J. O. Langley
JOL Interests Inc.
Dallas
There exists for any company an optimum number and optimum mix of producing properties.
"Rightsizing" is the process of eliminating nonstrategic, financially marginal, or other undesirable properties from the portfolio, along with a parallel restructuring of the organization in order to reach such an optimum. It also is the foundation for a plan of strategic growth.
This is in contrast to "downsizing," which means reduction of a certain percentage of properties and personnel without plans for growth.
I have managed rightsizing programs in two independent exploration and production companies. Analysis of each company revealed that 85-90% of cash flow and present value discounted at 10% (PV-10) was contributed by only 10-15% of the portfolio.
A strategic plan was developed for each company to retain an optimum portfolio. It eliminated high cost, high exposure operations and reduced overhead by about 40%.
The plan included growth elements of exploitation of latent development potential and a redirection of the exploration program to areas of higher potential. And it included procedures to better manage risk.
This article describes methodology employed in these cases, makes suggestions for similar projects, and presents results of these major restructuring projects.
FUNDAMENTAL CONCEPTS
Since the oil and gas boom ended in the mid-1980s, managements have been striving, with various degrees of intensity and success, to cut costs, increase productivity, and thereby improve profitability. Often, they have divested properties in pursuit of these objectives.
Unfortunately, in many instances overhead reductions and efficiency improvements did not completely materialize. My experience has led to the development of fundamental concepts that have been employed successfully (Fig. 1).
First is the attitudinal acceptance that significant change will be required in the portfolio and organization to effect significant cost and efficiency improvements.
The notion that a company can continue to do all the things it is now doing but with significantly fewer people simply by becoming "more efficient" can work to a point. But it will not supply the step change needed to achieve significant improvement.
Here is an example of a pervasive problem:
A staff group of operations, gas sales, accounting, legal, and engineering personnel was sorting through a complex gas sales and balancing situation. The problem was real and the work necessary to protect the company and royalty owner's interest.
Unfortunately, the company's net interest was only 5%, and the financial impact of all this good work would be essentially nil. This kind of effort needs to be directed where the financial impact is meaningful. It is management's job, not the staff's, to make this happen.
Changing these situations requires significant change in the portfolio and in the organization, and this must be acceptable or the program should not be undertaken. Once accepted, the program must then be managed to achieve desired results.
This leads to the second fundamental: that strategy development and decision making must be centered as close to the chief executive officer as possible.
If the CEO is unable or unwilling to lead the program, a very senior manager may be appropriate if he has the breadth of experience and managerial acumen and if the CEO is willing to publicly support the program. Anything less will not result in total support of key managers and departments and will doom the program from the outset.
On the other hand, using this approach will put the program on a 11 corporate mission" with key support. Frequent followup is necessary to keep the program on track and provide momentum. This enables pockets of resistance, finger pointing, turf battles, and the like to be held to a minimum or dealt with quickly, ensuring managerial and departmental adherence.
The third fundamental is the proposition that dimensions of the program should be developed at the CEO level to meet the strategic goals of the company.
This is in contrast to "summing up" proposals developed from the grass roots.
I believe in participative management, grass roots goals, and objective systems. However, this is not the place for it.
The expectation that several divisions or departments, each with varying operational, strategic, attitudinal, and even cultural differences, will achieve the desired corporate goal in the desired time frame is the managerial equivalent of believing in a fairy tale.
Rather, the program should be developed at the top, and key managerial allegiance should be obtained in group sessions where corporate mission is outlined, strategy developed, objectives set, and questions answered by senior management.
Fourth, a divestiture program of any size--more than $10 million--should be implemented with the assistance of professionals in the sales business. This will involve some modest added costs and require inclusion of a few quality properties to improve marketability.
However, this generally perceived detriment is more than offset, in my experience, with the benefits of an accelerated process and a much better matching of sales packages with the market. A high level manager should be in charge to ensure that the professionals also stay focused.
Fifth, the employee relations strategy must be developed early, with employee communication of prime importance. Productivity will suffer during the process in spite of management's best efforts, but meaningful work will stop altogether if communication voids develop.
A better approach is to tell people a date certain when they will be notified of their status. Then, above all, stick to it.
Sixth, the divestiture program development is better conducted by a select task force of personnel reporting directly to the CEO or his designate.
PROCESS DESCRIPTION
The methodology is to examine tentative cuts or divestiture program sizes and their corresponding operational, organization, and financial effects utilizing a simple seriatim--or value ranking--analysis.
Value distribution can be plotted in terms of the incremental percentage of value the company derives from incremental percentages of properties in the portfolio (Fig. 2).
This distribution is developed by plotting the value contribution of the most valuable well or property in the portfolio first, then the second, and so forth, continuing through the least profitable well. Curves developed in this manner will look remarkably similar, whether the basis of the valuation is PV-10, net income, first year cash flow, or something else.
The value selected should be at the lease level so that overhead charges do not distort the data.
Immediately, one can see that the majority of value is associated with a small percentage of portfolio properties. This will not be earth-shaking news. The trick is to determine a new portfolio for the company and to restructure to include only that complement of overhead necessary for efficient management of the new portfolio.
Determination of the desired portfolio is an iterative process. That is, it seeks the best portfolio configuration by testing a series of options" But to have meaningful effect from an organizational, cost, and efficiency standpoint, my experience shows the divestiture program will necessarily involve about 10-15% of reserves and cash flow and 50% of current wells.
SERIATIM REFINEMENT
Refinement involves testing the divestiture alternatives with consideration given to several factors (Fig. 3).
Divestiture of an entire producing area while continuing to explore in the same area generally doesn't make a lot of sense, so some strategic soul-searching may be in order. Wells holding acreage with exploration potential, horizontally and laterally, should be identified to enable management to make an informed decision.
Situations will occur in which divestiture of very profitable wells, while distasteful at the operational level, will enhance the ability of the company to achieve broader, more strategic goals such as elimination of a complete office or an undesirable operational or legal exposure.
Each property or well should be reviewed to ensure that the divestiture decision is made with full knowledge of future potential, such as reserves behind pipe, additional recovery, compression, reservoir blowdown, and gas storage.
Properties with legal or environmental problems should be cleaned up or removed from the plan, or specific arrangements should be made to enable purchasers to understand the risks involved. In the long run, the company is better served by facing those situations early rather than later, when adverse consequences will be greater.
Financially, program effects should be incorporated into current year profit and loss and balance sheet pro formas. Included would be benefits, such as cash flow from the sale and cost savings, offset by detriments, such as writeoffs, termination costs, and fees.
In addition, issues such as debt covenants, preferential rights, and production imbalances must be addressed. Also, any incentive compensation programs should be remodeled to accommodate program effects.
From a corporate viewpoint, an overall assessment must be made of the restructured company--including magnitude of layoffs and public opinion, including that of the financial community--so the CEO and board can understand and fully endorse the program.
Copyright 1992 Oil & Gas Journal. All Rights Reserved.
