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.

Energy security and geopolitics

This big topic was brought to mind during a recent breakfast with Capt. Mike Paterson (Royal Navy retired). In the oil and gas industry we are often at the mercy of large political forces playing out. This shows up in both commodity prices and physical security. Employees of few other businesses are as acutely aware of this as they are in Oil and Gas.

You don’t need me to tell you the current oil price nor the speculate about the reasons, but it is clear that there are national interests at play. Is Saudi Arabia waging a price-war to drive unconventional sources of production out of business? Is there some form of cross-state agreement to undermine the Russian position? Are there ulterior motives for allowing Iran back into the market? What will be the effect on South America and African politics? What will the destabilisation of Iraq and the Levant states mean?

Here is interesting view: CNBC saudi’s and Russians game of bluff.

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While it is interesting to ruminate on what the price will be, there is really nothing that I (and probably you) can do about it, and predicting which factors will combine with global economic growth and low-carbon technologies to influence Oil prices is something I’m not qualified to talk about. When I need to find an opinion my first port of call is my friend Delia Morris who is now with RigZone.

There were many theories around why OPEC (namely Saudi Arabia) would [refuse to cut production]. I am of the opinion that it was to make better sense/better predict the behavior of the US shale players (force them to consolidate, not necessarily to put them out of business). Frontier plays (like the Arctic and ultra-deepwater plays) and Canadian oil sands (which require huge upfront capital costs) I think were targets (by OPEC) to forcibly put them out of business. And we are seeing that play out now. Delia Morris quoted in Vice.Com [Link]

 

When Mike Paterson gave a talk on security at one of last year’s networking dinners, he provided a simple framework that every business can use to structure their thinking about emerging threats.

Where this really matters is for security of workers and assets within countries. That’s where the Oil and Gas industry and national security agencies start to align interests. There is are very intriguing analysis sets available from the military which provides many insights, this for instance:

The Baltic Sea is one of the busiest shipping areas in the world; the volume of maritime transportation navigating it has doubled in the last 20 years. Energy shipments from Russia are particularly important and the entrance to the Sea, through the Danish Straits, is one of the world’s eight strategic oil transit chokepoints. The Nord Stream gas undersea pipelines from Russia to Germany are also an important strategic element in the BSR. Energy dependencies within the BSR vary, with nations having different strategies, and most importantly, varying degrees of dependence on Russia. It should be remembered that the Russian economy is reliant on the energy market. Significant reductions in demand may, therefore, have a major effect on its economy, and potentially have a destabilising effect on regional security. “Future Security Challenges in the Baltic Sea Region” [Link]

There is a very thoughtful piece by Anusar written under the pen-name PolicyTensor which is available here [Link]. In this piece written in 2012 concerned why prices were so high, interesting to re-read this in the light of the current prices.

Oil prices will be volatile but your business may not be directly driven by them, you might be driven by the response of your customers – their response may be driven by technical or revenue-maximisation considerations – or, quite likely, financial constraints which drive decisions that do not maximise economic recovery, but do protect equity value in the face of debt covenants.

Watch out though – Mike Paterson alerted us to the correlation between grain prices and the Arab Spring. Perhaps low petroleum-state revenues will lead to reduced public spending which might lead to popular uprisings and increased instability. Unstable times ahead.