Joint ventures
OUTLOOK REMAINS STRONG DESPITE ONGOING COST AND SCHEDULE OVERRUNS
ADI KAREV, EY, HONG KONG
JOINT VENTURES (JVS) CONTINUE to gain popularity in the global oil and gas sector. More companies are opting for these structures to manage ongoing capital constraints and, with commodity price recovery very much uncertain, they will play a big role in funding capital projects in the year ahead.
JV structures provide companies with the benefits of collaboration while distributing risk and maintaining corporate independence. In many ways, they have all the benefits of a merger or acquisition without the economic or political risk. They are also a favorable route to capital funding in the current market environment. EY analysis shows, however, that JVs are far more likely to experience cost and schedule overruns than their single-entity counterparts. In fact, of 333 oil and gas capital projects reviewed, 92% of JVs experienced cost and schedule overruns compared to 83% of non-JVs.
JV projects can involve several partners; the larger the project, the greater the number of partners. These partners come in all different sizes. Analysis shows that companies, often independents, use JVs to participate in projects far above their own market capitalization. These characteristics do not necessarily predispose projects to cost and budget overruns but they do contribute to their complexity.
Several forces contribute to the downfall of JV structures. Errors in the planning stage are not the only areas that cause challenges. Companies often invest the most time and resources into pre-signature due diligence and fail to maintain oversight once the capital project is underway. While upfront planning is an essential component of JV success, the majority of problems take place throughout the project life cycle.
The life cycle of projects - particularly megaprojects - can be upwards of 15 years. A lot can change in that amount of time. The drop in oil price is the most significant example of an unforeseen market event. These kinds of developments have the potential to significantly disrupt a JV. Individual company objectives or, in the case of this example, capital capabilities may change over the course of the project. JVs set up prior to the drop in oil price undoubtedly now include partners under financial stress. This can lead to further project delays or, in the worst instances, JV exits. This example underlines the need for companies to invest in alignment throughout the entire project while preparing for the risk of an exit.
Critical areas that define success throughout JV planning, formation, operation and exit stages include:
JV structure
The JV structure is the framework for capital project success. Failure to select and engage the right partners or to develop an adequate commercial structure is an immediate indicator of trouble down the road. Strategy, culture, capability or priorities (as they relate to joint activities) require particular compatibility between partners. Finding the right partner is a growing challenge. Companies must anticipate future market dynamics that may influence the JV.
Alignment of goals and strategy
It is very common for JV partners to disagree on joint goals and strategies for the project and its activities. This results in disjointed planning and investment activities. Insufficient planning ultimately leads to a lack of preparation and disruption during the project life cycle. Companies must align and communicate goals and strategies in order to effectively address project needs.
Mutual benefit and the development of trusting relationships
Failure to adequately align goals and strategy can damage trust between partners. When companies lack trust, effort is often duplicated and bureaucracy takes over. If two companies are aligned, however, trust develops and companies can avoid misunderstanding within the JV team.
Effective integration
Integration of the JV from day one operations is critical. Lack of integration can lead to immediate disruption. This is especially important in regions where relationships are not regulatory driven. Companies can avoid material damages to their projects by setting priorities that build trust between partners. This may include developing a joint cross-party business case, performing scenario planning to understand the likely decisions of each partner and investing in an external, independent assessment of key decisions and cash calls.
Project/organizational leadership
Companies must dedicate the necessary time to jointly defining roles and responsibilities and appointing key personnel together. These individuals are tasked with managing all of the critical factors of operating a JV project. Ensuring the best possible resources are used to manage these relationships should be an ongoing consideration.
Timing of exit
A partner may choose to leave a JV for a number of reasons but the timing is not always planned. It is not always possible to predict when market forces may take their toll on a company. Companies can, however, plan for the unknown. Alignment between partners on exit/sales strategy can reduce the impact of an exit and allow the remaining partners to increase value.
Dispute resolution
Not all JV relationships end on good terms. Conflict or disagreement can arise between parties. Prioritizing investment into a dispute resolution agreement will allow companies to reach a resolution far more quickly without causing long-term damage to the relationship or the project.
Over the last year, the global oil and gas industry has moved from a period of relative stability to one of high instability. JVs will remain an important structure to bring capital projects online in 2016 as companies identify opportunities to pool capital and share risk. While research indicates that JVs have a higher probability of cost and schedule overruns, it also shows that they perform better on the extent of failure. For overrunning projects, completion costs were, on average, 107% above target for non-JVs and 84% above for JVs. That is good news. By undertaking the necessary steps to strengthen relationships and enhance project oversight, companies can bring projects across the finish line on budget and schedule.
ABOUT THE AUTHOR
Adi Karev is EY's Global Oil & Gas Leader. He has more than 25 years of global management and advisory experience guiding international energy and resource companies on business transformation initiatives to address cultural, economic and operational challenges. He is based in Hong Kong.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.