1. business and industrial

Adding Value Does Not
Mean Cost Reduction
Ron Doherty, INTECSEA Consulting
MCE Deepwater, London, March 2015
Adding Value
Value is an issue
Capital market confidence in the ability of upstream oil & gas
companies to create value—on the part of both majors and
independents—has been deteriorating significantly over time.
Disappointing exploration results, declining production
efficiency, exploding capital intensity and investments that
don’t drive growth are making investors uncomfortable with
the industry’s future.
McKinsey Global Exploration Service Line, McKinsey analysis
“Never let a good crisis go to waste”
Oil & Gas practice
December 2014
Copyright © McKinsey & Company
Adding Value

When the price of oil falls, then logically the cost of a development
must also fall in order to maintain an “acceptable” return

Many operators in this environment take cost reduction as their
main focus

Low oil prices will lead to reduced costs

This is “supply & demand”

Cost will rise again in a higher oil price environment
Adding Value
The majority of the “value” can be gained or lost long before the first
purchase order is issued for equipment.
Influence
curve
100%
0%
EPC
DD
FEED
concept
Feasibility
Opportunity to influence value
Influence Opportunity
Project
Process
Adding Value

Projects never “look back”, so any value lost at an early stage is
generally not seen. Certainly it does not get recorded……

To attempt to quantify the potential “value” that can be gained or
lost, a simplified example: A “Typical deep-water” Development
Adding Value
200 MMbbl of recoverable oil
No sales gas product
1000 -1500 m water depth
Fast track project (36 months to first oil)
25 year production life
Oil price of $100/bbl
Inflation at 2.5%
Adding Value
Typical “fast-track” schedule
First oil
Discovery Project start
36 Months
24 months
equipment
Appraisal
Full production
Adding Value
Actual schedule
First oil
Discovery Project start
Additional
wells
36 Months
24 months
equipment
Appraisal
Full production
Adding Value
Value (NPV) change
Original FDP
Missed Plateau
NPV, MM$
4,074
3,621
Delta, MM$
-
Delta, %
-
-11.1%
IRR, %
22%
20%
c
-453
Adding Value
Additional Production and Water Injector wells needed after only 2 years
of operation
CAPEX required for drilling, equipment procurement and installation.
(Loss of production during installation/hook-up/commissioning is ignored)
Original FDP
Missed Plateau
Extra Wells
DRILLEX, MM$
1,600
1,600
2,400
CAPEX, MM$
3,220
3,220
4,220
Total, MM$
4,820
4,820
6,620
Delta, %
-
0%
+37%
+ $1.8bn
Adding Value
NPV severely eroded
IRRs remain attractive
(IRR by itself is not a reliable indicator of good/bad project)
Original FDP
Missed Plateau
Extra Wells
NPV, MM$
4,074
3,621
2,075
Delta, MM$
-
-453
-2,000
Delta, %
-
-11.1%
-55.2%
IRR, %
22%
20%
16%
Adding Value
What was missing…?
Quite a lot … Engineering & Systems approach, Risk quantification
(e.g. risk quantification in relative terms)
CAPEX
Criteria
Adding Value

What is the cost of adding this value?

A full Feasibility & Concept phase would be in the order of $5
to $10 million

As a percentage of the “lost” NPV, this represents < 0.5%

So are costs really being cut in the right places…..?
Adding Value
Project delivery results have suffered. It is no secret that cost
and time overruns are common in the oil & gas industry. In
fact, most current projects miss both targets. Spiraling project
development costs may soon strain the ability of companies to
earn adequate returns. The culprit isn’t supplier margins or
commodity costs. It is soaring levels of inefficiency that can
be avoided.
McKinsey Global Exploration Service Line, McKinsey analysis
“Never let a good crisis go to waste”
Oil & Gas practice
December 2014
Copyright © McKinsey & Company
Adding Value
With reference to the example employed:

The value wasn’t lost due to equipment prices being too high
(Cost)

Or personnel being too expensive (Cost)

It was lost because the development was based on
assumptions (where risks are not fully quantified) and issues
were not clearly identified and resolved (Inefficiency)
Adding Value
So reducing cost
Can seriously reduce the value of a development
Adding value does not (just) mean cost reduction
Thank You
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