While it is fashionable to focus on cost management when commodity prices are low,

in the current environment it is necessary to devote attention not simply to the

application of capital to core asset acquisitions, divestitures, and development.
The upstream industry's increasingly competitive nature will drive successful
companies to move toward sustainable low-cost operations as well.
Specific steps such companies could take include:
Outsourcing in select areas. The largest E&Ps and super majors have long
recognized the cost benefits of business process outsourcing (BPO) in areas like
accounting, procurement or information technology. Yet relatively few large and
mid-sized E&Ps have taken this step, in part because of concerns it might backfire.
They should investigate the long-term benefits of outsourcing functions where costs
need to be lowered.
Centralization and standardization of processes. Wipro's research indicates
many large and mid-sized E&Ps do not maintain centralized or standardized processes
and systems in areas such as accounting and lease administration. Reliance on
manual systems and spreadsheets is especially common for ED&A; finance and
accounting; health, environment and safety; and legal. In addition to lowering
costs, standardization facilitates performance measurement.
Development of a measurement culture. Other industries have long recognized
the need to gather cost and performance data as part of a continuous improvement
process. It is perhaps the best way to identify improvement opportunities and
measure performance gaps. With sufficient data. benchmarking can also allow E&Ps to
assess the impact of acquisitions, divestitures, reorganizations or other strategic
changes.
Targeting technology investment. Even smaller E&Ps should be leveraging
technology allowing for production optimization, collaborative work environments,
real-time data management, and remote field monitoring and centers of excellence.
The benefits include streamlined information management (and reduced information
management costs), and more productive workforces and asset bases as well.
Without changes, higher-cost large and mid-sized operators, particularly those with
a natural gas focus, will face an uphill battle. Convincing senior management at
these E&Ps that cost management is not a seasonal activity designed for a low price
environment would be a useful first step.

The high cost of overhead among large and mid-sized E&Ps

04/01/2012

Steve Wright, Wipro Technologies, Houston

Many US exploration and production companies (E&Ps) have made some dramatic
strategic changes in the past several years. Many have chosen to shed non-core
assets and, in light of the current oil-gas price differentials, focus capital
dollars toward liquids-rich and oil plays. While they have been quick to re-focus
capital, they have not dedicated much attention to the allocation of human capital
or to the development of low-cost operating structures.
Examining cost performance and resource allocation among large and mid-sized US
operators, Wipro found that, relative to their larger peers, these operators
devoted much larger portions of their general and administrative (G&A) budgets to
non-core or back-office activities. Among large and mid-sized E&Ps, more staff was
devoted to finance and accounting than to any other G&A area. To remain
competitive, these companies must begin to reallocate resources toward greater
investment in core activities. Here I examine what is behind the observed
differences in core and non-core G&A spend, and what large and mid-sized E&Ps might
do to address this imbalance.

GROWING PAINS, SUPPORT COSTS

In terms of domestic production, large and mid-sized E&Ps have grown at a much
faster rate over the past five years than have the largest E&Ps. (Note: I define
"large" and "mid-sized" E&P consistent with the framework used in IHS Herold's 2011
Global Upstream Performance Review.) And relative to their larger peers, large and
mid-sized E&Ps are more likely to have a high percentage of their total production
from natural gas. Although a gas focus in the current environment should imply a
desire to keep costs down, the growing pains many companies have faced have
doubtless added to their support costs.
Wipro's upstream G&A Benchmarking Study, initially conceived at Arthur Andersen LLP
in 1994, defines G&A to include all gross costs above first-level field
supervision. It includes both in-house and outsourced costs. The study divides G&A
into two components: Technical and Operating G&A and Support G&A, each of which
should be managed differently from a strategic perspective (see Figure 1).
Technical and Operating G&A is related to supervision of core activities central to
the success of a competitive exploration and production company. Support G&A (often
referred to as traditional overhead) is a necessary expenditure, but additional
investments in those areas do not necessarily make for a more competitive E&P.
Information systems span both types of G&A.

Figure 2 demonstrates how large and mid-sized E&Ps allocate their G&A in comparison
to that of their larger peers. Note that the large grey area among super majors and
the largest E&Ps indicates their relatively greater proportion of Technical and
Operating (i.e., core) G&A spend. Note also the relatively bigger slices devoted to
finance and headquarters among large and mid-sized E&Ps. Overall, these companies
spent over 53% of total G&A in Support areas, whereas their larger peers devoted
only 43.5% to non-core functions.

Some may argue the results in Figure 2 are a function of the relative positions on
the growth curves of the two set of companies. Companies begin growth by hiring key
leadership and management (i.e., high-salaried) staff and then add lower-priced
talent in areas like finance and accounting. But neither that argument nor the
greater economies of scale among the largest E&Ps explains why smaller E&Ps are
relatively heavier in Support G&A per se. Our research suggests further these high
costs among large and mid-sized E&Ps are not offset by significantly higher
production. On a per barrel of oil equivalent (BOE), thousand cubic feet equivalent
(MCFE), or revenue basis, these companies have higher G&A than their larger peers
in all Support G&A areas other than Human Resources. On a production-normalized
basis, their headquarters G&A spend is 73% higher than that of the largest
operators, and their finance and accounting G&A is 65% higher. (The spend among
these companies is higher than their larger peers in all finance areas listed in
Figure 1.) Taken together, the percentages allocated to finance and headquarters
are larger than those allocated to operations and exploration, development and
acquisitions (ED&A).

Figure 2 demonstrates how large and mid-sized E&Ps allocate their G&A in comparison
to that of their larger peers. Note that the large grey area among super majors and
the largest E&Ps indicates their relatively greater proportion of Technical and
Operating (i.e., core) G&A spend. Note also the relatively bigger slices devoted to
finance and headquarters among large and mid-sized E&Ps. Overall, these companies
spent over 53% of total G&A in Support areas, whereas their larger peers devoted
only 43.5% to non-core functions.

Some may argue the results in Figure 2 are a function of the relative positions on
the growth curves of the two set of companies. Companies begin growth by hiring key
leadership and management (i.e., high-salaried) staff and then add lower-priced
talent in areas like finance and accounting. But neither that argument nor the
greater economies of scale among the largest E&Ps explains why smaller E&Ps are
relatively heavier in Support G&A per se. Our research suggests further these high
costs among large and mid-sized E&Ps are not offset by significantly higher
production. On a per barrel of oil equivalent (BOE), thousand cubic feet equivalent
(MCFE), or revenue basis, these companies have higher G&A than their larger peers
in all Support G&A areas other than Human Resources. On a production-normalized
basis, their headquarters G&A spend is 73% higher than that of the largest
operators, and their finance and accounting G&A is 65% higher. (The spend among
these companies is higher than their larger peers in all finance areas listed in
Figure 1.) Taken together, the percentages allocated to finance and headquarters
are larger than those allocated to operations and exploration, development and
acquisitions (ED&A).
MANAGING OVERHEAD COSTS