Partner and Associate Director
The upstream oil and gas (O&G) industry is in the midst of a value-creation crisis and has for the past decade delivered subpar shareholder returns. The demand collapse following the pandemic outbreak is both enhancing the urgency and acting as a catalyst for change. To survive, O&G companies1 Notes: 1 This article focuses on upstream O&G companies only. Whenever we refer to O&G companies in the text, we are referring to upstream O&G companies specifically. need to transform their legacy business to achieve a step change in performance. And they must innovate their business models to tap new value pools. Leveraging digital technologies is critical on both of these fronts.
To evaluate the industry’s current digital maturity, BCG recently conducted a Digital Acceleration Index (DAI) study of 46 O&G upstream operators, using a combination of online surveys and deep-dive interviews.2 Notes: 2 DAI is a BCG benchmarking tool that holistically evaluates digital maturity on the basis of a combination of online surveys and deep-dive interviews . As part our spring 2020 DAI survey of O&G companies, BCG asked managers and executives to assess their companies’ digital maturity against defined criteria on a scale from one to four in 38 categories. We also compared these results to the DAI surveys BCG has conducted in other industries. In 2020, BCG has assessed nearly 2,300 companies across geographies and industries with its DAI methodology. Given that most O&G companies are announcing capex cuts of 10% to 30% and opex cuts of 5% to 20%, the need to use digital to power fundamental transformation is greater than ever. The study generated three major insights: upstream O&G companies are struggling to deliver value from digital; digital maturity correlates with value delivery; and digital’s importance will grow during the crisis.
O&G Lags in Value Creation and Digital Maturity
While there is new urgency for transformation to improve performance, the industry has been delivering subpar value to investors for years. From 2010 to 2018 the O&G companies on Standard & Poor’s global 1200 list generated only 2% annualized total shareholder return (TSR), the lowest among the ten industries measured. And from January 2019 to February 2020, O&G TSR fell 9%, making it the only industry to actually destroy shareholder value. (See Exhibit 1).
O&G’s poor performance compared with other industries also shows up in the DAI results. As part of the survey we scored companies to place them in one of four categories:
The underperformance is somewhat surprising—particularly in that no O&G company is a digital leader—given that nine out of ten respondents said they have a digital vision for the company and two out of three said they have clearly defined digital ambitions. Moreover, many O&G companies said that digital is a key enabler of their business strategy. So where is the disconnect? Why the poor performance? Part of the explanation may be that only one in six O&G executives said that the digital strategy is fully understood throughout the company.
This lack of understanding clearly weakens the ability to move from strategy to execution. On five of the six DAI execution measures, the O&G industry trails all other industries that have been studied. (See Exhibit 2.) Less than 15% of O&G respondents said that digital has substantially contributed to value creation, 90% are not scaling their solutions across organizational and geographical silos successfully, and most are struggling to assign the right ownership for the adoption of new digital solutions. These frustrations are starting to show. As one executive put it, “Digital in upstream O&G has in the past delivered a lot of promises, but not a lot of value.”
The DAI survey sheds some light on the factors underpinning these execution issues. First, only one out of three companies has strong digital champions to lead the cultural change; this is a serious problem given that most large O&G companies are biased toward command-and-control cultures and tend to value predictability over agility. But agility is critical for digital success. Another important issue is digital talent: 80% report being dissatisfied with their ability to attract and retain digital talent. Finally, many feel that execution has been hampered by a piecemeal, incremental approach to digital improvements that doesn’t fundamentally rethink ways of working.
There are, of course, some pockets of excellence in the industry. For example, within the field of big data analytics, seismic interpretation has contributed to the development of supercomputing, and many O&G companies are quite sophisticated at leveraging digital technologies to monitor the state of equipment and, in some cases, predict failures. But most of these pockets of excellence are very specific within single disciplines. To unlock the full value potential from digital initiatives, companies must reinvent and optimize core workflows end to end. To do so they need to liberate data across silos using horizontal technology layers and deploy multidisciplinary operating models that can make fast, effective decisions. Tellingly, less than 10% of the companies in our study have leveraged data in this way.
Digital Maturity Links to Value Creation
Our second major finding from the DAI survey was a strong correlation between digital maturity and value creation, as measured by TSR, portfolio break-even price, and free cash flow. (See Exhibit 3.) Of course, correlation is not the same as causality. However, we have observed these correlations consistently across industries. Moreover, business leaders and investors consistently credit digital as an important source of value creation.
When analyzing TSR from February 2017 to February 2020, we see that the upstream O&G companies with the highest DAI scores (digital performers) average six percentage point higher TSR than those in the lowest scoring category (digital starters). Given that the average TSR in the industry over the past decade has typically been only a few percentage points positive or negative, a swing of six percentage points could very well make the difference between creating and destroying shareholder value.
There’s also a correlation between digitizing the core and a lower break-even price. While many factors determine the break-even price, the correlation with digital suggests that digitally mature companies can positively affect the break-even price by increasing production, reducing capex, and/or reducing opex. Finally, evidence also suggests that companies advanced in adopting new ways of working—such as agile and multidisciplinary teams—have higher free cash flow.
Pandemic Intensifies the Need to Modernize
The third major finding of the DAI survey is that digital’s importance will grow during the pandemic. This finding was reinforced by the soon-to-be-published results of another BCG survey of the energy industry in which 83% of respondents said the crisis makes digital transformation more urgent. Some of the common reasons that executives in the DAI survey cited for the increased importance:
What remains to be seen is how the industry will balance the need for digital transformation with tight budget realities. While 53% of respondents in the other BCG survey predicted that digital funding will increase, nearly all said digital spending will come under greater scrutiny. One big reason that digital investment may win over investment in legacy hardware technology is that payback times are often measured in months instead of years. Digital technologies such as robotics, machine learning, and big data analytics have proven this to be the case across other industries.
Transform for a Bionic Future
Peering beyond the current crisis, what does the “target” digital state look like for O&G companies? We believe it is about an end-to-end reimagining of the core upstream workflows in order to remove frictions. To maximize value creation, this implies augmenting human talent with digital technology in a seamless manner. It will also require upskilling the workforce to master the new digital tools. BCG uses the term “bionic” to characterize companies that achieve this state. We strongly believe that there is huge upside potential for those that get it right. (See Exhibit 4.)
Achieving this target state is no easy task. But O&G companies can begin to set more specific objectives and timelines by defining the bionic implications across four dimensions:
Take the Reins
Value creation depends on digital transformation, particularly in light of the COVID-19 pandemic. Companies need to transform their legacy businesses to drive efficiency, and to innovate new business models in order to tap new value pools. Most of the ingredients to do so are well known, but the formula for putting them all together is neither immediately evident nor easy to implement. In other words, the real challenge lies more in the “How” than in the “Why” and the “What.” In the end, success at scale comes much more from replicating the right approach than from replicating a series of digital products.
To succeed, O&G executives must take the reins, make transformation a priority, and focus digital initiatives on the biggest sources of value. It is much more powerful to define a handful of truly transformative initiatives that the business fully supports than to release a swarm of “mosquito” initiatives that do not move the needle and risk stealing management’s attention from what really matters. Bear in mind that the bulk of the effort and value lies in fundamentally changing the way people work—and how they interact with data and technology. Bringing humans and technology together in this way is the essence of a bionic company.
The authors are grateful to their BCG colleagues Michael Leyh, Prashant Mehrotra, Wilhelm Thorne, and Theodor Borsche for their contributions to this article.