Is cost cutting the right response?

- Wednesday, December 10, 2014

OK so the price of oil has fallen dramatically since June. The factors around this are well documented now, lower than anticipated growth from China and India amongst others, OPEC’s unwillingness to turn the tap off and the shale gas revolution in North America.


For those of you that have been in the industry for a long time this is not particularly new. Oil is after all a commodity and the price goes up and down as structural factors and confidence change. Indeed some of the factors are not new, the demand outlook, the vagaries of OPEC and changes in the sources of supply. Yes shale gas has been a game changer in many ways but it is just another source of supply as is oil sands. Reading the press at the moment one can be forgiven for thinking that the price of oil has never fallen before.

We have been in a bull market for a number of years and, of course, it wasn’t always going to the case. But the reaction by many commentators and companies has been interesting.

I have seen a plethora of graphs recently and they are all heading south between now and some arbitrary point in time in the future. Topics covered include the price of oil, North Sea production, capital projects and headcount. The list goes on.

There is no doubt that industry cost base has crept up over the last few years and some correction was inevitable. In reality many of the operators were already onto this before the recent price falls and pressure on the supply base was increasing. Perhaps not to extent of Premier Foods in the UK where they have written to all suppliers asking for upfront cash payments. Refusal to pay will result in removal from the PSL! Nonetheless the pressure was on. Late and over budget projects was becoming the norm (it was ever thus I hear you say).

But is it right to slash costs at this point? It is what shareholders generally want but this highlights flaws in the publically listed corporate model. Many investors hold global oil company stock, as the dividend return is good. Many global oil companies now seem to be looking at deferring projects and cutting costs to maintain dividend levels in the context of falling revenues due to oil price changes. Headcount is often the first in line. Given Rust’s line of business we would say this is wrong but of course. I have heard complaints of film star wages being paid and this is a reason for reducing head count. It is true that pay rates have risen during the boom times but in many cases this has been driven by the fact that when we last had a fall in prices the industry stopped recruiting and training so now we have an acute shortage of certain disciplines with the right experience.

This brings me on to the question is cutting costs the right answer?

Running a cost efficient organization is fundamental to a success so being sensible with the cost base cannot be wrong. Slash and burn, however, cannot be right. This is especially true for staffing cuts done in a very public manner. It satisfies some members of the Board and Institutional Shareholders but the remaining workforce gets the wind up (to use a First World War expression), general morale falls, good people leave due to the public uncertainty created and key positions become very difficult to fill.
Perhaps the better question to ask is “Will we have the right cost base, projects in play and resources when the market picks up?” When the market does pick up, good people will be few and far between. They will be very selective about where they work and what package they expect. That sounds familiar doesn’t it!
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