Good Governance and how to Drive Efficiency and Sustainability
Mohammad Faiz Azmi
Focusing on each issue on an individual basis is certainly important. Therefore, and following on from comments about liberalising the procurement procedure, how could overall governance be modified to improve working practices?
ExxonMobil EP Malaysia
In recent years, PETRONAS has been working on raising market entrant thresholds and increasing the ability of PSCs to engage in self-governance. This has been positive, although further progress on these matters is required. I fully support the development of the national industry and it is right that PETRONAS establishes overriding principles and frameworks. However, it could also establish local content requirements for Malaysian players, which would be a fillip to efforts to streamline the procurement process.
Mubadala Petroleum Malaysia (Mubadala)
One potential way to address the excess capacity in the market is to generate more demand. Since the oil and gas industry is global in nature, it is important that players do not simply confine their outlook to a particular country or region, but turn their gaze worldwide.
At the local level, the generation of more demand implies attracting increased investment while offering companies the best returns and an environment conducive to doing business. One pertinent factor to consider in this context is that different companies have different corporate cultures. When a company arrives in a new jurisdiction where they are constrained from implementing this culture, they are forced to adjust their modus operandi, which can be a challenging process. To avoid this situation from arising, it is important that countries allow international companies an element of freedom to operate according to their particular culture in order to maximise their expertise. If attempts are made to change the way they operate, the original reason for bringing them and their expertise to the country may be lost.
Mubadala has experience of how excess capacity is sometimes generated. The entity, which is a wholly owned subsidiary of Mubadala Development Company, which, in turn, is owned by the Abu Dhabi Government, conducted a study a number of years ago into how the United Arab Emirates should position its service industry to support the regional oil and gas sector. It concluded that focus should extend beyond just the national industry and concentrate on the regional and global perspectives. It also reported that too much involvement from the NOC or regulator in this segment led to negative consequences, including the development of immature local service providers that were overly dependent on the provision of short- or long-term work contracts. This dependency subsequently led to the generation of excess capacity.
While State provision of support and work to local companies may be positive in the initial phases, to help develop capabilities, it is not feasible in the long term. As a result, this should be considered in efforts to reduce excess capacity not only in Malaysia, but also in other global oil and gas locations.
The majority of Malaysian companies seek to become an international entity and understand that this requires the ability to raise funds, among other aspects. Thus, it is essential that any steps to reassess procurement in Malaysia take account of the segmented pricing structures in play and the consequences thereof. These sometimes result in foreign competitors being able to outbid Malaysian bidders because Malaysian companies may not be able to procure certain items at globally competitive prices due to country policies. Of course, every country has distinct dynamics and fiscal regimes and has different ways to attract business and develop local capabilities. Malaysia is no different. The key is to identify the most suitable form of governance for each particular country.
The most important step is identifying how industry players can contribute to making governance more efficient. From the operators’ perspective this includes how the level of governance applied and the degree of freedom granted facilitate the entry of expertise, creativity and knowledge.
One example of how governance could be liberalised relates to the process whereby Shell and other operators design a project and take their design to market for bidding. Efficiency could be increased in this process by enabling operators to work directly with one or a small number of service providers on the basis of a set budget in which the provider produces a design depending on that budget and in which costs are designed into the product. This design-to-cost approach is utilised in other industries and it could prove useful in the oil and gas sector. Critics claim that it sidesteps the competitive bid. However, a governance structure that facilitates its implementation would increase the ability of operators to make full use of existing capability and knowledge in the industry, thereby enhancing efficiency and innovation.
From the perspective of PETRONAS, in April 2016, we changed our organisational structure by combining upstream and downstream procurement, which were previously separate, into one single area. We also raised the threshold value of entities with whom we enter into PSCs, adding greater value to the system and allowing contractors more freedom. In raising this threshold, we have taken care to strike the right balance between our role as an NOC and enhancing how the market functions. On one hand, PETRONAS has a responsibility to nurture local industry in line with the national interest, while on the other hand, we understand the importance of driving down costs as much as possible.
In the context of our discussions about the upstream segment, I would like to refer briefly to its downstream counterpart and, specifically, the RAPID project in Pengerang. When we launched the open international bid for the engineering, procurement and construction of RAPID, our conditions stipulated a certain percentage was assigned for local content participation. The objective of establishing this local content was precisely to strike the necessary balance between international expertise and local industry development. Guaranteeing a certain level of local content participation in large downstream projects helps to ensure that Malaysian contractors contribute to specific pockets of work, thereby developing domestic expertise and talent. There are possibilities to replicate this on the upstream side.
Malaysian Oil & Gas Services Council (MOGSC)
I would like to raise a number of issues in the context of how working practices can be improved. First, the development of local industry and talent is important to all countries and that is understandable. On behalf of the industry, I would like to applaud what Samsudin said about PETRONAS needing to nurture local industry. Indeed, ‘nurture’ is the key word. As Malaysians, MOGSC will be happy to continue to work with our NOC to nurture and encourage the local players who add value to the sector and are willing to invest in order to grow. In fact, MOGSC stakeholders also share that responsibility, which is particularly important in the current scenario. Accordingly, in order to improve working practices in Malaysia, it is essential to clarify content definitions for each particular industry segment because general statements about local content development may not necessarily apply to all areas equally.
Second, one key aspect that is required in the context of the Malaysian oil and gas industry is additional conceptual thinking in the upstream segment and across the industry as a whole. For example, there is a general perception that local contractors are lacking in maturity and that this is holding them back. This perception is unjustified because many Malaysian contractors are highly skilled and experienced and so it is time to treat local contractors as mature entities.
Related to the idea of conceptual thinking, a sustained low oil-price of around US$50 per barrel is not necessarily an obstacle to growth because when I entered the industry almost three decades ago, the price was approximately US$25, and expansion was achieved. However, the cyclical nature of the industry and the subsequent ongoing pursuit of small changes deemed necessary for players to survive is an unsustainable model. That is why discussions like this one between leading players provide the perfect opportunity for all parties to jointly define exactly what we want for industry as a whole.
Mohammad Faiz Azmi
It seems there is consensus that the industry can improve efficiency without compromising the national agenda. I would like to move on to focus on specifics, so what particular feature could be enhanced or changed in the current setup to improve efficiency? Iain, what is Shell’s perspective?
The regimented way in which procurement is governed must be modified. The solution is relatively straightforward and relates to previous remarks. For example, one possibility is for players to agree on a percentage of local content involvement and for a list of qualified suppliers to be drawn up. Such measures will improve time to market by overcoming the lengthier practice whereby PETRONAS has to be involved step-by-step throughout the entire procurement process. Once such measures are implemented, the national agenda can be rightfully addressed and overall efficiency enhanced. In turn, streamlining the implementation procedure will help to unleash creativity in the sector, which is incredibly important for fostering innovation and sustainability.
Boustead is a proponent of the integrated services approach and one related area in which modifications could lead to improvements in efficiency is the Standardised Work and Equipment Categories (SWEC). The SWEC codes are a list of broad work categories concerning products and services across upstream and downstream oil and gas operational activities. The challenge is that the codes are piecemeal in structure, which affects the way contracts are drawn up. For example, vendors are sometimes categorised according to one specific area and the services of multiple vendors from distinct categories cannot be linked together under one single contract. This impacts on efficiency and cost because it sometimes results in the duplication of work. This is due to the need to enter into separate contracts to complete a particular project that would be more efficiently executed via an integrated services model.
One solution to such cost inefficiencies is the way in which Boustead acts as an umbrella organisation and guardian to smaller players to coordinate integrated service contracts that oversee the work from the top down in a more comprehensive and streamlined manner. Importantly, this integrated approach helps clients to reduce their overall costs.
Azman raises a significant point because there are companies in Malaysia, including Boustead, that are capable of acting as a guardian to smaller entities to build their experience and expertise. This does not require traditional notions of equity consolidation or a joint venture, since that approach will not directly address excess capacity in the market. Equity consolidation is also a lengthy process and by the time it has been completed the market may have moved on. Rather, working performance consolidation, or a similar model such as a performance sharing alliance, is a viable alternative. The success of this type of consolidation or alliance will depend on improvements made to the visibility of market activity and how companies in the respective segment are planning for the future. Visibility of this type will increase accountability in the system, enhance market confidence, and provide ownership of the process as a whole.
Moreover, the most fundamental way in which to bring about an efficient and sustainable oil and gas sector is for all players to work together towards the joint design of a simplified governance framework for the upstream segment that is conducive to creativity.
Fostering creativity, and therefore innovation, requires additional efforts to harmonise upstream standards. Although PETRONAS has a pivotal role to play in terms of governance, operators are also important. For instance, operators are keen to maintain their competitive edge and may take deliberate steps to preserve their design capability in-house. This is understandable to some extent, although it contradicts efforts towards the objective of nurturing creativity in the operators’ supplier community.
Iain mentioned the possibility for suppliers to design to cost rather than to specification. One challenge here is that many operators have their own in-house experts working on the specification side, in line with their particular internal standards, and these often differ from operator to operator. There is, therefore, a limited market for service providers to enhance their own creativity because specifications are being established by operators.
Different standards are applied not only to hardware, such as equipment, but also software, including safety standards and the way personnel are trained. The harmonisation of these standards would result in lower costs for operators since it is inefficient for industry players, particularly service providers, to replicate different ways of doing what is essentially the same thing. Thus, I concur with calls for operators to be less prescriptive or rigid about our own particular procedures.
We talk about cost effectiveness and process efficiency and yet in many areas that can be ‘commonised’, we had failed to achieve those objectives. The industry feels that it is important for stakeholders to align themselves to common requirements or to work towards an overall common requirement to optimise cost and efficiency. This may involve adapting certain requirements locally rather than, for example, imposing those from other jurisdictions, such as the North Sea.
Nevertheless, it should also be noted that the harmonisation of standards among operators is easier said than done. For example, previous efforts were made to harmonise pipeline welding qualification procedures, but progress was difficult due to the distinct requirements set by each of the operators, in line with their own internal standards.
One area that has not been mentioned is the role of local agents in the industry. The key to national industry development is for local companies to invest in oil and gas assets and build expertise. Instead, we frequently find that interaction with agents creates friction in the system and limited value-add to the industry.
In many cases, the role of the agent is limited and includes tasks such as adding mark-ups and requiring more interfaces and coordination. As Shahril said, agents add minimal value to the industry and instead provide more of a market entry function.
One suggestion for adding more value is to shift this relationship to a partnership arrangement with contractors who are able to complement or build local capabilities. For example, ConocoPhillips has, in the past, procured valves from a large, competent international supplier. However, in Malaysia, this exchange had to be undertaken through a local agent who is not a valve supplier and who provided merely a pass-through service. Yes, the agent makes a profit and provides employment but it is not developing sustainable competence. Therefore, partnering the international valve supplier with a local valve supplier who is capable of providing complementary services or equipment, or local aftermarket support, could be a more valuable and sustainable approach. Identifying these types of complementary arrangements could strengthen both the experienced and inexperienced halves of the partnership.
Everyone recognises the importance and value of involving local players, but to enhance efficiency in the system they need to become more accountable. At Mubadala, when we submit a call for prequalification, expression of interest or tender, we approach up to 150 companies and end up with just five or six that actually bid. This is an extremely lengthy exercise that wastes multiple man-hours. Introducing more accountability will help to remove unqualified players from the eligibility list and save companies considerable resources.
Therefore, introducing key criteria to safeguard national interests, while also enabling operators to deliver their business according to their own culture, would help to strike the balance between nurturing local industry and embedding efficiency and sustainability. Furthermore, liberalising and opening up the market to foster operator creativity is one way to bring additional value to the industry.
I would like to interject on a more general note to address competence building and knowledge transfer in the procurement process. Of course, I understand the need to strengthen and grow the Malaysian oil and gas industry and national employment. As I see it, the overall objective is to nurture local companies in a way that enables them to become strong, competent and capable of serving both the Malaysian and the global market. To achieve this objective in the oil and gas industry, vendors need to develop high levels of competence and knowledge so they can continually find new ways of adding value to their products and services.
A healthy level of exposure to competition, knowledge transfer and possibly even employee transfer from elsewhere can be more effective in developing the required competence and expertise. While shielding local companies from external competition can provide short-term business gains, it may result in local companies not receiving sufficient exposure and ‘cross-pollination’ to be able to develop the level of expertise and experience required to best serve the nation or the global market.
Mohammad Faiz Azmi
PETRONAS has taken steps to identify the companies that are adding value to the market as well as those that are not, and its vendor development has been based on transforming local players into globally competitive entities. Nevertheless, there is a perception, whether valid or invalid, that policy continues to support players that do not add value to the wider industry. What is the PETRONAS perspective on this?
Muhammad Zamri Jusoh
We are aware of these perceptions and agree to a certain extent about some of the issues mentioned. That is why we are taking proactive steps to emphasise which particular segments or sectors require additional support and which require further liberalisation.
In addition, PETRONAS is conscious of the extent to which other countries, such as Vietnam, Indonesia and the U.S., are taking steps to safeguard certain interests of their respective local industries. It is therefore essential that any approach we adopt moving forward takes these global realities into account.
I commend efforts to nurture local talent but if it is not done sustainably it results in oil being left in the ground. A lack of competition in this industry results in the inability to develop some of the more marginal fields, which is why it is so important that nurturing efforts enhance both competitiveness and capability. I think industry players will accept that it may cost a little more to ensure that these local players adjust to the learning curve during the initial stages in order to allow them to compete regionally or globally. However, it is important to introduce a timeframe in which players that are not able to perform to the required standard stop receiving this support.