Tuesday, October 31, 2006

Focus on Costs

Today's Washington Post and Wall St. Journal both covered the preliminary findings from the government committee investigating last year's explosion at BP's Texas City Refinery. The headline in the Post tells the entire story, "Cost-Cutting Led to Blast At BP Plant, Probe Finds." Or does it? Missing entirely from these articles, and from the Chemical Safety Board's press release, is the context of the sustained cost pressure under which BP and the entire oil industry has operated for many years. It is not surprising to read that BP had cut costs at Texas City by 25% after its acquisition of Amoco, the original owner of Texas City, but neither the media nor the CSB mentioned that those cuts were compounded on previous cuts made by Amoco as part of a general trend of intense industry competition going back to the 1980s, particularly within the historically unprofitable refining segment. Contrary to the public's perception of an industry flush with cash and profits, refineries have been on a starvation diet for decades.

Oil refining is an odd business. Here are these enormous facilities worth billions of dollars each, processing petroleum costing billions of dollars per year, and using vast amounts of fuel, chemicals and electricity in their operations, and yet manpower comprises one of the few truly "controllable" costs on which management can focus its attention. And in an industry in which margins rise and fall on factors beyond the control of the plant manager, the head of refining, or the CEO, keeping the cost structure lean is a critical success factor, a way to stay competitive in a product for which a few cents of cost per gallon make the difference between first-quartile and last-quartile performance. In the conditions that have prevailed since the price of oil collapsed in the mid-1980s, sustained poor financial performance at a refinery prompts increasingly severe responses, starting with management changes and escalating to either the sale or shutdown of the facility. The pressure on refinery bosses to manage costs is intense and personal.

This pressure to hold down staff and expenses isn't just driven by blind greed, starting with investors and equity analysts who believe the industry can and should operate more efficiently and deliver more of the margin to the shareholders. It can also result in genuine efficiencies that flow all the way to the gas pump, benefiting consumers. For example, years ago refineries reduced their permanent maintenance staffs to eliminate positions only needed during major facility maintenance, or "turnarounds." These workers moved onto the payrolls of contracting companies that the refiners hired to help with these tasks--outsourcing before anyone called it that. Everyone benefited, because a smaller aggregate number of workers could do all the major turnaround work for the industry in a region, with less idle time.

The CSB report cites a specific example of cost cutting in the elimination of 70% of the Texas City training staff. However, it's not clear from this statistic whether BP simply reduced training staff to cut costs, or if they changed the way they delivered training, requiring fewer trainers in the process. Training comes in many forms, including some that have been revolutionized by the internet. But in a highly technical industry in which the early retirement of the most experienced operating personnel--at 55 or even 50--has become the norm, good training is absolutely essential to transferring these skills to the next generation of workers. If inadequate training contributed to last year's fatal accident, as the CSB found, then this was a false economy.

Having spent many years in the downstream portion of the oil industry, I saw numerous cost reduction programs at all levels. Some were well-planned and executed, resulting in lower costs with minimal losses--or sometimes even gains--in effectiveness. Others were slash-and-burn operations clearly intended to reduce headcount and the associated cost. All of this was driven by an industry environment in which, whether prices were up or down, the emphasis was on "making your own margin," i.e. delivering results that did not rely on market factors beyond anyone's control. The trick is setting corporate guidelines that still allow good refinery managers to strike the right balance between efficiency and the urgent priority of keeping personnel and facilities safe. When your plant is on fire on CNN, no one will thank you for having saved a few bucks along the way.

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