Lagniappe

 

Oliver L Campbell:
Royal Dutch Shell aims to cut costs

Some years ago, when Shell was trying to reduce its London Head Office expenses, one of the areas for cost cutting was the restaurant for senior staff on the 23rd floor. The order was given that, among the choice of desserts, you could have pie with custard, ice-cream on its own, but not pie with ice-cream. This is fairly typical of accountants’ approach to cost cutting.

As a young man, I was taught “Look after the pence and the pounds will look after themselves.” Later on in life I learned quite the opposite was true, “Concentrate on what drives income and odd cost inefficiencies don’t really matter.” This is the Pareto Principle, which I have adhered to all my working life, expressed in another way. Though not exactly what Pareto stated, it has been translated for business as 20 percent of the cost items account for 80 percent of the total cost, or 20 percent of the income items account for 80 percent of total income.

So do IT costs fall into the 20 percent category of significant cost items? I very much doubt it. Outsourcing 3,200 IT jobs world-wide to specialist companies will only produce a material saving if the latter’s staff are significantly more efficient than Shell’s IT staff, or if their salary levels are substantially lower. India has a reputation for having good IT people but, if the Indian economy keeps growing as it is, the time is not far off when salaries there will jump up.

Other companies which have outsourced services have found it has several drawbacks. As an individual, talking to someone at a call centre in India about a problem with your washing machine in the UK is not always conducive to good customer relations! The same can happen where the customer is a Shell employee trying to sort out a problem with the IT company that provides the service from some other part of the world. Personal contact is lost as problems are discussed by email, conferencing and over the telephone. Seniority in Shell does not have the same clout with a third party, and it may be difficult to get priorities changed at short notice. Also, sensitive information will be in the hands of another company which makes industrial espionage that much easier.

Mr Jeroen van der Veer has stated operating costs have gone up 65 percent in two years but “operating costs” is a very wide term that includes large expenditure on exploration, production, refining, transportation, etc. The first thing is to identify which operating costs account for most of the increase--the 20 percent of the Pareto Principle. Many of these will be activity related--if you produce or refine more, you expect those costs to go up. It is where this correlation is missing that you need to concentrate.

To improve net income, many accountants’ knee-jerk reaction is to look for ways of reducing costs--eliminate pie à la mode. But the main drivers of the industry are oil and gas production. If every extra barrel can be sold for $90, then emphasis must be placed on producing more oil. Marketers will tell you the best way to improve the bottom line is through more sales rather than dubious cost cutting. That does not mean operating costs cannot be reduced but, under the present high-price scenario, the income side is more important.

Some of the proposed measures on remuneration packages for expatriate staff are sensible--pay more to those in dangerous or unpleasant postings, and less to those in agreeable and safe locations. The answer in Nigeria is to train local staff which are better equipped to deal with the problems of insecurity in production areas.

The total annual cost saving is estimated at $500 millions (£250 millions) before tax, but this is not a large figure if you consider a North Sea well can cost $20 millions.
The general public believe they are being ripped off at the pump when they see the high profits the oil companies are making. Shell staff know large profits are necessary to finance high capital expenditure. However, the magnitude of the profits and the return on shareholders’ capital--see below the jump from 2004 to 2006-- will hardly make Shell’s employees sympathetic to the call for staff reductions.

Net Income in Millions US$

	2006	2005	2004
ExxonMobil	39,500	36,130	25,330
Shell	26,311	26,261	19,257
BP	22,286	22,632	17,262

Percentage Return on Shareholders’ Equity

	2006	2005	2004
ExxonMobil	36.1	33.9	26.4
Shell	23.9	26.7	22.0
BP--not disclosed	N/D	N/D	N/D

In order to produce more oil, Shell needs to discover new oil provinces and increase its oil reserves. To increase the income from each barrel, Shell has to be an adroit refiner and a clever marketer. Traditionally, Shell has been poor at the first and good at the second. So rather than looking to pare costs, it should find and produce more oil and then create the largest added value it can by sophisticated refining and resourceful marketing.

During the 22 years I worked for Shell, I learned most of what I know about the oil industry. I thus have a soft spot for the Group and wish it every success. However, if the goal is to boost net income, I believe looking at ways to increase production and improve income is a better strategy than tinkering with measures to reduce overheads. Surely it is more profitable to sort out the problems in Nigeria and get production back on stream than to outsource some 3,200 jobs. With oil close to $100 a barrel, Shell needs to get its priorities right--income generation first and cost cutting second.

Oliver L Campbell, MBA, DipM, FCCA, ACMA, MCIM was born in El Callao in 1931 where his father worked in the gold mining industry. He spent the WWII years in
England, returning to Venezuela in 1953 to work with Shell de Venezuela (CSV), later as Finance Coordinator at Petroleos de Venezuela (PDVSA). In 1982 he returned to the UK with his family and retired early in 2002. Petroleumworld does not necessarily share these views.

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Petroleumworld News 01/09/08

Copyright© 2008 Oliver L Campbell. All rights reserved.

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