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Published: November 9, 2006

 
 

Unprecedented and Unseen: The Next Great Energy Challenge

Individually, each of the tensions facing capital projects would be difficult to deal with; taken together, the difficulty escalates. The result is an oil and gas environment that has changed so fundamentally that many traditional ways of doing business have become anachronistic:

• Frontier Regions: Most new capital projects take place in regions that are politically and socially unstable, such as West Africa, parts of Eastern Europe, and the Middle East. Investment in Africa and the Asia Pacific region has shot up 25 to 40 percent per year, while (the aforementioned Gulf of Mexico opportunity notwithstanding) investment in traditional production regions in the U.S. and Europe has stagnated or fallen. Oil and gas executives note that operating in frontier regions challenges companies’ political, diplomatic, and security capabilities as never before. Many of these countries, such as Indonesia, are new democracies, in which the old, autocratic way of doing business under former governments (Indonesia’s Suharto regime is an example) has given way to an even more daunting, decentralized maze, with laws that are not always transparent and court rulings that are often inconsistent. Nationally owned oil production companies, such as Indonesia’s Pertamina, Malaysia’s Petronas, or Kazakhstan’s PetroKazakhstan, play an ambiguous role; they sometimes represent government interests and sometimes expand internationally; some, like PetroKazakhstan, have been partially bought by overseas interests, for example, in China.

• Local Pressures: Projects in both frontier and developed regions face increased supply chain complexity. Host governments frequently require international partners to use local suppliers that have no established track records with oil and gas companies. Tight labor markets and stringent government regulations can lead to project delays and cost overruns, as they have in the oil sands project in Alberta, Canada.

• More Intense Competition: Big oil companies are no longer the only game in town, and they are facing increased competition from small and mid-sized producers, as well as national oil companies (NOCs), which now hold more than 75 percent of proven reserves. This represents a critical shift for the major companies; increasingly, they have to deal with these new players, either as direct competitors or as joint-venture partners.

• Project Performance Volatility: As the megaproject risk profiles change, it becomes more difficult to manage costs and other performance targets. Oil and gas companies and contractors are struggling to set budgets that are at once competitive and realistic. Traditional benchmarks, such as the Independent Project Assessment (IPA), are less helpful than they used to be in setting targets — there just aren’t enough “typical” projects to provide a reliable standard. The result, according to the survey: One-third of all oil and gas projects exceed budget and time projections by more than 10 percent. Failures to deliver big projects on budget and on schedule are highly publicized and damage the companies’ profile with capital markets that expect predictability and strong returns.

• Contractor Relationships: An uneasy “upstairs/downstairs” relationship between owners and contractors has resulted in a major disconnect, particularly in the planning and contracting stages. Oil and gas companies tend to look for lowest-cost contractors and to prefer short-term contracts; the contractors call for more integrated, long-term relationships that foster advance planning, effective use of resources, and more equitable sharing of risks and incentives. In high-risk projects, the contracts themselves are a bone of contention: Contractors seek time and material arrangements, whereas owners insist on lump sum contracts. Contractors argue that these turnkey contracts force them to include excessive contingency arrangements, and thus are not conducive to a collaborative approach to risk management.

• The Technical Talent Drain: The graying of the baby boomers is having a substantial impact on the oil and gas industry. The median age for technicians in operating companies is over 45, and it is over 50 for contractors. More than half of the workers in these companies will retire in the next five to 10 years. Moreover, this talent pool is not being replenished. The number of petroleum engineering diplomas awarded in the United States in 2002 was just one-quarter the number awarded annually in the 1980s. China, India, and even Europe currently outpace the U.S. in actual numbers of engineering graduates.

 
 
 
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Resources

  1. Global Upstream Performance Review, John S. Herold Inc. and Harrison Lovegrove & Company, 2006: Source of statistics on and forecasts of exploration and production investment and performance. Click here.
  2. Sachi Hatakenaka et al., “From ‘Black Gold’ to ‘Human Gold’: A Comparative Case Study of the Transition from a Resource-Based to a Knowledge Economy in Stavanger and Aberdeen,” MIT Local Innovation Systems working paper 06-002, July 15, 2006: Benchmark study of two North Sea oil and gas sites, focusing on innovation. PDF download. Click here.
  3. Matthew G. McKenna, Herve Wilczynski, and David VanderSchee, “Capital Project Execution in the Oil and Gas Industry,” Booz Allen Hamilton white paper, 2006: The article on which this “leading idea” was based goes into more detail for industry leaders. PDF download. Click here.
  4. “Oil Sands Costs May Rise 35%,” Energy Bulletin, November 2, 2004: Cost overruns in megaprojects in northern Alberta, Canada. Click here.
  5. Peter Parry, Otto Waterlander, Varya Davidson, “Resourcing the Challenges of Maturity: An Oil Industry View,” Booz Allen Hamilton white paper, 2006: Lays out the challenge of an aging workforce (and declining expertise base) in the oil and gas industries. PDF download. Click here.
  6. “Peak Oil Resolution in U.S. House of Representatives,” Energy Bulletin, November 20, 2005: Resolved that the U.S. create an energy project with the magnitude, creativity, and urgency of the “Man on the Moon” project. Click here.
  7. Andy Serwer, “The Gusher Paradox,” Fortune, September 21, 2006: Columnist argues that even megaprojects won’t mitigate the need for oil independence. Click here.
  8. John Wormald, “Engines of Change,” s+b, Summer 2006: Overview of recent books and resources that seek to make sense of future trends in energy and transportation. “A forced transition away from fossil fuel dependence is almost certain,” but no one knows for sure how quickly it will take place. Click here.
  9. Chevron Web site: Official announcement of the Jack 2 megaproject. Click here.
  10. Oil Career Web site: For professionals seeking careers and for those trying to understand the industry’s greatest points of activity. Click here.
  11. Rigzone Web site: Gazetteer of oil and gas projects worldwide, with pictures. Click here.
 
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