HERIOT-WATT UNIVERSITY

STRATEGIC PLANNING FOR THE OIL AND GAS INDUSTRY – DECEMBER 2021

Question 1

CONSULTANT’S REPORT ON GLOBAL EXPANSION FOR RJH GEOPHYSICAL

Products

Prospec: a computer system for exploration data collection and interpretation. The system is
primarily designed for land use but also has some application offshore. Market leader in the
US land market for 10 years. Launched in the West Africa offshore market three years ago.

Hydrocarbon-Quest (or HCQ): an updated version of the Prospec with improved features
which has been under development for three years; the plan is to launch in the US, West
Africa and Russia two years from now.

Problem

The investment in West Africa totalled $45 million in plant and equipment and RJH
Geophysical incurred losses amounting to $5 million in the first two years of operation. The
Prospec has now moved into profit, but it is an open question as to whether it will ever
generate an acceptable return on the investment, and this opens the question of what the
prospects for the HCQ are likely to be.

The rationale for expanding into West Africa was that the US market, where RJH
Geophysical is acknowledged as the market leader with the highest market share, had
stopped growing, while the West African market was not only much bigger but was growing
fast. The product requires no modification for offshore use. Market development has been
rapid – West African sales are now slightly higher than US sales – but the West African
market is fragmented and RJH Geophysical finds itself with a much lower market share and
competing against many exploration companies that specialise exclusively in offshore tools;
these competitors keep coming out with new ideas that clients really seem to like, which RJH
Geophysical has not attempted to copy. There is about 30% excess capacity and unit cost
would certainly come down if sales could be increased. Instead of exporting into West Africa,
RJH Geophysical felt that ‘acting local’ would enable more effective penetration of the
market and lower costs, given the relatively lower cost of labour; however, RJH
Geophysical’s US managers have had difficulty with accepted codes of practice in West
Africa.

RJH Geophysical has asked us to determine why losses have been made for so long in
West Africa and whether there are prospects for the Prospec to make the same return on
investment as in the US. We are also asked to comment on the prospects for the HCQ and
its potential contribution to RJH Geophysical’s future.

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 RJH Geophysical
Operating Account at end year ($000)
US W Africa
SALES REVENUE 11286 11200
COST OF GOODS SOLD 5430 9393
GROSS PROFIT 5856 1807
Corporate 800 600
Factory Overheads 400 500
Hiring & Redundancy cost 56 245
Development Expenditure 500
TOTAL OVERHEAD 1756 1345
OPERATING SURPLUS 4100 462
Cash Flow for year ($000)
US W Africa US W Africa
OUTLAY INCOME
Material Purchase 1530 2122
Loan Interest 1350 2800 Interest on Assets 40 20
Wage Cost 1400 3780
Line Cost 1200 1820
Product Development 576
Product Marketing 1280 2496
Total Overhead 1756 1345 Sales Revenue 11286 11200
Total Outlay 9092 14363 Total Income 11326 11220
NET CASH FLOW 2234 -3143
Balance Sheet at end year ($000)
US W Africa
FIXED ASSETS
Factory 12000 15000
Plant 25000 30000
TOTAL FIXED ASSETS 37000 45000
CURRENT ASSETS
Raw Materials 1000 1500
Finished Goods 754 2492
Cash 1000 1000
TOTAL CURRENT ASSETS 2754 4992
TOTAL ASSETS 39754 49992
OWNERS EQUITY 24754 9992
DEBT
Long-Term Loan 15000 40000
TOTAL DEBT 15000 40000
TOTAL LIABILITIES 39754 49992
Report on Prospec for year
US W Africa US W Africa
Market share (%) 40 4
Composition of Demand Composition of Supply
Orders 1188 1400 Output 1280 1560
Warranty demand 24 70 Start Year Inventory 100 300
TOTAL DEMAND 1212 1470 TOTAL SUPPLY 1380 1860
Distribution of Supply
Warranty Replacements 24 70
Sales to orders 1188 1400
End Year Inventory 168 390
Account at end year
Wage cost ($000) 1400 3780 Working time (%) 100 120
Assembly Line Cost ($000) 1200 1820 Labour attrition rate (%) 4 7
Cost of Material Used ($000)1280 1872
Product Development ($000) 576 0 Competing price ($/unit) 9500 8500
Product Marketing ($000) 1280 2496 Price ($/unit) 9500 8000
TOTAL COST ($000) 5736 9968 Unit Cost ($/unit) 4481 6390
Sales Revenue ($000) 11286 11200
Cost of Goods Sold ($000) 5430 9393
GROSS PROFIT ($000) 5856 1807
Report on Development of HCQ
US West Africa Russia
Launch date 2 years 2 years 2 years
Estimated market peak (units) 1000 3000 2000
Estimated market at launch (units) 750 1500 1250
Competing price ($/unit) 20000 15000 17500
Production cost ($/unit) 18000 13000 13000
Forecast market share (%) 50 20 10
Development Expenditure
Spending in year ($000) 500
Total to date ($000) 2500

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Required:

You are the strategy consultant and are required, first, to show what went wrong and,
second, to propose a strategy to resolve the problems in West Africa.
(Total 100 marks)

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Question 2

BP – A Historical Perspective

In July 2000 British Petroleum plc was re-launched as BP with the new slogan Beyond
Petroleum. This was coupled with a large advertising programme that was rolled out globally
with the message that BP was going in a new direction that was to include other activities as
well as oil and gas. The CEO at the time, Lord John Browne, said “I do not want BP to end
up as another British American Tobacco: we need to show that BP has a future.” This helped
to raise BP’s profile in the USA where it had recently acquired two large oil and gas
companies, Amoco and Arco. This rebranding exercise helped to cement BP’s image at the
time as the world’s best-run oil company.

Browne made many changes over the next few years – he installed solar panels in BP
service stations and in 2005 a new business, BP Alternative Energy, was created to manage
all of BP’s renewable energy interests. At one point during Browne’s tenure BP was the
largest solar power company in the world. From 2000 onwards BP continuously increased its
investments in renewable energy, peaking at a level of $1.4bn in 2008. This was
considerably more than industry rivals like Shell and Exxon.

However all was not well at BP; a string of serious accidents in the company’s US operations
between 2002 and 2005 culminated in the explosion at the Texas City Refinery that killed 15
people, the worst industrial accident in the US for a decade. Various whistleblowers came
forward and talked of a safety culture that left many workers afraid to go to work. This was
coupled with missed production targets three years in a row. In 2006 the company’s share
price started to decline and production forecasts were slashed 15% for the next few years.
Insiders felt that the company had been too busy with its newer activities and had lost focus
on its core activity – extracting and selling oil and gas. When Lord Browne left his post after
12 years, BP’s profitability and share price were lagging far behind that of other major oil and
gas companies. Insiders said that morale at the time was poor.

In May 2007, Tony Hayward took over as CEO of BP. He had previously been chief
executive of the company’s exploration and production division and made some radical
changes when he took over. He started a restructuring programme across the whole
company in order to reduce the layers of management and standardise operations across
the globe. He noted that BP had been plagued by inconsistency in different locations and
divisions and aimed to standardise the company’s approach. He said BP had done a
‘fantastic job assembling a great set of assets, but a much poorer job of making them run
efficiently.’ He reduced the number of support staff in all areas and simplified the
organisational structure. His stated objective was ‘simplicity and efficiency’. Hayward was
known to be more approachable than his predecessor and was keen for management to
listen to those working on the front line when making decisions.

Mr Hayward split the Gas, Power and Renewables segment up, creating Alternative Energy
as a separate division entirely and merging the Gas and Power business with downstream
operations. BP was now structured around two large segments – Exploration and
Production, and Refining and Marketing, with the Alternative Energy business managed
separately. To bind the segments together, Hayward introduced the following: a common
code of conduct, a standardised operating management system, a single digital
infrastructure, finance and control and human resources functions. He said that these were
what ‘made it look and feel all the same.’

Hayward criticised the previous set-up and was later quoted as saying that when he took
over as CEO, BP had ‘too many people who were trying to save the world’. As part of the
aim of standardisation the new setup was to give managers less freedom to ‘invent
themselves’ and a greater requirement to comply with company standards and guidelines.

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This restructuring was undertaken at a time when the industry was going through a period of
strong growth, mostly due to the increasing price of oil.

When Hayward took over as CEO the oil price was around $75 per barrel but in just over
one year it had increased to $147. This rapid rise in the oil price had both positive and
negative outcomes for BP – revenues for the Exploration and Production business increased
rapidly, but so did costs. Through 2008 the level of investment in upstream activities was
increased to around 75% of BP’s total capital expenditure and the company’s share price
increased due to the high price of oil. By the time the oil price peaked BP was having to pay
out large retention packages to senior managers to stop them going elsewhere, and cost
inflation across the industry was high.

However, by the end of the year, the oil price had fallen to $40 per barrel, which surprised
many managers throughout the oil and gas industry. BP set about renegotiating contracts
with suppliers and service providers, and cut 5,000 jobs in areas that were no longer
sustainable. Hayward was quoted in the press as saying that the company needed ‘more
engineers, fewer accountants’ continuing his focus on front line delivery. Around 17% of the
company’s onshore workforce was cut in the North Sea, where production was declining. BP
also sold off more than 700 filling stations in the US, deeming them to be non-core.

BP also benefited from its earlier restructuring programme, while other competitors were
only now considering following a similar path. Production at BP was increasing steadily and
the fall in revenue from the lower oil price was to some extent offset by lower costs and
higher production. The increase in production was due to successful completion of various
projects in places such as Angola, Azerbaijan and the Gulf of Mexico. One of the most
important of these was the Thunder Horse project which came online in 2008 after lengthy
delays due to the complex operating environment.

By the start of 2009, Hayward began to reign in their alternative energy activities, dropping
projects in biofuels in the US and other projects elsewhere. This was despite the fact that
most renewables markets were growing by at least 10% per year. The Alternative Energy
business had never generated a profit without subsidy of some kind and the executive in
charge of Alternative Energy left BP in early 2009. Hayward described the process of
reducing the activities in this sector as part of a ‘weeding’ process. The company kept the
more promising areas such as the solar panel production and installation business, which
was profitable and in which the company had considerable market share.

BP continued its capital spending on Exploration and Production through 2009 and
production levels increased by 2% in the first quarter. This was coupled with falling cost
levels across the company. Hayward described his focus as being on ‘continued
simplification and efficiency’. The company’s share price was boosted by a large oil
discovery in late 2009 in the Gulf of Mexico, the Tiber Field. This was at a time when Shell,
BP’s main rival was struggling with high costs and falling production levels.

Required:

1) Should managers in the industry have been surprised by the rapid fall in the oil price
in late 2008?

2) Use the Value Chain to demonstrate how Mr Hayward’s restructuring programme

affected the internal workings of BP.

3) Analyse Mr Hayward’s impact on the organisation using the process model.

(Total 100 marks)

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Question 3

Buchanan Resources is an integrated major oil and gas company with a global presence
covering both upstream and downstream operations. The company employs around 90,000
people and has recently expanded in response to increased global energy demand and
rising oil prices. The current CEO has announced his intention to retire at the end of this
year, so an executive recruitment agency has been employed to find the successor.

After various stages of interviews the recruiters are now left with two candidates:

1) Bill Up, currently CEO of Exploration and Production (North America) for Buchanan
Resources. The division has posted record profits for the past two years. Bill has been
with the company for 25 years after starting as a production engineer.
2) Jane Tech, currently CEO of a large electronics company with 30 different product
divisions spread across 40 countries. Jane has an impressive track record with her
current company, having doubled the market capitalisation in the space of five years,
and comes from a legal background.

Bill is well known by most members of the board and performed well in the earlier stages of
interviews. Jane has also impressed the board because of her track record and personal
qualities.

Required:

Compare the experience of the two candidates using the process model. Who is better
suited to the role of CEO of Buchanan Resources?
(Total 100 marks)

TOTAL 300 MARKS

END OF PAPER