Commodity Projects During the Downturn: Time for Value Engineering

By Rob Morrissey

Those who have been following know that 2015 has not been a good year for commodity markets. As of August, nearly all hard and soft commodities have dropped in value since January 1, other than a few outliers like canola and cocoa. Perhaps most significantly, oil is trading near a 6-year low, down 50% from just a year ago.

To cope with reduced cash flow from operations and still meet obligations, oil & gas producers have slashed their capital budgets by more than $200BN globally. According to the Financial Times, 26 major projects are currently on hold. This includes 10 in Canada, where the challenge of extracting bitumen from oil sands makes breakeven prices among the highest in the world.

Immediately after prices collapsed, repurposing planned CAPEX was one of the only strategic options available to many large players with near-term needs for cash. This has worked in small doses, but continuing this strategy indefinitely in the new price environment will lead to trouble. Producers need to find ways to keep projects viable to avoid putting their future market shares at risk.

There are numerous threats to contend with. Opec members appear fiercely committed to protecting their share of production during the downturn – Saudi Arabia reached record output in June. US shale producers have also been suggested as new “swing producers” by some observers due to their ability to quickly ramp-up and ramp-down in a volatile price environment, a liberty that large IOCs and other megaproject developers do not have.

Now that survival plans are in place, oil majors have the opportunity to focus on improving stalled projects to come out of the price downturn ahead of rivals. It is the best time in years to commit to rigorous Value Engineering. Here are some reasons why.

Mindsets are well-primed – Project engineers are capable of remarkable feats, though innovation can often run into barriers within project bureaucracies. Today’s challenging environment creates a burning platform for improving value and embracing change.

Financial returns are high – Spending several million dollars to improve project plans and reduce future costs by tens or hundreds of millions of dollars (which we have consistently found to be achievable) pays the investment back several times over.

More leadership bandwidth – With projects on hold, portfolio and project managers have spare bandwidth that can be devoted to special projects that would not be possible in busier times. With good talent in short supply, retaining project leaders to save on project costs can be a better option than the short-term savings by reducing headcount.

Project groups need a mission – Megaprojects have a way of captivating teams and providing a sense of shared mission for organizations. A concerted effort to improve the value of these projects can be a good way to fill the void when projects are put on hold.

Of course, if prices never recover this effort could be for naught. But if you expect prices to recover in the next several months, or even the next several years, investing the time and resource to improve project plans today will be the best way for thoughtful companies to remain viable tomorrow.

 

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