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Effective supply chain and procurement strategies

Dec 11, 2018
11 min read
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By: Vinodkumar Raghothamarao, Director Consulting, Energy Wide Perspectives & Strategy, IHS Markit EMEA

Oil and Gas companies operate in dynamic and complex environments, where they face constant challenges especially in terms of supply and demand for materials and services. Now with the oil prices hovering around US$70 and with respective GCC National Oil Companies (NOCs) striving forward with their individual local content and In-Country Value Strategy, this is an opportune time to evaluate the supply chain and procurement strategies and costs. The GCC based National Oil Companies (NOCs) need to focus not only on their product supply chains, but also on the non-hydrocarbon supply chains that handle the parts, materials and services required to run the business. The non-hydrocarbon supply chain is very critical to deliver the equipment and services required to find, extract, refine and finally market the oil and gas. Procurement and supply chain strategies are set to be in the forefront of critical decision-making issues within the National Oil and Gas Companies especially with the current volatility in oil prices.

We have found that oil and gas supply chain practices clearly lag behind (in certain geographies) those of some other industries that use advanced techniques such as optimised inventory management, collaborative supplier relationship management, digital supply chain and Procurement 4.0 and so on. In this article, we provide a brief insight about the opportunities and areas where supply chain practices can be improved amongst the IOCs/NOCs, and highlights other industries that companies in the oil and gas space can learn from, including improved service to internal customers and reduced costs.

According to Harvard Business School Review, purchased products and services account for more than 50 per cent of the average oil and gas company’s total costs. Thus, even a 5 per cent reduction in purchase costs can result in a significant increase in the profit margin for oil and gas companies. The arrival of Industry 4.0 is heralding the next era in supply chain management, in which suppliers and customers come together in entirely new ways, erasing organisational boundaries. The traditional linear supply chain is evolving into an integrated value chain of mutually beneficial relationships where suppliers and customers collaborate to achieve efficiencies and lower costs by exchanging information and securely integrating systems and processes. 

To achieve this, oil and gas companies should look at the following opportunities to deliver better supply chain value:

  • Supply Chain Market Intelligence
  • Materials/Supplier Relationship Management
  • Digital Supply Chain and Procurement 4.0

Supply Chain Market Intelligence is the process of acquiring and analysing information in order to understand the present and future market; support current and future sourcing and market sector strategy execution; and enable the business to better anticipate changes in the external marketplace and react before others do. Supply Chain Market Intelligence is key to any industry and more so for the dynamic oil and gas industry. Effective supply chain market intelligence helps oil and gas companies deal with strategic supply chain challenges such as constrained capacity, infrastructure and volatile markets. It also helps companies make the right decisions about which markets to buy from, how to determine the right price to pay and what benchmarks and targets will provide the right competitive edge. With the various Middle East Governments and NOCs driving In-Country Value Strategy programs, there is a greater need for local content supply chain market intelligence than ever before. We at IHS Markit have realized that most of the National Oil Companies (NOCs) in the Middle East have good knowledge of the Tier 1 supply chain market intelligence but the need of the hour is to effectively tap the supply chain beyond Tier 1.

Effective demand planning is the next step to improving the supply chain. It is a key factor to having better visibility into the future requirements, which in turn helps to step up or step down supply, and thus leverage demand based on scalability. Many of the oil and gas supply chain and procurement executives across the globe agree that challenges arise when their demand-planning measures do not match their forecast expectations. The main reason for this is because it is only being used in selective areas. For example, oil and gas companies may use demand planning in limited areas such as long lead time capital equipment but not for other critical areas of the project and that can cause cost overrun. Beyond that, many oil and gas companies do not use demand planning at all, and this leads to a situation where internal customers are not linked to any structured planning process.

The oil and gas industry is heavily dependent on suppliers to provide complex services and critical equipment to support on-going projects and operations. More than often, contract management and supplier relationship management are not up to the mark, and as a consequence, the oil and gas companies take on supplier risks. To improve supplier relationship management, the companies should adopt a method of supplier benchmarking. Oil and gas companies need to measure the robustness and performance of different contractors for various spend categories, and constantly seek dialogue with them so that the suppliers are in unison with the necessary obligations in terms of safety, training, equipment and staffing requirements. For contract management, we have seen some oil and gas companies with non-efficient processes such as non-compliance of contracts with established suppliers.

Another method that can help the oil and gas company in pricing negotiations is the use of the Should-Cost model, and in addition, the Total Cost of Ownership (TCO) model. In the former, the total acquisition cost for a particular equipment or service is arrived at by taking into account the design cost, supplier operating cost, supplier margin, and transaction and acquisition costs. The Should-Cost model for different spend categories will empower oil and gas companies to effectively negotiate contract terms and conditions with the suppliers. In the case of the TCO approach (more suitable for long lead and critical capital intensive equipment), the different costs including the acquisition costs, and operation and maintenance costs are arrived at before choosing the right supplier at the competitive price. Some of the IOCs have adopted measures such as the Should-Cost and TCO models but these are yet to be adapted by other regional and local players in the oil and gas industry. IHS Markit realizes that this area of supplier relationship management, especially in the GCC, will need a deeper analysis and smart approach given that local content mandate play a part in determining the right contracting and procurement strategy.

Even though materials management in the oil and gas industry is not critical like that of the healthcare supply chain, where it is a matter of life and death, the supply chain function is still evaluated on the turnaround and delivery of materials and services at the right time and right place. Excess inventory based on historical usage and inventory levels by stock keeping units that do not match the service level requirements are some of the typical bad practices that one should get away from. Instead, oil and gas companies should adopt practices wherein there is high level of availability with minimised inventory. Another area of materials management wherein best supply chain practice can be improved is the movement of materials to the project site. Most of the oil and gas companies deploy the services of third-party logistics (3PL) providers for transportation. Good tracking visibility, alternative material procurement, cross-docking and direct delivery are some of the measures that can be deployed to tackle challenges faced by using 3PL logistics providers.

Although the advent of technology has helped oil and gas companies to find and extract more oil and gas, there is a need to seriously consider industry leading digital supply chain and Procurement 4.0 solutions. Industry 4.0 creates a disruption and requires oil and gas companies to rethink the way they design their supply chain. Several technologies have emerged that are altering traditional ways of working. Digitising the supply chain can reduce procurement costs for all purchases of goods and services by 20 per cent, reduce supply chain process costs by 50 per cent, and increase revenue by 10 per cent.

Procurement 4.0 is the new paradigm in procurement, acting as a platform to support business planning and decision-making. It improves the performance of routine tasks like transaction processing, monitoring and enforcement of regulatory compliance. It increases transparency, eliminates middlemen overhead costs, improves competition amongst suppliers and eases management reporting.

The main benefits for the oil and gas industry to embrace Procurement 4.0 as part of its contracting and procurement strategy are the desires to:

  1. Transform procurement organisation by automating workflow, redeploy people for more value added strategic tasks and create additional value in procurement.
  2. Improve sourcing and transaction cycle time.
  3. Establish tighter integration with suppliers and customers.
  4. Provide accurate inventory information, complete spend information and supplier performance metrics.
  5. Minimise manual intervention and errors.
  6. Decrease internal procurement cost by having less maverick spend and hence greater volume with approved suppliers thereby leading to higher volume discounts.

As with any other industry, the oil and gas industry also has to grapple with the shortage of supply chain and procurement talent due to an aging workforce and growing skill shortages. Some of the measures that can be effectively adopted are digital supply chain and procurement 4.0 automation, establishment of supply chain centre of excellence and industry-academia collaboration to nurture supply chain talent.

The IOCs/NOCs to improve and deploy best in class supply chain practices can adapt and/or implement some of the practical measures listed below:

  1. Understand the “total value” of major spend categories. This requires thoroughly identifying costs and options across the supply chain for each category and determining appropriate interventions (e.g., seeking new supplier, changing specifications, altering contract terms)
  2. Build custom fit procurement processes that provide better clarity, engage suppliers early in the process. Moreover follow through to execution and into operations
  3. Manage risks across the entire spending portfolio—not just within individual projects or commodities, or splitting capital from operations spend
  4. Proactively manage the supply base, select relevant suppliers, focus on alignment and sustainability (i.e., dynamic relationships), and ensure company ownership and accountability is clear to suppliers
  5. Institutionalise the capabilities required for supporting procurement and supply chain activities. Today, these scarce skills are at a premium. In the next few years, it will be just as important to cultivate the right talent here as it will in the most critical technical and operational areas

Going forward, we realise that even though some of the supply chain best practices have trickled through the oil and gas industry, there is always still scope for further improvement. Integrated Planning and Execution with better end to end demand planning and optimised inventory management will help oil and gas companies maintain oil and gas equipment uptime and hence benefit from improved productivity. Improved spend category management and collaborative supplier relationship management coupled with increased automation of transaction processing, will lead to sourcing savings and identification of secondary saving opportunities. Effective deployment of supply chain best practices and adoption of digital supply chain and Procurement 4.0 is the way forward for the oil and gas companies to reduce costs in this era of volatile oil prices and to focus on oil and gas production and exploration in the most optimised way. It will be really interesting to see how oil and gas companies can effectively manage their supply chain seamlessly coupled with the adoption of best in class supply chain practices in 2019.

Vinodkumar Raghothamarao