Turbocharging Energy Operators' Procurement during Covid 19 and Low Oil Prices

Two massive shocks—COVID-19 pandemic and the sharp decline in oil prices—are simultaneously wreaking havoc with energy operators’ supply chains. The impacts are reverberating through every company involved in the value chain — drilling companies, oilfield service providers, engineering and construction firms, power equipment manufacturers, and more.

Operators have weathered their fair share of crises – massive drops in the price of oil in 2009 and 2014 immediately come to mind. But the situation is even more alarming this time around because vendors are already suffering from the impacts of COVID-19. As a result, just over the past few weeks, many suppliers to the energy industry have lost more than 50% of their market cap on average, and now are at risk of severe distress and bankruptcies.

There is no way to know how long the global shocks will continue to disrupt demand and supply for energy equipment and services. But procurement and supply chain managers (PSCM) should not stay passive, hoping supply chain resilience or better prices from suppliers will happen on their own. Instead, companies need to work closely with suppliers to reconfigure supply chains, avoid distress, and obtain better rates for the long term. See Exhibit 1.

Exhibit 1

Enhancing Six Capabilities

In our view, energy operators should enhance their supply chain capabilities in several key areas:

1.     Demand Management. As a result of changes in the price of oil, a work program created at the beginning of the year may no longer be accurate—a drop in barrel prices from $60 to $30 can greatly change the economics of any given project. So companies need to review their demand, given new breakeven oil prices.

This covers not only capital expenditures that many operators have already reduced significantly. It also includes turnarounds, small and medium capital projects, well work, civil work and construction, and facilities management. We see many operators rightsizing, deferring, and even cancelling activities to optimize their working programs in light of the lower oil prices.

2.     Tailored Category Intelligence. Companies need to understand how critical their categories and sub-categories are for continuity of operations. We typically see two equally important types of categories here.

Large global categories are typically important and critical for production operations. This includes, for example, drilling and completions, engineering, construction (EPC), and electrical equipment.

Smaller, local categories are critical for offshore and onshore production as well as for power generation in remote areas. Examples include local logistics (helicopters and boats) and spare parts and consumables become especially critical in a coronavirus-disrupted world. 

 3.     Deep Cost Intelligence. It’s also important to understand suppliers’ underlying costs. Granular should-cost models based on bill of materials, external cost intelligence and forecast of market indices (raw commodities, labor rates, logistics, electricity, and so on) will demonstrate the potential for value creation across suppliers and categories.

Take, for example, the cost of transformers. According to our should-cost analysis, transformers are likely to experience a drop of 6% to 12% over the next 6 to 12 months; drilling services could drop by as much as 30%. Maintenance costs, by contrast, are likely to increase, since they are people intensive and therefore affected by COVID-19.

If the cost of something is expected to go down, there is room for negotiation. Operators can deploy different negotiation methods depending on the strategic importance of the supplier. 

4.     Relevant Vendor Intelligence. To get insights on supplier-specific risk, energy operators need to be thinking about each vendor’s manufacturing capacity and logistics capabilities to understand whether they can still deliver products and services with the appropriate level of quality on time. Detailed qualitative assessments can help identify where disruptions could arise.

For example, an energy operator in SE Asia experienced a delay on the delivery of electrical equipment because of issues with one of its global suppliers. The vendor didn’t have a problem with the components, which all arrived from China, Europe, and Latina America on time. But that was not the case with the European engineers needed to conduct assembly, quality assessment, and control processes. A COVID-19 lockdown by local government made it difficult for them to get the necessary visas, while the cancellation of airline routes made travel unfeasible.

5.     Supply Risk Management. To avoid a situation where vendors suddenly don’t have the required capacity, it’s critical to identify alternative sources of supply and reconfigure the supply chain with a one-to-three year horizon in mind. Operators should aim for multiple origin sourcing.

Companies also need to get a good grasp of their suppliers’ financial circumstances. Understanding which suppliers are at risk of default and therefore will need help is important information for operators that may need to reconfigure their manufacturing base.

6.     Joint Supplier Collaboration. A crisis of these proportions provides an opportunity to step up collaborative efforts with suppliers. The creation of a joint taskforce will make it possible to evaluate and execute plans to mitigate risk for both sides. While the goal is to ensure that the supplier avoids financial distress in the short term, the operator may be able to negotiate lower prices in the long term. The key is to ask suppliers what they need: squeezing them is counterproductive.

Preparing for What Comes Next

To ensure they are ready for whatever is going to happen, energy operators need to talk to their vendors, prepare for the avalanche of bankruptcies and force majeure, and start thinking about the future.

In addition to analyzing data on their suppliers’ financial health, energy operators should survey their suppliers on a weekly basis to monitor delays in delivery and leading indicators of financial health. In addition, PSCM leadership should reach out to the C-level executives at the 30 to 50 most critical suppliers to discuss whether financial assistance or joint value creation initiatives are a good idea. Collaboration is the key to value creation. It’s the best way to reduce costs without pushing vendors into distress.

PSCM teams are adept at handling one or two force majeures in a year. But this time, there will probably be dozens and dozens across different geographies, categories and business units. Operators, therefore, should consider developing a vendor distress manual as well as training staff globally on how to handle force majeure and distress. To be prepared for any crises that may arise, it’s a good idea to create cross-functional teams with people from legal, PSCM, operations and finance functions who are skilled at crisis management.

No less important, companies need to start thinking about the more distant future. In a year or two, only 30% of current vendors may still be around. It’s important to identify these vendors and the steps that will be required to improve their resilience. Operators need to proactively telegraph their expectations to help bolster supplier preparedness now—and secure the partnerships needed for preferential status after the crisis is over. 

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While the confluence of events is unprecedented, it doesn’t preclude similarly devastating events from occurring in the future. Energy operators need to take immediate steps to stem the impact of the disasters at hand while securing their supply chains down the road. The future of their businesses may well depend on it.

This piece has been developed and co-authored in collaboration with: Jose Rodriguez, Raphael Desi, and Harish Hemmige