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(originally published by Booz & Company)


Six Industries in Search of Survival

Furthermore, demand for gasoline will also remain under pressure in the coming years as mandates for biofuels, the popularity of hybrid and diesel vehicles, and perhaps the use of natural gas in fleets and elsewhere exacerbate supply pressures.

Natural gas producers also have little to cheer about. U.S. natural gas inventories remain high at approximately 3,800 billion cubic feet (bcf), almost 500 bcf above the five-year average from 2004–08. Moreover, many unconventional fields are continuing to produce at higher-than-expected levels, despite significant declines in drilling activity. And marginal liquefied natural gas (LNG) cargoes, although down more than 15 percent from two years ago, continue to add to the oversupply. Consequently, despite a slight recent run-up, natural gas prices are still languishing at less than half of their July 2008 level. One positive, though still far from certain, possibility for natural gas producers: Carbon legislation pending in Congress could greatly expand natural gas usage in power generation as well as in transportation.

In our view, the key element of any viable future strategy for refiners and natural gas producers is “shifting to the left” on the supply curve. Although some incumbent positions will be difficult to overtake (for example, mega-scale refineries integrated with petrochemical operations), we foresee shifts that integrate and consolidate existing assets into stronger, more resilient positions. Equally important, in light of industry maturation and continuing segmentation in asset types and markets, companies should push harder to identify and capture advantages in execution. Both in oil and in gas, emerging asset classes including deep water, extra-heavy oil, unconventional gas, and LNG create opportunities for skill advantages.

Shifting left is not an easy assignment for many companies because they tend to form attachments to hard assets and find it difficult to make investment and divestment decisions based on forecasts. There is always the possibility that the predictions may be wrong and the race to the left may be foolhardy — what if demand rebounds and shifts the curve to the right? But that’s not likely. Moreover, companies often struggle to objectively assess their existing capabilities to determine which — if any — are differentiating, and which are needed to win in each asset class. Yet refiners and natural gas producers stand at a critical juncture and need to carefully assess the implications of reducing capacity to bring the overall portfolio in line with new forecasts for future demand and supply. They must also consider how to out-execute competitors; e.g., through better operating approaches and improved use of technology. We envision an escalating M&A and joint-venture environment as companies seek to achieve these advantages in position and operations.

To shift to the left side of the supply curve, we recommend a combination of the following four actions:

  • Concentrate on and invest in areas where you have, or can build, significant capabilities that give you the “right to win.” For example, an emerging segment of the gas business, unconventional gas, offers increased opportunities to create competitive advantage based on differentiated execution skills, such as through application of lean manufacturing techniques. Likewise, LNG offers differentiation opportunities around market and trading skills, among others. At the same time, cut costs deeper in areas that are undifferentiated. This represents a break from the traditional industry approach of indiscriminate, across-the-board cost cutting.
  • Focus on and nurture your best assets, the ones that are outperforming or that can outperform the competition on the relevant supply curve. Holly’s integration of Group III refining assets and Devon Energy’s decision to shed international and Gulf of Mexico assets to focus on its unconventional gas and other positions in North America are recent examples of this strategy in action.
  • Divest or shut down lagging assets, permanently or temporarily. Sunoco and Valero have already employed this tactic on the refinery side. Suncor Petro-Canada and others are moving in this direction upstream.
  • Pursue M&A, and joint ventures, as needed to create or access advantage in position and execution. For example, several international oil companies (IOCs) have partnered with unconventional gas specialists to access both their operating model skills (e.g., lean manufacturing) and first-mover positions in prospective shale gas basins. Long-term crude oil agreements between national oil companies (NOCs) and Gulf Coast refiners could make the difference between creating a sustainable position under a new operating model and becoming a marginal refinery.
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