Chapter 1
Step one: know the situation
Detailed analysis must be done by market. Cash is not always fungible across regions, and a liquidity crisis can quickly escalate.
For oil and gas company treasurers, the first step is a deep understanding of liquidity levels now, as well as dependable forecasts of short-term needs, and solid points of view about how cash inflows will be impacted by oil and gas price movements. How much cash is on hand, and what knowable events are on the horizon that may impact future cash flow? This detailed analysis must be done in every market. Cash is not always fungible across regions, and a liquidity crisis in one business or market can quickly escalate.
Once those individual analyses are complete, they can be consolidated at the corporate level to provide a top-down view of the company’s overall liquidity situation and aggregated risk metrics.
Throughout this process, it’s imperative to perform stress tests that can provide insight into how the company’s liquidity would be impacted by further oil and gas market disruptions, changes in price volatility, the shutdown or delay of startup of some operations and other critical swings to cash flow.
One important area of focus for these stress tests is your company’s credit exposure. Which customers today are most likely to slow pay or no pay? What events might cause an otherwise viable customer to struggle?
Your company may be financially stable with strong cash flows, but if major customers delay payments, what impact will that have? Your company suddenly becomes susceptible to customer, supplier and trading counterparty’s stress, and even the financial problems of their customers, suppliers and trading counterparties. Markets are a tapestry and in extreme stress situations, one company’s liquidity problems can be everyone’s liquidity problems.
Assessing credit risk is essential and can be challenging in normal times. In times of extreme market dislocation, with multiple unknown unknowns, it can become a herculean task. Smart companies will put additional resources toward measuring and managing counterparty risk over the next 12 to 18 months, and possibly longer.
Heightened counterparty credit management requires more than just increased vigilance. It may also require revisions to normal methods of measuring credit risk since payment history does not necessarily reflect a company’s future ability. In addition, credit analysis algorithms may need to be reviewed and revised.
Companies may also have to carefully weigh actions they take against late payers. Do they block shipments, or work with the customer to come to an alternate arrangement? Normal thresholds for blocking shipments (or other actions) may result in cutting off a large number of customers and damaging the company’s business overall.
Chapter 2
Step two: understand the options
Knowing in advance where additional sources of liquidity are available is critical as it enables you to act quickly if needed.
Oil and gas companies should have a detailed understanding of all sources of available liquidity — including existing financing arrangements, revolving credit lines, access through banks or markets, asset sales, even cash on hand that can be transferred across regions or business units. Reach out to current and potential lenders if needed to assess viability of extending or expanding credit lines or securing new forms of funding.
Knowing in advance where additional sources of liquidity are available — both inside and outside the company — is critical because it enables you to act quickly if needed.
The types of detailed analyses required in steps one and two aren’t easy to accomplish in a short timeframe. Pulling an experienced project team together to handle these tasks may be the difference-maker that enables your company to survive and thrive in challenging times.
Chapter 3
Step three: secure the future
Treasury’s expertise can help ensure everything from procurement staging to milestone payments are planned with liquidity in mind.
Once Treasury has a strong short-term liquidity plan in place — one that has undergone robust stress-testing — it’s time to take longer-term actions to improve financial performance and enhance future cash flows. Oil and gas commodity prices may not rebound significantly for some time and the industry needs a laser focus on squeezing cash from — and enhancing the profitability of — its existing operations and capital investments.
These are operational matters, but the company’s financial leadership can play a major role in strengthening the company’s overall performance.
For example, financial leaders should be pushing for investment in and adoption of technology upgrades that allow for better predictive analytics, machine learning, and enhanced forecasting to improve risk monitoring and measurement. Financial teams need to be able to do more with less, and digital technology can automate time-consuming routine tasks and allow staff to spend more time on analysis and forecasting.
A financial data network underpinned by advanced digital technology makes it possible for CFOs/treasurers to ask smart questions and get accurate answers quickly – for example, “what impact would a second wave of COVID-19 have on our cash flows, and what steps can we take today to mitigate that risk?” Technology enables the treasury function to have a deeper, more precise understanding of the various impacts to financial performance — and plan accordingly.
Treasury also needs to be more involved in capital management. Oil and gas companies are often complex organizationally, which hinders the ability of senior leaders to effectively manage capital investments. All too often, low-return projects get funded while higher return or lower risk projects are passed by because there isn’t a consolidated view on how capital is deployed, and the returns that it is generating.
Companies need to ensure they have a robust capital allocation/budgeting system in place that measures anticipated return on investment and risk consistently across investment opportunities. This will help leadership to make the best-informed decisions on where to invest capital.
In addition, effectively managing your company’s working capital reduces the amount of cash tied up in operations, freeing cash to pay down debt and reinvest in more profitable parts of the business. While effective working capital management requires the involvement of many parts of the organization, Treasury can take the lead in organizing and driving efforts.
CFOs and treasurers also bring a unique perspective on project development, contract discussions and capital investment decisions. For example, project managers or proposal planners don’t often think about corporate cash flow, credit ratings, the impact of credit, commodity and currency exposure and other financial risk on the corporation. The treasury function brings the perspective and expertise necessary to protect the company and ensure that everything from procurement staging to milestone payments are planned with liquidity in mind.
Financial leadership makes a difference
As oil and gas companies navigate through a collapse in demand and the second price collapse in a decade, financial leadership is imperative. Strong companies will utilize the expertise and skill of their CFOs and treasurers to manage short-term liquidity issues as well as develop longer-term enhancements to drive cash flow and profitability.
Summary
Structural oversupply from COVID-19 and the global economic shutdown reduced demand and prices. Strategically managing liquidity is imperative to navigating this critical time.
