In the last decade, the development of local content – defined in the Energy industry as the share of local suppliers and service providers in project procurement expenditure – has been driven by International Oil Companies (IOC) and involved a passive government role. To date, this model has not managed to fully achieve globally competitive local capabilities or establish thriving industries in developing hydrocarbon-rich states. This is primarily due to the fact that IOC-led initiatives come with business and risk considerations and are limited by the boundaries of each company’s resources. In parallel, in recent years, there has been a significant rise in focus by National Oil Companies (NOC) on their procurement process as an effective tool for national economic sustainability. In line with this premise, Management consulting firmBooz & Companyhas assessed that, in order to unlock the long-term development promise of local content, NOCs must adopt a truly holistic vision.
A NEW ROLE
In recent years, myriad NOCs have begun to view their own capacity to build local content as a means to develop a globally competitive oil and gas supply base, as well as diversify the national economy and generate sustainable job creation. In light of this, they have become more assertive about reaching local content targets and strongly proactive in implementing strategies to strengthen the national oil and gas supply chain.
Local content champions
NOCs in countries such as Saudi Arabia, Kuwait, Kazakhstan, Nigeria, Indonesia, and Trinidad & Tobago are aiming to replicate the effective models established by Norway, the UK, Malaysia and Brazil. As a result, international contractors, suppliers, and oil field service providers alike are facing stringent conditions pertaining to local content in the form of new policies. Thoseimpose legally-mandated targets, minimum local ownership, and preferential treatment of local suppliers, modified bases for contract awards, advance payments to local suppliers, minimum training commitments and local content reporting requirements.
A two-sided market
“An effective introduction of spend-based local content regulations relies on terms for both the buyer and supplier,” explained George Sarraf, Partner with Booz & Company. “On one side,the buyer must be transparent on its long-term spend showinga sizeable and credible expenditure program as well as have competent human resources capable of managing increased supply chain complexity. On the supplier’s side, there must be a readiness on behalf of local businesses to invest in increased capacity, and an availability of skilled local human resources and financing. Both need to operate within a private sector-friendly policy framework and possess effective local content monitoring and enforcement capabilities.”
The new wave of local content regulations is also very susceptible to political pressures. “The successful development of the local supply base requires a comprehensive overview of national priorities, industrial competitiveness, government revenue growth, and foreign direct investments,” said Dr.Shihab El Borai, Senior Associate with Booz & Company. “If policymakers do not adopt a methodical strategy to local content development, procurement expenditures maylikely prop up inefficient industries instead of driving economic growth.”
Exposure to risk
In the oil sector, every large Exploration & Production (E&P) program incorporates significant risk factors due to uncontrollable factors such as technical sub-surface challenges or global project EPC market cycles. In the past decade, the increase in local content requirements within the Brazilian offshore industry highlights how such risks can be amplified – if an overly-aggressive plan is applied. “In recent years, companies in Brazil had ‘over-bid’ on local content commitments in order to secure access to resources,” said Dr. Raed Kombargi, Partner with Booz & Company. “By doing so, they introduced an inordinate amount of complexity and risk to an already challenging E&P program. Consequently, The Brazilian National Agency of Petroleum, Natural Gas and Biofuels (ANP) had to review the concession granting process for developing recently-discovered large offshore reserve and impose a maximum limit on local content commitments in addition to a minimum requirement.”
Similarly, local content initiatives in Kazakhstan, Malaysia and Nigeria have created internal tensions within organizations by introducing competing imperatives between project development and procurement functions. In order to manage such conflicts, a systematic and strategic approach to local content development must be adopted. This new strategy will include a gradual introduction of appropriate local content requirements as well as leverage existing capabilities and projects to effectively manage demand and scale. Also, it must proactively monitor the impact of local content in the midst of changing economic conditions.
A HOLISTIC STRATEGY
The past experiences of NOCs in markets ranging from Brazil and Indonesia to Kazakhstan, Malaysia and Nigeria suggest that a well-defined, holistic and effective method can help achieve the full economic potential of local content. Such a strategy must answer questions along two fundamental dimensions: the optimization of local content targets and the definition of strategic enablers.
Local content targets
The first dimension – the optimization of local content target setting – requires a quantitative analysis of planned project expenditure, and the assessment of domestic supplier capabilities to identify a reference baseline scenario for local content. Targets are then defined by cost category, aggregated and bottomed-up into long-term objectives, and then prioritized and sequenced to produce year-on-year results. “This particular analysis should take into account the impact on overall costs, schedule, investor profitability, government revenues, job creation and foreign direct investment – to quantify the trade-offs associated with local content policies,” said David Branson, Executive Advisor with Booz & Company. “Only after developing an integrated economic model can the NOC – in collaboration with government stakeholders and international partners – improve its local requirements, define reasonable ramp-up rates and curb costs.”
The second dimension – the definition of local content enablers – requires putting in place the prerequisites of an effective local content strategy in areas such as:
- Education and training: Multi-stakeholder partnerships between NOCs, international suppliers, local private companies and domestic institutions can help attune education to the requirements of the job market. A multi-stakeholder environment led and hosted by the NOC can close the feedback loop between industry and academia and expedite the development of skills that would allow locals to assume more value-added, analytical and decision-making roles in the Oil & Gas value chain.
- Technology transfer: Establishing innovative Research and Development centres capable of producing and commercializing intellectual capital has proven a challenge for most NOCs. Experience suggests that breaking into the technological development process is best achieved through sequential learning based on repeatable project designs, license arrangements for Original Equipment Manufacturers, and local/international joint ventures for ‘low-end’ technology components and services.
- Procurement process: Each stage of the procurement cycle presents opportunities to foster the development of local content. A first step would be determining the materials, technologies and contracts thatallow the use of local resources and create opportunities for local companies to participate, join forces and compete on a global scale. In the subsequent prequalification, contract awards, contracting and monitoring & compliance stages, NOCs should alsoencourage first tier contractors to develop the capabilities of lower-tier suppliers and sub-contractors.
- Private sector incentives framework: Local small and medium enterprises (SMEs) often have limited access to finance, infrastructure, and capabilities. To help them overcome such challenges, NOCs can either work with specialized government agencies that provide direct funding through specialized financing schemes or indirect support through advance/prompt payment policies and long-term visibility on planned expenditures. Infrastructure challenges, however, can be overcome by creating serviced zones or parks where local industries can benefit from this shared venture and other cluster effects.
Today, NOCs are well-positioned to play a leading role in spearheading the development of an internationally-competitive local industrial supply base within their respective countries. And while they are certainly not the only possible contributors – as key players such as large mining companies, national power and water utilities and infrastructure development also have the requirements to support a national ‘local content’ vision – NOCs do possess the most advanced institutional capabilities. However, in order to truly accelerate economic development and establish sustainable local industries, they must first embrace an all-encompassing approach that beginswith a well-defined local content strategy featuring reasonable targets, institutional and regulatory reforms, and new partnership models with international and local private companies.