Long before the predatory Saudi Arabian oil production attack and Covid-19 there were signs of trouble in the global oil industry. The five supermajors (BP, Chevron ExxonMobil, Shell, and Total) have been delivering disappointing financial and operating results for years. Collectively, these five shed hundreds of billions of dollars in market value from 2018 to 2020. Share prices for the five firms were lagging far behind the S&P 500 well before Covid-19 emerged. The pandemic has served as an accelerant – exposing some of the fundamental weaknesses of an industry that has gambled on status quo and poor strategy in the face of significant shifts in the environment.

The Icarus Paradox1 explains how successful organizations are often prone to failure. The paradox, stated simply, is that the strengths of successful companies can lead to excesses that cause their downfall. With success can come confidence, complacency, exaggeration, dogma, and ritual. Collectively, these attributes may sow the seeds of failure. One of the characteristics of organizations that fall into the Icarus trap is staying with the same core strategy when there is growing evidence that it is no longer working.

The fundamentals of the global oil industry have changed. The rapid development and maturation of unconventional oil development like that of the Permian has fundamentally altered the upside of future activities and profitability forever. Strategy and the capital allocation associated with the execution of corporate strategy are now critical. The margin for error and the days of overspending on mega-projects like Kashagan and Gorgon are long gone.

We contend that three areas, vertical integration, global reach, and an insular culture, that underpinned much of the industry’s historic success are sowing the seeds of decline, dragging down the firms and dimming the lights on their corporate futures.

Vertical Integration
Vertical integration continues to be a core strategy for the majors and national oil companies (NOCs) like Saudi Aramco, Kuwait Petroleum, and Sinopec. The oil majors have long argued that vertical integration results in two distinct benefits, business-line synergies and as a hedge against sector business cycles. The synergy argument relies on the efficiency gains of a combined overhead for upstream and downstream, and cost synergies arising from combined procurement and shared best practices. When asked about the value of integration on a recent quarterly earnings call, ExxonMobil CEO Darren Woods said there were two main benefits: synergies across the units such as a common project management organization and new upstream developments that could be linked with the refining and chemicals company.

Our research2 shows that arguments used to support vertical integration are not defensible. There are few real synergies across the upstream, downstream, and chemicals. The knowledge and skills necessary to succeed in each of these sectors differ dramatically. As the industry has migrated from market inefficiency and the lack of specialists to efficient markets and specialized players, there has been a reduction in the advantages to be gained from vertical integration. The majors have been left with huge integration cost structures without the attendant benefits.

The hedge argument, that a down sector will be offset by an up sector, is a myth. The five majors all have earnings which are predominantly driven by the upstream. When upstream earnings fluctuate, there is little evidence that downstream earnings offset them either in direction (upstream losses versus downstream profits) or magnitude because downstream earnings are always smaller in good times and bad. The best argument that can be made is that the two business sectors are unrelated and independent.

When an ex-CEO was asked recently by the authors if vertical integration really made business sense, ‘We are still to figure that out’ he replied. It is long past time to reconsider whether the benefits of vertical integration are really that huge to warrant the enormous costs it imposes.

Global organizational reach
Over time the supermajors have attempted to expand their organizations from a patchwork of regional developments to a global matrix of immense reach. In many ways, the industry became the poster child for globalization. This expansion came at great expense: the costs of co-ordinating global operations, the loss of regional business acumen; and the substitution of inflexible corporate standards and dogma that sapped strategic agility and resilience.

The oil and gas industry is not going to become less global, especially for the supermajors. At the same time, it requires a highly specialized set of inputs in the form of labor, technology, capital, and experience. Retreating behind country walls is clearly not realistic; rethinking the approach to geographic operations is. The challenges of tomorrow will center on a firm’s ability to leverage the benefits of global reach without the costs of global operations, while navigating the constant threat of nationalism. This calls for a rethinking of organizational structure and design. Regional/local structures and decision-making are more in tune with emerging reality.

Simultaneously, the relative emphasis that firms have historically placed on STEM disciplines versus other fields in hiring decisions need to be revisited. Engineers for example, can hardly be expected to help steer the firm through the attitudes toward risk-taking are endemic. The expectations of ‘making the numbers work’ permeates decision-making, often fostering questionable analyses in order to pass through more and more bureaucratic hurdles.

The confluence of Covid-19, climate change and the rising emphasis on renewable energy calls for new thinking about strategy and its consequences for the oil and gas industry. In an era of depressed oil and gas prices, every oil and gas company in the world is making efforts to cut operating costs. While managing costs is important for all organizations, firms cannot cut their way to success. Growth requires innovative and disruptive thinking outside the ‘we know it all’ mindset. Bold leaders are needed to break free from the pillars of past success that are so clearly constraining the future.

Icarus failed because he expected too much of the same wings that had been the instrument of his salvation. The global oil industry is in danger of the same.

1 Miller, D. 1992. The Icarus paradox, How exceptional companies bring about their own downfall. New York: Harper Collins.
2 Inkpen, AC & Ramaswamy, K. 2017. The oil and gas industry: Value chains and vertical integration. Advances in International Management 30: 55-80.

Kannan Ramaswamy is the William D. Hacker Chair Professor of Management in global business at Thunderbird School of Global Management. Andrew Inkpen is a professor of management and the J. Kenneth and Jeanette Seward Chair in Global Strategy at Thunderbird School of Global Management. Michael H. Moffett is an associate professor of finance and holds the Continental Grain Professorship in Finance at Thunderbird School of Global Management.Thunderbird School of Global Management is a unit of the Arizona State University Enterprise. For more than 70 years, Thunderbird has been the vanguard of global management and leadership education, creating inclusive and sustainable prosperity worldwide by educating future-ready global leaders capable of tackling the world’s greatest challenges.

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