Greenfield procurement

Summer 2011

Dealing with ageing oil platforms isn’t something many CPOs will do. However, its detail is highly applicable to new or emerging areas of spend.

By Paul Yates

 

Reports of the demise of the North Sea oil and gas industry have been greatly exaggerated. For more than 30 years, commentators have been forecasting dwindling reserves and the imminent collapse of this critical part of UK plc. However, with the UK government approving investment projects valued at $13.8 billion last year, the oil field originally developed in the 1960s is proving remarkably resilient.

At the same time, alongside the Gulf of Mexico, the North Sea is one of the world’s most mature offshore oil regions. With more than half of the approximately 600 platforms being older than 15 years, operators are facing the consequences of their old age – the challenges of decommissioning. Oil and Gas UK, the industry trade body, estimates that almost half of the existing platforms will be decommissioned in the next decade at a cost to operators of around £9 billion.

Decommissioning is a long, complex and costly business. Following initial engineering and planning, work moves offshore to plug wells, clean and decontaminate the site and prepare the platform for removal. Massive heavy-lift vessels, capable of lifting more than 10,000 tonnes, are engaged to remove top-side and sub structures and transport them to yards where materials can be reused, recycled or scrapped. Finally, any pipelines remaining in situ must be flushed, filled, plugged and buried to avoid any future incident. From start to finish, projects can take more than seven years.

While only a few global procurement executives will ever be involved in purchasing for North Sea decommissioning, this activity is still relevant for any purchasing professional faced with a new, or emerging, category of spend. Early approaches to category strategy can set a pattern within an organisation and even drive market structures across the industry that, once established, become difficult to change.

Those responsible for purchasing decommissioning services in the UK face several challenges:
 Existing supply chains are complex. The market tends to be characterised by specialist vendors for each stage of the decommissioning process. To date, operators have mostly been project managing and co-ordinating the multiple vendors to deliver a successful outcome.

 The market is immature. While more than 2,000 platforms have been decommissioned in the Gulf of Mexico, the lessons for the North Sea are limited. Platforms in the Gulf of Mexico tend to be in shallower water, closer to shore and with fewer large concrete structures. This also means there is limited opportunity to share the supply base, as many of the suppliers involved in Gulf of Mexico decommissioning tend to be smaller-scale, local companies.

 Demand is not fixed. The timing of the decommissioning of any platform is driven by a series of complex factors, including revenue potential, the cost of continuing to operate as well as those of decommissioning, and changes in the regulatory environment. The combination of high oil prices and new technology has typically extended the economic life of platforms in the North Sea in recent years, pushing decommissioning dates out. The constantly shifting goal posts make supply chain optimisation difficult.

 Shortage of skills, equipment and knowledge. While there appear to be no immediate pressure points in the supply of services and equipment, rapid growth in activity will put an increasing strain on the skilled resources and equipment required to do this work. Growth in other sectors, such as offshore wind farms and the oil industry’s own investment programme, will add to competition for these resources. Obvious areas for potential bottlenecks include heavy-lift vessels and onshore deconstruction facilities.

Operators do not typically see decommissioning as a source of competitive advantage since, by definition, it represents the closure of production capacity. However, there is potential for creating disadvantage – as shown by Shell’s bad experience with the Brent Spar platform in the 1990s. Although cost is a priority for successful decommissioning, it comes much lower on the list than completing the activity safely and complying with regulations, with minimal environmental impact. So, while category managers will look for strategies to optimise cost, avoiding becoming the subject of media headlines will always take precedence.

So what are the key lessons for those involved in “greenfield purchasing”?

1. Think strategy, not category

One of the most common complaints from procurement is that it is rarely involved in projects at an early enough stage to be able to truly drive commercial advantage. With new and emerging categories, purchasing can seize the opportunity to be a part of the strategic decisions, rather than being considered only at the end of a purchasing request.

For example, in the Gulf of Mexico many operators have looked to “outsource” decommissioning activity by selling installations nearing the end of their operations to specialist operators skilled in getting the maximum out of end-of-life production, before decommissioning at low cost. This approach is an interesting spin on the “make versus buy” – or in this case “sell” – decision.

2. Influence the plan – don’t just react to it

Timing can often play a key role in procurement success. Examples range from having a clear view of future demand that allows bundling to drive down cost, to understanding market dynamics to exploit timely opportunities. For many, getting a reliable view of forward demand is challenge enough.

However, even armed with this information, procurement can only be reactive: providing optimal results based on the stated requirements. By contrast, a new category of spend provides an opportunity for procurement to actually become part of this planning process, bringing its
commercial insight to influence demand and produce the optimum commercial outcome for the organisation.

In the decommissioning world, equipment, such as heavy-lift vessels, is both a major driver of cost and a potential future bottleneck. Market analysis carried out by procurement can help in understanding the competing demands for this equipment and even in plotting usage patterns.

This input can be used to model decommissioning costs and to drive decisions on the decommissioning schedule. For example, decommissioning can be delayed to coincide with downtime for the world’s fleet of heavy-lift vessels.

3. Establish global category scale

In almost all industries over the past 10 years, there has been a trend towards greater centralisation, bundling of spend and global category management. Many organisations have struggled to make this model work, as it is difficult to break away from established practices and localised decision-making. However, if the model is correctly set up, managers of new or emerging categories can be spared this pain. By establishing the category manager as the nexus for all commercial decision making and setting up the right networks for stakeholders, a global category strategy can be established that the business will buy into and implement.

The oil industry has enthusiastically embraced the trend for global category strategies over the last 10 years. Procurement’s focus on the benefits of global scale was sharpened by having to battle against significant input price inflation before the financial crisis, then by trying to realise the deflation dividend during and post recession.

However, realising these benefits has not been without its challenges. Strong and autonomous local asset management traditionally looked to protect local interests and relationships, thereby slowing progress. However, the decommissioning process offers procurement a clean slate on which to establish the right network and relationships, avoid areas that have slowed progress and take a place at the top table to drive the strategy and the plan rather than just processing the request.

4. Build the marketplace you want

Most procurement takes place in mature marketplaces, with established industry structures. Carrying out Porter’s five-forces analysis at the outset of procurement strategy development illustrates this, as it would include the questions, “what is the environment in which I am operating, and how am I going to react to it?” Discontinuities tend to come from innovation through new entrants, new technologies or new approaches. Sometimes these can be driven through procurement, but more typically they are driven by vendors looking for new opportunities.

In the case of “greenfield” procurement, markets are often immature and there is no established industry structure. However, given sufficient demand, the market will grow to fill that gap quickly and a market structure will be established. Category strategies implemented at this stage have the advantage of being able to influence market development. The influence can be either at strategic level, determining the nature and breadth of services provided; or more at tactical level, such as on how services are priced and measured.

The key is to implement a category strategy to drive a market structure that serves the purposes of the purchasing organisation. Whether the objective is to minimise cost, develop full service providers or maintain sustainable competition in the market, the category manager should work with their organisation to clarify objectives and then develop a category strategy that influences the market to grow in a way that serves them best.

In the decommissioning world, almost all the projects to date have been run by the operator of the platform – the oil companies – and been standalone projects for each asset or platform being decommissioned. So several different suppliers are engaged, each being responsible for a different part of the process, with operators taking responsibility for the overall project management to co-ordinate suppliers.

If this de facto sourcing strategy continues, the marketplace is likely to consolidate, with multiple specialist vendors providing discrete services at each stage of the decommissioning process. With many decommissioning projects on the horizon, though, category managers at the major operators have the opportunity to revisit this strategy. They should look at opportunities to develop prime providers that will provide vertically integrated services, or bundle requirements across multiple projects and develop supplier capabilities to exploit economies of scale.

5. Do your homework

Market intelligence is the lifeblood of effective category management. This is particularly true for greenfield procurement, where inaccurate information or unreliable sources can create opportunities for both buyers and vendors to exploit. Category managers who develop a deep understanding of the supply marketplace, particularly the cost structures of their potential suppliers, will have a significant advantage during the sourcing process. This understanding is vital if category managers want to be involved in more strategic decision-making and to advise the organisation on optimal commercial decisions.

Providers of decommissioning services tend to be existing suppliers to the oil industry – typically at the other end of the project lifecycle, during build. So the operators will already understand the market to some extent. However, to be able to contribute to strategic decisions and drive the timing and structure for the decommissioning programme, procurement will need to build on this understanding, and on skills learned during capital project builds, to provide insight and modelling for decommissioning costs.

6. Examine new buying structure options

The emergence of new categories of spend provides an opportunity to move away from the norm. The category manager also has a chance to consider new structures for going to market without having to deal with resistance to change.

Such structures might include different forms of outsourcing procurement, forming industry buying groups, vertical integration, and even forming a service provider organisation either on its own or in collaboration with other industry participants. As with all strategic decisions, this involves detailing the objectives of the organisation and assessing them against the prevailing environment, to determine the optimum outcome. In the case of the greenfield category manager, the
prevailing environment may allow for a broader range of strategic options.

In the case of decommissioning in the North Sea, operators are aware that they and their supply chain partners face a steep learning curve. They have identified their key objectives as achieving completion safely and with minimal adverse environmental impact, while agreeing that, although cost is a factor, there is no source of competitive advantage to be gained. It is a situation ripe for enhanced industry collaboration.

So far, this collaboration has focused on knowledge sharing and the development of market intelligence. But in future we may see a more integrated form – such as joint planning of decommissioning activities to optimise supply chain costs, or even purchasing collaboration – driving greater benefits for operators.

As exemplified by North Sea decommissioning, the challenges for greenfield category management can be considerable. Fragmented, immature markets, limited market intelligence, skills shortages, lack of experience and poor analysis of what the future holds all make the job of the category manager difficult. However, you will reap what you sow. New or emerging
categories offer procurement the opportunity to drive company strategy and even to shape the marketplaces in which it buys, unencumbered by the baggage of experience or existing structure.

☛ Paul Yates is a principal at Booz & Company, a global management and strategy consulting firm