Ford Motor Company
Ford Motor Company unveils its new electric F-150 Lightning outside of its headquarters in Dearborn, ... [+]
Oil and gas companies are—or should be—paying special attention to Ford’s announcement for two reasons. For one thing, the electrification of Ford’s best-selling line of vehicles means that millions of trucks on U.S. roads soon won’t rely on traditional fuels. Demand for hydrocarbons—which is already poised to decline as the energy transition gains momentum—may fall more quickly than previously anticipated. It’s not that Ford’s annual sales of 900,000 soon-to-be-electric vehicles will leave the energy industry awash in oil. It’s that the magnitude of Ford’s commitment is likely a canary in the oilfield. If a company like Ford is going all in on decarbonization, it’s not unreasonable to think that other companies that have traditionally relied on hydrocarbons will soon follow suit.
The second reason oil and gas companies are acknowledging Ford’s move is that the automaker is, in effect, providing a master class in reinvention. Energy companies would be wise to take notes.
Necessity is the mother of (re)invention
The 2020s is shaping up to be the make-or-break decade for the energy industry. The challenges posed by dwindling cash flows, stagnant investment returns, talent scarcity, investor apathy and regulatory pressures have been years in the making. So have consumers’ growing preferences for clean energy products and services. Technical advances in low-carbon technologies and the availability of low-carbon products like Ford’s electric vehicles have sparked a demand-driven transition that will only speed up.
In this environment, oil and gas companies have no choice but to reinvent themselves. That’s the only way they will achieve profitability and maintain their relevance during and after the energy transition.
Reinvention in the energy industry can take many forms. But I believe every successful reinvention strategy gets four things right. It embodies a new purpose. It sets aside long-range planning in favor of capabilities geared to predicting and responding to market volatility. It’s grounded in integrated (not siloed) value chain capabilities. And it enables a company to operate with greater agility and an optimal balance of risk and reward. That’s where optionality comes in.
A new approach to portfolio optimization
Historically, our energy system has been relatively homogenous; the world needed energy and most of that was supplied by hydrocarbons. Moving forward, as the world accelerates its push to decarbonization, the industry must shift to a more heterogeneous approach—one that takes different energy sources and the energy demand of different regions into consideration. It’s about providing more energy options for consumers. And more options through which oil and gas companies can meet consumer demands and generate healthy returns.
As a first step to creating this optionality, oil and gas companies need to understand market-by-market demand dynamics. Why? Because it’s only with that granular understanding that they can effectively adjust their asset portfolios to the most economical and lowest-emissions plays.
Gaining the necessary insights requires a new approach. Tools that supported traditional capital-allocation decisions and exploration strategies don’t work in an environment crowded with new sources of energy (i.e., solar, wind, geothermal and others) that have fundamentally different economic and environmental characteristics. Companies must now evaluate all energy system components and, most importantly, the potential profitability of each asset class in their portfolio. And they must be able to do so dynamically.
One way to evaluate an asset’s absolute value-creation potential is by focusing on profitability per joule unit of energy (USD/J) instead of cost per barrel. This new measure enables companies to incorporate factors beyond cost-effectiveness into the capital-allocation equation. These factors include customer preferences, the costs associated with extraction and processing, regional dynamics, and even the cleanliness of energy sources. At the same time, energy companies should assess the joules delivered per unit of capital (J/USD). Doing so will allow them to incorporate other measures (e.g., cost of capital, capital efficiency, development costs, and incentives for cleaner energy) in the capital-allocation process.
These two measures, when multiplied together, provide a tremendously valuable metric: the return on invested capital (ROIC) of a particular asset class. Another advantage of this approach is that energy companies can quickly see how their asset profitability might change if any of the influencing factors such as regional demand or cost of carbon or capital were to change. This creates a much more dynamic scenario-planning capability, with nearly limitless possibilities.
A new approach to capital allocation enables energy companies to ensure the most advantageous assets ... [+]
More than a formula
There are several reasons why I think these new measures will be critical in modeling energy portfolios going forward. They enable like-for-like comparisons of different asset classes and energy sources, which presents a snapshot of the level of optionality that is possible. They ensure a focus on capital returns, which is top of mind for investors. And they enable companies to incorporate fluctuating variables such as subsidies, taxes and product premiums into their value assessments—something that hasn’t been widely pursued to date.
But simply adopting a new asset-assessment approach will never be enough. While identifying an optimal portfolio mix is a major step forward, energy companies will need to be able to act on their capital-allocation insights to generate healthy returns over time. That’s what Ford has done. It has assessed its industry’s demand dynamics—and almost certainly its profit potential—and made the bold decision to rebalance its vehicle portfolio in favor of EVs. Equally important, the company is backing up its decision with operational and infrastructure investments (e.g., three new battery factories) to bolster the likelihood of its strategy’s success.
For oil and gas companies, decisions to rebalance asset portfolios must similarly be supported by operational changes, talent acquisitions and technological advances. Critically, energy companies will need to enable their strategic planners and operating teams to collaborate in new ways. This means equipping them with a powerful analytics platform that can correlate multiple variables in real time and provide the insights they need to optimize margins.
Such a platform, in turn, requires a robust data foundation that can access internal and external data, which otherwise would reside in functional silos. Companies will need to dismantle those silos so that critical data can be shared across the business—from operations to commercial to corporate. When they do, data not only becomes a company’s most strategic asset, but also further enhances the company’s agility.
In addition, long-range planning that included 10-year outlooks to drive capital investment decisions must become a casualty of the changing industry. Things change fast today and decisions, based on applied intelligence, need to be made quickly. The most successful companies of the future will be those that have the agility to reassess their plans several times a year, rather than once a decade.
Rebalancing for relevance
Many companies that are heavily reliant on hydrocarbons are now reinventing themselves to better serve their customers—and shareholders—during and after the energy transition. Ford, with its bold commitment to EVs, is just the latest example.
It’s time for oil and gas companies to heed these canaries in the oilfield and take actions to become more agile and more responsive to customer demands, regulatory pressures and industry volatility. And more appealing to investors and future workers. Adopting new capital-allocation approaches is one way for them to navigate the transition with greater confidence and, like Ford, emerge stronger and more competitive. Their future relevance and social license to operate may very well depend on it.
