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Overcoming the E&P CEO Succession Challenge

CEO succession is a key moment of truth in the lifecycle of any company, yet too few boards are fully prepared to handle that transition in a planned and controlled manner. Complex internal dynamics come into play, such as managing sensitivities related to the incumbent CEO, aligning the board on future strategy and an ideal CEO profile, and evaluating fairly internal and external candidates.

In addition to these common challenges, exploration and production (E&P) companies face a set of additional pitfalls inherent in the very nature of the industry. These include:

  • A sustained high demand for CEO-ready talent; combined with
  • A structurally limited supply of that talent; leading to
  • A runaway growth in compensation packages.

These elements combine to create a significant challenge to CEO succession planning for E&P company boards.

A sustained high demand for CEO-ready talent

At an individual level, E&P talent generally flows from larger to smaller companies. A typical career path for an E&P executive would be to start in the upstream arm of a major, where training and broad international exposure are gained. Often a mid-career transition is made to an E&P independent, where autonomy and larger responsibilities are the attracting factors. Finally, the last part of one’s career might be spent in a more nimble, entrepreneurial company with a (potentially) significant financial upside and the opportunity to leave a legacy.

From a macro perspective, the need for energy resources will remain high for the foreseeable future as the middle class of emerging economies grows by the hundreds of millions over the next decades. New disruptive technologies in fields such as shale gas or liquefied natural gas (LNG) are changing the face and economics of the energy industry and creating plenty of new opportunities for E&P companies — or reshaping existing ones, such as the retooling of new LNG projects in North America from import to export facilities.

All of these developments combine to create a market where the demand remains high for qualified executive talent who can fill the E&P C-suite. And given the long-term trends supporting the industry, this is unlikely to change in the near future.

A structurally limited supply of CEO-ready talent

E&P is a highly technical field in which a large number of CEOs have an operational background. For instance, nearly 60 percent of CEOs of the top 200 E&P companies globally have engineering or science degrees, according to our analysis of CEO compensation and career paths from 2007 to 2012. This bias toward technical expertise makes it hard for executives with non-operational backgrounds to stake a claim to the top role.

In addition, the E&P sector is traditionally reserved to industry insiders, and very few executives make a mid-career entry into it, even from adjacent fields. Our study of the top 200 E&P companies revealed that more than 90 percent of their CEOs have been E&P insiders who spent the vast majority of their careers in the industry. Once again, this bias artificially restricts the supply of talent that would be considered ready to take the helm of an E&P company.

Finally the “great crew change” in the oil and gas industry in the ‘80s and early ‘90s created a generation gap in the sector’s executive pool globally. This is the generation that would be at, or close to, the CEO level today. The industry will suffer from this gap at the C-level for the decade to come.

A runaway growth in compensation packages

As a result of the structural supply-demand imbalance of CEO-level talent in the industry, compensation packages have crept up significantly over the years. According to our study, median total CEO pay at the top 200 E&P companies globally increased by close to 60 percent over the five-year period from 2007 to 2012. By contrast, median compensation increased by a mere 8 percent for CEOs of S&P 100 companies, and decreased by 3 percent for the CEOs of FTSE 100 companies.

The upward trend in E&P CEO compensation is most apparent in mid-cap companies, particularly in the $500 million to $1 billion market capitalization range, for which CEO compensation has more than doubled from 2007 to 2012. Mid-cap companies often are the most ambitious with respect to their compensation policies because they are small enough to be flexible and aggressive on pay, yet they are also large enough to afford to pay top dollar for talent.

Additionally, it is interesting to note that E&P CEO compensation has greatly outpaced shareholder value creation, as the average market cap of the top 200 E&P companies in our study only increased by 8 percent from 2007 to 2012, which perhaps should give E&P boards some pause for reflection.

So what is an E&P board to do to overcome the CEO succession challenge?

Based on our worldwide experience in helping recruit CEOs of E&P companies, we can highlight a few key lessons that E&P boards might need to bear in mind in order to overcome these challenges to CEO succession planning.

Think “above ground” — The E&P sector prides itself on the technical nature of its work and, as discussed earlier, senior industry executives often have engineering backgrounds. However, the oil and gas world is progressively shifting: it is not any more about, “Can we get the resources out of the ground cost-effectively?” but much more about, “Will we even be allowed to play?” Today’s E&P CEOs, particularly for on-shore businesses, must focus on “above ground” issues, including managing government relations, community stakeholders and non-governmental organizations (NGOs), which requires a skill-set that is very different from the “smart operator” CEO profile that used to be the hallmark of the industry. By thinking more expansively about the capabilities needed in the next CEO, boards will tap into a potentially significant source of executive talent.

Be explicit about the trade-offs — At the time of a CEO transition, boards can fall in love with the idea of a proven CEO candidate who has “been there, done that” as CEO in another E&P company. As a consequence, they can miss the chance to engage in a fact-based review of the company’s specific strategic direction and how a broader slate of candidates may fit the stated criteria. It is particularly important to level that playing field when both internal and external candidates are being considered. The use of external executive assessment, in particular, can help in that process by providing a granular and holistic view of internal candidates’ capabilities and potential to step up to the CEO role.

Align CEO incentives with value creation levers — E&P boards frequently tie financial incentives to some measure of share price performance (usually total shareholder returns) versus peers. While this is conceptually appealing, since every company attempts to outdo its peers and pay at, or above, the 50th percentile, it only accelerates the compensation treadmill for everyone. As a counterpoint, one E&P board we are familiar with chose to move away from the traditional annual long-term incentive model to one structured against specific value creation milestones in the company’s future development. This innovative approach ensured a full alignment of the CEO incentives to shareholder value creation, while avoiding the pitfalls of TSR-based compensation programs.

About the methodology

Spencer Stuart collected and studied the data of the 200 largest independent oil and gas E&P corporations by market capitalization across Australia, Canada, Greater China, the U.K. and the U.S. The study focused on the five-year period from 2007 to 2012. We analyzed the compensation and career patterns of the CEOs of these companies. In addition, for benchmarking purposes, we also collected and studied similar information for the broader S&P 100 and FTSE 100 companies in these years.

The CEO compensation included in this research represents the total annual compensation, which included base salary, bonus (including performance-based stock awards), non-equity incentive plan compensation, option awards, restricted stock awards and all other types of compensation.

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