Managing Contractors in the Oil Industry – Part 1

One of the main tasks in my current position is to manage contractors, i.e. companies to whom we are outsourcing work, on behalf of my employer, a major oil company.  In fact, this is pretty much the main role for a lot of people working for major oil companies, as they are set up more to manage works than execute them.  Almost everything is outsourced, and so the management of contractors is essential to the operation of any department in an oil company.  But somewhat surprisingly, this is an area in which oil company employees are often very weak, and you’ll be hard pushed to find any formal training which contain what I consider to be the fundamentals of managing contractors.

One of the reasons for this is that oil companies like to recruit people fresh from university, blank canvasses ready and willing to be turned into a production-line automaton in the service of the Company.  Most managers (I would say well over half) in a major oil company have been recruited straight from university, and hence have never worked for any other company.  In my case, since university, I have worked for a telecoms giant which collapsed within 6 months of my joining (not my fault!); a third-rate American risk and engineering consultancy which stayed in business largely because its parent company reaped the financial rewards of protectionist policies back home; a rough and ready scaffolding and insulation company whose coarseness did not prevent them from being able to do a pretty damned good job when it came down to it; an independent oil and gas operating company, albeit managed by a supermajor, which was a hoot to work for; a reasonable brownfield engineering firm whose Sakhalin operations were thankfully not typical of the company as a whole; and now a major oil company.  With the exception of a major EPC contractor like Fluor or Foster-Wheeler and specialist vendors, I have covered pretty much the whole contracting food chain in the oil and gas business, albeit only for short periods in each one.

It’s drawing on this wide, albeit shallow, experience that enables me to do my job and bring to you a multi-part guide on how to manage contractors if you find yourself working for a major oil company.  Additional parts will be added from time to time.

Part 1 – Understand how to negotiate.

Firstly, learn what your contractor does and how he makes money.  Understand that contractors make money by employing human capital to directly produce something, which is then sold.  Contrast this with the fact that oil companies make money by opening a tap and flogging what comes out the end.  Understand that whereas the profits of an oil company are wholly unrelated to the utilisation of human capital, for contractors the two are almost always one and the same.  So whilst you in your comfy oil company seat do not feel the wasted costs of ten blokes sat around doing nothing, or do not see the costs of bringing an additional five bodies onto the job, a contractor will live and breathe this concept from day one.  If you want him to do extra work, he will need more money.  If you want him to do something different, he will need more money.  If you want him to take on commercial, contractual, or technological risk, he will need more money.  Finally, if you want him to do some work then you must pay him.  There is no such thing as a free lunch.

One of the most annoying habits of oil companies (and some EPC contractors) is to immediately ask for a 10% discount on commercial figures submitted in response to a call for tender.  This is pathetic, yet is sadly all too common.  Somebody in the contracts and procurement department thinks he is saving the company 10% on costs expended, without having to put any effort in himself.  Good, yes?  Well, no.  If a contractor is going to reduce his costs across all items by some arbitrary amount, then he is going to reduce his effort expended on that job by that same amount.  Oh, he’ll not tell you that he’s skipping NDT inspections, using second-hand parts, or not bothering with functional tests to get his costs down by 10%, but that’s what he’ll do.  So what part of the job does the client want removed?  The smart-arse in contracts and procurement doesn’t know, as he thinks the contractor will take the hit out of his profits.  The contractor isn’t going to tell you which corner he’s cut, so it’s up to the client to find out when the equipment or design fails in mid-operation costing several million dollars in lost production.  In order to save 10% on a $50,000 job.

You need to understand that buying engineering or oilfield services is different from buying soya beans in a Lagos market.  If somebody offers you a kilo of beans for 1,000 Naira in Lekki market, then it is fair enough to haggle down the price of those beans as you’re still going to be getting a kilo of them.  But if you get offered a kilo of new potatoes in a Tesco in Manchester for £1, and you refuse to pay more than 50p, then you’ll be going home with half a kilo by the time the deal is wrapped up whether you realise it or not.  Buying oilfield services has far more in common with a British Tesco than a Nigerian farmers’ market, but surprisingly few people in the industry understand this.  Part of the problem is culture and egos (or both, to the extent that the former often drives the latter). There are some cultures in this world that forbid anyone with any self respect from accepting the first price he is offered.  Like the comical scene in Monty Python’s Life of Brian, “you have to haggle”.  But there’s a big difference between haggling and negotiating a price.  Haggling is arguing about the price assuming the product stays the same.  Negotiating a price is the process by which you arrive at a product and price acceptable to both parties.  The problem with haggling is the person on the receiving end often finds out that what he’s bought isn’t what he thought it was.

The added value a decent manager can bring to an oil company is the ability to break down a contractor’s price, identify which items or services being offered were requested or are desirable, and ascertain whether the price being charged for each is reasonable given prevailing market conditions.  But first, he needs to look at where the actual costs lie.  If you are looking at a total price of $100k and $60k is in personnel hire, $38k is in equipment hire, and $2k is in consumables, there is no point arguing for a week over the consumables.  You’d be amazed at how many people don’t understand this, or allow their egos to get the better of them and attempt to argue about everything.

The skill of a manager is in being able to identify the major costs items and ask the right questions – without prejudice.  Perhaps the $130 per day you’re being asked to pay for hire of a compressor is a fair price?  But without a comparator, how do you know?  Well, you can ask – or find out online – what the capital cost of the compressor (or other piece of equipment) is.  From there you can work out how quickly it will have been paid for at the proposed hire rate.  Then  you take a guess at the lifespan of the item and judge whether the payback period is reasonable.  If you’re hiring a compressor which costs $10k to buy and typically lasts 2 years under site conditions with some maintenance, then charging it out at $1k per day is taking the piss somewhat.  Charging it out at $30 per day will have it paid for in about a year, which is more reasonable.  I had a client grill me on this very issue with regard to vehicle hire in Sakhalin once, and I learned from it.  He had bought identical vehicles a short time previously and (quite rightly) objected to me trying to get them paid for in under a year.  I reduced my prices sharpish.

The point is, don’t automatically assume you’re being ripped off when presented with a high price.  If you’re going to challenge it, you must have a basis for doing so.  Moaning that “this is very expensive” without being able to say why is not going to get the price down any.  Personnel costs are a bit harder to judge, and chances are you won’t be in a position to challenge the rate much.  So you challenge the man-hours or man-days instead.  Find somebody to give you a rough idea how long the job should take, if you can’t figure it out for yourself.

If you think what you’re being charged is fair but the price is still too high, then you need to look at the scope of work.  Is there anything which can be removed?  Did some dickhead in HSE bolt on ill-defined “training” at some stage of the scope development which is now a major cost item?  Is your contractor really the best person to be updating Company documentation on this project?  Is that new deluge system really required?  This is the time to get rid of the expensive “nice-to-haves” and concentrate on what is essential.  But if the “nice-to-haves” comprise only a fraction of the overall cost, by all means leave them in.

Finally, you need to remember that you’re only looking to avoid getting ripped off here, not to get the bargain of the century and impress the bosses with your supposed business acumen.  (If you think you’re getting a bargain in the oil and gas business, come and see me when the job gets delivered and we’ll talk then.)  So if somebody is proposing 20 days to do a job and you think it should be 10, get it down to 10 or 12.  But if you think it should be 18 or 19, then leave it at 20.  The small stuff doesn’t matter, and if you’re a manager, you cannot get bogged down in such details.  Get the price approximately right, and don’t worry if the contractor is making a little bit more than the absolute minimum.  Provided he’s not taking the piss and ordering his Sunseeker when walking out of your office, you’ll have done your job.


7 thoughts on “Managing Contractors in the Oil Industry – Part 1

  1. “Get the price approximately right, and don’t worry if the contractor is making a little bit more than the absolute minimum. ”

    Absolutely precisely spot on. The bigger question is “what is the overall project worth to me and how much is it worth to me to get it done better, quicker and with much more goodwill downstream because people are generally happy that they’re not being screwed over?”

    The answer: “much much much more than the potential savings on offer”.

    I always try to get past the bloody sucking salesman to talk to the guy who actually knows how the thing is going to get delivered. Get him on side and you’ve got a chance. Let the salesman do the talking and you’re probably toast.

  2. Oh and if your contractor sees your approach and then still takes the piss, you know you’ve got a bad ‘un that should never get any work from you ever again.

  3. Bargaining on price is something that happens when there is asymmetric information between the buyer and seller: the seller knows what a fair price is but the buyer doesn’t. Even then, if the seller has a reasonable expectation of repeat business, a decent seller will not take the piss because he knows the buyer will find out later what a fair price is and he won’t get that repeat business. (A little bit of bargaining may still go on if these conditions are satisfied for the buyer and seller to discover how price sensitive the other is, but it will be much quicker and politer).

    (Try going into a tourist market knowing what an exact fair price is for something on sale, offering that price, and then turning around and walking away. If the price is indeed fair, the seller will rapidly agree to it. In the event that both sides have information, bargaining is completely optional).

    If you are setting the price for work that has not yet been done, then you probably want the contractor to be making a bit more than the absolute minimum. Workers who are being properly paid for the work that they are doing and feel appreciated do a better job. I am sure that is even true in Nigeria, or possibly particularly true in Nigeria.

  4. Pingback: White Sun of the Desert » Managing Contractors in the Oil Industry – Part 2

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