Overhead

Test Your Knowledge

Quiz: Drilling Down on Overhead

Instructions: Choose the best answer for each question.

1. Which of the following is NOT considered an overhead cost in the oil & gas industry?

a) Salaries of drilling crew b) Rent for company headquarters c) Insurance premiums d) Research and development

2. Why is understanding overhead costs crucial for accurate costing?

a) To calculate the profit margin of each barrel of oil produced. b) To determine the true cost of exploration and production activities. c) To compare the cost of different drilling techniques. d) To evaluate the environmental impact of oil extraction.

3. Which of the following is NOT a strategy for controlling overhead costs?

a) Utilizing automation and digital solutions b) Increasing production targets c) Negotiating favorable contracts for services d) Implementing lean management principles

4. How does understanding overhead costs impact investment decisions?

a) It helps assess the feasibility of new drilling projects. b) It determines the price of oil in the market. c) It influences the size of the drilling rig required. d) It decides the amount of oil to be extracted from a field.

5. Which of the following is an example of an administrative cost?

a) Maintenance of drilling equipment b) Salaries of engineers working on new drilling techniques c) Legal fees for environmental permits d) Costs of transporting oil to refineries

Exercise: Overhead Analysis

Scenario: An oil & gas company is considering investing in a new drilling project. The project's estimated direct costs (drilling, extraction, transportation) are $50 million.

Task: Calculate the company's total project cost if the estimated overhead costs are:

• Operational Expenses: 15% of direct costs
• Administrative Costs: 10% of direct costs
• Research & Development: $5 million
• Depreciation: $2 million

Instructions:

1. Calculate the operational expenses based on the direct costs.
2. Calculate the administrative costs based on the direct costs.
3. Add all the costs (direct costs, operational expenses, administrative costs, research & development, and depreciation) to determine the total project cost.

Techniques

Chapter 1: Techniques for Measuring and Allocating Overhead

This chapter dives into the various techniques used to measure and allocate overhead costs in the oil and gas industry.

1.1 Traditional Overhead Allocation Methods

• Direct Allocation: Directly assigning overhead costs to specific projects or activities based on a simple, direct relationship, such as square footage used or equipment hours.
• Activity-Based Costing (ABC): A more sophisticated method that identifies and assigns overhead costs to specific activities related to production, such as drilling, completion, and transportation. This approach provides a more accurate picture of the true cost of these activities.

1.2 Advanced Overhead Allocation Methods

• Target Costing: A proactive approach that sets a target cost for a product or service and then works backward to determine the necessary overhead allocation to achieve profitability.
• Value Stream Costing: Focuses on the entire value chain of a product or service, allocating overhead costs to each stage, from exploration to sales.

1.3 Considerations for Choosing Overhead Allocation Methods

• Industry Practices: Understanding how other companies in the oil and gas industry allocate overhead costs can provide valuable insights.
• Company Structure: The size and complexity of the company, along with its organizational structure, will influence the appropriate method.
• Data Availability: The availability of detailed cost information is crucial for applying more advanced methods.

1.4 Challenges in Overhead Allocation

• Identifying Indirect Costs: Distinguishing between direct and indirect costs can be complex, especially in complex projects.
• Allocating Joint Costs: Allocating costs related to multiple products or activities can be challenging.
• Accurately Tracking Activities: Monitoring and tracking the activities that consume overhead costs can be difficult.

1.5 Key Performance Indicators (KPIs)

• Overhead Rate: A measure of overhead costs as a percentage of direct costs.
• Overhead Absorption Rate: The percentage of overhead costs assigned to products or services.
• Overhead Variance: The difference between actual overhead costs incurred and allocated overhead costs.

By understanding these techniques and challenges, oil and gas companies can improve their overhead allocation accuracy and gain valuable insights into their operational efficiency.

Chapter 2: Models for Analyzing Overhead Costs

This chapter explores different models used for analyzing overhead costs in the oil and gas industry, helping companies identify cost-saving opportunities and improve efficiency.

2.1 Pareto Analysis (80/20 Rule):

• This principle suggests that 80% of effects come from 20% of causes. Applied to overhead, it means that a small percentage of overhead drivers are responsible for a significant portion of the total overhead costs.
• Application: Identifying the top 20% of overhead drivers and focusing on reducing their cost can yield significant savings.

2.2 Cost Breakdown Structure (CBS):

• This model systematically breaks down overhead costs into their components, allowing for a detailed analysis of individual costs.
• Application: Pinpointing areas of high cost and potential for optimization, revealing opportunities to reduce overhead costs.

2.3 Value Stream Mapping:

• Visualizes the flow of value-adding and non-value-adding activities in a process, including overhead costs associated with each step.
• Application: Identifies areas where overhead is incurred for non-value-adding activities, leading to cost reduction and efficiency improvements.

2.4 Activity-Based Costing (ABC) Model:

• As mentioned earlier, ABC assigns overhead costs to specific activities based on their consumption of resources.
• Application: Provides a deeper understanding of the true cost of different operations, leading to more informed decisions about cost optimization and resource allocation.

2.5 Sensitivity Analysis:

• Examines the impact of changes in different variables, such as oil prices or overhead costs, on project profitability.
• Application: Helps companies assess the risks associated with fluctuating overhead costs and make informed decisions about project feasibility.

2.6 Lean Management:

• Focuses on eliminating waste in all areas of the business, including overhead costs.
• Application: Streamlines processes, reduces unnecessary activities, and optimizes resource utilization, leading to significant overhead cost savings.

By employing these models, oil and gas companies can gain a comprehensive understanding of their overhead costs, identify key drivers, and develop effective strategies for optimizing efficiency and profitability.

Chapter 3: Software for Managing Overhead Costs

This chapter explores the various software tools available to oil and gas companies for managing their overhead costs effectively.

3.1 Enterprise Resource Planning (ERP) Systems:

• Comprehensive software systems that manage all aspects of a company's operations, including financial management, inventory control, and project management.
• Benefits: Track overhead costs, allocate them to projects, and generate reports for cost analysis and control.
• Examples: SAP, Oracle, Microsoft Dynamics

3.2 Cost Management Software:

• Specialized software designed for managing and analyzing costs, including overhead costs.
• Benefits: Identify cost drivers, track spending, allocate costs, and generate cost reports.
• Examples: Workday, Coupa, Procore

3.3 Project Management Software:

• Tools for planning, scheduling, and managing projects, often including cost tracking features.
• Benefits: Monitor project budgets, track overhead costs allocated to specific projects, and generate reports for cost performance analysis.
• Examples: Microsoft Project, Jira, Asana

3.4 Data Analytics Tools:

• Software that analyzes large datasets to identify patterns, trends, and insights, helping companies understand their overhead costs and optimize their spending.
• Benefits: Identify cost drivers, forecast overhead costs, and analyze the impact of different cost-saving measures.
• Examples: Power BI, Tableau, Qlik Sense

3.5 Mobile Apps:

• Mobile applications that allow employees to access cost data, submit expense reports, and track time spent on projects, enhancing cost management and efficiency.
• Examples: Expensify, Zoho Expense, QuickBooks

3.6 Cloud-Based Solutions:

• Software hosted on cloud servers, providing accessible and scalable solutions for cost management, especially for companies with remote operations.
• Benefits: Improved data security, scalability, and cost-effectiveness.

By leveraging the right software tools, oil and gas companies can streamline their overhead cost management processes, gain real-time insights into their spending, and optimize their efficiency.

Chapter 4: Best Practices for Controlling Overhead Costs

This chapter outlines key best practices for controlling overhead costs in the oil and gas industry, enabling companies to maximize profitability and achieve sustainable success.

4.1 Establish a Clear Cost Management Strategy:

• Define the company's cost management objectives, policies, and procedures.
• Ensure clear understanding and alignment among all departments and personnel.

4.2 Implement a Cost Tracking and Reporting System:

• Use software tools and processes to track overhead costs accurately.
• Generate regular reports and dashboards to monitor cost trends and identify deviations from budget.

4.3 Conduct Regular Cost Audits:

• Analyze overhead costs and identify areas of potential savings.
• Evaluate the efficiency of existing processes and systems.

4.4 Implement Cost Reduction Measures:

• Identify areas for process improvement, automation, and outsourcing.
• Negotiate favorable contracts for services and supplies.

4.5 Foster a Culture of Cost Consciousness:

• Encourage employees at all levels to be mindful of overhead costs in their daily work.
• Provide training and resources to support cost-effective decision-making.

4.6 Focus on Value-Adding Activities:

• Identify and eliminate non-value-adding activities that consume overhead costs.
• Prioritize activities that directly contribute to the core business objectives.

4.7 Continuously Improve Processes:

• Use data and insights to identify areas for process optimization and efficiency improvements.
• Implement lean management principles to eliminate waste and reduce overhead costs.

4.8 Leverage Technology:

• Utilize software tools for cost management, data analytics, and process automation.
• Embrace digital solutions to enhance efficiency and reduce overhead costs.

By adhering to these best practices, oil and gas companies can effectively control their overhead costs, improve operational efficiency, and enhance their overall profitability.

Chapter 5: Case Studies on Managing Overhead Costs

This chapter presents real-world case studies illustrating how oil and gas companies have successfully managed their overhead costs, highlighting key strategies and results.

5.1 Case Study 1: ABC Implementation for Improved Cost Allocation

• Company: A large oil and gas company with a complex project portfolio.
• Challenge: Difficulty in accurately allocating overhead costs to specific projects, leading to inaccurate cost estimates and inefficient resource allocation.
• Solution: Implemented Activity-Based Costing (ABC) to assign overhead costs to specific activities based on resource consumption.
• Results: Improved accuracy of project cost estimates, optimized resource allocation, and increased profitability.

5.2 Case Study 2: Outsourcing for Reduced Administrative Costs

• Company: A medium-sized oil and gas company with a significant administrative overhead.
• Challenge: High overhead costs associated with administrative functions, such as payroll, accounting, and human resources.
• Solution: Outsourced administrative functions to a specialized service provider.
• Results: Reduced administrative overhead costs, streamlined operations, and improved efficiency.

5.3 Case Study 3: Lean Management for Improved Efficiency

• Company: A small oil and gas company seeking to improve operational efficiency and reduce costs.
• Challenge: Wasteful processes, inefficiencies, and high overhead costs.
• Solution: Implemented lean management principles to identify and eliminate waste in all aspects of the business.
• Results: Improved process efficiency, reduced overhead costs, and increased profitability.

5.4 Case Study 4: Data Analytics for Cost Optimization

• Company: An exploration and production company with a large volume of data.
• Challenge: Difficulty in analyzing data to identify cost drivers and optimize spending.
• Solution: Implemented data analytics tools to analyze spending patterns and identify cost-saving opportunities.
• Results: Reduced overhead costs, optimized resource allocation, and improved decision-making.

These case studies demonstrate the real-world benefits of employing effective overhead cost management strategies. By learning from the experiences of other companies, oil and gas organizations can implement similar initiatives to achieve their own cost optimization goals.