Online Exclusive. Downstream oil and gas amid COVID-19: Succeeding in a changed market
Downstream oil and gas amid COVID-19: Succeeding in a changed market
By Gopal Chakrabarti, Tim Fitzgibbon and Micah Smith, McKinsey and Company
The global COVID-19 pandemic caught the oil and gas industry unprepared for a completely changed landscape. Long after countries tentatively emerge from quarantine, constantly on the lookout for another surge in COVID-19 cases, the oil and gas industry will face the twin specters: sudden travel interruptions (and longer-term demand decline caused by an economic downturn) and a rise in telecommuting (and the accelerating shift to greener energy sources).
To adjust, oil and gas companies will have to transform radically. Those that succeed will shape the industry’s future; those that fail will become consolidation targets. Even among companies ultimately acquired, there is an important benefit to getting as far down the path of transformation as possible. The further they progress, the higher their valuations will be.
How do oil and gas companies make such a rapid and substantive shift? A successful response to the fundamental market changes seen in the COVID-19 crisis can be divided into three phases. Those phases build on each other chronologically and overlap.
Phase one: Readjust to preserve cash. In phase one, downstream oil and gas companies will need to preserve cash until the market improves. They should exercise the full set of cash-management levers, including reducing inventory positions, lengthening suppliers’ payment terms, reducing receivables terms, deferring capital expenditures and halting equity disbursements. Many companies have already embarked on several of those efforts. However, such actions are just a start. A successful transformation requires a significantly deeper commitment to change.
Phase two: Reimagine to drive performance improvement. In phase two, downstream oil and gas companies will need to take several actions to achieve success. These include:
- Rightsize general and administrative (G&A) functions. First, they must reduce G&A costs (e.g., by using industry benchmarks that account for the possibility of continued depressed demand for gasoline, diesel and jet fuel). Such benchmarks could include measuring the ratio of G&A costs to revenue. Given the fact that industry players have spent a decade positioning themselves for a growth market, we see the potential for a 20%–30% reduction in G&A costs from pre-2020 levels.
- Launch operations improvements. Firms should unlock the full slate of management opportunities in operations and expenditures. Our experience indicates that the average refinery stands to boost its margins by up to $1.50/bbl. To achieve that, companies must take decisive action in several key areas:
- Repair and maintenance. Spend less on maintenance by adjusting the way equipment is operated and managed. That could include measuring the contributions that certain pieces of equipment make to the overall profitability, safety and environmental footprint of an organization. To illuminate the best course of action, ask questions such as, “How would the failure of our hydrogen-system compressor affect processing capacity, emissions and repair budget?”
- Operating choices. Update the way decisions are made. As refineries begin to work under new operating conditions, maintenance routines for specific pieces of equipment should be adjusted to ensure correct cost-to-performance trade-offs. Options include taking a critical look at how often spares are switched and when new thresholds for vibration or process conditions are established.
- Staffing levels. Reduce technical-support ratios, such as the number of engineers per operating unit, or total engineering spend. There are several ways to do that: focus on the highest-value activities, review when and how to use third-party contractors, cross-train employees so that they can perform multiple tasks and reconsider overtime practices.
- Product quality. Create value through precision. Limit how often a product exceeds its minimum-quality requirements by improving product-demand forecasting, blending processes or using in-line-measurement tools. Players with optimized operations planning spend less on the components that make up their finished products, from gasoline to asphalt.
- Operations planning. Continually improve modeling to understand how each raw material affects operations. That allows refiners to make better selections and to optimize how plants are operated.
- Reconsider supply chain and procurement. These include the following areas:
- Protect crude- and product-transportation relationships, including pipeline-shipping history and third-party tank positions. Find ways to capture long-term value when infrastructure is choking on crude and products. Initiatives could include guaranteeing favorable logistics and creating value through joint ventures and partnerships.
- Streamline the supply chain to reduce costs while ensuring the solvency of critical suppliers. That could include consolidating vendors, renegotiating prices based on volume, understanding “should cost” analysis, establishing long-term supply contracts, and re-evaluating the total cost of ownership of equipment.
- Optimize trading capabilities. Companies should adjust crude- and product-trading strategies to account for changing market dynamics. Reductions in North American shale production or long-term reductions in jet-fuel demand would change the relative value of different crudes and constrain logistics for North American refiners. Therefore, firms ought to re-examine the role of trading operations.
Phase three: Reform to position for growth. In phase three, downstream oil and gas companies will need to take the following actions to achieve success:
- Reimagine functional-support delivery. Introduce zero-based approaches or test the use of more agile support models. Such actions are particularly valuable for multi-refinery companies in which resource pooling can be a strong lever. In a cost-focused environment, a shift back toward centralized organization structures could unlock significant value.
- Deploy advanced analytics and machine-learning applications. Integrate new technology across the value chain—several areas are ripe for transformation. For example, we have seen terminal-level pricing engines for products help capture margin by understanding local market dynamics, including price elasticity and digitizing operations has boosted refinery yields and throughputs.
- Revamp planning processes. Amid ongoing price volatility, it is particularly important to limit short-sighted investments by improving forecasting and planning. Focus on reducing the risk of overinvesting during peaks and suffering illiquidity during the valleys of future market cycles.
- Reassess portfolio strategies. As transformation illuminates the intrinsic value of assets, build a clear vision for both five- to seven-year strategies and 10-yr (and longer) strategies—and the accompanying investment controls. That shapes the foundation for seizing opportunities for growth and value creation in the short and long runs. Where and how companies do that will be determined by their leaders’ views on key issues, such as asset retirements.
In the decade leading up to the demand shock unleashed by the COVID-19 crisis, the downstream oil and gas industry in North America was making the best of a good situation. Refiners capitalized on the twin benefits of a new, abundant, and relatively cheap supply from U.S. shale producers and an increased demand for their own products. Companies shifted their focus from controlling costs to capturing opportunities for growth.
Today, those same companies face a very different world. The global pandemic has not only amplified the weak signals of disruption that have been forming over the past decade but also fundamentally changed the market itself. Players may no longer exhibit the resiliency they mustered during prior oil shocks. To uncover another decade of value growth for shareholders, downstream companies will have to radically transform how they do business. Those that succeed will shape the industry’s future; those that do not will not survive to tell the tale.
This article was originally written and published by McKinsey and Company.
About the authors: Gopal Chakrabarti is a consultant in McKinsey’s Houston office, where Tim Fitzgibbon is a senior expert; Micah Smith is a senior partner in the Dallas office.
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