COVID-19 and the oil price collapse: Pulling the right levers to achieve rapid cost reduction

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With the rapid fall in crude prices, Exploration & Production (E&P) companies have largely responded by reducing their capital expenditure (CapEx) budgets. These spending cuts, in turn, have dramatically driven down demand for oilfield services and equipment, especially in the US.

While this response has been understandable and necessary to help preserve cash in the near term, it falls short of what energy companies need to achieve in order to emerge from this new environment in a competitive position. To compete in a low oil cycle environment, companies should look beyond trimming CapEx. They should consider fundamentally changing their cost structure and ways of operating to survive. They need to consider how to become significantly more efficient across their value chain. To get there, we see two key “levers” the industry can pull: Reducing demand for third-party spend and improving rates paid to suppliers.

Trim third-party spend

This unprecedented market requires companies to assume a zero-based approach to their activities. This means ruthlessly drawing a line between “nice-to-have” activities that drive third-party spend and those that are essential to run the business. For example, what are the customer service standards in corporate IT? In real estate services? Do we subsidize an employee cafeteria? Through a more operational perspective, can we better utilize owned equipment and pare down rental costs? Do we have a solid understanding of our contract labor strategy, and are we able to make workforce changes quickly and agilely? Is contingency built into individual cost center budgets? If so, it should be stripped out and consolidated at a higher level.

To sustain dampened demand for third-party spend requires two elements. The first is a fact-based approach to analyze costs in detail. The second is creating a cost culture that makes these same owners accountable for managing third-party spend on a week-to-week basis. This also provides a mechanism for draws on the newly-consolidated contingency for unplanned events. On average, we have seen companies achieve a 23% reduction in third-party demand through rigorous application of these elements.

Renegotiate supplier rates

The second lever is revisiting supplier rates. Every supplier exposed to the oilfield — and many that are not — are operating in a deflationary environment. Prudent companies are renegotiating rates with all suppliers. This may seem daunting, but as you begin the process, keep three considerations in mind to guide you in carrying this out successfully: speed, breadth and a systematic approach.

In the current climate, speed is paramount. The fastest-moving companies can hold a distinct advantage in negotiating with their supply base. This starts with understanding your spend — how much in each category and with each supplier. This is not always easy with disparate systems and poor data some companies grapple with. However, this analysis is expected to inform the right strategy for engaging with suppliers. Companies that haven’t started engaging are already behind. This applies not only to “transactional” suppliers that provide indirect or corporate materials and services, but also to more strategic ones.

This is why the second consideration, breadth of supplier base, is so important. Many companies have fragmented supply bases with many suppliers per category — and, most important, far too many for the current low-cycle environment. They are possibly failing to take advantage of leverage with a few key suppliers (which may be available to them). Companies should engage as many suppliers as possible for cost reduction. But in doing so, they should use their time and resources in targeted ways and have their spend analyses inform the right approach for each supplier. High-value strategic stakeholders should be approached for formal, direct negotiations with multiple stakeholders to help identify cost reductions. Whenever possible, use RFPs to consolidate spend among a select group of suppliers within categories. And the long tail of suppliers should be handled by a supplier letter campaign.

The third consideration, a systematic approach, is especially critical for major spend categories. Competing or negotiating supplier agreements means constantly balancing speed and analytical rigor. For the largest category, this means issuing tenders for competitive proposals and systematically evaluating them against a predefined set of criteria. These criteria should go beyond price. In the current market, suppliers’ long-term financial health, for example, shouldn’t be overlooked. For smaller categories, it may be as simple as understanding your suppliers’ costs and associated rates. Taking a systematic approach can raise your confidence and proficiency in applying the right tools to each supplier, maximizing the realized savings. 

One final thought on rates: They’ll only result in cash savings if they can be enforced. Companies should consider how they could embed new prices in purchasing systems, create mechanisms to enforce the use of preferred suppliers and audit purchases to ensure buyers and suppliers are adhering to agreed terms. 

By carrying out these strategies and initiatives well, companies can potentially achieve rate reductions of 12% or greater, particularly in today’s market, according to PwC analysis.

Reducing third-party costs is no guarantee of success. Companies will still need to maintain their license to operate, instill operational excellence in their workforce and maintain overall financial and portfolio discipline. Taking a resolute and thorough approach to cost management may place them at a distinct advantage and help make it more feasible to succeed in any commodity cycle.

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Mike  Scheller

Mike Scheller

Principal, PwC US

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