Disruption: Preparing for the unknown
Disruptive innovation is changing the face of the oil and gas industry at a pace, and on a scale, that has not been seen since Colonel Drake first drilled for oil in Pennsylvania in 1859, according to A T Kearney’s Eduard Gracia and Sean Wheeler
Disruptive innovation is changing the face of the oil and gas industry at a pace, and on a scale, that has not been seen since Colonel Drake first drilled for oil in Pennsylvania in 1859, according to A T Kearney’s Eduard Gracia and Sean Wheeler.
During the last decade, innovation has dramatically changed the nature of both the supply and the demand forces shaping the oil and gas sector.
On the supply side, after more than a century – during which, every innovation in oil and gas would improve production at the expense of higher capital expenditures and longer lead times – shale technology has transformed the business into a faster-cycle one. Shale operators can rapidly scale production to market conditions while keeping costs per barrel low enough to compete even at low market prices. As a result, North America has regained its rank as a leading oil and gas producer, and is now posing the biggest challenge to OPEC since its inception.
On the demand side, the pressure to reduce carbon emissions is changing the energy value chain. Gas, as a clean fuel, is increasing its market share at the expense of oil and coal, substantially supported by the development of liquefied natural gas (LNG) shipping technologies. At the same time, cost-competitive renewable energy technologies, such as wind or solar, are rapidly expanding their footprint – albeit from a very low starting point – and are aiming to partially replace hydrocarbon-based power sources. Furthermore, electric cars, while remaining a small factor in today’s market, are also becoming increasingly competitive, and may threaten to dent the share of oil in the transportation sector in the long run.
All these technological developments translate into change and uncertainty, which means opportunities for those that adapt, as well as risks for those that do not. This is precisely the type of environment for which scenario planning was originally designed, as it enables oil and gas firms to better prepare future-proof strategies, maximising value generation.
Scenario planning is still a poorly understood tool, particularly when it comes to addressing disruptive and unpredictable opportunities and risks. All too often it is approached as an “anything goes” brainstorm, leading to an unmanageably large number of scenarios purportedly aiming to cover every single conceivable future development, but which add precious little insight.
Conversely, a good understanding of the mechanisms that drive innovation in the real world allows the most unlikely scenarios to be weeded out, making it possible to focus on a small set of plausible, consistent ones that provide real insight into the risks and opportunities that deserve to be addressed through a comprehensive strategic plan. Indeed, history teaches us that three key drivers underpin the process of innovation.
1. Time to develop
Invention may well start with a flash of inspiration, but its translation into applied innovation takes time and, particularly in long-cycle industries such as energy, this can be a long time indeed. A good example is shale. The roots of shale technology go back to US-government sponsored research on unconventional hydrocarbon sources back in the 1980s, followed by horizontal drilling techniques developed in the early 1990s. From this starting point, shale technology developed, first slowly and then at a more rapid pace, until, in the high oil-price years of the early 21st Century, it grew to become the game-changing force it is today.
2. Economic case
No innovation succeeds without a clear economic case, and the energy industry, with its huge risks and massive investment projects, is a perfect example. From the introduction of steam-powered drills in the 1870s, to the fast development of shale and ultra-deep water drilling technologies in the 2000s, oil and gas innovation has always picked up when the prevalent oil prices were at a high.
Sometimes, of course, the economic case is not purely market-driven but government-induced: for example, the rapid development of cost-competitive renewable energy sources in the last couple of decades has owed a lot to environmental regulation and subsidies, which have stimulated innovation in this area with remarkable success. Either way, bright ideas alone do not suffice to trigger the often large and risky investments that enable innovation in the energy sector: a strong economic case is a must.
3. Favourable environment
Last but not least, innovation can only flourish in a favourable environment. It is no coincidence that shale technology was first developed in the US, and ultra-deep water technology in the Gulf of Mexico. The reason has nothing to do with the relative abundance of such resources in North America; rather, it is spurred by favourable regulatory frameworks, the availability of venture capital sources, and a pervasive entrepreneurial spirit.
These three drivers are key to disruptive innovation and thus limit substantially the range of plausible future scenarios, particularly in an oil and gas context where long cycle times and large capital investments are the norm. Understanding them leads to planning against a small, manageable number of realistic scenarios, which is the key condition for scenario planning to be useful at all.