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McKinsey on Oil & Gas

Number 2, 5 13 20
Winter 2009 Finding the oil How will the financial Improving value
supply–demand crisis impact the from megaprojects in
Perspectives on balance in natural gas industry? upstream petroleum
Oil & Gas uncertain times

26 33 39
This is the time to Getting to the CO2 abatement:
deliver on upstream next level of operating Exploring options
operational excellence performance in for oil and natural
petroleum refining gas companies
26

This is the time to deliver


on upstream operational
excellence
With oil prices squeezed, now is the time for oil and gas companies to focus on
operational excellence. What lessons can managers draw from world-class operators
in the business?

Chris Laurens and The recent collapse of oil prices from a peak of them to reduce operating costs, rationalize
Otto van der Molen $147 has once again made operational excellence investment budgets, and boost operational effi-
a central imperative for upstream oil and gas ciency. Many of these programs focus on
companies. Previous industry cycles have shown short-term expenditure reductions by cutting
that companies should use a price drop as an nonessential costs such as travel, mini-
opportunity to drive through fundamental improve- mizing inventories, postponing maintenance,
ments in the way their operations function. deferring projects, and renegotiating service
Three factors influence a company’s ability to do contracts. Though such measures are useful in
so: a comprehensive approach to improvement a cash-constrained environment, structural
across all functions; a continuing focus on building opportunities for sustained operational effective-
capability; and a permanent shift in leadership ness can be missed. Worse, as some exploration
attention. Done right, world-class operational and production companies learned to their
execution can add up to 30 percent of value to the detriment in the last oil price cycle, deep cuts
production asset base. in maintenance and production budgets can
damage asset integrity, reduce reliability and thus
The fall of oil prices has exposed an inflated cost production, and lead to the loss of the most
base in many oil and gas companies, forcing capable operations staff.
27

Upstream companies should remain focused on once flourish because they were better at explora-
operational excellence for structural as well tion or project development now find that they
as cyclical reasons. Many hydrocarbon provinces must achieve excellence across the value chain.
have moved into the mature stages of their life
cycle. Likewise, production facilities reaching the We base our experience in upstream operations
end of their economic if not their technical life on a proprietary database of benchmarks and best
spans require modifications and increased practices as well as on our recent support in
maintenance. The widespread application of infill upstream operations across all basins for almost
drilling, water-flooding, and enhanced oil recovery 40 clients, a few of which involve large-scale
schemes has increased activity levels and operations performance transformations. Our
associated operating costs. operational benchmarking and client work
demonstrates that world-class operators extract
At the same time, there are fewer opportunities more volume and operate at lower cost than do
to create value from greenfield exploration average operators in comparable situations.
and development projects. Access to the most
promising provinces, such as the Middle The result is that the financial upside from
East and South America, is restricted. Competition operational excellence could be up to 30 percent
for the remaining opportunities is intense, and higher net present value (Exhibit 1). To realize
the commercial terms and conditions have become this game-changing potential, companies need
more onerous, putting ever more pressure on to address four major aspects of produc-
capital and operational efficiency. Access is often tion performance.
Web 2010
granted only to those companies that can
MoOG Upstream
maximize operations
recovery of the marginal barrel in a Total maintenance reliability. World-class opera-
Exhibit 1 of 3manner. Companies that could
cost-efficient tors achieve a best-practice-facility reliability of
Glance: Improved operations deliver up to 30 percent more value from producing assets.
Exhibit title: Better operations bring big rewards

Exhibit 1
Better operations <75 Poor
Facility availability,
bring big rewards % uptime
85 Average
97
World class
Improved operations deliver up
Well production performance, –15
to 30 percent more value from % increased volume vs average 10
producing assets. • Improvement in all these areas could
result in up to 30% higher net present
Reservoir performance, –10 value (NPV)
% increased volume vs average 10 • World-class performance on one
dimension typically goes hand-in-hand
Unit technical costs, with world-class performance on all
50
% cost deviation in $ per barrel of –25
oil equivalent (boe) vs average

Safety performance, 100


% incident rate deviation vs average –30
28 McKinsey on Oil & Gas Winter 2009

95–98 percent even at old facilities serving and more safely, and efficient processes allow man-
depleted reservoirs. Their maintenance costs are agement to be out on the site for most of the day.
30 percent less than the average, with preven-
tive jobs accounting for the majority (70 percent or Identifying opportunities for
more) of maintenance hours. The value of their operational excellence
small-modification project portfolio can be up to Operational excellence involves focusing on the
50 percent higher than that of average operators most important activities and then executing them
because of better prioritization and optimization. well. Of the 25 or so processes that deliver value
in upstream operations, the four just outlined
Lean-process execution. World-class operators should be given priority. Effective management of
achieve a schedule compliance of more than 80 per- cost reductions also plays an important role in
cent. The effective time frontline workers spend achieving operational excellence.
on value-adding activities is 50–60 percent, com-
pared with an industry average of half that. Total maintenance reliability. We often observe
Planned overhaul shutdowns typically take half a reactive culture in operations, with many
the time that is needed by average operators. unplanned breakdowns and maintenance issues
being solved as they come up during the day.
World-class well and reservoir management. This typically results in poor reliability and safety.
World-class operators extract more than 15 percent World-class operators frequently review
more production from existing wells than the maintenance policies and nurture a culture of
industry average through better understanding continuous elimination of all sources of loss.
of well and reservoir performance and better They optimize preventive and condition-based
delivery of interventions. They increase the ulti- maintenance for critical equipment, while
mate recovery of their fields through better minimizing additional maintenance for less-critical
injection-pressure management. Their well inter- systems. Key requirements are a full under-
ventions typically cost less than $5 to $10 per standing of the criticality of equipment, a complete
barrel of oil equivalent (BOE). maintenance log, and a readiness to draw on
all available expertise in optimizing maintenance
Superior contractor management. Best practice policies. When regular maintenance policies
contract managers continuously monitor fail to eliminate losses, the best operators propose
contractors to make sure their activities do not modification projects with clear businesses
stray beyond their original mandate. Such cases and rank them according to return
additional activities often add up to more than on investment.
10 percent of contract expenditure. Operators
also maximize value when they ensure that con- Lean-process execution. Many facilities face a
tractors’ incentives are aligned with their own. substantial backlog of maintenance work, despite
having enough resources to complete it. The
Operational excellence also pays a safety dividend. root cause is a poor planning and scheduling sys-
Preventive maintenance results in fewer hazardous tem that fails to allocate tools to frontline staff
situations, planning and scheduling allow man- efficiently. World-class operators run an integrated
agers to think about how jobs can be done better planning and scheduling process that covers
This is the time to deliver on upstream operational excellence 29

MoPetro 2009
Upstream operations
Exhibit 2 of 3
Glance: The benefits from well and reservoir management can be significant.
Exhibit title: Rewards of well and reservoir management

Exhibit 2
Rewards of Good well management can have a big impact . . . . . . and case studies prove that it can be captured
well and reservoir Additional volume delivered by well and Volume from increased well and reservoir management activity,
management reservoir management,1 % example of International oil company, thousands of barrels per day
17
Gas-lift valve replacement 1
Upside from well and Injector cleaning 2
reservoir management can Acid stimulation 6
be significant. Producer clean out 9
Well conversion 7
Gap = 16 Recompletion 7
Pump resize 5
Tubing optimization 5
Lift conversion 5
Additional perforation 5
1 Water and gas shutoff 15
Sand control 3
4th quartile 1st quartile Zone change 9
Fracturing 10
Cost per barrel of $10 $2
oil equivalent Side track 11
Total 100
~15% of production

1 Based on benchmark of 40 assets in North Sea.

all on-site activities, from drilling to safety audits. long in advance while working closely with
Crucial to this are “gates” at fixed intervals— the subcontractors.
for example, 90 days, 28 days, and 7 days before
execution of the plan. The gates ensure that all World-class well and reservoir management.
preparations and approvals are locked in to allow One of the largest sources of value in operations
the activity in question to take place. The cen- is to extract more volume from existing wells,
tral planning team owns the plan before execution, with activities ranging from acid stimulations of
while site management owns the plan during individual wells to optimizing the water injection
execution and manages deviations and interrup- pressure rates in the reservoir. World-class
tions throughout this phase. operators have up-to-date, transparent data on
their wells’ technical potential and track
For major overhauls, world-class operators mini- how much additional volume is delivered by
mize the duration of the shutdown. They take out optimization activities. These businesses
activities that do not require shutdown and have a correspondingly strong focus on data
perform these outside the overhaul. They identify management for up-to-date well and res-
and compress the essential activities, as is done ervoir understanding. Cross-functional optimiza-
in a Formula 1 pit stop, and they plan and prepare tion teams, consisting of petroleum engineers,
30 McKinsey on Oil & Gas Winter 2009

operators, planners, and well services staff, value for the operator. Thus a well service
run frequent well reviews to analyze performance provider is not rewarded according to the volume
gaps and identify ways of restoring and optimiz- of acid used to clean up wells but receives
ing volume. The well services function ensures that incentives based on incremental production
operators apply expert knowledge in well volumes. World-class operators manage
interventions, use prior learnings and optimize suppliers globally and maintain development
production (see Exhibit 2, which shows the programs with select companies. They
significant volume opportunity from superior well develop an in-depth understanding of supplier
and reservoir management). cost structures and continuously squeeze out
waste while allowing margins appropriate to the
Superior contractor and supplier management. current market environment.
In the past few years, the market for oil field
services has been very tight, and hence it has been Cost-optimization management. World-class
difficult for many operators to tightly manage operators make the right decisions about which
performance on existing contracts. World-class costs to reduce, thus avoiding a downward
contract managers have a robust performance- spiral in reliability performance (see Exhibit 3,
Web 2010
management system in place and hold frequent which illustrates the vicious circle that many
MoOG Upstream
dialogues operationsThey know how to
with suppliers. operators can go into when reducing maintenance
Exhibit 3 of 3 so that the contractor optimizes
set incentives expenditure). In addition to the cost opportu-
Glance: Short-term cost savings must be balanced against long-term performance.
Exhibit title: False economies

Exhibit 3
False economies Maintenance cost gap, Producing assets Specific producing
% to top quartile asset, over time

Short-term cost savings 50


must be balanced against long- 2001
45 Increased focus on
term performance.
preventive maintenance
40
brings slow improve-
35 ment in reliability
2000
30
Falling reliability forces
25 operator to spend more on
reactive maintenance 1998
20

15
1999 Operator cuts cost by
10 eliminating planned
maintenance activities Target
5
area
0
60 65 70 75 80 85 90 95 100
Production efficiency,
% of production potential
This is the time to deliver on upstream operational excellence 31

nities inside the core delivery process described length of shutdowns. Management also needs
earlier, overhead support functions and supply to ensure that performance-management metrics
chain and procurement management can signifi- match across functions. For example, operators
cantly affect costs. Best-in-class operators and petroleum engineers should both be respon-
understand the costs of each business support sible for water injection targets, to maximize
function in detail—for example, the cost of production volumes.
a specific report—and continuously prioritize must-
have activities over nice-to-have activities. They Capability building. When getting the organization
also minimize the waste inside processes by to adopt new ways of working, it is not sufficient to
cutting waiting time and the need to repeat tasks, distribute a CD-ROM handbook with best-practice
reducing each activity to its technical limit. In processes. The entire organization must upgrade
supply chain management, great use of logistics its skills, and adults learn best by doing. Therefore,
services can yield big cost savings. capability building is critical to the success of
any attempt to transform operational performance.
Shaping a successful program Action learning methods should be used to
Successful operations transformation programs infuse new ways of working in everyone’s daily job.
have three factors in common: cross- This also requires coaching to become part
functional integration, capability building, of the performance dialogues at all levels in
and leadership mind-set alignment. the organization.

Cross-functional integration. A clear distinction Leadership mind-set. Senior managers at world-


between an average and a world-class operator class operators focus on operational performance
is the extent to which the value-delivering processes and know what success looks like. They have
are coordinated. Especially in functional or clear performance expectations for both leading
matrix-type organizational models, management and lagging indicators, such as mean time
needs to ensure that planning and scheduling between equipment failures and well test
encompass all functional activities. For example, compliance. Reporting lines are clear at all levels
ensuring that facilities and subsurface activ- and across functions. Targets cascade down
ities take place simultaneously minimizes the all the way to the front line, and regular reviews
32 McKinsey on Oil & Gas Winter 2009

ensure that everyone holds the proper per- operations “project” then exceeds initial
formance dialogues, with the purpose of closing expectations and becomes an operations “per-
any performance gaps. formance transformation.”

Finally, we recognize that a successful performance


transformation needs to be driven both by real
impact and by frontline engagement from the start. Over the past few years, value in upstream
A common failure pattern occurs when the operations has shifted from gaining access to new
program’s design, start-up phase, and diagnostic fields and delivering development projects to
take too long, creating the impression that delivering best-in-class operational performance.
the program is having little impact. As a result, Today’s challenging economic environment for
frontline staff do not take ownership of the oil and gas operators means that better operational
program. But achieving tangible impact and real performance—both in costs and production
frontline engagement early on generates a volumes—will play a significant role in delivering
pull effect from the front line—the work becomes positive returns over the coming years.
more attractive and employees’ performance
improves—which then gives the program
further momentum across the organization. An

The authors wish to thank Robert Samek for his invaluable input into this article.

Chris Laurens (Chris_Laurens@McKinsey.com) is a principal in McKinsey’s Dubai office, and Otto van der Molen
(Otto_van_der_Molen@McKinsey.com) is an associate principal in the Amsterdam office. Copyright © 2009 McKinsey &
Company. All rights reserved.