Understanding Operating Costs In the Energy Industry

The energy industry plays a vital role in industrial growth and the economy at large. This sector involves oil and gas drilling, exploration of oil reserves, and refinement of those naturally occurring chemicals. Renewable energy, coal, and other power utility companies are also part and parcel of this ever-growing industry.

Like any other business, companies in this industry have to incur upfront expenses before they can start generating profits. These operating costs, however, vary depending on the goals of the organization, the size of the company, and other economic factors. As such, there isn’t really a specific average value that cuts across the board. Keep reading to learn more about this rather complex matter.

What Is Operational Cost?

Operational costs may be defined as the revenue required for the administration of a business and carrying out daily maintenance procedures. Also known as operational expenditure (OPEX), these expenses are a combination of many components, one of which is the cost of goods sold or COGS. This is basically the cost of producing any goods or services offered by a company.

Other factors include labor costs, sales commissions, depreciation, maintenance, insurance benefits, and any other expenses that keep the business running. The profits generated per dollar of sales after deducting all those expenses are measured using the company’s operating margin. This is basically done by dividing the operating income by the total net sales.

A higher ratio shows that the firm’s operations are streamlined and the strategy of turning sales into profits is working efficiently. One way of ensuring higher profits is reducing the aforementioned operating costs, and that can be done by securing easy working capital loans or getting rid of those tasks that don’t add value to the business.

Operational Costs In The Energy Industry

Now that you understand what the phrase means, how does this apply to the energy sector? Before going any further, it’s worth noting that the energy industry is made up of many companies with different goals and business paths. Some are there to drill oil or gas, others are only looking for reserves, while others are generating and supplying power. Therefore, as earlier mentioned, there’s no average value because the operational costs of these organizations vary widely.

The companies involved in the production of gas and oil, for instance, boast the biggest profit margins of about 14.97%. This can be attributed partly to their operating expense margin of about 12.3%, which is the lowest in the industry. One thing that works to the advantage of these organizations is the fact that they can manage their fixed costs like selling, general, and administrative expenses.

Those who’ve ventured into the power generation and renewables sector will tell you the margins are among the lowest in the whole industry. Large amounts of power can be generated from wind and solar with very low upfront costs. However, due to stiff competition, no one has been able to generate massive profits. The U.S., Denmark, Germany, and China are among the big players in this area, but none of them has since asserted its authority in the sector.

How Energy Companies Are Reducing Operating Costs

As mentioned in previous sections, one of the best ways of ensuring that a company generates more profits is by reducing its operating costs. But how can this be achieved? 

Reducing Personnel

The most obvious route taken by most companies today when trying to reduce operating costs is the reduction of personnel. This shift of workforce in the energy industry has been inspired by the transformation brought by artificial intelligence (AI) and automation. Like many other sectors, the COVID-19 pandemic pushed most players in the oil and gas industry to the limits.

So inasmuch as technological advancement has been around for quite a while now, most business owners started embracing it after feeling the pinch a few months ago. Take Shell, for example; the oil and gas giant has turned to AI for predictive maintenance in a bid to reduce their total operating costs. This has allowed the company to reduce the number of its employees by a significant margin, which is one way of increasing profits.

Taking The TOTEX Approach

Another option considered by many companies in the energy industry today is the total expenditure (TOTEX) approach. Historically, companies have always preferred to take capital expenditure (CAPEX) and OPEX as two separate buckets. In fact, the team that takes care of the launch phase is completely different from the one given operational responsibility.

As such, there is a huge gap created between the two phases, which could lead to substantial economic issues. How is that? Well, take an electrical power plant, for instance. The contractors responsible for designing the power plant are only concerned about their specific domains. Rarely do they focus much of their attention on the operation and maintenance of the machines within the plant. For instance, the location of equipment within the plant might pose challenges to the maintenance team, which, in turn, could increase operational costs.

So how does the TOTEX approach solve this issue? Here, the whole life cycle of the plant is considered at the planning phase. As such, the total expenditure over the long-term operation of the plant is computed early enough. This approach has become popular in recent months following the impact of the COVID-19 pandemic.

Conclusion

The energy industry is one of those that were greatly affected by the coronavirus pandemic. Lockdown rules implemented in many countries worldwide led to a significant drop in oil and gas demands. As such, many business owners in the sector have developed various strategies to reduce operational costs and ensure that they continue generating enough profits to sustain their companies.

One of the main actions taken is the reduction of personnel and replacing them with tech-based solutions. Shell is among the oil and gas giants that have considered automation and artificial intelligence. The total expenditure approach has also become quite popular among these companies as they try to get rid of traditional operation policies and adopt new techniques.