30 Apr Managing the Risks of a Digital Transformation
Embarking on a digital transformation journey in oil and gas is not an easy matter. There are many risks to be managed. Here’s a few of the biggest.
Staying competitive is a challenge these days. Cost structures of digitally driven companies will reset to new lower levels reflective of greater automation and analytics support. Productivity of assets will rise as digital helps solve optimisation challenges. Stock market valuations will reflect these gaps in performance between market leaders and laggards. Most concerning, new disruptive business models may emerge that have more fundamental impacts on the industry. Standing still has not served other sectors well (see Amazon and retail).
On the other hand, embarking on a digital journey is not without its risks either. Fortunately, early adopters of digital have already discovered the biggest risks to be managed, and in many cases, these risks are not specific to any one company or industry. They apply equally to the oil and gas industry and its suppliers. Here’s a few to take to heart.
Poorly structured programs
The industry thinks long and hard about spending shareholder capital in the pursuit of new hydrocarbon deposits and asset investments, as it should. Geologic uncertainty, technical risk, commodity price movement, available infrastructure, tax policies, royalty regimes, likely productivity of the assets, expected lifetimes, on-going capital requirements – all weigh into the decision to allocate capital to an investment. The industry is generally comfortable with understanding and modeling these uncertainties, and managing them through the capital spend phase. Oil and gas capital investments tend to dwarf all other kinds of spending, and so receive the lion’s share of management attention.
Information technology investments, on the other hand, are smaller, less familiar to oil and gas executives, and the implications are usually not fully appreciated. In my experience, technology-led business change is less of a priority, receives less management attention than other investments, is handed to an executive for part time sponsorship, is not profiled at the Board level, receives limited resourcing in funding and talent, and is not held to a high standard, all of which signals a lack of serious intent.
Poorly structured digital agendas that lack direction, organizational clout, appropriate resourcing, and demanding performance measures will fail to deliver meaningful results.
Orientation to incremental change
It is completely reasonable for companies to experiment with one-off digital investments in narrow areas of business to gain insight and understanding into how these technologies behave and are likely to change. Many oil and gas companies fund a portfolio of smallish experiments and proofs of concepts, to drive innovation inside the fence, or more narrowly, inside a silo of the business. In my experience most of these experiments do successfully demonstrate that individual digital technologies can and will deliver a benefit to the business.
Pursuing a series of individual digital innovations is not going to be enough. Using robotic process automation in the finance function to reduce data capture costs from field tickets will remove some headcount from accounting, but the problem of manual field tickets remains. This is akin to a taxi company publishing an app that allows a customer to get in contact with its call center to book a cab. The call center is still intact, the payment system hasn’t changed, the cab driver still doesn’t know where to take the customer.
Some portion of innovation investment will need to be redirected towards the potential of combinations of technologies working not just in functional areas but beyond the fence line. Some innovation investment should also be directed to understanding how business models in the industry may be disrupted, particularly in the following areas:
- The potential to separate the analysis of data about an asset from the ownership of that data and the owner of the asset – using cloud services to crowd source analytics for third party subsurface assets.
- The potential to extend business models beyond current boundaries enabled by digital – achieving full inventory management for petroleum products to customer tanks, including vehicles.
- The potential to create new financial assets based on highly accurate machine data – using blockchain to record actual environmental emissions (water, air), and enabling trading in true actuals
It is at times of change when opportunities are the greatest. Digital innovation is one of the most powerful, widespread and fastest change drivers in recent memory, and opportunities to reinvent business practices are at hand. Many industries have learned the hard way that digital innovators have disrupted the status quo in painful ways.
Intel, a leading microchip designer and manufacturer, was presented with the opportunity to develop microchips for a novel new device called the smart phone, but their analysis at the time was that the smart phone would not have a market. They passed it up.
The music industry, under siege by peer-to-peer music sharing services, decided to sue rather than innovate in music sharing technology, profitability in the sector collapsed for a decade, and music streaming companies like Apple and Spotify now dominate the sector.
The taxi industry in many cities enjoyed a monopoly of high prices, constrained capacity, poor customer service and low technical innovation, until Uber appeared and thoroughly destroyed their business model.
Another risk to squandered digital investment is through “inside the fence” organisational misalignment. For many digital investments to achieve their full potential, business functions other than that controlled by the main executive sponsor need to get on board. For example, a coal seam gas company experimented with using a collaboration tool in its field operations to convert traditional well delivery from a discreet project effort to more of a manufacturing process. This initiative, called the Gas Factory, sat in the operations team, who scheduled well delivery, collaborated with the services companies and engaged with the land owners. Progress was stellar – well delivery started out at 4-5 wells/month, and in time Ops began to deliver 30 wells a month, or one well a day, 7 days a week.
Like all upstream companies, Finance owned the “authorisation for expenditure” or AFE process, which stipulated that all wells required Board approval. Aside from the fact that the Board only met infrequently, their process required at least a week per well of financial review, analysis and modelling. Wells continued to be treated as discreet financial projects, and took a week to set up in the ERP system. The finance function had not bought into the idea of being part of a manufacturing business – they were hired into an oil and gas company. They were unable, and in some cases, unwilling to change their whole process to speed up to match the Operations function. The initiative stalled.
The most impactful digital initiatives will involve the organisation, not just its components, and not merely inside the fence. Innovations that collect data directly from sensors in the field or on assets or from suppliers, treat that data through a fully automated process, that apply machine intelligence to assist with interpretation, that turn the data into incremental value through sharing, will drive outsized value. Leaders will need to recognise when organisation power structures block successful innovation.
Short term thinking
Maintaining funding for digital innovation across planning horizons takes organisational will. A digital innovation is unlikely to be the best marginal investment in oil and gas at all times of the economic cycle. Consider just the simple math of a producer of 100,000 barrels per day. Assume the price of oil moves from $45 to $50, or $5/bbl. That’s an addition $182m revenue in a year and no increase in cost. For most oil and gas companies, the smartest economic decision when prices are rising is to cut digital innovation and direct resources towards incremental production.
Effectively, the only time a digital investment would be the best marginal investment is when production costs are well above the recovered price (the net back is zero or negative), supplier costs have been slashed sufficiently to trigger bankruptcies, capital spend is just keeping the lights on, and the workforce has been trimmed to skeletal levels.
Oil and gas companies that have a history of short term thinking on innovation in general, and digital in particular, are unlikely to achieve much benefit with a pattern of investment followed by disinvestment. Talent will quickly figure out that their efforts are unlikely to be successful and will behave accordingly.
Getting over cyber worries
An organisation that embarks on a digital transformation journey increases its exposure to cyber issues. More digital devices means a greater attack surface for cyber activity. Concerns about cyber are now a common topic at the Board level, and reports of cyber events appear all too frequently in the media. It would not be good to be on the Board of a company that has experienced a serious cyber event – share prices usually tumble following cyber attacks, shareholders will ask hard questions, and regulators may intervene.
It is all too easy to slow walk, delay or cancel outright a digital transformation journey because of cyber concerns. Unfortunately, the introduction of vulnerable digital technologies into the sector is already well underway – many suppliers of technologies to the industry now offer full internet access for their devices as a standard feature.
Digital initiatives, regardless of size, scale and focus, must incorporate some risk analysis of cyber possibilities and incorporate appropriate remediation.