Published: 22 May 2020
Analyst(s): Rich McAvey, Simon Cushing
Cost management is once again a top priority for oil and gas CIOs, but it is more nuanced, as IT must compete with other urgent priorities during COVID-19 and help business units respond to market disruptions. CIOs should use these 12 milestones to correctly align with business priorities.
Demand destruction sparked by the COVID-19 pandemic has created intense financial pressure across the industry. However, the dynamics of this crunch are different, as IT has multiple urgent mandates (such as pandemic response) that conflict with simple cost reduction steps.
Some companies will be pushed toward bankruptcy and pursue extreme cost reductions that make routine IT operations nonsustainable or noncompliant with policies. Other companies will be opportunistic and look to acquire assets or selectively accelerate digital programs at bargain prices. Most companies will be somewhere in the middle, presenting CIOs with a complex mix of inconsistent cost optimization objectives.
Over the last several years, most CIOs have earned significant trust among their business partners by establishing lean IT operations and carefully balancing IT spend among competing priorities. Now, this trust is in jeopardy, as many CIOs are suddenly forced to make significant cuts quickly, each involving a painful trade-off decision that impacts business units differently.
CIOs involved in oil and gas digital transformation and innovation should:
Maintain efficient control of diverse cost optimization activities while responding to individual business unit priorities by mapping objectives into a shared framework. Use the framework to consolidate synergies among business units and make outliers transparent.
Maintain business confidence that IT will continue to balance aggressive, yet fair, cost reductions among all business units by identifying management gaps in current capabilities and investing in tools, processes and relationships to close the gaps.
Prepare for the worst by developing a game plan for cutting IT resources below sustainable levels before it is required. If such extreme cuts are needed, take them in an ethical manner by communicating the plan, identifying the inevitable operational breakdowns and estimating the future cost of restoring sustainable operations.
In 2020, oil and gas companies were hit with a series of disruptive shocks. First, the COVID-19 pandemic disrupted their operating model, requiring a near-instantaneous shift from office-based to home-based work. Then, as COVID-19 impacted the population at large, demand for oil products dropped roughly 30%, disrupting hydrocarbon supply chains and reducing cash flows.
Initially, OPEC+ producers responded to demand decreases by increasing production rates, sending oil and gas prices to unsustainably low levels. Eventually, they made historically heroic cuts to production, but they were not enough to offset demand destruction. By April, it became apparent that global hydrocarbon stocks were getting close to filling all available storage (see Figure 1). The harsh reality of imminent production shut-ins and refinery shutdowns sent prices to negative levels for the first time.
Financial pressure flowing from this series of shocks was intense. All companies were impacted, but not in the same way. The pressure pushed some companies to the brink of bankruptcy, demanding extreme cost cuts from their CIOS. Other companies, for a variety of reasons, were positioned to weather the storm, and their CIOs were challenged to accelerate portions of their digital transformation plans (while trimming costs in other areas). Most companies temporarily set aside long-term plans and focused on responding to their immediate challenges.
Cost optimization has once again become a top priority for oil and gas CIOs. However, the situation is more complex than prior industry downturns in the following ways:
CIOs earned well-deserved trust for tightly managing IT costs since the 2014 market collapse.
IT cost reduction opportunities are too small to improve the overall enterprise situation.
Discretionary projects are being scaled back, but most were tied to critically important business priorities.
Some companies are fighting for survival; others are accelerating business transformation.
IT is in the midst of its own transformation to hybrid cloud platforms, IT products and other new practices. These transformations are not easily deferred.
As companies move past their initial reactions to the disruptions of 2020, CIOs must intensify their efforts to establish cost optimization as an ongoing discipline (see ). However, the situation is complex. It is not enough for CIOs to take action against a generic list of cost management best practices. As shown in Figure 2, a more-nuanced approach is required.
Since business leaders are critically dependent on digital technology for their own cost optimization efforts, CIOs must meet each business leader where they are and guide them onto a shared cost optimization trail. Many difficult decisions must be made, most involving unclear trade-off decisions that pit one business unit against another. Nine of the 12 milestones address this challenge. CIOs must also take steps to protect and strengthen the trust they have built as these decisions are made. Two of the 12 milestones address this challenge. In addition, some CIOs will be forced to make near-term cuts that damage their sustainability. These mandated cuts will break some corporate policies and result in additional disruptions from avoidable operational/security incidents. The final milestone addresses this issue.
In a commodity-based industry like oil and gas, cost optimization has been among the list of top business priorities for many decades. Most CIOs have provided strong leadership, periodically refreshed their best practices and developed broader governance to establish a strong state of IT cost optimization. However, changing business conditions (such as the current pandemic), stubborn cultural realities (such as independent organizational silos) and technology advances (such as IT process automation) always result in some degree of suboptimization. As shown in Figure 3, CIOs need a continuous cycle of examination and adjustment to achieve and sustain an appropriate state of cost optimization for their organization during volatile market fluctuations. In today’s market, this work is particularly challenging, because there are multiple objectives and many trade-off decisions are required.For example, the need to enable working from home due to COVID-19 may increase IT short-term costs during the reactionary phase to the pandemic. However, it might open future business cost optimization opportunities that reduce commercial real estate costs in the following months/years.
By focusing on the following nine milestones, CIOs can align similar workstreams and better allocate IT resources.
These are actions taken as part of the immediate response to the 2020 disruptions. As business priorities change, discretionary work is reduced, and CIOs can take rapid steps to rebalance IT resources:
Defer or eliminate: Engage business leaders and work with them to reduce the near-term demand for IT resources associated with discretionary projects. Also, presume all IT-sponsored discretionary work, such as an ERP upgrade, can be deferred until 2021. Unless the project is essential for enterprise business priorities, suspend 2020 work.
Rationalize: Use the change in mindset sparked by the crisis to push through the rationalization of nonstandard applications, hardware or IT services demanded by leaders in change-resistant organizational silos. Also, reexamine volume-based IT cost drivers, such as software licenses, and reduce them to balance with the lower level of discretionary work. Focus on areas where business slides have sustained overcustomization of business technologies, such as geoscience data management, asset management analytics, inventory reporting systems, marketing/customer management and environmental, health and safety solutions.
Renegotiate: Leverage current market conditions to reduce spend with third parties. For nonstrategic vendors, work with procurement to adopt aggressive negotiating postures that push all legal options in contracts to the limit. Cancel contracts to force negotiations where you have a tactical advantage. For strategic partners, especially ones with multiyear agreements, look for ways to shift spend into 2021. True partners will offer (reluctantly) to provide additional work — especially if it displaces a competitor — or alternative payment terms.
Beyond brute cost cutting, implement steps to structurally reduce IT spend in the near term.
Simplify: Incremental changes over years inevitably introduce suboptimal work processes, such as creating spreadsheets that consume IT resources to generate reports, transform data or connect vendor-based processes. Reexamine all processes and streamline; eliminate anything that consumes resources for low-value outcomes.
Standardize: Vendor products and services change over time. Look for opportunities where current offerings overlap to eliminate a vendor and standardize policies, technical standards and workflows. Eliminate all nonessential customization. Historic efforts to expand standardization have often been hindered more by internal business requirements than by vendors. Current business conditions shift priorities in favor of CIOs.
Automate: Take advantage of technologies, such as robotic process automation, to automate work and eliminate IT resource consumption for repetitive work. Look beyond work performed directly by IT personnel. Call all IT service vendors to reveal how they are using automation to reduce the cost of service. Combine with “renegotiate” to capture higher portions of the value that automation delivers for the work it performs.
CIOs can do more for enterprise cost optimization by expanding the use of data and digital technologies to drive value through efficiencies in business operations (see “Use Digital Factories to Drive Deep Optimization Across the Enterprise”):
Align and plan: Most oil and gas companies have spent the last two years developing sophisticated digital roadmaps. These programs identified critical business objectives, such as delivery of significant profit improvement results by 2022 through 2025, that are not easily abandoned. Yet, current business conditions are likely to require rapid de-escalation of these programs. IT can provide value by realigning their goals alongside those of the business leaders and resetting implementation plans that minimize the loss of near-term value creation.
Measure and adapt: The pace at which business transformation plans are changing makes it challenging for enterprise leaders to track the impact on near-term business outcomes and risks.CIOs, especially those who have earned the confidence of business leaders since the last market downturn, can add value by leveraging their position as the largest implementers of digital transformation across the enterprise to track and make transparent real-time changes.
Most business leaders do not have a solid understanding of IT cost drivers or the practical implications of managing them. Nor do they want to develop such knowledge. That said, cost optimization under current conditions requires many trade-off decisions to be made rapidly — too rapidly for normal hierarchical processes, such as quarterly financial planning, to effectively govern.
Hence, it is critical for CIOs to have the confidence of their peers that they are acting fairly and are basing decisions on objective facts aligned with enterprise priorities. Trust may be tested in 2020, because additional actions that are best for the enterprise might increase IT spend in the near term (see Figure 4). For example, IT will be required to spend additional money during the recovery from COVID-19 to create pandemic-resistant work environments in remote locations, such as offshore rigs or refinery control rooms.
As shown in Figure 4, CIOs can keep trust from eroding and perhaps even position IT to deliver greater value in rapidly responding to market volatility by focusing on two milestones:
Participative governance:Oil and gas CIOs accept that governance over IT spend, including items that are IT-specific, such as cybersecurity, should not be managed solely by IT. However, traditional governance methods, such as showback/chargeback reporting and committee-based decision making, are fraught with practical and political challenges. All traditional approaches are overly complex, poorly understood, too slow and overly resource-intensive for today’s business environment. They do little to make appropriate decisions in a timely manner, and naturally provoke critical responses when unexpected results become manifest (see ). As financial transparency improves, CIOs should shift to more collaborative forms of IT governance, such as IT products (where consumers of a service bear its costs directly).
When their companies are hit extraordinarily hard, business leaders may be forced to take extreme actions to preserve cash flow. CIOs are no exception. The impact of COVID-19 disruptions is pushing some oil and gas companies to the brink of ruin. Some bankruptcies have already happened in 2020, although it is not yet clear if the level of stress will rise to that of 2015/2016, when roughly 100 oil and gas companies went bankrupt.
CIOs in companies experiencing financial duress must face the unavoidable reality that IT spend must be slashed below sustainable levels, regardless of future consequences. They realize that such cuts will degrade IT service quality, introduce new business risks and make IT inadequately responsive to external threats. In short, IT will violate policies (enterprise and IT) and may expose the company to external legal actions. As illustrated in Figure 5, when pushed into this corner, CIOs must address the twelfth milestone — one that falls outside sustainable cost management and is warranted only under emergency conditions.
Regardless of the cause, unconventional IT cost reductions will only provide temporary relief, will break business sustainability by opening pathways to near-term business disruptions and will create the need for future spend to restore normal operations. Unfortunately, business leaders demanding such cuts likely have an inadequate understanding of the immediate or long-term consequences. Accordingly, it is incumbent on CIOs to act ethically, even as they take steps to break business sustainability.
Situations that require such severe cost reductions are rare, but they do already exist at some oil and gas companies. Consequently, this path is not well-traveled, and there is little best-practice guidance available for CIOs who are forced to act under these conditions (see). Ideally, unconventional cost reductions should be implemented in a progressive manner, beginning with the actions that maximize benefits and minimize negative consequences. However, due to the nature of the emergency conditions that are forcing the adoption of unconventional methods, there will likely be inadequate information available to support a methodical approach.
Preparation is the key for unconventional IT cost reduction. It is possible that a strong effort of preparing may, in itself, be sufficient to avoid the need to act. Most business leaders are risk-averse, and during periods of financial distress, they will try to minimize the number of risks that must be managed. It is possible that, if they clearly understand the risks and harm associated with unconventional methods, they may elect to seek savings elsewhere. This possibility is enhanced as opportunities for more significant business optimizations are becoming more prevalent by leveraging digital technologies to redefine legacy workflows across the enterprise.
Guiding Principles on Independence and Objectivity.