IT IS NO SECRET that a company's CEO, owners, shareholders, and creditors have a deep interest in how a company is progressing. This short article explores an important question: if CEOs, shareholders, or creditors are asked to single out only one key performance indicator (KPI) to measure the overall performance of a multinational oil and gas exploration and production company, which one will they pick?
There are a number of KPIs that measure the performance of an organization by assessing its financial health, physical performance, operational excellence, and health, safety, and environment (HSE).
Company management will often develop a series of KPIs for each category and display them on the management dashboard to assess the health of the organization. The objective of such KPIs is to enable management to make appropriate and timely decisions in order to steer the company towards its set objectives. For each category, there could be many KPIs, and each one of them is undoubtedly important. However, if the shareholders, CEO, or creditors are interested in one single KPI, which one should be given greater emphasis and why?
The discussion must start with oil and gas company objectives linked to corporate strategy. Any layman can come up with the main objective of an oil and gas company: maximize profit and increase the value of the company year after year.
For this they need to generate more revenues and cut costs in order to increase profit. To achieve this apparently simple objective, a company must enhance its oil and gas production level year after year. For the sake of discussion, we are assuming that oil prices will remain steady at about $50 per barrel for many years. This means that revenues and profitability hinge on the production level and vigilance of reducing costs.
That is, the company must constantly invest its available financial resources in exploration and development activities in order to continue to add more oil and gas reserves to its portfolio. Adding more proven oil and gas reserves to a company's resource base will improve the company's market image, which will in turn elevate the market value of its shares. Thus, it is important to increase the value of the company by dutifully sticking to the main business of E&P and adding new reserves.
To achieve the objectives of maximizing profit and increasing the value to shareholders, a company needs to produce oil and gas at a sustained rate, but it must also try to produce more in each succeeding year. But production of oil and gas resources from a given reserve means that a barrel of oil or MMSCF gas produced today will not be available tomorrow. That is, with the production of each barrel of oil or gas, the remaining proved recoverable reserves will deplete unless new reserves are added to replenish the quantity produced. This is what is called Reserves Replacement Ratio (RRR), and this is the KPI that CEOs, shareholders, or creditors would be interested in to measure the overall performance of the organization.
Thus, if the company fails to discover and add new proved reserves, then the available resources eventually will be exhausted and the company will not be in a position to achieve its corporate objective of growth; rather, it may go bankrupt. Therefore, stakeholders are quite interested in this ratio and want to ensure that in any given year, this ratio should be greater than one or 100%.
This ratio is crucial as it indicates the overall progress of the company, including how well the company's upstream operations are performing, i.e. exploration and development activities. Are they acquiring enough blocks, acreage, drilling exploratory wells and making enough discoveries? Failure to achieve this single KPI means the company is not able to increase oil and gas production year after year, and this will be reflected in the financial performance of the company and its profit and loss statement.
Dr. Salman Ghouri is an oil and gas industry advisor with expertise in long-term forecasting, macroeconomic analysis, and market assessments. He holds MS and PhD degrees in petroleum economics from the Colorado School of Mines.
The views expressed in this article are his personal views and do not necessarily reflect the views or interpretation of his organization.
