The oil and gas industry is in trouble, and not because of plummeting barrel prices, although that doesn’t help matters. Rather, the trouble has been brewing for much longer than the recent price drop and won’t be fixed by market forces: operational inefficiency.
Ask just about anybody who’s been in the industry for a while, and they’ll tell you that oil and gas firms are notoriously short-sighted about boom times and bust times. When times are good, they increase production by throwing more resources at production, and when times are bad, they decrease production by cutting off those same resources. And this works in the short term; it gets cost down quick and has a dramatic effect on earnings per share (EPS) in the current quarter. But in the longer term, it’s a terrible approach.
During boom times, yes, oil and gas firms increase production and make more money, but they do so at the expense of operational efficiency. The only reason they’ve increased revenue is that they’re producing more. But their operating expenses have stayed the same, or, more likely, those expenses have increased as they’ve scaled up operations without improving them.
During bust times as well, oil and gas firms contain costs and reduce the hit to EPS, but as in boom times, they do so at the expense of operational efficiency because they terminate projects, employees, and partnerships that may well have been bringing great value to the organization – which makes a firm less efficient, despite the positive effect these measures have on costs. And when the bust ends and oil and gas firms ramp up again, the start-up costs for those previously shut-down projects are huge, and the negative impact on project delivery times and overall quality is staggering.
As pervasive and deep-seated as this boom and bust mentality is in the oil and gas industry, the way out is clear, because manufacturers in every other sector are already doing it. In boom times, you increase production not by blindly committing resources to production, but rather by improving efficiency in your production processes to gain capacity. This not only leads to increased revenue, but also increased margins, which are more important anyway.
But doing so also prepares your organization for the bust times because overall efficiency has been improved, which allows you to better weather the bust times. And the discipline of improving efficiency carries over into bust times, so that your organization can address a bad market by – you guessed it – continuing to gain efficiency, only resorting to workforce reduction or changes in the supply chain when absolutely needed. When boom times come around again, as they almost always do, the start-up costs will be lower as well, because you’ll have made fewer cuts to your workforce and supply chain that then need to be reversed.
Although the path is straightforward, walking it will be anything but for the oil and gas industry. If the example of the U.S. auto industry is any indication, it will be a long road. The automakers first got serious about adopting the Toyota Way in the 1980s, and in many ways, they are still working to fully embrace it.
The good news is that since the 1980s, adoption of Lean methods among manufacturers has been widespread. This gives oil and gas organizations plenty of pioneers to look to and follow, as well as mentors to work with. Hopefully, this will allow the oil and gas industry to make quicker progress toward operational efficiency and the positive effects it will have on revenue, margins, and, yes, on Wall Street in terms of EPS.