We’re all seeing how today’s unpredictable economic environment is creating multiple challenges for asset-intensive organizations – especially in the utilities, oil and gas, chemicals and mining sectors. Volatile commodity prices, ageing infrastructures and the weight of regulatory compliance are just some of the issues that are squeezing margins and forcing companies to balance short-term cost reduction with the need to sustain revenues and grow business. Over the next 12 weeks, I’ll be discussing some of the critical issues facing asset-intensive organizations in optimizing capital asset lifecycle management processes, and how to drive efficiencies – starting in this first post with strategic planning.
I read recently that PwC predicts the fallout from this in the oil and gas sector alone will be a 30% drop in capital expenditure during 2016. I guess this kind of focus on cost is an obvious first response. But the danger is, in a fast-moving landscape, it could leave companies well behind the curve for the next upward phase of the business cycle. This got me thinking about alternatives to the slash and burn approach and the wider issues around asset lifecycle management – particularly the critical role of strategic planning in controlling costs and improving efficiencies.
Making the right project selections
McKinsey’s recent study of infrastructure spend found that 7% of capital was wasted through poor project selection or misalignment with overall corporate strategy. These are savings that could be invested in other projects or dividends, or to pay down debt. And when you consider the scale of the projects we’re talking about, they add up to some big numbers. McKinsey also looks at the impact of inadequate strategic planning processes in their article, Making better decisions about the risks of capital projects. They say that companies evaluating a new investment project sometimes rush into an assessment of risks and returns without fully understanding the sources and magnitude of the risks they already face.
Take the example of a North American oil company evaluating a new investment. After quantifying the existing risk from commodity price uncertainty, transport congestion and regulatory developments, they realized their initial cash flow assumptions were overly optimistic. In fact, there was only a 5% chance that performance would meet their original projections. Once they mapped likely cash flows against capital requirements and dividends, they had only a 5% chance of meeting their capital needs before the project’s fourth year, and on average wouldn’t meet them until year six. And they’re not alone – I regularly see similar issues in many other organizations.
Improving the odds of success
In situations like this, the companies I work with have seen how technology such as the solution provided by Oracle’s Primavera take the gamble out of strategic planning processes. With the right tools to hand, business planners can make sure they choose projects that will not only meet annual capital and operating budgets, but also deliver against a pre-determined set of drivers – from generating positive cash flow and acceptable ROI, to ensuring regulatory compliance. The ability to reset and re-evaluate these drivers means they can model different scenarios, accurately assess risk and make objective decisions based on fact.
These are just some of the benefits that resulted from our work with a large Middle Eastern national oil company after they implemented Primavera’s strategic planning solution as part of their portfolio management approach. It’s enabled them to optimize capex value by ensuring their portfolio profile lines up with strategic goals, as well as meeting the constraints of cost, cash flow and commodity price. They’ve also been able to improve the quality of financial reporting by applying probability analysis to potential financial outcomes. And by integrating financial and operational plans, they now have a consolidated view of the bigger picture.
Managing the entire asset lifecycle
This kind of strategic planning capability plays a crucial role in leveraging portfolio performance and controlling costs, but I’ve often seen it overlooked in the wider context of asset lifecycle management. Given the challenges of the current economic environment, I think it’s more important than ever before – and an essential part of an integrated approach to Enterprise Project Portfolio Management. I’ll be exploring some of the other critical elements in future posts, with the next taking a closer look at the key issues around the execution of capital projects, specifically at the Front-End Engineering Design stage.
This post was authored by Geoff Roberts, director, energy industry strategy, Oracle Construction and Engineering