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Written By: Godwin Ikwue, Dr Leesi Gborogbosi,
Oil and gas industry operators should seek an advisory from experienced consultants on how supply and trading create value for E&P oil and gas business.
If you need advisory on offtake agreements, supply and trading support, you may contact the authors of this article
The petroleum business is a value chain which traverses exploration, development, production, refining and marketing activities that add value to consumers’ energy requirements. The oil & gas industry is considered to be one of the largest, most complex and most vital businesses.
Oil and gas supply and trading value chain is an integrated web consisting of oil and gas companies, operators, refineries, storage facilities, distribution as well as transportation channels that interact to deliver value to end-users of petroleum products in diverse geographical locations. In this special supply chain, there is a large number of vendors.
The major supply chain link in the oil and gas industry takes the following flow:
Exploration ⇒ Production ⇒ Refining ⇒ Marketing ⇒ Consumer
The oil and gas industry’s supply chain (its value chain), is divided into three major processes, namely: upstream, midstream and downstream. The petroleum industry’s primary focus is on value streams. This is one major feature that distinguishes it from a conventional supply chain which entails the physical flow of information, materials, people and funds as well as intangible aspects such as relationships.
Supply and trading which is the nexus of this article is one of the basic elements of the downstream value chain. Although downstream and supply and trading are technically different, for purposes of simplicity, the two terms will be used interchangeably in this article.
It is important to note that the downstream stage of the industry is as crucial as the other two preceding stages. As a result, E&P companies should plan their activities on an end-to-end basis to cut across the entire spectrum of the value chain from conception to delivery to the end-user. Where appropriate, this should even incorporate an interest in managing financial risks.
In many cases, Exploration and Production (E&P) companies emphasise the upstream phase and to a lesser extent, the midstream stages of the value chain. Perhaps this focus aligns with an effort to concentrate more of their limited resources on the area of their core competence.
Timing of offtake agreements
Delaying planning and finalization of arrangements on how to evacuate and market petroleum may result in the E&P company getting stuck in unfavourable contracts, losing significant resources and in an extreme case, cessation of business.
For example, some E&P companies make the mistake of waiting to complete all upstream activities such as exploration, drilling of development wells and production before firming up agreements to market and sell the oil and gas. This puts the organization in a weak negotiating position relative to the buyers.
For instance, there is a common presumption that once oil and gas are produced, there is always a ready market for the commodity. As a result of this ‘half-truth’, all resources become highly skewed towards ensuring that production commences while paying little or no attention to what happens thereafter.
This is a sub-optimal business approach for a number of reasons. First, the market may not be ‘readily’ available. Secondly, the buyers identified under such a harried circumstance may not be interested in long term liftings or relationships which is preferred for new companies. Moreover, the company may find itself in a position where the price on offer by opportunistic buyers is less than the production cost.
Choosing the right buyers
It is important to choose the right buyer and early in the process too. Liquefied Natural Gas (LNG) has a peculiar advantage in this regard. For this commodity, long-term sales contracts are entered into several years before the commencement of production. For instance, partners in the Train 7 Project of the Nigeria Liquefied Natural Gas Company (NLNG) took a Final Investment Decision in late 2019 while it is estimated to take several years to complete.
In the meantime, sales contracts for the Liquefied Natural Gas (LNG) expected to be produced from this new plant have already been signed with buyers, covering a future delivery period of 20 years. Consummating contracts with buyers as soon as possible is particularly vital in the early years of petroleum production and sales.
New entrants
New entrants into the E&P business typically bring to the market, relatively unknown crude streams and brand names. Such companies need a strong, reputable supply and trading partner to help it penetrate the market.
New entrants should beware of opportunists who try to take advantage of their (new entrants’) excitement and lack of knowledge of oil marketing dynamics.
Some new entrants actually enter into ever-green contracts with trading partners in advance of production. In this regard, the price of the new oil stream may be tied to and oscillate in tandem with a globally recognized index such as Brent or Bonny Light, with an appropriate discount agreed between the parties to the contract.
A good point of departure will be to leverage the strength of an International Oil Company (IOC) such as Shell, Total or ExxonMobil to use the new crude stream in their refineries and trading networks. This penetration strategy leads to building a track record which will enhance the crude stream’s demand and price.
Inadequate focus
Paying less attention to supply and trading of petroleum could spell doom for an E&P company. After spending huge costs on exploration, development and production, the company may end up with ‘stranded barrels’. For revenue to be realized, oil and gas have to sold, transported and delivered.
Logistics
After oil and gas production, the company will have to manage logistics, supply and trading on a regular basis. The oil has to be transported (via pipelines and vessels), stored in tanks, shipped to refineries and supplied to end-users. There will be all sorts of commercial agreements between buyers and sellers.
As a minimum, it is imperative for all parties to be conversant with standard Incoterms and other relevant legal provisions relating to sales contracts. How well the company manages this stage of the business may determine its competitiveness and ultimate survival.
Outsourcing of supply and trading
Many E&P companies outsource the supply and trading stage of the petroleum value chain to third party organisations. In many of such cases, the E&P entity at best has minimal knowledge of what transpires beyond the oil & gas production phase.
While it is a good idea to engage third party companies in an outsourcing arrangement, it is also crucial for the E&P organization to have a basic knowledge of the principles of supply and trading as this could save significant costs and materially improve profitability.
As mundane as the above assertions may sound, it actually happens in practice that E&P companies are wont to pay less attention to supply and trading of their output. Here are a few examples which I encountered during my career in the downstream oil & gas sub-sector.
1. An E&P company operating offshore contracted a third-party company to install a storage facility to store its crude oil prior to export. The challenge with the storage tank was at full capacity, its size would be uneconomic to store a parcel of cargo for shipment. Even when the option of co-loading with other parcels was considered, it still did not make economic sense to have such storage capacity.
Fortunately for this company, this challenge became evident early during an informal conversation and appropriate steps taken to correct it. Although it cost the E&P company significant money and delays to ameliorate the situation, it could have been worse.
2. Another E&P firm which did not take oil marketing seriously and paid dearly for its inactions. This oil and gas producing company was convinced that the key to unlocking the cashflow was to find the hydrocarbon, drill wells, develop the necessary infrastructure and produce the oil. Buyers will always be available.
It turned out that serious buyers were not that easy to connect to particularly for new entrants. After a lot of avoidable troubles, the company finally found a couple of buyers who appeared to be serious. The problem then became that the terms proposed by the buyers were far below the seller’s expectations.
Although the company survived the debacle, it took much longer for it to break-even, than would have been the case. With a little bit of forward planning and support of relevant experts, such unnecessary challenges could be avoided.
3. The third example is that of an E&P company that invested in a number of storage tanks without thoroughly matching capacity with production and future expansion plans. The storage facility was way out of sync with the company’s actual production as well as offtake plans. The result was a significant volume of unutilized capacity and wasted dollars.
Later, it was revealed that the idea was to have enough storage capacity ab initio, in readiness for future expansion. The expected growth never happened at least not under that company’s management. The business became moribund for some years until it was taken over by another company which invested significant funds and time to bring it back on stream.
4. The last example concerns an oil and gas producing company that virtually got to start of production without even a firm arrangement for evacuating the product. It took it for granted that either buyer will be ready to evacuate the oil and gas from its production facility offshore or it could pump into the facilities of another nearby producing company, for a fee.
In reality, neither of these two options worked well. The company was forced to start looking for an appropriate storage vessel for lease or outright purchase. The organization found out that this is usually not as easy as it sounds, particularly when done under pressure.
1. Have a back-up or contingency plan: This might involve entering into a Joint Venture (JV) or alliance with other players and in some cases, competitors. The key argument here is to ensure that the company has more than one option at every point in time.
2. Build scenarios: This is related to the preceding point. As activities are undertaken, it is vital to create several possible outcomes by continually asking ‘what if’’ questions and attempting to provide answers to these.
3. Treat the value chain as one integrated system. This is because events in one segment of the value chain could impact one or more of the other parts of the system. In planning activities, carry out an end-to-end evaluation and come up with flexible plans that cover the entire spectrum from beginning to end. Plans should be amenable to alterations as conditions change or more information and opportunities become available.
4 Use the services of Experienced Consultants: The services of experts would be very useful in guiding the company through this especially dynamic stage of the value chain.
The oil & gas business is made up of three major segments; upstream, midstream and downstream. All of these three phases are vital for optimizing the petroleum value chain. It is therefore important to give due consideration to all the segments on an end-to-end basis from upstream right through to the ultimate consumer in the downstream stage.
E&P companies that paid less attention to the dynamics of supply & trading had experienced huge operational challenges and sub-optimal returns. It is therefore imperative to consider the oil & gas value chain as an integrated system, employ the services of knowledgeable consultants, have a backup plan in case outcomes are out of sync with expectations and regularly test expected results by creating probable scenarios.
The authors of this article are experienced oil and gas experts with over two decades of experience who worked with the leading multinational oil and gas company SHELL.
Godwin Ikwue | Nigeria | https://www.linkedin.com/in/godwin-owoicho-ikwue-mba-fca-6250a557
Dr Leesi Gborogbosi | Nigeria | https://www.linkedin.com/in/leesi-gborogbosi
Chima, C. (2007) ‘Supply-chain management issues in the oil and gas industry’, Journal of Business and Economics Research (JBER), 5 (6), pp. 27 – 36.
Chopra, S. (2019) Supply Chain Management: Strategy, Planning and Operations. 7th ed. New York: Pearson.
Fernandes, J.L., Relvas, S. & Barbosa-Povoa, A.P. (2012) ‘ Design and planning of downstream petroleum supply chains’, Computer-Aided Chemical Engineering, 30, pp. 432 – 436.
Inkpen, A.C & Moffett, M.H., (2011) The global oil and gas industry: management, strategy and finance. Tulsa, OK: Pennwell.
Mangan, J., Lalwani, C., Butcher, T. & Javadpour, R. (2012) Global logistics and supply chain management. 2nd ed. West Sussex, UK: John Wiley & Sons.
Reed, E. (2019) NLNG Greenlights Train 7 Energy Voice, 30 December. [online] Available at www.energyvoice.com Accessed 4 October 2020.
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Published origninally on 18th Oct 2020 20:13:37
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