New Rules for a New Game – Optimising Working Capital in Asia’s Oil and Gas Sector

Historic low oil prices are forcing oil and gas companies to overhaul their operations through various cost-reducing measures. Speakers at HSBC's working capital roundtable, shared that implementation of financial efficiencies can prevent losses and stimulate cost-competitiveness, and prepare for future growth.

David Andrada

Regional Sales Sector Head, Resources and Energy Group, HSBC Global Payments and Cash Management

Arguably, the biggest story in the global markets over the past two years has been the somewhat spectacular decline of oil prices. Indeed, in June 2014 Brent Crude was priced at around USD115 per barrel (bbl)[1] – 18 months later, it was lower than USD40 bbl[2].

The cause of the commodity's price drop has been attributed to numerous factors. First, the US's shale revolution, where domestic oil production has soared and imports from places like the Middle East have dramatically slowed; second, demand from China has also cooled, where the nation's transition from a fossil fuel-powered industrial-base to an economy driven by cleaner energy has seen demand for crude wane; and third, the Organization of the Petroleum Exporting Countries has maintained production levels in member countries like Saudi Arabia, Kuwait and United Arab Emirates, which has further contributed to oversupply worldwide.

The decline in oil's pricing has been further exacerbated by resource-rich markets selling the commodity to Asian customers for as low as USD25 bbl [3]. All of the above has made operating conditions highly problematic for oil and gas companies globally, irrespective of whether they operate in the upstream, midstream or downstream segments. "Anything that happens in one part of the value chain will have a profound impact on what happens in another," says Mark Elia, Director, Energy and Natural Resources, KPMG. "There are so many different interests that are interlocked, and at the core of this is working capital – the relationships between people, the arrangements between companies, and how all parties work together," he adds.

Restructuring and Refinancing

In a recent KPMG study, which examined the views of more than 160 CEOs from the energy sector globally[4], around 60 per cent of respondents said that they were planning either operational restructuring or financial restructuring, with more than one-fifth considering refinancing. Additionally, almost 25 per cent of respondents said they were considering a merger of equals, and more than half said they were eying an acquisition. While historically these activities have taken place among oil and gas companies, irrespective of the state of the market, today's appetite for such measures is notably greater than usual. This is in part due to the fact that few energy companies are able to breakeven at an oil price of less than USD60 bbl, according to research compiled by Wood Mackenzie[5].

Elia notes the measures various types of energy companies are taking in order to operate in today's low oil price scenario. For upstream companies, these include exiting marginal or low-return plays, company-wide cost-cutting, deferral of new projects, and divestment of current assets. For downstream players, these incorporate limiting exposure to low demand areas, optimising costs, and rationalising overheads. For midstream companies, these include a reassessment of trading strategies, and an increasing of storage capacity to house assets until prices rise. All of the above are being actioned against the backdrop of corporate overhead rationalisation, among other measures.

All is not bad, however, as today's low oil price environment is presenting downstream firms with the opportunity to purchase inexpensive feedstock. It is also enabling governments, like those of Indonesia and Malaysia, to curb fuel subsidies and reallocate these funds to developmental initiatives in areas like infrastructure. "The oil and gas industry has traditionally favoured growth over other financial strategies. Today, however, managing the efficiency of the balance sheet and optimising the supply chain are key enablers of industry competitiveness," Elia adds.

Efficiency and Optimisation

While certain cost-reducing measures can bring about stable growth, working capital optimisation arguably creates greater financial strength for businesses. According to Ng Poh Yee, Head of Sales, Global Trade and Receivables Finance, HSBC Singapore, optimising a firm's working capital is a continuous exercise, which ordinarily involves three components: process efficiencies; financial efficiencies; and supply chain management.

Ng advises that all working capital optimisation initiatives should include a transactional cost review. This is designed to better understand the parts of the business that are more capital intensive and, where possible, introduce efficiencies through use of tools like automation and outsourcing of trade documentation. Supported by a review of workflows and the streamlining of tasks, these measures make businesses more productive and hence more profitable.

In the case of improving days payable outstanding, oil and gas companies can turn to supplier financing solutions to manage liquidity and protect cash flow. Corporate treasuries are also now seeking to collaborate with other parts of the business, like procurement, to explore ways of optimising working capital.  According to David Andrada, Regional Sales Sector Head, Resources and Energy Group, HSBC Global Payments and Cash Management, and Winnie Wong, Vice President Commercial Payments Solutions, MasterCard, wider use of procurement cards is taking centre stage across many national and integrated oil companies in order to improve efficiency in the procure to pay process, and create value by monetising a company's payables. 

"Corporate cards, which traditionally have been used for employee's travel and entertainment, are now becoming a standard in the procurement space. This is already a popular practice in North America and Europe, and while Asia is a later adopter, demand is growing at a rapid pace," Andrada says.

For days sales outstanding, receivables financing solutions ensure businesses get paid earlier for goods or services rendered. They are also an effective risk management tool, and enable treasury to focus on cash generation and other high-value tasks.

"When businesses enter a market where the risks are high, receivables financing can aid their decision-making in the form of credit cover, so they don't overload their balance sheet unnecessarily. Relationships between all parties in a project is important and where possible all parties should leverage each other's balance sheet strengths to bolster the financial health of a project," Ng says.

Future Industry Expansion

HSBC explains that working capital solutions can be both ad hoc or programme based, and can be implemented on selective projects, countries or across an entire portfolio. With the current environment of the sector, there is a business case to explore creative methods that enable oil and gas companies to weather subdued market conditions and maximise profitability when more prosperous times return.

Indeed, the International Energy Agency (IEA) predicts the price of oil will return to USD80 bbl by 2020[6]. And in Asia, there are numerous large-scale gas power projects slated for completion by 2025, which present new opportunities, like those earmarked in Indonesia, for instance[7]. "Businesses that manage their working capital better can offer more competitive prices. And those that can offer better prices will be in a better position to win work. Those that can compete effectively in this space and manage the ecosystem of suppliers and partners will thrive. Everyone else will fall to the side," Elia concludes.

[1] http://www.bloomberg.com/quote/CO1:COM

[2] http://www.bloomberg.com/quote/CO1:COM

[3] http://www.bloomberg.com/news/articles/2015-12-14/never-mind-35-the-world-s-cheapest-oil-is-already-close-to-20

[4] https://assets.kpmg.com/content/dam/kpmg/pdf/2015/10/global-CEO-outlook-energy-perspective-v2.pdf

[5] http://www.woodmac.com/content/portal/energy/highlights/wk2_Jun_15/Wood%20Mackenzie%20Paris%20Briefing_June%202015.pdf

[6] http://www.iea.org/newsroomandevents/pressreleases/2015/november/low-prices-should-give-no-cause-for-complacency-on-energy-security-iea-says.html

[7] https://www.eia.gov/beta/international/analysis_includes/countries_long/Indonesia/indonesia.pdf

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