Introduction
Effective strategy formulation is one of the most important considerations that the management of every firm should consider. Well formulated strategies enable the firm to attain a high competitive advantage compared to other firms in the industry. In addition, the firm is able to attain its profit and wealth maximization objectives in the long term. This is due to the fact that the firm will be able to survive into the future as a going concern entity. Porter defines strategy as the direction that is taken by the management team of a given organization in an effort of attaining its long term goals (1980, p. 23).
In formulating business and corporate level strategies, the management team should ensure that it conducts industry analysis. The analysis will enable the management identify the trends within the industry. Currently, firms in various industries are faced with challenges considering the increased complexity of the competitive environment. Management teams of various firms are more concerned with how they can develop strategies to improve on their firm’s competitive edge.
The degree of competition in an industry is a key determinant of the strategies to be adopted by the management team. According to Porter (1980, P. 14), to be able to succeed in this environment, a firm must attain a higher competitive position in the industry. Well formulated strategies act as a defense to a firm’s competitive challenges. In addition, industry structure is one of the key factors that determine the nature of competition within a given industry. He also asserts that the nature of competition in a given industry (Porter, 1980, P.15).
According to Phillip (2001, p.1), oil and gas industry has witnessed significant change over the past few decades. One of the challenges that the industry is facing is increase in the rate of competition. This has resulted from increased rate of economic integration culminating into a high rate of market openness. In addition, the industry is characterized by high profit potential which acts as incentive for a large number of investors to venture into the industry. Evolutionary perspective theory postulates that formulation of long term strategies becomes complex upon the market becoming more hostile, competitive and dynamic. The theory further asserts that three elements should be considered in the process of formulating strategies. These include the company itself, its environment interface and Intra Company (Robert, 2003, p.1).This paper is a report on oil and gas industry.
Aim
The objective of the report is to conduct a strategic analysis on Saudi Arabia’s oil and gas industry. In addition, the report entails an analysis of how a firm’s competitive position is determined by the industry structure in which the firm operates.
Scope
The report entails an analysis of the current trend within oil and gas industry. The assessment entails and an analysis of the environment in oil and gas industry. The report also considers the application of evolutionary perspective theory amongst firms in their process of formulating competitive strategies. A SWOT analysis of the industry is also conducted to illustrate the strengths, weaknesses, opportunities and threats facing the industry. The report also entails a PESTLE analysis of the Saudi Arabia’s oil and gas industry.
The analysis illustrates the political, economic, social, technological and legal factors affecting the industry. The current situation of the country’s oil and gas industry in its lifecycle is also illustrated. A critical analysis of industry structure as a key determinant of competitiveness of a firm in a given industry is conducted. The Porters five forces are used in analyzing industry structure. Finally the conclusion and recommendations are made. The report does not consider the specific strategies to be implemented by firms in the industry.
Trends in Saudi Arabian oil and gas industry
Oil industry is very important in the economic growth of a country since it forms a significant proportion of a country’s Gross Domestic Products (GDP). In addition, the sector forms a significant component of the Critical National Infrastructure (CNI) in most economies (Spears, 2009, Para. 4).
For example, Saudi Arabia’s economy is mainly dependent on oil and gas industry and other related industries such as petrochemical industry. The country has witnessed rampant growth in the production of oil and gas. According to a study conducted by International Monetary Fund (IMF), it is estimated that oil and gas accounted for approximately 90% of the country’s total export (Saudi Arabia, 2008, p. 2). In addition, the country is the largest consumer of oil and gas in Middle East.
Saudi Arabian oil and gas industry is composed of two segments which include upstream and downstream segments. The downstream sector consists of production and distribution of crude oil and natural gas. The industry provides numerous consumer and industrial products such as gasoline, transportation fuels, heating fuels, such as liquefied petroleum gas (LPG). Over the past years, there has been a reduction in productivity of oil and gas in the already existing wells. To boost the productivity the industry’s productivity, the government through Saudi ARAMCO, is committed to undertake more drilling in other fields. This will help in compensating the decline in the volume of oil and natural gas produced from mature wells.
Oil and gas industry SWOT analysis
The table below illustrates SWOT analysis of oil and gas industry
PESTLE Analysis of Saudi Arabia oil and gas industry
Political and legal environment
Saudi Arabia has a relatively level of political stability. This makes it possible for firms in the oil and gas industry to operate more effectively due to low level of political risk. The government also supports the industry through formulation of policies aimed at enhancing research and development in relation to exploration and drilling of oil and gas. For example, in 2009, Saudi Arabian government invested US$ 50 billion in an effort to boost exploration of crude oil. In addition, Saudi Arabia the government is committed towards doubling the country’s refining capacity by 2012(World oil and gas, 2009, Para. 6). The government has also enhanced the domestic oil and gas consumption rate through incorporation of large fuel subsidies.
Saudi Arabia oil and gas industry faces a risk from increased rate of terrorism. However, the government has formulated effective security policies to counter possibility of terrorist attacks (Saudi Arabia, 2008, p. 8). The country has an effective legal system which contains comprehensive commercial regulations. This enables firms in oil and gas industry to function more efficiently through creation of a good business environment. For example, the legal system ensures enforcement of business contracts within the industry.
Economic environment
Economic globalization has impacted Saudis oil and gas industry. For instance, the country’s accession into World Trade Organization (WTO) has had a significant impact on the country’s oil and gas industry. As a member of WTO, Saudi Arabia has been able to increase its market for oil and gas products. This has also contributed to increased economic growth of the country through expansion of its trade. For example, by being a member of WTO, Saudi Arabia has been able to penetrate new markets effectively due to a reduction in tariffs between WTO members states is greatly reduced (Tim, 2008, p. 4).
Technological environment
Saudi Arabia has a well established technological infrastructure which supports the oil and gas industry. For example, the country has a well established pipeline network which ensures efficient distribution of oil and gas within the domestic market. In addition, the Saudi Arabia is well equipped with the current oil and gas exploration technologies. Most of the plants within the industry are utilizing the current technologies in their operation. The technological environment also provides the industry with superior pipeline inspection technology. These technologies ensure that the operations of the industry are not interrupted by pipeline defaults.
Social-cultural environment
The oil and gas industry in Saudi Arabia is favored by the fact that most of the individual and institutional consumers have integrated oil and gas energy as their main source of energy. In addition, the society has developed a positive attitude towards these firms. This arises from the fact that these firms have incorporated the concept of corporate social responsibility in their operation.
For example, these firms participate in. Some of these strategies relate to operating in a social responsible manner through incorporation of the concept of Corporate Social Responsibility (CSR). Through CSR, the society has developed a positive attitude towards these firms (Fredrick & Fawaz, 2008, p. 5).
Position of the Saudi Arabia oil and gas industry and its lifecycle
Saudi Arabia oil and gas industry is in its growth stage. There is high probability of the industry witnessing rampant growth in the future. This is evident from the fact that there are numerous oil and gas reserves which have not been tapped. Saudi Arabian government is committed to increase its oil and gas exploration in the country (Saudi Arabia, 2008, p. 3).
According to Saudi Arabia oil and gas industry (Anon., 2009), 3 natural gas and 5 oil fields were discovered in 2009. 95% of oil production in Saudi Arabia is undertaken by Saudi ARAMCO which is a government parastatal. It is estimated that the Saudi Arabia will contribute 21.5% of the total oil and gas demand in Middle East by 2014. During the 2007 financial crisis, the industry was affected due to a global decline in demand for oil and gas. However, this trend is expected to be reversed by 2014 upon the recovery of the global economy.
According to business monitor international (2009, para. 3), it is expected that there will be an annual growth of 3% in demand of oil in Saudi Arabia from 2009 to 2014. In addition, there will be a growth of 28.6% in the country’s oil production during the period ranging from 2009 to 2019. In relation to gas production, the country is expected to have a market share of 20.20% by 2014. The rampant growth in Saudi Arabia’s oil and gas industry will result from an increase in oil and gas consumption. It is forecasted that consumption rate will increase with a margin of 34.3% from 2009 to 2019 (Business monitor international, 2009, Para. 3).
Industry structure
Effective operation of a firm is affected by both internal and external environment in which a firm operates. Therefore, it is important that the management of firms consider the environment in the process of formulating its competitive strategy. The external environment is composed of various elements such as the degree off competition. According to strategy, business information and analysis (Anon., 2009), the industry forms a key element of the company’s competitive environment.
This means that industry structure is one of the factors that the management team of a firm considers in the process of determining its business level strategy such as the competitive strategy to adopt. Different industries have varying degree of competition. Some industries are characterized by intense competition while others have mild competition. The objective of developing a competitive strategy is to enable the firm position itself more effectively within the industry.
Through effective positioning, a firm is able to deal effectively with the competitive forces. Porters (2008, Para. 5), asserts that competition within a given industry is influenced by the competitive forces which are a key determinant of the industry structure. In addition, the strength of the competitive forces has an impact on the profit potential of the industry. Some of the competitive forces which are used in evaluating an industry structure include threat of a new entrant, buyer and supplier bargaining power, degree of rivalry within the industry and threat of substitute products. Considering the fact that firms in the oil and gas industry form a significant part of downstream firms, developing their competitiveness is paramount for their survival.
Baker Hughes Incorporation is a firm that is established within the coal, gas, oil and related services in the United States. The firm’s has international operation with its headquarters located in Houston, US. Some of the countries in which the firm operates include Canada, United Kingdom, Venezuela, China, Saudi Arabia and Norway. The company’s customers include firms which deal with major integrated oils (Baker Hughes Incorporation’, 2009, Para. 3).
The firms operations are divided into two segments these include;
- Drilling and evaluation.
- Completion and production.
These activities are conducted by various firms of the incorporation. For instance, drilling and evaluation is conducted by Baker Atlas, Hughes Christensen, INTEQ and Baker Hughes Drilling Fluids. On the other hand completion and production is conducted by Barker Oil Tools, Centrilift and Baker Petrolite. Drilling and evaluation component deals with the provision of various products and services necessary for drilling the wells. The completion and production division deals with provision of equipments and services which are used in the completion phase in the entire productive life wells (Baker Hughes Incorporation’ 2009, Para. 3).
According to the future of the offshore oil and gas industry to 2020 (Anon., Para. 6), oil and gas industry is becoming very competitive. It is important for the management of firms in this industry to formulate effective competitive strategies. This will enable these firms to attain a high competitive position.
Analysis of oil and gas industry using porter’s five forces
Rivalry within the industry
According to Porter (1980, P.27), the degree of rivalry within an industry is determined by the extent to which firms in the industry compete amongst themselves so as to attain higher returns compared to other firms in the industry. Various factors affect competition within a given industry. Some of these factors include the quality of products and services and degree of innovation.
Over the past few decades, there has been an increment in the degree of rivalry within the oil and gas industry. This is due to an increase in the number of players venturing into the industry culminating into increase in the degree of competition. For instance, the emerging economies such as China and India are amongst the countries which have increased their investment in exploration of natural gas and oil.
This results from the fact that energy is a key determinant of a country’s economic growth hence the increment in its demand. Increased demand for natural gas has also resulted into an increase in the number of firms venturing the industry. This is due to the fact that natural gas is environment friendly. The ultimate effect of an increase in demand for oil and natural gas is an increase in the sector’s growth rate. To deal with the dynamic nature of the industry, management teams of these industries have incorporated evolutionary perspective theory in the process of formulating their firm’s competitive strategies.
Richard (2001, p. 16), asserts that integration of evolutionary perspective theory will enable firms in hostile competitive environments to survive. The management of Baker Hughes Incorporation is committed investing significant financial resources towards expansion. This will enable the firm to obtain a high competitive position. According to Porters (1980, p.30), if the degree of rivalry within a given industry is high, the management of firms sacrifice a significant proportion of its profits towards expanding the firm.
Oil and gas industry is also characterized by high exit cost. This is due to the fact that specialized technology is required upon venturing the industry. High exit cost culminates into an increase in the degree of rivalry in the industry. This is due to the fact that the only alternative firms is to develop competitive strategies despite the decline in the industry’s profit potential
Threat of new entrant
There is a high probability of a firm venturing into oil and gas industry succeeding due to the lucrative nature of the industry. The industry experienced an increase in the level of profits from 2004 due to an increase in the prices of oil and gas (Pirog, 2005, p.2). According to Porters (1980, p.34), the new firms entering into an industry bring with themselves new resources in an effort to gain significant market share. In addition, new entrants result into an increase in the number of competitors in and hence a reduction in the industry’s level of profitability.
This is due to increased degree of price war amongst firms in the industry. In addition, the degree of rivalry is also increased by entry of new firms into an industry. Despite the high profit potential characteristic of the oil and gas industry, firms venturing the industry incur considerable costs. These costs relate to both financial and human capital. For instance, a significant amount financial cost will be incurred in the process of purchasing and implementing the necessary infrastructure. Success of firms in this industry also demands specialized skills to operate these facilities.
In addition, the firm has to invest a lot in research and development which is a costly undertaking. The high cost requirement of entering into the industry acts as a barrier for the entry of new firms into the industry. Bakers Hughes Incorporation has been able to position itself effectively in the market due to possession of effective human and financial resources.
For instance, during the firm’s financial year which ended January 2009, the firm’s sales revenue averaged US $ 11, 864,000,000. This indicates a strong financial base which enables the firm to conduct effective investment for its expansion. In addition, the firm also has superior human capital which ensures efficiency and effectiveness in the operation of the firm (‘Advancing reservoir performance’, 2009, Para. 3).
Baker Hughes Incorporation also has a high competitive position in the market due to its global scale of operation. Currently, the firm operates in 90 countries which enable the firm to attain high economies of scale. Through high economies of scale, the firm is able to price its products and services more competitively. This is due to the fact that the industry is characterized by minimal differentiation which makes price to be the key competitive factor in the industry.
Substitute products
According to Porter (1980, p. 39), substitute products result into a reduction in the industry’s profit potential. Porter asserts that this is due to the fact that substitute products leads into establishment of price ceiling. This limits the firm’s strength in setting a price that will result into high profit margins. The emergence of bio-fuel poses a threat to firm in oil and gas industry. This is due to the fact that there is an increase in the number of individual and industrial consumers who are considering bio-fuel as an alternative source of energy for their transportation purposes.
The US government is committed towards ensuring that it does not depend on importation of oil and gas to meet its energy needs. This has resulted into increased investment by the government towards production of bio-fuel. For instance, British Petroleum has intends to invest US $ 500 million for the production of bio-fuel as an alternative source of energy (‘Investment in bio-fuels’, 2009, Para. 1).This means that Baker Hughes Incorporation has to develop effective competitive strategies for it to survive in the market. However, the increasing demand for natural gas presents a bright future for Baker Hughes Incorporation.
Buyer and supplier bargaining power
According to Porter (1980, p. 43), bargaining power refers to the ability of either suppliers or buyers have an influence on the price. Suppliers in the oil and gas industry are relatively high. This is due to the fact that OPEC controls approximately 40% of the global oil supply. This control makes it to have strong impact on the price of oil and gas. The buyers of oil and gas products consist of both individual and industrial customers. Buyer power in oil and gas industry is relatively low. This is due to the fact that upstream suppliers have the capacity to limit the supply of the raw materials and keep prices high.
Conclusion
Firms in Saudi Arabia’s oil and gas industry have witnessed rampant growth over the years. This is due to increased demand for oil and gas products. The country’s political, economic, social, technological and legal environments have played a significant role in the growth of the industry. The future of the industry is bright considering the fact that it is in its growth stage. The high profit potential of the industry has resulted into an increase in the number of firms venturing the industry.
As a result, management teams of incumbent firms are becoming more concerned with how their firms can position themselves in the market more effectively. To achieve this, more emphasis is being paid on effective formulation of strategies. Considering the hostile nature of the industry, management teams are considering the evolution perspective theory in the process of formulating their strategy. In addition, the managements are also considering the industry structure in developing their competitive strategies. This ensures that the strategies adopted are effective in attaining a high competitive advantage.
Recommendations
- Evolutionary perspective theory should be incorporated by firms in the industry in their strategic management processes due to its competitive nature. This will enable these firms to survive in the challenging environment.
- The management of firm’s in oil and gas industry should consider conducting industry structural analysis during the process of formulating their competitive strategies.
- Firms in the oil and gas industry should invest in technological and other infrastructural development for them to attain a high competitive position.
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