An unexpected surge in production coupled with weakened global demand has resulted in a 50 percent drop in the price of crude oil since June 2014 and currently averaging US$50 a barrel. The Organization of the Petroleum Exporting Countries (OPEC) announced it would leave market forces to determine crude oil price and would not cut oil output. The current oil price is the lowest it has been since Spring 2009. As oil and gas companies begin to feel the pressure of oil price volatility, efforts become focused on reducing capital and operating costs while maintaining, or improving operational services, particular technology services.
In parallel with this trend, the Middle East is one of the world’s fastest growing information technology markets with total technology spend predicted to have exceeded US$32 billion in 2014 and 10.71 percent of such spending attributed to the GCC oil and gas sector. Executives in the oil and gas sector recognise the need to invest in technology goods, software and services in order to maintain competiveness in global energy markets and to protect the critical infrastructure of their companies from cyber security threats. In the foreseeable future this recognition will be balanced against the need to manage or reduce costs associated with technology services.
So how can oil and gas companies achieve this? Here’s four approaches to consider:
1. Effective asset management: Does the company pay maintenance fees for “shelfware”, i.e. software or hardware that was bought in bulk but is not actually being used? Such fees rapidly erode any volume-based discount obtained for buying the software or hardware in the first place and over time can become a significant drain on technology budgets with no corresponding benefit to the company. In addition, the absence of centralised asset management capabilities within a company can sometimes result in the procurement of additional licenses to use software or additional hardware, notwithstanding existing stockpiles of unused software licenses or hardware in a separate part of the company. According to a Gartner research paper from 2013, introducing an effective asset management programme can help companies achieve savings of 30% in associated technology costs within one year. Part of an effective asset management program includes reviewing existing technology vendor agreements to understand the company’s ability to reuse or transfer software and hardware within the company, to return unused software or hardware and to terminate ongoing maintenance and support arrangements related to unused software and hardware.
2. Renegotiate existing vendor agreements: If a vendor agreement is coming up for renewal, or if the company is planning to procure additional goods or services from a vendor then the company should seek to renegotiate the commercial terms previously agreed with the vendor to share the risk caused by the volatility in oil prices. This may be achieved by agreeing on lower rate cards for personnel involved in the provision of services, discounted unit prices for software and hardware and a flexible pricing mechanism that allows the company to reduce its spend with the vendor as needed to reflect changing demand within the company for the vendor’s goods and services.
3. Outsourcing: Outsourcing of a company’s specific technology or business process functions is a proven way of reducing both capital and operating costs. By outsourcing, a company can transfer the need to make significant capital expenditure, such as large investments in technology infrastructure, to their vendor and enter into an arrangement whereby the vendor agrees to provide the outsourced function, like application management and support, back to the customer over an agreed period of time for a lower cost than the customer can itself provide the same function.
4. Cloud computing: The cost-efficiency benefits of cloud computing are widely acknowledged yet concerns relating to data security and integration have impeded large-scale deployment in the region. According to IDC only 30 percent of oil and gas companies operating in the Middle East and Africa have implemented a private cloud solution, and only 15 percent have adopted the public cloud. The cloud is not the solution for all of a company’s technology needs, but can present an effective solution for hosting volume-intensive public-facing components of a company’s technology environment, such as corporate websites and customers apps.
One, or a combination of these approaches, can form the basis of effective strategy for oil and gas companies to deal with the competing challenge of increasing technology performance while reducing technology cost. Execution of such a strategy not only requires collaboration and alignment across a company’s technology, procurement and finance functions, but also requires the involvement of a company’s internal or external lawyers to ensure that the company understands its ability to achieve cost savings in existing vendor agreements and capture
s agreed performance improvements and cost savings in new or renegotiated vendor agreements, as well as identifying and mitigating risks associated with the procurement of technology.
In addition, execution of any cost-reduction strategy should not sacrifice or dilute a company’s information security and governance mechanisms or increase the risk of the company being subject to a cyber-attack. Cybercrime is, unfortunately, a growing trend in the Middle East and globally and companies must continue to take measures to maintain and strengthen their defences against security vulnerabilities and ensure they have a plan in place to deal with the consequences of a security breach. See our previous blog post “5 Ways to Protect your Business from a Cyber Attack” for more information on this topic.
Latham & Watkins’ technology transactions and outsourcing team has advised on many of the world’s largest and most complex business process, IT and network outsourcing transactions and is ranked as one of the top technology and outsourcing legal practices in the world. Please contact us if you would like to receive further information or discuss this topic further.