There is growing awareness throughout the industry of just how much value is being left on the table as a result of too little focus on working capital management.
The global oil and gas industry is experiencing rapid and dramatic change in its business environment.
The recent global downturn, a primary challenge for many other industries, is in this case only one of many issues exerting significant pressure on cash-flow, financing and operations.
The industry’s added complexities include:
- Smoothing the investment cycle through periods of price volatility
- Tackling higher exploration and development costs and risks
- Navigating an era of increasingly stringent regulations
- Evaluating the implications and opportunities from the emergence of alternative energy sources
And in spite of so many diverse and considerable challenges, the industry is still being called upon to produce significantly more product to satisfy expected surges in demand for energy and other oil-based products emanating from emerging markets.
There is growing awareness throughout the industry of just how much value is being left on the table as a result of too little focus on working capital management.
Why cash is being left on the table
Too often, various industry characteristics and conditions draw attention away from sound working capital management. Consider volatility and in particular, any interval of relatively higher oil and gas prices.
Under such circumstances, operating managers in exploration and production (E&P) have a strong incentive to get the oil flowing even if that means offering better terms to an oilfield services provider or other contractor.
Of course, when prices are falling, the argument could go in the other direction — seeing less demand and fewer customers, oil field services companies might be incentivized to provide all manner of concessions in pricing and terms. However, soft prices for oil didn’t last long.
Today, oil is actually trading at a relatively stable level. Consequently, any bad habits in working capital management that were initially corrected may now be returning.
Price volatility itself is another factor that tends to discourage the industry from active management of working capital.
A 5%, 10% or 15% improvement in working capital metrics can be overcome almost overnight by a major price swing. However, this does not provide a justification for poor working capital management practices.
Overall performance: 2009
It has been six years since the last detailed sounding of the oil and gas industry’s performance in working capital management.
The bad news: measured in terms of cash-to-cash (C2C), oil and gas companies displayed far higher levels of working capital in 2009 than in 2003. For the companies analyzed, C2C grew from 24.9 to 32.0 days (an increase of 7.1 days, or 29%) between 2003 and 2009.
But there is some good news, as this expansion of the industry-wide C2C cycle is driven by increases at just 20 of the 34 companies studied.
As for the other 14, their C2C cycles for 2009 remained relatively equivalent to 2003 levels. However, the difference between best performers (C2C down 8%) and laggard performers (C2C up 46%) is considerable. It is also worth mentioning that the analysis reveals no direct relationship between the size of the company and the level of C2C change.
Change in C2C and oil and natural gas prices, Q4, 2003–Q4, 2009
Source: Ernst & Young analysis, based on publicly available financial statements.
There is generally a direct relationship between changes in oil prices and changes in the industry’s C2C performance, the degree of which varies across its core segments. At the end of 2008, for example, when oil prices reached their lowest levels in more than four years, C2C returned to within just 8% of the level recorded at the end of 2003.
Nonetheless, there were also periods where the correlation waned. This is particularly true in cases where the changes in oil prices were large and swift, resulting in greater differences between the initial acquisition price of the fundamental commodity and the value of finished products.
Note also that in mid-2005, refining and chemicals production in the US Gulf Coast region was severely disrupted by hurricanes Katrina and Rita, resulting in diverging fluctuation patterns between sales and working capital through the year for the industry.
Trends in working capital
Demand for oil and gas products traditionally follows a seasonal trend, with a large drop allowing companies to shut down refineries for maintenance and to build inventories to meet peak consumption later. By comparison, most chemical makers are not significantly affected by seasonal factors.
However, with growth in demand for oil and gas increasingly coming from emerging countries, the International Energy Agency predicts that consumption patterns are gradually changing. As such, the industry can expect a number of additional refining and logistic challenges.
Overall C2C performance was also positively impacted, to a small degree, by changes in the industry sales mix. In particular, many in the oil and gas industry are disposing of their refining and marketing (R&M) and chemicals interests, sectors that typically carry higher working capital levels.
As more firms focus heavily on E&P, their relative working capital performance should begin to improve. However, companies should be careful not to use such passive gains as an excuse to put off more substantive steps to improve working capital management.
