1981. That was the last time cost inflation was this high. Cost inflation combined with a weak economy led to what some could argue was the worst recession since the Great Depression.
1981 was also the peak of the oil boom when oil prices were $31.77 per barrel. A period of prosperity for oil and gas when companies were “growing through the drill bit.” A time when cost inflation was an afterthought to the pursuit of acquiring acreage. Capital efficiency wasn’t as much of an imperative.
Then everything fell apart. Propelled at first by high-cost inflation, oil prices fell with demand sinking below daily production leading to the “1980s oil bust” — the downturn to benchmark all others.
Fast forward to today which sees cost inflation spiraling once more, this time propelled by supply chain disruption. The rising freight costs, pandemic, ongoing lockdowns in China and Russian sanctions means scarcity is routine and commodity prices are volatile. And the oil and gas industry is not spared.
This time around, there’s more fiscal prudence.
But how exactly has cost inflation impacted operators?
“Operators are not strangers to volatility and adversity, maintaining strong performance despite rising prices. Cost inflation and rising rates are two factors affecting investing decisions, but inflation doesn’t have as big an impact on FCF/EV yields, which remain above 10% despite 40% cost inflation,” said Andrew Gillick, managing director at Enverus Intelligence®| Research, in the Nov. 15, 2022, Morning Energy article.
As for 2023, in our “Finding the Valuation Floor: Cost-Inflation and Discount-Rate Scenarios” report published last November, Jonathan Goodwin, senior associate with Enverus Intelligence®| Research, shared, “We would agree with a 15-20% uplift in NAM D&C spending. Enverus’ current outlook only calls for a ~5% increase in total L48 completion activity in 2023 as compared to a ~20% increase in 2022; we expect well cost inflation to run ~12% E/E in 2023.”
And how are operators insulating their performance against rising inflation this time around? The short answer is technology.
- While we used to drive paper invoices, source-to-pay suites now make digital invoicing as simple as a click.
- Today we can track complex pricing that previously lived in forgotten draws in the most remote of locations.
Gregory Hill, COO of Hess, shared last October how they managed to cut the impact of inflation in half through lean manufacturing, strategic contracting and technology.
So here are three price management capabilities to look for in your next technology investment that will help you offset cost inflation.
Automate internal price management controls
No one person or department should have absolute control over decisions.
While the Sarbanes Oxley Act requires publicly listed businesses to establish internal controls, there are no similar requirements for private businesses.
Checks and balances are usually synonymous with good governance. With controls in place, you reduce errors, prevent improper use and ensure each person or team has clearly defined duties.
Permission workflows within your pricing or invoicing software help you achieve good governance. As you assign responsibilities to individuals or teams, you’ll help ensure accountability and add an extra layer of security.
Next time you shop for a solution make sure you can restrict permissions to selected roles or groups, or to admins only. But also make sure you can control access to workflow steps and limit visibility to relevant spend categories, so your team focuses on what’s most relevant and impactful.
Internal controls also promote operational efficiency. By setting price validation workflows on one platform, approval and processing are that much faster and three- and four-way matching is a breeze. You limit manual touchpoints in the process and shorten your invoice cycle from weeks to days.
Look for Conditional Auto-Approval and Auto-Reject features to allow you to automatically approve, validate or reject any invoice or pricing below or above a certain threshold.
Finally, internal controls help mitigate fluctuations in commodity prices so you can leverage hedging to protect yourself and maximize your bottom line.
When looking at price management software options, make sure you ask about a Lock-in Price for Inputs feature so you can limit how much suppliers can charge for certain materials and services.
Implement price compliance workflows
Ensuring prices are consistent and in compliance with contractual agreements and obligations is another way to offset cost inflation. Though, standardizing your pricing process is easier said than done, especially in oil and gas. Sophisticated processes, complex regulations and decentralized operations are some of the variables that make standardization cumbersome.
One way to overcome these variables is by having all your pricing and contractual obligations in one place to ensure pricing is applied with consistency and accuracy. Another way is to ensure you can monitor pricing activities within the same system you document pricing decisions, so you can spot pricing errors or violations early. This will also help you demonstrate ESG compliance, specifically the “G” for “governance.”
Price compliance workflows will help you run accurate compliance reports so you can find ways to detect patterns, discrepancies or suspicious activities.
And while you mitigate supply chain disruption through better visibility into compliance with general ledger reporting, in-line spend analytics will allow you and your team to examine line items referencing price books and agreements. With a more complete and detailed view of your procurement spend, you discover more cost-saving opportunities and increase your bottom line.
Adopt strategic contracting like Hess
In a recent McKinsey study, 60% of surveyed B2B companies cited active pricing management techniques as a means to increase profitability.
One pricing management technique is strategic contracting — the process of planning, negotiating and managing contracts with suppliers to achieve a long-term mutually beneficial relationship.
You’ll recall the COO of Hess mentioning strategic contracting as one of the reasons its team was so successful in minimizing the impact of cost inflation.
But are we surprised? Strategic contracting allows you to focus not only on the immediate transactions or cost savings, but also on the overall value and impact of contracted agreements on your organization’s goals and objectives.
For you to achieve strategic contracting, you need to adopt a structured approach that includes:
- Pricing and contractual obligation negotiation, so operators and service providers closely collaborate in one place for shorter turnaround time.
- Price management, so agreements are implemented and managed effectively, but also to monitor supplier performance.
- Escalation processes to address issues that arise and resolve disputes, ensure obligations are met and notify the responsible party and escalate to a higher authority if necessary.
If you want to make strategic contracting a reality, you will need features like Price Change Rules, Notification Alerts, Enhanced Supplier Collaboration, Agreement Generator and Line-Item Editor alongside the features mentioned above.
Price management software made for oil and gas
Despite all the innovation, operators still struggle to find the right price management solution. It’s certainly an option to manage pricing in your CRM or ERP, but often your team ends up spending countless hours manually importing or applying pricing. Simply put, today’s pricing management solutions are not designed to handle the scope and complexity of oil and gas pricing.
Enverus OpenContract PriceBook is. Our price management solution lets you track and compile all your pricing, agreements, and terms and conditions in one platform integrated to your invoicing, ticketing and ordering. This software, made for North American oil and gas, allows you to automate internal price management controls, implement price compliance workflows and adopt strategic contracting to mitigate cost inflation.
Interested in learning more about how your business could benefit from OpenContract PriceBook? Check out this on-demand webinar today to see it in action!
About Enverus Intelligence®| Research
Enverus Intelligence Research, Inc. is a subsidiary of Enverus and publishes energy-sector research that focuses on the oil and natural gas industries and broader energy topics including publicly traded and privately held oil, gas, midstream and other energy industry companies, basin studies (including characteristics, activity, infrastructure, etc.), commodity pricing forecasts, global macroeconomics and geopolitical matters. Enverus Intelligence Research, Inc. is registered with the U.S. Securities and Exchange Commission as a foreign investment adviser.