Falling oil prices in the past ten months might be good news to companies that stand to gain from lower production costs. However, the sharp decline has unnerved boards and treasurers following years when prices were much higher. With oil prices likely to remain subdued for some time, there is a compelling case for prudent treasury strategies and robust working capital management to help treasurers navigate the current volatility.

Since June 2014, the price of benchmark Brent crude oil has fallen to around USD50 per barrel (bbl), touching the lowest point in more than five years and about 58% lower than its year-to-date peak of USD115/bbl in mid-2014.

A number of factors have caused the oil price to plummet, which include:

• Strong growth in US production, which has pushed imported crude back onto the international market.
• Resumption of significant Libyan oil production (from 200,000 barrels of oil per day (kbopd) in June to 900kbopd by the end of September).
• Weaker than expected global demand, particularly in Europe and Asia with China production rising at its slowest pace since 2008; the IMF reducing global economic growth forecast for 2015 from 4% to 3.8%; the OECD reducing its expectations for economic growth through 2015; and noting an increasing likelihood for the eurozone to re-enter recession.

This downturn has been exacerbated by Saudi Arabia and other Gulf countries being unwilling to cut production. Instead, they have preferred to defend their market share through an aggressive “price war”.

As a consequence, oil majors, mid-tiered and oil services companies have been forced to implement drastic cost-cutting measures.

Braving volatilities

To weather lower oil prices, some immediate steps company boards may consider include:

1. Deferring major projects requiring significant capital expenditure (capex).
2. Booking impairments following asset write downs.
3. Selling and leasing back pipeline infrastructure.
4. Making redundancies.
5. Cutting discretionary spending.

The current period of price drop is the longest peak-to-trough decline since the 1980s. Although analysts suggest oil prices are likely to remain at depressed levels for the foreseeable future, such protracted swings will not last forever.

With some market estimates suggesting USD150 billion of capex is at risk if the oil price remains around USD50/bbl, swift action is essential.

One priority is for companies to quantify their exposure under different oil price scenarios for the period ahead and to determine how resilient they are. Findings from this modelling may call for the following measures:

• Reduce usage of cash: reduce overall capital expenditure by delaying discretionary and non-essential projects. If possible, boards should consider reducing dividends to ride out the current downturn.
• Maintain adequate liquidity buffer: exploration and production companies with an insufficient liquidity buffer should consider reducing or deferring capital expenditure accordingly. Additional funding measures should be considered to repair stretched balance sheets.
• Migrate from organic to inorganic growth: delay investment or replace projects with opportunistic acquisitions. Explore the possibility of substituting organic growth with inorganic growth, which is earnings accretive. Strategic mergers and acquisitions are likely to increase as illustrated by the Halliburton acquisition of Baker Hughes in November 2014 and more recently Shell’s acquisition of BG.
• Reserve for the future: acquisitive firms have maintained a lower leverage level to keep “dry powder” for future acquisitions. If leverage is not high, potential acquirers should issue now to build a liquidity buffer. If leverage is high, consider raising equity to strengthen the balance sheet.
• Reduce financing costs: consider refinancing higher cost debt and lock in lower rates available in the current low interest rate environment, replace short-term debt with longer tenor debt.
• Deploy strategic hedges: establish a hedging policy that ensures appropriate action can be taken when the opportunity arises. Issuing in US dollar provides a natural hedge as oil is a US dollar-denominated commodity.

That said, treasurers should examine tactical measures to optimise processing efficiencies and drive down often hidden costs across their treasury operating environment. These include:

• Benchmark and optimise working capital: review end-to-end treasury processes and front-to-back operations to ensure best-in-class solutions are deployed for optimal working capital management.

In that regard, we have worked with our clients using Citi’s Treasury Diagnostics benchmarking tool to measure their treasury practices relative to their industry peer group. The diagnostic is specifically designed to evaluate treasury practices by measuring a company’s performance relative across six critical areas of treasury operations: Governance and Controls, Liquidity Management, Cash and Working Capital Management, Subsidiary Funding and Repatriation, Risk Management and Systems and Technology.

Based on a detailed questionnaire providing insight on the client’s treasury performance, a customised benchmarking report is generated. This is then evaluated against industry peers and best-in-class companies, namely, those that continually set benchmarks of truly world-class practices.

• Control and visibility of cash: treasurers should also review their existing cash flow forecasting (CFF) processes. Manually intensive processes, which typically use Microsoft Excel to gather data from operating entities before the treasurer has a clear view of cash availability across the organisation, should be improved.

As cash availability and CFF assume even greater importance, how fast this information is collated, transmitted and disseminated is critical to ensure excess cash is deployed to where it is most needed.

• Cost control for travel and entertainment spend: since discretionary spending is an obvious area for cost cutting, it is surprising that some organisations have not yet deployed regional or global solutions to capture, manage and monitor travel and entertainment spend. Implementing such a solution to capture consolidated spend data on a globally consistent platform will ensure companies’ spend policy is adhered to. Redirecting spend to strategic partners can also generate volume discounts and working capital benefits.
• Utilise procurement cards: the order-to-pay process can be significantly enhanced by redirecting spend from traditional channels to procurement cards, which are also known as virtual or ghost cards.

By driving spend to strategic partners willing to take card-based payments, companies can reduce the inherent cost of traditional order-to-pay processes: cost reductions can be generated as companies’ working capital benefits from a significantly longer settlement period.

For merchants accepting card-based payments for procurement, it enhances the commercial relationship, which in turn may direct more spend towards them as they become strategic partners.

• Evaluate counterparty risks: treasurers should assess the risks of counterparties embedded in their supply chain to minimise the impact on their company’s financial health.

Depending on the strength of these relationships, collaborative action such as redeploying key assets following project postponement may help ensure utilisation rates and associated cash flows are maintained.

Greater oversight of account receivables processes ensuring credit limits and commercial terms are not breached are critical to reduce and eliminate the incidence of bad debts and fraud. Preemptive action is essential and an important part of ensuring the health of key suppliers does not move to impairments.

Sustained oil price weakness will continue to challenge the industry. Whilst history suggests that this episode will pass, opportunities abound for treasurers who take swift action to implement a more robust treasury operating platform so that their organisations are better placed when the upswing takes hold. Doing so is not an option, but an imperative.