Redefining Capital Investment: A Steady Hand in an Unsteady Time

Abstract

Over 57% of Oil & Gas mega-projects exceed original budget and delivery timeline and this figure grows to over 80% for mega-projects internationally. This is detrimental to capital investment returns, especially when posed against a backdrop of weak oil prices. Integrated Oil Companies (IOCs), National Oil Companies (NOCs), and investors looking to maintain or gain a strong position in the oil and gas market are silently struggling to properly assess and secure viable strategies for capital investments. Even in a world where oil price fluctuations can be mitigated, returns are relative to each company's evaluation of capital projects and execution strategies. Unfortunately, current capital project selection methodologies are unfit to account for such wide discrepancies in performance outcome. At the corporate level, each entity develops a framework for appraising and assessing the economic viability of its capital investment opportunities. Business cases and investment analyses employ variations of Net Present Value analysis (NPV) and Internal Rate of Return (IRR), modified to create company specific metrics that are meaningful for selection of capital projects. Yet, the prevalent overruns, in budgets and delivery timelines, translate directly into significant reduction of capital investment capability, and erode returns. These negative results are often not realized until the capital is irreversibly committed. Past sprints of high oil prices provided a forgivingly large margin of return that made profitability certain. Moreover, the long-term nature of oil projects obscures the impact of cost overruns. However, extended low oil price environments, such as the current state, expose critical gaps in existing capital management methodologies within project driven entities. A more rigorous investment study is required for future capital allocations to ensure profitability, and in some cases, solvency. In this paper, I present a conceptual framework for capital allocation management. This new framework, Advanced Risk and Capital Allocation Management (ARCAM), aims to synchronize risk, strategy, and capital decision modeling to ultimately give better visibility of future performance of capital investment opportunities. For the purpose of this paper, the investment decision makers are the IOCs, NOCs and oil service companies. I will begin by referencing challenges highlighted by executive management in earning calls of top oil corporations and jointly looking at performance data of mega-projects in recent years. After taking into account the impact of low oil price environment, we will explore how applications of ARCAM framework can be leveraged to better assess the financial viability of capital investments within the oil and gas sector.