By Geoffrey Cann
Managers in oil and gas rely on various rules of thumb to accelerate decision making, but at times these biases get in the way of making better decisions. Biases that were at one time helpful are now a kind of risk.
In 2017, I was invited by the International Energy Agency (IEA) to contribute to one of its major studies. They had been reading my weekly series on the impacts of digital innovations on oil and gas, and they felt I could make a contribution to their assessment of digital’s potential to improve the global energy industry.
At the workshop sessions hosted by the IEA, I was quite struck by a comment made by the head of the digital delegation from one of the global super majors. He said that unless the super major had clear line of sight to a billion dollar impact from a proposed digital innovation, they were highly likely to give it a hard pass.
That’s a pretty high hurdle. I suppose the logic was that any digital innovation needed to compete on equal terms with their other investment candidates, such as opening up some new off shore field, or building a new LNG plant, or debottlenecking a refinery. Even so, there are few innovations in digital that could possibly hit this target on a short runway.
This bias—applying borderline unachievable targets to candidate investments in digital technologies—served to keep the company from ever Investing in anything very innovative.
The IEA story parallels one I heard from an investor who was concerned that his portfolio analysis team was systematically avoiding investments in digital innovation in favour of more traditional opportunities. To test his hypothesis he constructed a pitch off for his analysts using MBA students from a local university. The students were instructed to pitch camouflaged versions of Facebook, X (Twitter at the time), AirBnB, and Uber, and a few other wildly successful digital plays. As expected, his analysts turned down every single investment opportunity.
I see these kinds of biases playing out regularly throughout the industry. Here are a few of the more common ones
The dominant bias in the industry is to favor volume above all else.
I totally get why production volume is the first priority for upstream companies. Reservoir decline curves force companies to replace production every year, ensuring that production proposals receive priority treatment. Reserves on the balance sheet create no value until they are converted into revenue via production, which also favors production proposals. Upstream engineers grow, both in wealth and professional capability, by managing increasingly larger budgets and more complex projects, often related to production.
It is the same in the midstream (pipelines, gas plants, refineries, LNG facilities). Midstream companies grow by putting shareholder capital to work in the form of infrastructure. It is the project managers and engineering teams that gain professionally by translating that cash capital into steel and cement.
This bias to absolute production volume crowds out investments that are not related to production. Digital ideas that might improve production or operational efficiency but fall short of replacing the natural decline curve loss in the short term will trail investments that do. In my experience there are few digital innovations that feature the dual impacts of improving productivity or lowering costs, and simultaneously converting a balance sheet asset to income.
And yet, after a dozen years, the market value of the top six digital companies is now US$12.6 trillion, an order of magnitude greater than a century-old oil and gas super major.
There’s an old joke about the mythical oil and gas Olympics—no one wants the gold medal and everyone competes vigourously for the silver. This bias surfaces in the requirement that any proposed digital innovation must already be deployed somewhere in the industry, ideally more than once.
This bias to the proven means that truly novel innovations that could ultimately confer an early mover advantage, create a scale effect, or lead to a permanent structural shift in the industry, rarely (never) get a look. Following the leader can work, but there first needs to be a leader.
Underlying this bias is the reliance by the industry on the waterfall method of change, where a change moves progressively through stages of increased elaboration and stage-gate stop-go decisions. Digital innovations follow an iterative development approach, and truly breakthrough gains may not become apparent until several iterations have been completed.
This bias is a flip on the ‘not in my back yard’ or NIMBY maxim. Instead, the industry has an overwhelming preference for those innovations that originate in the industry, or ‘only from my back yard’ (OFMBY). Good ideas from outside the industry are viewed with deep suspicion. An illustrative example is cloud computing, which has been in existence as a service for 15+ years, and is even used by many organizations whose information assets are highly sensitive (national security and banking). Despite this track record, 60% of oil companies only started to deploy cloud computing during the recent pandemic because they were forced to.
The bias to copy only innovations from others in oil and gas mean that good ideas from outside the industry are weakly considered, or more likely dismissed. But oil and gas is actually a composite of many industries—real estate, manufacturing, construction, supply chain, transportation—and innovations from those sectors do apply.
The industry’s natural bias towards secrecy and confidentiality works against digital innovation suppliers. Suppliers of innovation to the industry, particularly small technology companies, are often prevented from advertising their successes via such mechanisms as press announcements. In-house legal counsel, public relations or investor relations can block a business unit from making public statements about their success with a digital innovation.
I see this play out on my weekly podcast. The majority of the guests on the podcast are what I call innovation supply side, and very few are innovation demand side. This is certainly not intentional as the voice of the customer is of vital interest. Virtually all of the supply side guests tell me that they can’t convince their customers to appear on camera to say anything nice about the innovation.
This bias has several side effects. Innovators struggle to convince other companies to give them a try when the initial customer refuses to reveal their success. Venture and private investors won’t invest because they can’t see a positive market impact. Employees in the innovator company become discouraged when customers privately rave about their work, but refuse publicly to even acknowledge their existence.
I’ve worked in many industries (automotive, healthcare, consumer goods, retail), and the sense of urgency that informs the rhythm of competitive industries is lacking in energy. There is a built-in bias to slow and steady. After all, demand is largely inelastic. Pricing is set by the commodity market. The resource is secure and on the balance sheet. Competitors take years to build their assets and enter the market. Few big energy businesses have ever gone bankrupt because they took too long to do anything.
In contrast, this bias to dawdle is really destructive to digital innovators who are usually financed hand-to-mouth. Go-live is key because they rely on the monthly recurring revenue. Getting the next client is contingent on getting the first (see Go for The Silver above).
These biases are really hard to combat because they are rooted in mental models of how the world works, and are often based on logic that was at one time sound. It requires leaders to challenge decisions, maintain vigilance through multiple budget cycles, and sustain effort to change ways of working.
Here are six tactics that industry leaders deploy to counteract the natural biases in the industry.
Budget Approach
Set aside budget for innovations. Protect the budget from corporate raiders. Build some of the expected results from digital innovations into the committed financial forecast to make it painful to pull the financing. Invest in innovators.
Portfolio Inspection
Challenge the project portfolio to make sure that digital spend is not being systematically eliminated from the future.
Promotional Model
Ramp up your efforts to promote your digital suppliers publicly because your success working with them is ultimately dependent on their long term success in the broader market. Showcase their logos as partners on your website, issue frequent joint press releases, and appear on their publicity initiatives (such as my podcast!).
Decision Process
Simplify the digital innovation business case. Instead of demanding a detailed business analysis consistent with proposals normally requiring board approval (as is the case with capital spend for new production facilities), create a simplified application that is easy to complete. Allow for greater uncertainty in expected outcomes by accepting that the innovation will improve as it iterates.
Management Approvals
Thin the approval hierarchy for digital spend to as few levels as possible. Instead of multiple layers of management who have to approve a digital investment (and feel compelled to alter it slightly as a condition of acceptance), reduce to one or two only. In particular, eliminate the typical requirement that any innovation be backwards compatible with every prior technology investment.
Timeline
Shorten the approval timeline to increase the urgency. Instead of forcing all digital proposals to fit within the normal oil and gas annual budget cycle, allow for continuous consideration of good ideas.
When times are stable, biases are perhaps a convenient way to facilitate decisions and gain unanimity at the management table. However, the industry is facing far greater complexity than in the past, and such biases are now a risk to be managed.
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