditional exploration and production structures in which one company operates a venture and others participate mainly as investors with limited managerial influence. Trends noted by Ernst and Steinhubl in this area include:
- Streamlining administrationof OBO positions.
- Consolidation of OBO holdings into operations with fewer partners and larger stakestoreduce administrative costs.
- Using minority stakes as vehicles for learning and sharing technologyand process know-how.
TheMcKinsey consultants pointed out that the different alliance types need to be managed at different levels.
Big consolidations andspecialist alliancesableto unlockvaluein mature asset areas should be handled at the levels of business unit leaders and presidentsoflarge regions. Creation of advantaged networks of producers and suppliers in emerging areas also needs to be managed at that level.
These types of partnership are most likelytoincrease value of a basin-wide position or offer the chance for preemptive strikes where the number of attractive partners is limited, Ernst and Steinhubl said.
Responsibility for outsourcingand enhanced relationships with suppliers belongs to managers of individual properties or assets at lower levels. OBO upgrading can be handled by the head of asset sales and trading or an executive in charge of OBOproperties across a region.
"The winning companies," Ernst and Steinhubl wrote, "will be those that understand the range of alliance types, build internal skills to handle the growing number of alliances, link partnerships to regional and asset strategies, and focus on the few deals that really matter."
Keys to success
In 1997, the evolution within the oil and gas industry toward increased cooperation was still in progress. Companies were still learning as they went along.
They were, however, learning from experience and beginning to discuss the principles that guide successful cooperative ventures.
In the Apr. 7, 1997, issue of Oil & Gas Journal, David Reamer, vice-president of integrated solutions for Halliburton Energy Services, described 15 key elements of successful joint ventures, as his company and its Brown & Root subsidiary had come to see them. They are:
- Complementary skills. While some overlap of skills is inevitable and even useful in an atmosphere of trust and cooperation, too much redundancy can create conflicts of interest.
- Avoidance of weak partners. Companies shouldn`t form alliances to correct their weaknesses but rather to leverage their unique strengths. A member seen as having weaknesses works at a disadvantage to other members and can`t gain sufficient trust to support the project. "A successful alliance is not necessarily built around having the absolute best in class of every specialty," Reamer wrote. "It`s about being able to make the best use of the best that each member has to offer."
- Avoidance of corporate culture clash. A multi-company relationship must involve entities with similar values, strategies, and business methods. Partners` formal policies must permit flexibility and the consideration of new ideas.
- Member commitment. Companies inexperienced with alliances must be willing to work outside the conventional business model. All alliance members must be willing to provide personnel with authority to make decisions and commit corporate resources and, once commercial structures are approved, to carry out coordination of design and implementation.
- Long-term dedication. Parties to the alliance must be willing to dedicate quality personnel and sufficient resources throughout the life of the relationship.
- Building consensus. An alliance should use an integrated management team with representatives from each member. The team should ensure that each member has access to and can provide input to all aspects of the project.
- Eliminating barriers. Alliance members must overcome barriers between companies caused by traditional concerns about liability and profit. Participants need assurance that goals and incentives are appropriately aligned and must work as a team.
- Structured planning. Formulation and implementation of an alliance require careful attention to details. On complex projects, different parts of each member`s organization may need to become involved for specific pieces of the venture. The effort may require subcommittees or special purpose teams, which must have authority to handle the issues they are assigned. The alliance should provide a framework for interaction between these groups and the core decision-making body.
- Alignment, measurement, and goals. A successful alliance properly aligns interests and allocates risks. It defines clear measurement techniques that permit it to reach its goals. Alignment of interests ensures that attainment of the goals doesn`t benefit one member more than others. The goals themselves should be adjustable to account for improvements in efficiency and returns as the project progresses.
- Well-conceived implementation. Alliances must establish clear boundaries from the beginning to govern the close interaction between organizations. Flexible yet explicit contracts provide the foundation for the relationship.
- Organizational structure. Alliances must address governance issues including leadership, management, and dispute resolution. Documented procedures for certain common situations can clarify members` expectations and reduce disagreement when difficulties arise or decisions must be made quickly. Guidelines for alliance preferences can be useful. Delegation of authority to an appointed alliance executive committee is indispensable. The executive committee should be able to approve general alliance expenditures, special work, cost overruns, reallocation of member interests, and other important issues. Day-to-day work, however, should remain under control of an integrated management team.
- Responsibilities. An alliance should define responsibilities and the expertise that each party is to contribute, then give members wide latitude to implement their portions of the project. It should address overlapping expertise and use it only on a consultative basis. Only one member in each discipline should have an active role in project implementation and be responsible for results. Each member should be free to consult as necessary when it needs additional expertise.
- Intellectual property. The alliance should clearly designate confidentiality requirements and areas of expertise and set guidelines for ownership of new technologies developed in the course of the project.
- Member regulation. An alliance agreement should provide for the addition of members and set out precautions for member defaults.
- Administration. Administrative guidelines should be simple and flexible, precluding elaborate procedures. They should provide for regular meetings, clear voting procedures, and delegations of authority. They also should delineate changes of scope requirements, payment schedules, audit rights, assignments of interest, and subcontracting guidelines.
Pattern of innovation
To at least one observer, increasing use of strategic alliances and outsourcing followed a pattern of innovation by which the petroleum industry was redefining itself in the 1990s.
Oil and gas companies have unique experience in cooperative operation, noted James G. Crump, chairman of the Price Waterhouse World Energy Group, in several speeches in 1997 and in an article in the March 31, 1997, Oil & Gas Journal. They have long worked with partial interests and shifting alliances and thus can easily adapt to a business environment in which, in Crump`s words, "A competitor today is an ally tomorrow. A strategic partner in one market is an adversary in another."
Similarly, outsourcing is nothing new to the petroleum industry. The oil services industry developed because of past outsourcing, Crump noted. In his view, the industry`s ability to adapt to evolving business practice will help it capitalize on key technological trends and the broad convergence of energy markets.
In 1997, Crump asserted, petroleum companies were in the process of redefining themselves as energy companies. "In the new energy age," he said, "the largest energy companies will range from the wellhead to the electric light switch."
An industry of companies distinguished by the energy forms they offer will give way to a collection of diversified companies producing and selling energy in a variety of forms. The transition will push the evolution of strategic alliances and innovation of business practice.
Noting the trend of mergers between electric and natural gas companies, Crump said utilities have unbundled operations but repackaged wholesale and retail services and produced new forms of alliance. He cited an alliance between a power company and data systems firm that offered bundled services including network meter reading, billing, and credit collections.
And he noted that energy companies had formed alliances with telecommunications firms to provide two types of service billed through a single customer service number.
"As energy companies dream of ways to bundle energy and telecommunications services with grocery shopping, entertainment, and virtually anything that can be ordered from and delivered to the home, the opportunities for strategic alliances appear intriguing-and virtually unlimited," Crump said.
"It`s clear the energy services company of today is fast becoming the household services company of tomorrow."
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