(John Kemp is a Reuters market analyst. The views expressed arehis own)
By John Kemp
LONDON, June 9 (Reuters) - Cost-cutting is set to remain themain focus for the oil industry for at least the next two yearsas petroleum producers adjust to an environment of much lowerprices.
If the boom was characterised by an emphasis on ambitiousand complex engineering and technology projects, the downturnhas brought a renewed focus on simplification and efficiency.
It marks a return to what was called "operationalexcellence" during the long years of low oil prices in the1990s.
Operational excellence is about more than just short-termexpenditure reduction.
But not even the free fruit for employees at BP's giant campus at Sunbury near London has been spared from thesearch for economies.
The fruit is a good symbol of the industry's approach tocost control: it was also axed during a previous cost-cuttingdrive in 2008 only to be restored when prices and revenuesboomed again.
But the current round of cost cuts and efficiency measuresseems set to go deeper and last longer than in 2008/09.
Unlike the previous downturn, which was associated with adrop in demand many considered temporary, the current drop inprices is the result of the supply side shale revolution thatmost expect to lower prices for at least several years.
CYCLE OF COST CONTROL
The cost of finding and developing new oil fields (coveringeverything from leases and seismic surveys to hire rates forrigs and pressure pumping equipment) has always been stronglycorrelated with oil prices.
In boom years, the race to develop new resources causes theindustry to lose control over the cost of everything fromroustabout wages and drill pipe to consumables like frackingsand and drilling mud.
When the bust arrives, surplus rigs are idled, field workersdismissed and field developers renegotiate the costs ofeverything with their contractors.
The industry has experienced busts before in the 1960s and1980s when the number of rigs drilling for oil and gas in theUnited States fell by more than 50 percent.
The current downturn is no different with developers andoperators looking to cut costs which had become inflated duringthe 2004-2014 boom.
"We all get a little lazy, a little flabby," the chieffinancial officer of drilling contractor Transocean admitted at a conference recently about the impact of years whenoil prices were above $110 per barrel.
"It's been painful, but (the downturn) allowed a lot offolks to extract efficiencies" said an executive from anotherservice company ("Energy companies grew lazy and flabby whileoil prices were high" June 4).
Drilling and completion costs have fallen by as much as20-30 percent since the start of 2015, the Dallas district wrotein its contribution to the Federal Reserve's Beige Book forJune.
The Fed's survey of regional economic conditions is mostlybased on anecdotal contacts so caution is advised before placingtoo much emphasis upon it.
But it is consistent with other reports that show developersand contractors cutting wages and prices to improve returns.
The industry is pursuing four major strategies for cuttingcosts.
First, reducing wage rates and contractor fees. Britain'sNorth Sea operators have imposed a 10 percent reduction incontractor rates across the board and are pressing offshoreworkers to move from a shift pattern of two weeks on/three weeksoff to three weeks on/three weeks off.
Second, cutting fees and hire rates to service companies.Saudi Aramco has demanded steep reductions of as much as 30percent in hire rates for drilling rigs and other oilfieldequipment.
Third, standardising operations as much as possible. Shell is centralising its procurement and logisticsoperations in Canada's oil sands region to boost efficiency andsqueeze economies of scale.
Finally, cancelling or postponing capital projects which areirreducibly complex, speculative and offer the highest risks andmost marginal returns to improve performance for the portfolioas a whole.
OPERATIONAL EXCELLENCE
"The recent collapse of oil prices from a peak of $147 hasonce again made operational excellence a central imperative forupstream oil and gas companies" management consultants forMcKinsey wrote in 2010.
"The fall of oil prices has exposed an inflated cost base inmany oil and gas companies, forcing them to reduce operatingcosts, rationalize investment budgets, and boost operationalefficiency."
The lesson is even more important now that prices areexpected to remain lower for some years.
"Previous industry cycles have shown that companies shoulduse a price drop as an opportunity to drive through fundamentalimprovements in the way their operations function," McKinseyconcluded ("This is the time to deliver on upstream operationalexcellence" Feb 2010).
The shale revolution is transforming the entire industrybecause of where it sits on the cost curve.
The mature shale plays of the United States are moreexpensive to develop and produce than the low-cost giantreservoirs of the Middle East.
But they compare favourably with higher cost resources suchas Canada's oil sands and Britain's North Sea fields.
And they are certainly cheaper and less risky than some ofthe mega-projects that have been proposed for areas like theArctic and ultra deepwater.
Compared with ultra deepwater projects and high pressurehigh temperature wells, the technology employed in the shalefields is relatively straightforward.
Shale is more like a mining or manufacturing process than atraditional oil exploration and development one and it rewardsthe same mindset and approach.
The focus is on process efficiency, standardisation and costminimisation, rather than complicated, bespoke, cutting edge andexpensive engineering.
As shale output has effectively become the marginal barrelin the oil market it is forcing other oil producers to rethinktheir approach.
Complex engineering, megaprojects and big oil still have aplace in the next few years, but only if they can become costcompetitive with simpler shale plays. (Editing by David Evans)
