Cost reduction in the oil and gas industry is now top of the agenda as we face the consequences of the market downturn and a volatile oil price. That’s not surprising or unusual, but where can cuts be made and what affect will it have? Very rarely can we achieve a cost reduction that does not affect the functional requirements of the system. Generally, every cut generates a trade-off on performance or other aspects of the life of field economics.
Is reducing the amount of front end engineering a good cost reduction strategy?
Absolutely not. Front end engineering addresses the optimisation problem we face. It is not about cost reduction, it’s about value optimisation. The main objective of a field development project (FDP) conceptual study is to design an optimum facility that gathers hydrocarbons from the reservoir to process and transport them to be sold with the maximum economic gain for the owner. As projects have many stakeholders, in addition to the shareholders of the company, maximising economic return is not the only objective. Some of the key stakeholder groups could be environmental, community, contractors, employees, government, etc. Each group has special interest in the project and expects their own performance requirements to be met. The economic objectives of all parties must be defined at the outset of the study.
Value optimisation! But what is value?
A rigorous definition of value is absolutely necessary to provide an optimisation target. A robust tool is required to evaluate the myriad of economic trade-off in value optimisation. We need a mathematical definition of value that compares the compromises between capital expenditures and revenue, the initial investment and operating cost; while also considering cost of capital and risk.
Each oil company can have different drivers. Xodus Subsea’s value engineering optimises value in a holistic systemic approach. All the elements of the Net Present Value (NPV) equation are considered together, although not necessarily all of them can be quantified with mathematical rigour: eNPV(i) = Price*Prod-DRILLEX-CAPEX-OPEX-ABEX-RISK
The expected project Net Present Value (eNPV) captures the cost of capital and risk in the rate of return (i). The positive term of the equation focuses on the functional requirements: production profile and quality of the commodities sold. The capital investment in drilling and facilities are considered as an outflow during the project execution (DRILLEX, CAPEX). The operating cost (OPEX) through the life of the field and the abandonment cost (ABEX) also detract from the eNPV. Last but not least, cost savings can lead to unacceptable increases of risk. The optimisation of value can only be achieved in a holistic approach by looking at all the terms of this equation in a system-wide approach.
‘Systemic’ refers to something that is spread throughout, system-wide, affecting a group or system. ‘Holistic’ relates to a view of a system lifecycle that addresses all phases of its existence to include system conception, design and development, production and/or construction, distribution, operation, maintenance and support, retirement, phase-out and disposal. The optimisation of the value equation considers all elements of the FDP and all phases of its lifecycle. Value optimisation is not a trivial exercise that can be achieved by maximising cost reduction of the individual components and phases. Front end engineering creates value by exploring all the components of the value equation and finding an optimum combination that maximises the eNPV by implicitly reducing the cost per barrel produced. This is only feasible during the early stages of the project when all the options are still open.
Investing in front end engineering can generate several order of magnitude returns
Xodus Subsea systematically explores the value drivers of the project with the objective of maximising the economic value. It is important to recognise the mutually exclusive compromises that drive the economic value of the project. The process is full of difficult trade-offs. Each project has its own unique set of value enhancing strategies. The specific value drivers of the project will be identified together with the client subject matter experts during early stages of the study and can be revisited as the study progresses. Generally, value enhancing strategies should:
- Manage risk
- Improve cash flow
- Minimise capital expenditures
- Reduce operating cost
- Reduce abandonment cost.
Systems engineering requires a special mindset, or mental process, more akin to an architect than to an engineer. It requires synthesis more than analysis, involving a top down view of the system which goes further than an intimate analysis of its parts. The value equation also challenges our Cartesian training. It is not a deterministic equation, it is a stochastic problem riddled with risk and uncertainty.
Understanding and managing risk and uncertainty is very important to avoid value erosion
Reservoir and produced fluid uncertainties are probably the biggest risk to the project. In addition to the reservoir risk there are other important obstacles to minimise: human lives, environment, geopolitical, business, project execution, technical, operating, etc. Systems engineering is a multidisciplinary effort. A sound conceptual engineering process must deal with risk and a stochastic nature by considering multiple feasible scenarios and Monte Carlo simulations.
The positive term of the equation is the revenue stream, which equates to more production at a better price. This term can be achieved by optimising the production profile or the sale price of the commodities. Additional processing, at more capital cost, can improve quality of the product to achieve a better market price. Farther transportation to a better point of sale can also improve the revenue. Improvements of the production profile can also create value by increasing recoveries, improving the production rate and accelerating first production with good value enhancing strategies. In many projects the option to capture upside opportunities is a very good gamble.
Cost reduction, in the context of engineering, generally refers only to reducing capital expenditures. Achieving capital cost reduction without affecting the functional performance of a facility is indeed a good value enhancing strategy. Traditional value engineering seeks cost reduction while keeping the functionality intact. Good project management to keep cost and schedule as planned is a sound way to prevent value erosion. These are trivial conclusions!
Value optimisation strategies in the context of the eNPV equation are much more interesting. Reduction of the production capacity creating an extended plateau, can significantly reduce capital expenditures and create a great deal of value. Even the zero production/zero CAPEX solution can be a positive eNPV outcome. Sell the block with the reserves in place. Some typical cost reduction strategies are:
- Fit for purpose design
- Use of existing infrastructure
- Project management
- Competitive sourcing.
Systems engineering addresses those non-trivial cases where optimisation of the components does not lead to reduction of the cost of the whole facility. For example, selection of a cheaper hull can lead to very expensive riser configurations, more costly than the saving on the hull. Reduction of capital cost at the expense of operating cost, reliability or availability are also common mistakes of cost reduction focused engineering.
Cost reduction is not value creation. Short-sighted, analytical specialist engineering to reduce cost can lead to value erosion. Full understating of the value equation and its stochastic nature is necessary to optimise FDPs. Systems engineering with a systemic and holistic approach is required. Every effort in conceptual engineering can generate many orders of magnitude of value creation.