Innovation is a hot topic in the oil and gas (O&G) industry these days. The favorable business conditions of the 90s have changed and the industry is falling behind similar industries such as defense, automotive etc. in generating revolutionary innovation ideas. Pressure on energy demand /supply dynamics, volatility of oil prices, increasing costs and the energy transition create significant uncertainty and the industry will need to evolve to be able to adapt to these tougher market conditions.
The O&G industry has in principle a long and successful history of innovation. Hydraulic fracturing in the U.S. is a great recent example of a game-changing innovation in the industry, whose success was based on a strong entrepreneurial culture, a deep knowledge base, and readily available capital. Which one of these critical elements are missing from the equation now?
The industry over the last few years has been passing through difficult times with increasing pressure on several fronts. The oil price’s volatility and downward trend over the last decade has been pressuring the revenues; increased complexity of the technological requirements of the industry and increasing environmental focus shifting demand towards low carbon solutions are critically pressuring costs of the O&G players. Shale technology, renewable energy sources, and pressure to reduce carbon emissions are increasingly changing the supply and demand dynamics. In order to survive, O&G players need to develop long-term transformational solutions.
While the industry’s need for innovation to address these critical issues is clear, O&G players are spending these days less on R&D. It is true that the size of the R&D budget is an important driver, but how these funds are managed within the organizations is also critical. A recent Monitor Deloitte study suggests that O&G executives are focusing on shorter term, incremental innovation ideas and only 3% of spend (instead of a needed 10% or more) seems to be focusing on long term, transformational innovation ideas. This is mainly because the approach to establishing an innovation portfolio is starting with mostly traditional ideas that can be managed within the existing structures and are funded by the business units; which limits the transformational effect of these ideas. Ideas are contained within the limits of the business units and create incremental impact on the business. Also, measurement of success is through traditional key performance indicators such as financial returns and not non-financial metrics such as risk-taking (or failure), which eventually creates a risk-averse approach.
An old, established industry like Oil and Gas needs more than just incremental innovation; it should invent ideas that go beyond the existing products, processes and customers.
A well-developed innovation ecosystem has 3 main dimensions: Configuration,Offering and Experience. Configuration is how organizations create value, Offering is the products and systems designed; Experience is how the offerings are delivered to the customers. The Monitor Deloitte study also found that while most O&G executives perceive Offering as the most critical dimension, Configuration drives longer-term, transformational innovation. At the heart of configuration lies how organizations collaborate to create value; which is an area that most organizations struggle with. A significant portion of the executives also acknowledges the organizational shortcomings to form successful and sustainable collaborations. It is not just about M&A among the existing players; different collaboration set-ups should be established. For instance, supply chain collaboration may require re-thinking the current operating model as it has to some extent remained unchanged for decades. As such, there may be many other ways for companies to collaborate, for example, through joint ventures, investing in startups, and working with non-governmental organizations and researchers.
Going forward O&G players will need to rethink how they manage innovation and create the favorable conditions for ideas to flourish. They need to enable agile organizations that support risk taking. Establishing separate innovation verticals with dedicated and protected fund structures can help increase faster decision making and flexible funding. Developing fewer and bolder ideas protected from the existing organizational structures increases organizational focus. Measuring success with new, non-financial metrics, such as number of failures, number of successful collaborations encourages risk taking (and failure, naturally). Dedicated innovation teams operating separately from the core business enables fewer hierarchical structures.
Challenging market conditions present risks but also bring opportunities to those who embrace and adapt. The O&G industry will survive in the short term but change is unavoidable to thrive in the long term.