SPECIAL REPORT: Managing E&P performance with improved information

With oil and natural gas prices hovering at all-time highs, shareholders’ return on investment over the past decade have been an astounding 14% average annual return (AAR). However, not all exploration and production companies are enjoying similar returns. The E&P firms leading the pack are averaging ROI of 22% AAR, whereas companies in the lowest quartile are averaging 10-year stockholder returns of just 8%.

Why are some upstream companies able to achieve almost three times the level of stockholder return than other upstream companies? The “on-the-surface” causes of the differing ROIs include the makeup of producing property portfolios, debt structures, geographic scope, and economic valuation standards. Although “on-the-surface” contributing factors for achieving “better-than-average” success in the E&P market varies, there are underlying internal reasons for better-than-average success.

It is neither by coincidence nor by dumb luck that some E&P firms have sustained higher return portfolios versus the industry average. Executive management in better-than-average companies have made decisions based upon the right information, at the right time, with the right resources to maximize their asset portfolios. Simply put, the more successful companies were equipped to execute their strategy.

Performance management

Equipping E&P companies to execute their strategy is not simple. E&P firms work in complex environments and have equally complex corporate structures that can lend themselves to silos. Better-than-average E&P companies have developed various internal programs to obtain the right information to manage internal performance and track progress toward the defined strategies.

Most of the internal programs fall under the category of what is termed “performance management.” The mere mention of the words performance management raises the specter that many experienced during the mid-1980s when “management by objectives” was the rage. This experience typically started with the dissecting of financial and operational reports to identify, for example, how much it costs to buy a pencil. These irrelevant costs were then used to measure executive performance and dole out nonexistent bonuses. Performance management has come a long way since then.

In the upstream environment, performance management spans the organization incentives, processes, and technologies related to managing the company assets-from economic valuation, planning, budgeting, and forecasting to asset evaluation, production analysis, capital tracking, reporting, and linking compensation to performance.

Performance management includes programs such as improving the quality and timeliness of production information, improving the accuracy of forecasting reserves, generating new drilling or completion opportunities from the information hidden in current field data capture, production accounting, general accounting, drilling management, and economic systems.

The ultimate goal of the performance management programs is to help management steer the organization to a better-than-average (or higher) return on assets through reduction in lease operating expenses, improved reserve replacement, increased production, and reductions in general and administrative costs.

Importance of information

At the heart of the performance management programs is access to more timely, relevant, accurate, and consistent information.

Traditionally, and still today, E&P companies have relied on a variety of stand-alone systems and spreadsheets to generate information about overall investment and asset performance: Economic systems provide volume forecasts and reserve estimates, field data-gathering systems capture volumes, oil field workstations generate gross daily production estimates, revenue-accounting systems generate sales volumes and the plethora of spreadsheets the company uses to track and report the information.

Field operations rely on the oil field workstations, spreadsheets, and phone calls to their pumpers to gather daily production estimates for their properties. Marketing relies on inconsistent data from their marketing systems plus phone calls to various regions to get the accurate view for nominations.

To navigate through this information labyrinth, management typically has to wait several days to see production results. A reasonable picture of capital spending takes weeks to calculate via spreadsheets. Not surprisingly, the economic models produce lease operating expense assumptions inconsistent with the operations view of lease operating requirements. Variances between production volumes and sales volumes are attributed to “shrink” or the “unknown.” Finally, executive management waits several weeks for their revenue systems to be updated to see the monthly financial results.

Meanwhile, on the drilling side of the business, drilling systems are used to capture most of the capital spending; however, much of the tracking process is supplemented with spreadsheets and personal databases to help engineers estimate their projected spend on work-over and drilling projects. To make matters worse, many of the projected spend estimates are not sufficient for finance to accurately project cash flows.

From an overall financial perspective, tying drilling and production activity to the financial results is-as an understatement-a challenge. The relationships between properties, wells, and divisions in the financial systems do not typically align with the relationships in the production, capital, and economic databases. The data relationships cause a challenge in analyzing and correlating the operational impacts with financial results. Consequently, the financial statements become a mystery to most of operations, and disconnects between operations and finance are created.

In sum, upstream companies traditionally have struggled with tying together business performance information to allow them to improve their understanding of production and sales variances, and to project cash outlays and tie in operational results to financial results.

Overcoming information gaps

Traditionally, E&P firms have attempted to overcome the information gaps with a sea of spreadsheets containing multiple versions of the truth, created by people who are taken away from their real job of running the business.

How can today’s leading upstream companies address the information challenges related to performance management?

Deloitte Consulting LLP has helped a number of upstream companies address these challenges and determined that they must address four dimensions of information and performance management: organization, process, data, and delivery.

• Organization. The organizational aspect of performance management is the most critical and can easily be translated to mean that there is accountability at the individual and team level for results. This sounds good, but how can the people in the organization be held accountable for metrics they (1) agree with, (2) understand, (3) allow for business variability, and (4) tie to the corporate goals?

Most organizations give their people certain metrics, against which they are held accountable, and the defined metrics tie to the corporate goals in one form or another. But assigning metrics is the easy part. For example, a division manager is held accountable for a lease operating expense per unit of production or an engineer is held accountable for the accuracy of his drilling projects in terms of budget and timing. However, the challenge-and where most companies fail to see the light-comes in understanding, agreement, and business alignment.

For example, the data produced by the production and expense accounting systems for lease operating expense per metric cubic foot of production calculation does not tie to the spreadsheets the division managers or engineers have been using to run their individual parts of the business.

Furthermore, the metrics produced by the system do not allow the division manager or engineers to intuitively see the detailed data comprising the metric for understanding how they can impact what they are being evaluated on. Ultimately, the division managers and engineers virtually ignore the metrics and the people accountability program becomes a waste of time.

For a company to be successful in assigning, evaluating, and motivating based on metrics, it must give people in the organization access to information consistent across the company. Appropriate access to information allows people within the organization to agree upon the details backing up the metrics against which they are being measured. Additionally, this will allow the people to take action and control the factors driving the metrics.

For example, the division manager being measured on monthly lease operating expense should not only be charged with managing the expenses incurred but should also be able to tie the actual lease operating expenses incurred to the total operating metric calculation. Leading companies have eliminated corporate expense allocations that become diluted when general and administrative costs are spread across regions. Leading E&P companies have built models or reporting systems allowing their managers to see the high-level information they are accountable for and easily link to the detailed information. The managers can compare their goals to results and quickly drill into the detailed information that drives the results, allowing for the manager to take quick action. In other words, we are suggesting a single version of the truth to manage the business, where information is tied together for organization accountability.

• Process. Efficiently run organizations require some level of consistency of process across the organization. Many of today’s larger E&P companies grew through acquisition. The acquired businesses have differing processes for estimating production volumes, developing financial budgets, capturing drilling and capital spend information, and viewing their financial statements.

For example, divisions may use different schedules for capturing daily production estimates from their field data capture systems (e.g., SCADA). Additionally, the acquired company typically defines and uses certain key data elements differently than the legacy divisions in the company. If the timing and data definitions among operating divisions differ, a challenge is created for the organization as a whole to capture information on a timely basis to meet all divisions’ needs. Therefore, the divisions and corporate office start to rely on spreadsheets to manage the business and do not trust their production systems for reliable data.

To resolve the consistency issues, companies need to look at their processes that impact information and develop consistent policies and procedures across the organization for information capture, whether it means timing consistency, data definition standards, or the like.

Developing consistent processes is not an easy task and requires significant resource commitment across the organization. In the companies Deloitte has worked with, the operating groups and production accountants have worked collaboratively to develop and agree upon consistent processes across the organization. The process improvement efforts also require the company to take a deep dive into how they plan, budget, and forecast to develop consistent, forward-looking approaches. The company must align its planning, budgeting, and forecasting processes among the individual groups within the company, so, for example, the economic and reserve forecasts tie to the detailed operating assumptions generated by the lease operating budgets and production forecasts.

Commitment and leadership is the key for successful and sustainable process change. The operating groups must be committed to changing the process and should understand how process change benefits the company overall. Leadership should be ready to eliminate rogue activities and align processes with the corporate standards.

• Data. When managing performance, companies rely on their core systems to provide the data used to manage performance. The systems typically include revenue and production accounting, field data capture, marketing, economics, and drilling-management systems. However, many companies have baseline data issues within their current systems. Does this mean that the systems need to be replaced with an integrated Tier-1 “ERP” like SAP? Not necessarily.

The issues boil down to a misuse of the existing systems and lack of training. Examples of real issues include: differing property hierarchies between systems, misuse of freeform or predefined data fields, missing data, and inaccurate meter grids. As a result, virtually all organizations turn to spreadsheets to manually manipulate data for performance and management reporting. Spreadsheets are prone to errors-studies have found that 90% of spreadsheets with more than 150 lines contain errors. It is doubtful any company wants to manage their business on information with such an error rate.

Although many of the information issues stem from process issues, the information issues first require data cleanup, followed by ongoing process improvement. The data issues are at the crux of why external spreadsheets are used for daily production reports, capital tracking summaries, and financial statements. Addressing the data issues requires a focused data cleanup effort, as well as cross-functional data definition teams to define how certain data elements will be used for reporting purposes. Addressing the data issues requires cross-division commitment and buy-in just as the process changes do.

Another part of the process improvement effort is changing processes to avoid future data cleanup efforts. For example, when new wells are brought online, a process for synchronizing the update of accounting, economic, and production well information needs to be defined. Improving the process not only improves the time in which data and information is obtained, but also increases the accuracy and value of the data created.

• Delivery. Unfortunately, most organizations are quick to jump first to the delivery or software solution (e.g., business intelligence, data warehouse, etc.). Invariably, taking this route results in failure because the projects never seem to end. Key information is not captured or reported, and executives get frustrated because they’ve spent millions of dollars on a “whiz-bang” tool but are not getting any more information than they had before the tool was implemented.

The delivery or software solution needs to be assessed along with the process, organization, and information dimensions. Implementing the delivery or software mechanism alone will result in a software tool nobody uses. The delivery mechanism needs to answer the following questions: What technologies are we going to use to deliver information to the divisions, corporate, and field organizations? How is the new software environment going to be integrated into the flexibility they have come to expect with the current spreadsheet environment? How is the planning process going to be integrated into the delivery mechanism?