Steady state: Prioritising stability in a volatile market

How Santos CEO Kevin Gallagher led a comprehensive reform of the Australian energy company’s operating model.

When Kevin Gallagher became CEO of Santos in 2016, he set about to create a new operating model—one that could withstand the boom-and-bust impact of a volatile industry. As leaders across business sectors grapple with the uncertainties of the postpandemic era and the impending energy transition, we sat down with Gallagher to reflect on his experience and discuss how leaders can embrace the reinvention potential of 2021 and beyond.

The challenge: Stepping off the merry-go-round of price volatility

While demand-based market pricing is an alluring factor for commodity companies, volatility is a two-way street. Following the 2009 boom, for example, by 2015 oil and gas companies were living beyond their means—with a track record of overspending and unreliable dividends.

In 2016, Kevin Gallagher was the new CEO at Santos, Australia’s largest domestic gas supplier. As he surveyed yet another reckoning of the boom-and-bust effect of flux in oil and gas pricing, he realised that a realignment of priorities, or a “costs-out” program, would bring only temporary benefits. It was time to reappraise the company’s entire operating model and build a new model that could sustain enduring business shifts. It was time to change the rules of the game.

“I’d seen how oil and gas companies just kept repeating this cycle, so I knew something structural was at fault. I didn’t know yet what the right model was, but I knew the current one didn’t work, and therefore I didn’t want to perpetuate it.”

The response: An operating model that can withstand market fluctuation

To reach its goal of becoming Australia’s leading natural-gas company by 2025, Santos needed to focus on stability, simplicity, and predictable shareholder returns. In support of this strategy, the company introduced its “disciplined operating model” in late 2016.

The new model was far more than a pursuit of efficiencies. By incorporating strategic considerations, it was the linchpin of the company’s recovery from a challenging position. The new model enabled Santos to remain an investable, high-performing company that pays reliable dividends throughout market cycles and can self-fund growth through operating cash flow from the base business.

The operating model provided a disciplined framework that helped Santos make the most of its talent, knowledge, and financial capital through the following strategies:

  • simplifying the business by defining the core long-life assets of the company—those that deliver stable, long-term returns—and divesting the remaining noncore assets
  • focusing only on activities that contribute to these core business assets and delivering value through them
  • setting a break-even oil price as a simple, consistent metric to generate free cash flow through the cycle (analysis of historical oil prices showed that if Santos could reach cash-flow breakeven at less than US $40 per barrel, it could be resilient throughout the commodity cycle)
  • infusing these priorities into every aspect of the company’s leadership, culture, and remuneration, budgeting, and performance systems

“This was not a process to take costs out. If you just want to get costs out, you can do that. But they just come back in the future—and they come back bigger.”

“This was a complete structural and cultural change to make Santos’s assets cash-flow positive throughout the cycles of market pricing. The operating model does not just serve the strategy, it is the strategy. Because if your business can be robust at the bottom of a price cycle, then it will be fantastic at the peak.”

The result: Independence, stability, and a high-performance culture

Five years after implementation, the benefits of the Santos model are clear—both within the company and to the market. The renewed focus on simplifying the business and the asset mix, together with the disciplined approach to the core business, has reaped performance improvements—and has created an explicit culture of performance that supports financial stability and funds growth.

Following significant cost reductions resulting from its disciplined approach, Santos holds an enviable position as one of the lowest-cost onshore operators in Australia. With a strong balance sheet—more than US $1 billion free cash flow in 2019, up from a negative cash flow of US $2.5 billion in 2013—the company can not only live within its means but also grow comfortably.

The operating model continues to evolve in the face of changing market imperatives, accommodating new targets such as reduced emissions and capital prioritisation. Steady cash flow enables the company to comfortably fund its investments in future-facing decarbonisation initiatives such as carbon capture and storage and hydrogen.

The company’s shareholder returns reflect this success—Santos outperformed the Dow Jones Oil & Gas Index by as much as 150% on total shareholder return from 2016 to 2021 (exhibit).

Santos outperformed the Dow Jones O&G Index by as much as 150% from 2016 to 2021.
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The COVID-19 pandemic offers perhaps the clearest proof of Santos’s foresight in pursuing stability and diversity in market exposure and product pricing—the company has a well-balanced combination of domestic gas, liquefied natural gas (LNG), and international oil pricing. The changes introduced in 2016 enabled Santos to weather pandemic-related shocks to oil and LNG pricing with relative ease. The company’s resilience paid off in no layoffs and no reduction in activities during 2020—in sharp contrast to sector peers.

“The market understands the robustness of our model now because they’ve seen it perform in both boom and bust and through moments of crisis.”

“Whether it’s an earthquake at an asset site or the impact of a pandemic, the market can look at us and see how, thanks to the discipline established in our model (and our diversified portfolio), we don’t skip a beat as a company.”

The lessons: How leaders can reinvent their companies in 2021 and beyond

Santos’s experience is a textbook example of how companies benefit from taking a fresh look at their strategy and operating model and reassessing underlying sources of value creation. Santos’s all-in approach to restructuring its operating model underscores the big—and multifaceted—moves that win big gains.

Our conversation with Gallagher reinforced the value of five consistent messages:

1. Establish one clear, consistent, and simple strategic narrative.

  • With Gallagher, Santos had a highly visible CEO championing the operating model at every turn. The model story has been told at every investor presentation since 2016, and it’s part of every board meeting.

    “Spend more time than you think is practical or useful explaining the vision, the strategy, and the model to the top leaders in the business. Then make sure they understand the need for them to do this for their direct reports, and so on. People need to be completely steeped in the operating model, because then it becomes infectious.”

    “After investor road shows I would do town halls for the whole organisation. I would take any question. And I would be candid and honest, because people appreciate the truth! What they hate is management-speak that says nothing, because then they know it’s going to be bad for them.”

2. Simplification, resilience, and focus are key.

  • Santos reduced its core assets from 23 to five, balancing assets across geographies, products, and pricing structures to build resilience.
  • The company established clear rules governing how business units could earn and spend.
  • Performance was managed throughout the year with no moving of goalposts.

    “I cut off everything that distracted leaders and told them they could only look at the core. Lo and behold—efficiency innovations emerged in the core business!”

3. Move quickly to get the right structure and people in place.

  • While Gallagher was prepared to invest heavily in cascading communications and changes to operating levels, he knew that trying to achieve this at leadership levels would burn too much time and capital.

    “I could tell from the questions being asked by leadership at the outset that cultural change would be required. But I didn’t have time to run a cultural program and then wait to see the results down the line. I needed to know, quickly, do I have the right people to help me build the culture I need? And on that question, as with so many in leadership, you really have to go with your gut.”

4. Match the culture to the model.

  • All leaders had a clear understanding of the company’s market assumptions—assume a market oil price of US $40 per barrel at all times—and of the importance of maintaining that assumption.
  • Leadership reinforced the mantra that no off-season exists—that year-over-year improvements should always be a priority—and linked this approach to incentives.
  • Bonuses were paid only for extra achievement, not for just meeting targets.

    “Two related things were critical: we set the vision and then we set the six core values to support it. We focused on specific and tangible values that directly support the business model.”

    “We also realigned all our incentive structures to support the operating model and values—so when I set KPIs, I set them in the context of values.”

5. Make transparency of performance a mantra, both internally and to market.

  • Santos established clear internal and market reporting protocols to deliver the good, the bad, and the unexpected to both shareholders and stakeholders in real time.
  • Similarly, Gallagher created a culture of “bad news fast”—in which internal issues were flagged and resolved as quickly as possible to provide the best chance of mitigation.
  • Gallagher believes that “walking the talk” on this has created employee trust and performance, even during times of challenge.

    “Take the emotion out of the numbers. Just give the facts and then we can all be informed about why we’re doing what we do.”

    “Companies often talk to the investment community about share price, financial metrics, et cetera, but we don’t take the time to talk about them internally.”

    “In Santos’s case, I’m confident that the structures we’ve set up—and the way in which we have embedded the Santos disciplined model into all aspects of our work, culture, and remuneration—will help ensure that this is a legacy system.”

    “That’s a testament to the way we have brought all our staff along on this journey, which has been not only fair but empowering to them as employees. Everyone now understands the ‘business end’ of the business, which is empowering for Santos and for those individuals, no matter where they might choose to work in the future.”

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