Steps to Enhance the Current Ecosystem


Tengku Muhammad Taufik
PwC Malaysia

Much of the conversation has focused on how to achieve the desired balance within the procurement process that would, consequently, establish whether or not all players can, or indeed should, be supported to survive in the current low oil-price environment. Related to the latter is tackling the excess capacity in the market, which, in turn, concerns the visibility of up-coming projects in the industry. This is important because visibility has the potential to facilitate company planning in terms of the level of capacity required, and could therefore preclude the creation of additional excess capacity. Samsudin, what is the PETRONAS stance on visibility?

Samsudin Miskon
PETRONAS

In March 2017, PETRONAS took a significant step towards enhancing visibility in the system with the release of its market info flow. This mechanism will enhance the transparency of scheduled activities over the coming months and years and facilitate the wider planning process for all relevant players.

One of the goals of the market info flow is to address the situation of excess capacity, which can be summed up using a food analogy that I would like to share with you all. During the high oil-price environment, all market players were enjoying a beautiful party and eating a large, three-tiered cake and everyone had big plates filled to the brim. Today, people still have the large plates to hand but rather than taking pleasure in an indulgent gateau, everyone is now having to share just a single cupcake! The challenge is how all the guests divide the cupcake to fill the same large plates. In order to do so, it is important for everyone to realise that there is less cake available and that perhaps their plate is too big for what is on offer; maybe a saucer is more appropriate. Ultimately, excess capacity is best addressed by means of natural attrition rather than forced consolidation and we are expecting the market info flow to help towards that end.

Iain Lo
Shell

Increasing visibility in the market is very important and it should facilitate planning. If this market info flow enables operators to better gauge the pipeline of projects, particularly in relation to when others are coming to market with a tender, it will be a positive addition to the industry.

Shahril Shamsuddin
Sapura Energy

Increased visibility is certainly important, but the most effective way to address excess capacity as a whole is to remove it from the system entirely. In two of the segments most affected by this issue, which are drilling and supply vessels, the problem is global and so the excess assets cannot simply be reutilised in different markets beyond Malaysia.

Azman Ahmad
Boustead

Increased visibility will help to address excess capacity in certain segments, including fabrication yards. Significantly, the provision of increased visibility requires not only input from PETRONAS and its market info flow, but also the operator community. Similarly, Malaysian efforts, by all stakeholders, to increase the visibility of the pipeline of projects taking place across the wider region would be a very positive and transparent step. It would also help to reinforce the country’s objective of becoming a regional hub for oil and gas.

Samsudin Miskon
PETRONAS

In addition to the market info flow, PETRONAS is taking additional proactive steps. First, the SWEC codes have been mentioned and there is general sentiment that they are somewhat fragmented. As a result, during 2017 PETRONAS will be consolidating the codes from the implementation and operations perspective in order to simplify the procurement process and bolster the system as a solution-based service. Second, similar steps are being taken via the Cost Reduction Alliance CORAL 2.0 programme to standardise specifications with regard to PSCs and PETRONAS itself, in an attempt to increase efficiency and expedite cost reductions.

Crucially, and to reiterate Azman’s point, PETRONAS cannot do it alone; we need ongoing input and collaboration from PSCs and stakeholders from across the industry, which is why roundtables such as this as so beneficial.

Ernest Miller
ExxonMobil EP Malaysia

Regarding input from the rest of the industry, I would like to request that PETRONAS involves the stakeholder community in the process of rationalising the SWEC codes, from the implementation and operational perspective. Such participation from operators and the service community, including MOGSC, would help to refine the process and safeguard against a potential situation in which discrepancies and problems arise for operators and service providers further down the line. It would also provide participating parties with a sense of ownership, from start to finish.

Samsudin Miskon
PETRONAS

The CORAL platform provides an element of involvement for other parties in its attempts to drive down costs, and PETRONAS has been continually engaging with associations, fabricators, vessel owners, and others, but we are open to ideas.

Similarly, in terms of enhancing the services being offered, PETRONAS is in the process of raising minimum entry-level requirements for service providers wishing to enter the sector. Importantly, these steps are not being taking to maximise the win-win situation for PETRONAS and the private sector. Rather, they are to ensure a survive-survive one in which players are able to make the necessary adjustments to endure the current choppy waters and then push ahead when conditions improve. They are also aimed at ensuring that Malaysian operators, and all those who have invested in local actors, do not lose their investments by the time the market rebounds.

Concurrently, now that the metaphorical market cake has shrunk to a cupcake, certain external players are able to enter the Malaysian market at relatively low prices, including those that may be subsidised by their respective national governments. Thus, PETRONAS is taking steps to ensure that local players are not priced out of the market.

Azman Ahmad
Boustead

The point about being priced out of the market relates to the possibility of introducing a joint-commitment approach or model in which operators and service providers share on both the upside and the downside. At present, service providers are being asked to decrease their costs by operators due to the low price of oil. Consequently, companies such as Boustead are having to re-benchmark themselves by reducing fixed costs to survive at the new price reality. History tells us that when the oil price rises again, service provider margins do not always necessarily improve in the same vein.

This potential model does not have be a fixed- or variable-price mechanism, but some form of synergy between the two communities would help service providers to offer increasingly optimal delivery performance when the market improves.

Aravindh Kaniappan
Baker Hughes

Azman is right. Margins are incredibly thin in the industry and so many service providers would benefit from oil companies indicating their support for some kind of sharing mechanism or model. Of course, operators are applying their own adjustments to reduce costs, but such a commitment would help to ensure that service providers are not left behind with a low-cost scenario when prices rise and operators’ top lines start to increase.

Tying any new mechanism to price is likely to cause friction between the service provider and operator communities and so a new approach based on open dialogue is required.

Shahril Shamsuddin
Sapura Energy

To ensure a sustainable, long-term relationship, it is essential that all players, including operators, revise both the pricing and contract terms. In recent decades, oil companies have passed risk down to service providers, but the issue of establishing a reasonable margin to cover this risk has never been adequately addressed. It is therefore important to begin discussions about price and contract terms in order to ensure a fair price is being paid, while simultaneously upholding safety standards in the local industry.

Stefano Raciti
Mubadala

In terms of risk, the central point relates to my previous comment about company culture and different ways of doing business. The best party to manage risk is the one that is the most qualified. Some organisations are unable to take on the associated risk and so it is adopted by a contractor. Others, meanwhile, have the experience and the necessary structure in place to manage the risk.

I think this choice is something that needs to be allowed in a market economy. Diverse organisations with distinct structures and varying levels of expertise provide a healthy and, indeed necessary, element of freedom and differentiation.

Tengku Muhammad Taufik
PwC Malaysia

There is a degree of thematic consistency here. How feasible or desirable would it be for PETRONAS, separately or alongside PSCs, to issue a statement of intent that declares their support for service providers to share on the upside if oil prices rise?

Ernest Miller
ExxonMobil EP Malaysia

Rather than issuing a statement of intent, I think such discussions will need to happen between each operator and service provider on a contract-by-contract basis. There has always been an element of negotiation between the two parties in the drawing up of contracts and I see no need to change this dynamic moving forward.

Iain Lo
Shell

Operators try to reduce costs in the way mentioned by Azman in an effort to calculate the ‘should cost’, i.e., what the cost of the services should be, regardless of the oil price, and this is done by breaking down the different work elements into their constituent parts. It is clearly in the interest of operators to ensure that service providers make a margin and are able to survive because, without them, we have no future either. Significantly, if and when the oil price rises, there will be a natural inflation in costs, so from our perspective, as long as parties understand what the cost should be, calculating the correct sums becomes easier.

Shahril Shamsuddin
Sapura Energy

It would be a complex mathematical process to build in a feature such as a fixed- or variable-price derivative required to guarantee some form of service provider upside. Generally, while certain aspects require clarification, such as the risk element I mentioned, it is competition that provides assurances in terms of costs competitiveness.

Aravindh Kaniappan
Baker Hughes

The issue of competition is pertinent here. We have discussed whether all service providers should be kept alive in the current low oil-price environment. This links directly to the contention that service prices are kept from rising on the upside due to the extensive competition in the market, including many of these companies that, perhaps, should be allowed to drop out. This correlation is another reason why natural attrition is so important. If the players that fail to adapt and overcome are not allowed to die, excess capacity will never be addressed and this will have a continuous knock-on effect on service prices.

Tengku Muhammad Taufik
PwC Malaysia

During the first half of the roundtable we briefly discussed governance issues and possible lessons that can be learned from the downstream segment. What examples are there of how governance for the upstream segment could be simplified, based on what we have talked about in terms of consolidation and procurement?

Aravindh Kaniappan
Baker Hughes

One possible example to follow is Indonesia. There, authorities have identified an associated local content level for each element, whether manufacturing, human resources, or something else, within national legislation. This clear, simplified system enhances governance objectivity which, in turn, improves the understanding of market players and helps in terms of measurement and efficiency.

David Hendicott
ConocoPhillips Malaysia

If you set a type of high-level framework in which each segment has clear governance objectives and then allow competition in that market, it is possible to achieve positive results. It is not necessarily the case that all Malaysian contractors should be helped to survive in the downturn. In fact, there is an argument to say that PETRONAS’ overall objectives will be better served if, for example, only 80 per cent of existing players survive. This would cause short-term hardship for those dropping out, but in the long term it may help to stimulate a healthier and more efficient market in which the entire industry is able to prosper.

Muhammad Zamri Jusoh
PETRONAS

In fact, we have reached a figure very close to 80 per cent. There are approximately 3,700 vendors licensed under PETRONAS at present and we are aware that such numbers cannot be sustained given the current environment. The acute excess capacity is serious and that is why PETRONAS is taking the steps to raise entry level requirements, aligning the SWECs, and removing superfluous agents.

In terms of governance, one of the main objectives of PETRONAS is to create an environment conducive to low costs. However, there is an additional element in play which relates to the quality of the service for which an operator is willing to pay. Some operators are prepared to pay more for what they deem to be improved quality and reliability, and guaranteeing this choice must not be overlooked in discussions of simplifying regulation and removing excess capacity.

Tengku Muhammad Taufik
PwC Malaysia

Part of the rationale behind calls for simplified governance is based on the premise of improving costs and efficiencies and, therefore, the quality of the final product or service being delivered. This raises the question of how much flexibility should be accorded by a simplified governance framework because a key aspect of a flexible structure is its capacity to unleash creativity.

Examples from other markets show how creativity within an ecosystem can generate positive change. For example, ongoing consultative processes in Norway between operators and their respective service providers led to Statoil, which is majority owned by the Norwegian State, reducing the break-even point of some of the more difficult fields in the country from approximately US$70 to US$27. There is no reason why this kind of knowledge sharing cannot be replicated in Malaysia. Thus, how are players working towards unleashing creativity and expertise? And where does PETRONAS stand in terms of a broader, more flexible regulatory framework?

Samsudin Miskon
PETRONAS

PETRONAS has overseen a process of reorganisation since April 2016 to simplify matters and drive down costs, with the objective to ensure that certain projects that are unfeasible at present, due to the low oil price, become more feasible thanks to cost-structure improvements. Furthermore, we have played a pivotal role in negotiating general cost reductions in Malaysia, for international as well as local service providers in an effort to stimulate the market.

Regarding creativity and flexible frameworks, we will be announcing certain actions over the course of 2017 as part of wider efforts to tackle the low oil-price environment.

Iain Lo
Shell

At Shell, we would welcome the ability to select and incorporate service providers at an early stage in order for them to help us achieve best value for money. This would be preferable to the current reality whereby we develop ideas from scratch with consultants and then go out to market.

Azman Ahmad
Boustead

There has been an element of inflexibility from both PETRONAS and industry players in general in Malaysia. As a consequence, a framework where industry players can contribute ideas at the very top level has not been fully realised. When proactive steps are taken to introduce change, the change management process is often slow and unresponsive at the middle and lower levels. This translates into us having to pursue the traditional bidding process, which, as has been said, can be lengthy and inefficient.

One way to resolve this situation would be to enable service providers to devise and conduct small pilot schemes, similar to the information technology industry’s proof of concept method. For example, a simple five-step process could be followed to submit such a pilot scheme application: first, the applicant could outline how their proposed business model would add value to current industry practice; second, this proposal could include a financial simulation model to prove the overall hypothesis, prior to entering into discussions with the relevant operator; third, if approved, a non-disclosure agreement could be signed to enable the applicant to input genuine field data to test the model; fourth, a project execution plan for the pilot scheme could then be drawn up, in which financing options are laid out, such as deferred payment if the operator decides not to proceed with the model, despite the pilot proving a success; fifth, if the operator decides to proceed, engagement could be formalised via the most appropriate contractual agreement.

The oil and gas industry is perfectly capable of applying this kind of proof of concept approach and I believe it would help to accelerate positive change and embed innovation within the sector.

Ernest Miller
ExxonMobil EP Malaysia

PETRONAS has done an excellent job over the last few decades to implement change, transparency and communication at the highest industry level. The challenge now is to replicate this by filtering change down to the lower levels of all organisations, including service providers. I therefore fully support the idea of pilot schemes as a way to expedite creativity.

Sharifah Zaida
MOGSC

MOGSC experience is that the senior levels of PETRONAS are very open to change. However, there is a belief that more could be done from the PETRONAS management side to roll out innovative ideas or initiatives internally and not just externally. This is important because it would ensure that everyone within PETRONAS, as well as across the wider industry, were on the same page.

Aravindh Kaniappan
Baker Hughes

Moves to enhance flexibility in the system should also consider how service procurement is conducted, with the aim of enabling Malaysian service providers to work in a variety of ways. Azman has mentioned one possible example in terms of an integrated services approach. Another is for service providers to operate under performance-based contracting.

Tengku Muhammad Taufik
PwC Malaysia

Moving on to the final part of the roundtable, I want to return to the topic of excess capacity in the market to gauge consensus on what needs to be done moving forward. There is general agreement as to the excessive proliferation of commoditised services and specialised assets that lack the commensurate capabilities and which are absorbing valuable investment and resources.

This is true for both the Malaysian and international market. For example, the utilisation rate for global rigs and offshore supply vessels at the end of 2016 was approximately 50 per cent. There are also large amounts of old and commoditised tonnage in Malaysia and in certain segments, such as pipe-laying barges, where we have heard ourselves that of the five 900-tonne level vessels available in the country, there may in fact be only enough work for one. This is resulting in large-scale stacking, which in itself is expensive for operators.

General sentiment at the roundtable has been to allow the response to this situation to be market driven but with an element of management from PETRONAS to ensure local industry is still nurtured to some extent. I would like participants to openly comment on this matter and to explain how they think this balance can be struck.

Iain Lo
Shell

One key aspect regarding the market-driven approach is to provide the market with sufficient information, and this requires the visibility we have been discussing. Such visibility will enable the parties accountable for the assets to decide how to react, in the full knowledge of what demand there is in the local market.

Azman Ahmad
Boustead

As I have said, the pursuit of working performance consolidation is the key here. From my position at Boustead, I have no problem working with another yard, if it makes sense in terms of efficiency outcomes, variables, cost structures and whether such cooperation is competitive.

Shahril Shamsuddin
Sapura Energy

One way to strike the right balance involves establishing a baseload of work, in which the increased visibility highlighted will help suppliers to plan. This baseload would provide work to sustain suppliers and service providers in the short to medium term. It would also strengthen the system in the long term because new projects and, therefore, capacity will be needed in the future due to the cyclical nature of the industry and the natural decline of existing producing assets.

Iain Lo
Shell

This idea from Shahril is interesting because although there are limited new projects in the short term, other work is available that could constitute this baseload and, in turn, utilise some of the excess capacity. For example, rejuvenation work on abandoned wells would be highly beneficial to the Malaysian market. In order to create this kind of baseload and ensure that certain assets and human resources are kept busy and productive, collaboration between operators is essential.

Samsudin Miskon
PETRONAS

PETRONAS is certainly willing to provide a certain baseload along these lines. However, one issue that we have encountered in the low oil-price environment is that few IOCs are willing to spend money to engage in new initiatives that do not significantly impact on their top line. I therefore reiterate Iain’s call for operators to work together towards this baseload, in collaboration with PETRONAS.

Aravindh Kaniappan
Baker Hughes

I agree that not enough focus is placed on areas such as well abandonment. I understand that it is not a particularly attractive or profitable line of work, but this is a liability for oil companies and addressing it in the short term will be cheaper than doing so in the long term.

Tengku Muhammad Taufik
PwC Malaysia

It is clear that there is agreement on the need for PETRONAS and PSCs to work together to create a baseload of work in areas such as rejuvenation, decommissioning and probably even some near-field expansion. Commercially speaking, it makes sense for some IOCs to creep up their production levels in this way to generate a more acceptable value in terms of a per-barrel basis.