The Virtual Oil Company
Authors: Garibaldi C.A. , Haney R.M. , Ross C.E. 
Published: December 2007

Original SPE manuscript received for review March 27, 1995. Paper peer approved June 12, 1995. Paper (SPE 30052) first presented at the 1995 SPE Hydrocarbon Economics and Evaluation Symposium held in Dallas, March 28-29. Journal of Petroleum Technology, September 1995.

Summary
In anticipation of continuing declines in upstream activity levels over the next 15 years, the virtual oil company model articulates a vision of fewer, leaner, but financially stronger firms that concentrate only on their core competencies and outsource the rest through well-structured partnering arrangements. Freed from the "clutter," these leading companies will be in better position to focus on those opportunities that offer the potential for renewed reserve and revenue growth.

Introduction
E&P firms are under unprecedented competitive pressure. Stock returns have been mediocre, the romance of oil price upside has vanished, investors challenge the value of integration, and environmental expenditures are rising rapidly owing to political pressure. As a result, survival, rather than equity appreciation, has become the primary concern of many E&P companies.
Dramatic change is under way. In a cost-cutting frenzy, most E&P firms are wrestling with change in one form or another, ranging from sporadic, isolated, or marginal efforts to all-out re-engineering. However, surveys show that many of these efforts have been disappointing so far or have produced unintended side effects. In a recent survey by Arthur D. Little Inc., oil company executives reported that while they have achieved most of their objectives in overhead reduction, they were less satisfied with results in the areas of employee satisfaction, profitability, and productivity improvement. At the same time, they thought that a clear vision of what the company is to look like once change efforts have taken place is crucial to successful implementation.
In this paper we argue that while many change initiatives are based on sound thinking, they are likely to fall short of expectations unless they are focused by a clear integrating vision of the end state of the change process.

Unprecedented Competitive Pressure
Stock Returns Have Been Mediocre. In recent years, oil company returns to stockholders have often been mediocre and not in line with the inherent risks. Figs. 1 through 4 compare annualized shareholder returns for 1990-94 for integrated major and mid-sized companies and for upstream and downstream pure plays. Major oil companies have returned close to the general market and a few pure upstream firms have outperformed it, but mid-sized integrated firms, pure downstream firms, and certain independent upstream firms have fared poorly during this period. Particularly these last three groups will be under pressure in the future.
The Price Romance in Holding Oil Stocks Has Vanished. Apart from the Gulf War price spike, oil prices have been nearly static since 1986, eliminating the upside price potential from the minds of many investors. Milder price swings, along with the development of a wide range of financial instruments to hedge their effects, have limited the industry's ability to rely on price spikes to bail out its weakening financial position.
The Value of Integration Is Being Challenged. Our research shows that smart institutional investors are pragmatic and demand proof of added value. These investors focus on the expected net present value of free cash flow for each investment opportunity and thus demand an explanation of how a company expects to grow free cash flow in the future. For example, investors want to know the areas of motivation and focus for narrow-scope companies and how integration and synergy will work in broad-scope firms.
With information technology on their side, many investors are choosing portfolio fragmentation over consolidation to pick winners and avoid losers. The ability to determine transfer prices at all links of the value chain (reserves, wellhead, raw feedstock, refinery gate rack, and street corner) enables participants to focus on a particular area of expertise. Investors can thus build their own portfolio of assets rather than depend on the asset mix of a particular firm. Fragmentation has also pushed accountability and responsibility to individual business units, and these groups focus on their own financial health.
Environmental Expenditures Are Rising. Political pressure is causing oil industry environmental expenditures to increase rapidly. One recent study notes that the refining industry alone may shoulder $25 billion in costs during the next 15 years. This additional burden will force firms to focus more efforts on reducing costs and developing efficiencies in their operations.

Everyone Is Trying Hard
Change Is Painful. Reacting to these unprecedented competitive pressures, E&P firms are more worried about survival than equity appreciation and acknowledge that improvement is mandatory to survive. Most of these firms are wrestling with change in one form or another, ranging from marginal incremental efforts to high-level re-engineering. In recent years, many firms have jumped from program to program, grasping at each new approach: total quality, re-engineering, downsizing, rightsizing, and empowered teams among others. Several large firms have announced or completed significant restructuring, with varying amounts of accompanying fanfare. Some have spun off units through public offerings, while others have replaced a few operating companies with many smaller business groups. This cost-cutting frenzy is intended to make these firms immune to even lower prices.
Satisfaction Is Not Guaranteed. These change initiatives have resulted in varying levels of satisfaction among companies and within each company. Both our own and third-party surveys show that many restructuring and other change initiatives to date have been disappointing or have produced unintended side effects, or both. In late 1993, we conducted a survey of approximately 350 executives in 14 industries, about 12% of whom represented oil companies. Oil companies agreed with other respondents that a clear vision was critically important for effective implementation of change (Fig. 5), but oil companies were more likely than average to encounter problems and unintended side effects and were less likely to have improved employee satisfaction or company profitability. Cited as the most important barrier to change was the lack of employee buy-in that change is necessary (Fig. 6).
In terms of intracompany results, the degrees of satisfaction are also varied. Upper management is often satisfied with efforts to reduce overhead costs and consequent increases in productivity. Fig. 7 shows that for a group of seven major companies, a head-count reduction of one-third since the early 1980's has not affected the level of activity, which often remained constant or increased. Commonly, profits have grown as a result of trimming the overhead fat, but such effects are only ephemeral. Growth must be genuine and sustainable. The resulting paradox is how to grow a company while it is shrinking. Line employees are also often satisfied with the changes. Many now work in empowered teams, have more exposure and responsibility, and perceive a reduction in bureaucracy.
Middle management and supervisors, however, are often very demoralized and, in many cases, have lost any sense of purpose and career security. They are frustrated because they haven't been shown where these restructurings will take the firm.