O&G – Exploration and industry 4.0

In an earlier post [LINK] I briefly introduced the four areas of upstream value chain that could benefit from the 4th Industrial Revolution. Here I put forward some potentially controversial points about how this may (or may not) affect Exploration.

First of all my definition: Exploration is concerned with finding and appraising new deposits of Hydrocarbons trapped under the surface of the earth. It’s the identification of these that I am addressing here, not how (or if they can be) exploited.

There have been many advances made in technology in the previous 25 years that have transformed the process of finding deposits. The two most notable have been around the use of remote sensing through Seismic Data, and the accuracy with which deviated wells can be drilled. Seismic acts like an x-ray into the composition of the rocks, while new wells use precision direction control and combine it with analysis of real-time feedback from rock measurements surrounding the drill bit to let operators steer the trajectory in real-time.

Many of the advances that have been harnessed could legitimately be described as pioneering in the technology of sensing, big-data, simulation and automation. These are the key technologies underpinning the 4th industrial revolution. Exploration got there first.

In my work with small companies seeking investment I continue to see a slew of new start-ups with fancy seismic algorithms claiming to be able to spot even more obscure sources of previously unidentified hydrocarbons. Maybe they work. Who cares?

In my view the major gains from the 4th Industrial Revolution have already been captured in exploration. Perhaps we are close to entering an era of more stable oil prices – driven by: elasticity of supply from shale; abundant reserves released from both tight reservoirs and hydrates; and managed demand through smart technology, electric drive-trains, renewable generation and batteries. So the commercial pressure to find obscure resource pools may have gone.

In the North sea there are over 300 pools of hydrocarbons already discovered but not yet developed [LINK]. So the question is: even if the new technologies are successful will they have a significant impact for operators? I suspect the answer is no.

New algorithms and systems may provide marginal gains around the edges of existing fields and provide additional in-fill development opportunities. They may reduce the number of people in G&G dept 10%. Commodification of techniques (as happened for 3D animation) may see the demise of some companies and job-roles. But I don’t think it’s going to provide a revolutionary impact. Of course, I may be wrong.

If I am right, this suggests that there will be two main opportunities for companies providing technology here – either to provide an “add-on” to the main interpretation platforms (Petrel, OpenWorks) and then sell small numbers of seats to operators in special circumstances, or attempt a wholescale assault to replace the platforms already in place. Neither of these are revolutionary for operators and result in minor cost reduction by pitting service company against service company.

I think the 4th industrial revolution is likely to provide only a small impact on the dynamics of this part of the value-chain. There may be a displacement of revenue from one software vendor to another, there may be some marginal in-fill development opportunities that will add more elasticity to oil supply (and help to further stabalise prices) but neither of those are going to be massive nor revolutionary. I think that the 4th Industrial Revolution gains have been captured already – AI, auto-pickers, attribute statistics, simulations, integration, cloud, geolocation, computing power in the hands of individuals – the main technologies are already in place. Gains from here-on-in will be marginal.

There is one thing that may change my view, however. If this happens it will have a profound impact and swing power towards the national resource owners. If these innovations are adopted at the level of the nation state things may change.

National Data Banks were established in the 1990’s (example LINK) to hold archives of seismic and well data and make them publicly available. These may get a boost.  Cloud technology and on-line AI-based mining-algorithms may change the way that license economics work by de-risking exploration and encouraging competition. If this is combined with a stable oil price there is a potential recipe for reduction in the incentives needed for exploration companies. That could change the economics and the structure of the discover, farm-down, refinance, develop and keep carried-interest process that is used today.

You heard it here first folks…

I’m not normally known for left-leaning political judgement but – just in case you missed it the Scottish Government is being asked to consider a motion to fund public investment in the infrastructure of the North Sea.

“UK OIL would work with the Oil and Gas Authority to identify strategic assets that are potentially profitable. That would help to prevent platforms and pipelines being lost earlier than planned, and potentially help fund new ones for the future.

“We urgently need imaginative thinking like this now – otherwise the oil and gas sector could continue to decline due to lack of investment.”

Here’s the [link]

13 month’s ago this blog published an article which, amongst other points said:

To address this will require restructuring the way that the industry operates. If not outright nationalisation of parts of the network, this – at least – requires more control and probably limited subsidies. For goodness sake – we subsidise the tracks that our trains run on, I can’t see any argument for the creation of economic value there that does not apply to our North Sea processing and export network.

Here’s that [link]

 

 

ITF Aberdeen: Oil 2.5 vs. Industry 4.0

I was at the ITF Showcase in Aberdeen last week. It was an interesting event, if mildly concerning in some ways. Here is the link to the presentations [Link]. The encouraging notes were that there appeared to be some money being made available and that the industry had focussed on key themes around the MER UK forum [link]. Less encouragingly for me is the speed, energy and sense of urgency that was lacking.

I noted that the room consisted of 90% men (often in grey suits) and I reckon 75% were older than 50. So where are all the young people?

I have always been impressed with the approach of Colette Cohen [Link] from Centrica, a strong proponent of adopting technologies from other industries. Despite being a fully-fledged, dyed-in-the-wool oil and gas executive she retains an energy of purpose, nurturing of young people and a curiosity needed to drive innovation. She was on fine form and provided a welcome boost to the enthusiasm of the room while being the voice of reason when asked why wire-guided rockets couldn’t be tested on Centrica wells. Can we have more pioneers like her please?

I am based in London and the innovation and technology events I attend (and the informal networks I am part of here) feel very different. There is an energy and drive in the FinTech and internet sector that appears missing in Oil. Also when I go to events I find plenty of trendy young people brimming with ideas, and there are plenty of women there too (still not 50% but still way better than last week by a country mile). Diversity will be important for innovation. To be successful we must learn to harness the view-points that come from all sorts of diversity: racial, sexual, age, experience, industry, education – and find ways to encourage and shape ideas.

My next post is going to cover some thoughts on innovation, the fourth industrial revolution and what will drive productivity in the next 20 years. But suffice to say it will rely on data and automation, but many speakers [I’ll name no names] took great pleasure in informing the audience that they didn’t believe in the cloud and that they had piles of paper on their desk. When describing new tech there were plenty of references to “if you don’t understand this tech, then ask your kids”. It reminds me of ancient bankers who use fountain pens and a paper diary. It’s not cool it’s deliberately Luddite and crusty and an attitude that will kill our industry. Perhaps it’s time to get with the program or step aside.

One thing that stood out was the problem of accessing markets and testing new product. In my experience operators are generally not too interested in experimenting with new tech, and often their operating philosophy revolves around large frame contracts which means that they don’t really control access to the supply chain. The consolidation of suppliers, the integrated nature of their offerings and the point-nature of new technology development does appear to lead lock-outs and stifle innovation.

The Graph above is from Colette’s presentation. It’s an SPE graph, it shows that Oil and Gas has been great on innovation in the past, and we haven’t had a breakthrough for a while. What strikes me is that since 1946 all the innovation has been in finding or developing fields. My money is on operations and maintenance to join the party. And that will be driven by what the cool kids call “Industry 4.0” [link].

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Headline image Link

Digitally disrupted operations

I have already said that I believe the time is now for O&G operations to become digital. Radically different cost models are going to be needed and digital is one way they will be achieved.

“When assessing the implications, consider the fact that that new digital business models are the principal reason why just over half of the names of companies on the Fortune 500 have disappeared since the year 2000. And yet, we are only at the beginning of what the World Economic Forum calls the “Fourth Industrial Revolution,” characterized not only by mass adoption of digital technologies but by innovations in everything from energy to biosciences.” Pierre Nanterme – Accenture CEO [Link]

For me this revolution started with a computer programme called Mosaic, the first internet browser – which I discovered in 1993 while goofing around using Kermit, WAIS, Gopher, FTP and downloading cool stuff from GNU. I was being paid to generally muck-about and call it work. Since that moment I have witnessed a massive rise in computing power, information storage and interconnectivity that has left me gawping in awe. The chart below, from The New Machine Age, illustrates the trend.

Five Phases of Disruption

I model this disruption in 4 overlapping phases that are well established (each relying on the ones before it to progress) – and we’re about to see the fifth phase make itself felt.

Phase 1: Pure Information Industries

This was the first to be disrupted. It started with libraries, newspapers and advertising. As technology progressed this then disrupted industries requiring higher information capacity (bandwidth & storage) such as music and radio, and is now doing the same for television and cable companies. Bi-directional communication led to the X-Factor, the Huffington Post and any number of citizen journalists and bloggers.

Phase 2: Customer Engagement

As more people started to have access to and use the internet it was a small extension to make commercial transactions and shopping. As this ramped up customer experience of retail, customer-service departments and opened up access to a vast array of diverse products that could never be held in stock on the high-street. Now there are very few consumer engagements that do not have to integrate a digital channel into their offerings. Coffee and haircuts can’t be online – just about everything else can. Even there Starbucks is integrating a digital offering into their coffee order-to-pay process.

Phase 3: Co-ordination and logistics

It started with on-line parcel tracking, cross-docking and behind-the-scenes scheduling algorithms. Adding mobile GPS and mobile data allowed supply chain and logistics to start its transformation. Firstly on the containerisation and automatic freight and now down to warehouse location, stock control and soon perhaps delivery by dedicated drones [Link]. Phases 1, 2 & 3 have combined to give me my Occado delivery today at 12:30 (sharp).

Phase 4: Asset and resource sharing

This phase is still young and we’re seeing it play out in the consumer space first – a reversal I’ll elaborate on later. Companies like AirBNB, Uber, ZIPCar and others. In general this is the idea that Assets are not fully utilised by their owners all the time, and spare capacity can be made available through a brokering and booking service – and then scheduled and delivered.

Phase 5: Machine-optimised operations

Remote sensing, predictive algorithms, human-machine teaming – integrated with maintenance planning (plus all the attributes in phases 1-3) should lead to more reliable plant constantly optimised and operated by fewer people. This phase is being referred to as The Internet of Things.

“The Internet of Things (IoT) is changing manufacturing as we know it. Factories and plants that are connected to the Internet are more efficient, productive and smarter than their non-connected counterparts. In a marketplace where companies increasingly need to do whatever they can to survive, those that don’t take advantage of connectivity are lagging behind.”  Forbes Magazine [Link]

The reversing order of adoption

Sometime between 1992 and now a reversal in adoption sequence occurred. Prior to Mosaic the sequence of adoption was: Military, Big Business, Small Business, and Consumer. There was also a geographic sequence that meant technologies emerging in California took a few years (5+?) to make it to Europe and the same again to make it to Asia. The order has now reversed and the spread of ideas is both bi-directional and super-fast. For instance we’re going to see individuals install HIVE before most plant install remote operations. So I think we can already see the new technologies and ways-of working being successfully deployed for consumers – the question is how will the Oil and Gas industry adapt them for its use?

How could real-time sharing of Oil and Gas assets and equipment be made to work? How could we create an “Oil-Uber” for self-employed drilling engineers? How can we scale-up technology like HIVE, algorithms for maintenance diagnostics, combined with the GPS on a tag like that in my £100 Garmin watch attached to and despatch the most available uber-spare-part.

Of course, innovations will sneak up on us through lots, and lots, of small changes but the effect will dramatic – looking back we will see the change, but it will happen gradually with the companies that use more efficient technologies buying assets from those that don’t – or, more accurately, buying assets from their officially appointed receivers.

Collaboration reduces costs?

There has been a lot of hand-wringing around collaboration recently. For instance Paul Goodfellow Manager of UK Upstream at Shell said companies working in the North Sea need to learn from other industries on how to work together [Link]. Quite which industries he is talking about I’m not sure, also I am not sure what type of collaboration he’s looking for.

Worryingly for me there seems to be a focus on input costs. For instance one quote in the article stands out: “work with the supply chain on how to collaborate and get common purpose whilst driving waste from the system and driving unit costs down”.

When I analyse situations like this with clients I encourage them to take a view on both industry and supply chain, and be clear about the distinction. In Shell’s case their industry consists of other oil and gas operators. MMO companies, Scaffolding providers, helicopter operators and a myriad of other companies are part of the supply chain. They belong their own set of industries. Of course many companies supply services in more than one industry – so I need to consider them both in relation to their “competitors” and their own internal structure.

Here are three ways that cost can be removed:

  1. Industry collaboration between operators – to increase standardisation or share resources
  2. Adoption of new technology and methods
  3. Drive new processes to reduce unnecessary steps

These actions can increase efficiency which I define as the ratio of units of output to units of input. Assuming that output remains constant then efficiency comes from reducing system costs by removing labour or materials. This will increase the profit available for distribution among companies within the supply chain.

Reducing costs within the supply chain does not necessarily mean that Shell will see their input prices reduce – the location in the value-chain where profits are captured is subject to other factors. One model to explain how profit is captured was described by Michael Porter [Link]. Supply chain collaboration is, of course, important to organisations such as Achilles backed by my friends at Hg Capital [Link]. They set out some of their views on the issue here [Link].

In a commodity industry – like crude Oil and Gas production – there is little that producers such as Shell can do to change the selling price of their product (of course OPEC might have a different opinion [Link]). To protect profits producers need to reduce cost. At the moment operators seem to be forming committees to squeeze the supply chain. They are also laying off employees to cut overhead. I don’t see any action from Operators to collaborate with each other to reduce their own structural costs. Claims that they are seem to be a joint-ganging-up to encourage the supply chain to collaborate and reduce prices. That’s different.

Oil and Gas UK have stated that the North Sea needs to reduce costs by 40% within 5 Years or face very tough times indeed. Stephen Marcos Jones, Oil & Gas UK’s business development director, said: “Companies are having to make tough decisions on their capacity during the downturn and are individually taking measures to improve efficiency. However, co-operative working across the industry … can also help deliver the cost and efficiency improvements required to secure a long-term future for the UKCS.” [Link]

This quote from the Shell article highlights the inefficiency in buying within a single operator:

One very enterprising supplier came forward and said we’ve got a great piece of quick erecting scaffolding, but we don’t understand why you haven’t been picking it up. The reason was because they were trying to work at various front-line levels of the organisation and it wasn’t important to one individual, because they didn’t know the totality of what we were spending on that service. When they came in through the strategic contracting team and demonstrated to the facility managers and made the decision there and then and we’re in the process of deploying it across every facility and rig we have in the UK sector.”

I feel this is an example of an operator missing new technologies due to their internal bureaucracy and inefficiency. My clients can tell me about literally hundreds of examples of this type of behaviour. The reality of course is more complex. When I ran the technology investment process at a major operator I found that the cost (and risk) of scaled change was such that it can easily outweigh the demonstrable benefits delivered from a new technology. Therefore this type of change can be slow and the results can be counter intuitive.

So in summary to drive out costs we must answer the following:

  1. What time scale and magnitude do we need to work to (some are long-term structural and will take many years to deliver, other are tactical and can reduce Op-Costs quickly)
  2. What can we do to reduce the cost within the supply chain, and how will we ensure that those costs flow to the prices we are charged?
  3. What can we do to reduce costs within our industry by collaboration and standardisation
  4. What can we do to reduce our individual costs by simplifying what we do, eliminate unneeded activity and increase work-rates?

Of course, as you would expect, the professional services firms have opinions on this. Their approach and advice is nuanced and reflects many of the same themes. Some of what they are thinking can be found here: PWC [Link], Deloitte [Link] and [Link], EY [Link], Bain [Link] and KPMG [Link].

Incidentally the word-cloud image at the top of this post contains many of the words I’d expect to elicit from a group of oil executives. It comes from VOTE – an organisation based in New Orleans – the Voice of the Ex-Offender. It is a grassroots, membership based organization founded and run by Formerly Incarcerated Persons (FIPs) in partnership with allies dedicated to ending the disenfranchisement and discrimination against of FIPs. [Link]. Goes to show that many of the issues that surround collaboration are human ones and not things specific to our industry.

Private Equity Buying O&G Assets

With the INEOS deal completing I cast my mind back to 2014. It was rumoured then that over 75% of North Sea assets were for sale, but questions around ability to shoulder decommissioning liabilities and inability to agree on an oil price stifled deal making. Prices are depressed but major operators wish to raise cash and stifle outflows the interest for private equity investment is increasing. Managers such as Bluewater Energy [Link], Riverstone[Link] and many others are said to be considering deals.

The Financial times reports that this month’s redetermination of reserves in relation to asset-based lending is unlikely to cause havoc [Link] but it may accelerate deal making.

I recently asked a senior partner at a well-known advisory firm what he thought would be different with private equity arriving. He pointed out that the PE players backed management teams – such as Siccar Point, Fairfield and others. He thought that these management teams might be surprised about the amount of data and “proof-points” that the PE backers would require, he also reflected that some management teams would be used to working within large corporates with in-house teams they can mobilise. They will now have to find providers they can trust and who are credible in-front of investors.

The known model of exploration and farm-down during development is now giving way to a new world where valuations are determined using a DCF model and a decommissioning cost. There are no proven rules-of-thumb here now. This means that investors are more cautious doing deals in this context than before. It does appear odd that in a business known for taking investment risk on exploration there is almost no appetite for assuming risk or unknown in this investment stage.

Another advisor at a large accountancy firm noted that very few companies operating in the North Sea were likely to make a profit any time soon (not only because of tough trading conditions, but also because they have various offsets and other tax-shields). This means that decommissioning offsets and other tax-carry forwards are of little interest to them – this might suggest that either a change in the rules is required or that sale to a profitable entity could provide differential value and hence facilitate win-win deals.

Shell recently announced its opinion that oil prices may spike upwards soon [Link], that may be music to the ears of financial buyers. If this is the start of deal-making season it will be interesting to see who the players looking at acquiring assets are. Will it be PE backed new Co’s, will it be established late-life operators like Enquest, or will assets be acquired into existing profitable entities to enable tax optimisation.

INEOS, Small Fields, Politics and Tie-backs

Political intervention can swing both ways.  Political intervention in the L1 acquisition of DEA assets has enabled the INEOS deal announced today [Link]. This sees Jim Ratcliffe enter into the Upstream business with an opportunistic deal to buy assets reluctantly removed from the DEA portfolio [Link]. INEOS previously looked to be moving into shale developments in Scotland [Link] – the logic of vertical integration to supply his other assets is compelling. The shale move was stalled by the Scottish Government [Link]. Plus Ca Change, Plus C’est la meme chose as they say in the French Speaking regions around Lake Geneva where Jim’s HQ is located.

Perhaps Jim may consider lending his political influence to influence the debate over offshore developments – an area which is controlled by the UK goverment not the whims of the Scottish Parliament.

Perhaps he will point out the difficulty faced by new developments of  a small offshore oil-field which must find a way to process and transport the fluids to where they can be used. One way is to hook up to old platforms – many of which are now operating below their design capacity. As fields age production rates decline and this means platforms and pipelines built to support them become underutilised.

However, oil price declines means pressure has mounted to decommission the infrastructure that supports some of this production in the North Sea. For example Alex Mitchel [Link] says that he believes that the current fundamentals will lead to significant growth in decommissioning activity on the UKCS. He adds that operators are under increasing pressure to reduce exposure to high-cost regions, and remove decommissioning liabilities from balance sheets. Without traditional sale routes, operators will increasingly make strategic decisions to push forward with asset decommissioning. Advantages for first movers are evident, with the opportunity to avoid constraints in the supply chain, and take advantage of suppressed rig rates for P&A.

I asked a member of the Bestem Network who negotiated the commercial terms of some of the recent marginal developments what he thought. He told me that an FPSO option is often chosen not because it’s best, but because it increases control and reduces uncertainty. Tie-backs would be better but the modest initial tariffs can quickly change to become uncontrollable cost-sharing agreements.

FPSO’s require a certain volume to work effectively so they will inevitably not drain fields as fully as other options. Other fields will never produce enough to make an FPSO a viable option.

Once key infrastructure is gone, it is gone for ever. It will never be replaced. We have to act now if we are going to save this national asset.