Friday, November 28, 2008

Bloomberg is reporting

A little off topic but the scope of the economic difficulties is coming into focus. Bloomberg is reporting the Fed and Treasury are prepared to provide unlimited financial resources to the market to offset the threat of deflation. If you have read the Preliminary Research Report that I wrote in May 2004 I expressed a concern that if left unchecked, the economy could slide into a deflationary period that would be particularly brutal. It would seem that the Fed is in agreement that this must be avoided and is willing to spend up to $7.4 trillion to eliminate the risk. 

Are we not pushing on a rope? Having the value of money erode in the market is one thing. Having the governments contribute to its further erosion by dropping interest rates and bailing out potentially failed organizations just seems wrong. People need higher interest rates in order to encourage savings. The more logical solution to this problem is to get people motivated to invest by giving them a decent return for the risk they are taking in their investments.

We can generally agree that the source of this problem was the low interest rates of the early part of this decade. (See my entry on mis-allocation of capital.) When capital provides little to no returns, with high risks associated with those returns, money is considered cheap. If money had a cost, would it not allocate financial resources to the projects with the highest return. When money is worth little investments have little to compete with. When the government guarantees every and all transactions, a sloppiness in the capital allocation process starts us down the road to moral hazard. 

I know this is contrary to current economic thinking but I have to ask are we only making this problem greater by further diluting the already sloppy capital allocation that has been carried out? It seems to me to be the case.

Our current policies of expansive money supply were created in the great depression. They are assumed that these are the means in which to have the economy return to a normal operating environment. But is this assumption, which is based on the lone event of the great depression interpreted incorrectly? Stuffing the banks full of cash does not make them want to loan it out. Handing money to consumers does not make them want to spend. What motivation is there to take a risk?

One unforeseen consequence of this over-stimulated economy is the demand for energy was obviously significantly overstated. The current price declines are a reflection of the influence of deflation in a market and the long term capital deflation appears to be right around the corner.  To make matters worse, the decline in reserves and production are only exacerbated by the energy industries long term capital projects being shelved. How many times have we seen these big projects stopped and never return. It will be a gutsy investor who stands up and says their building a new offshore drilling rig. Making our future production horizons even more constrained.

There are serious distortions being introduced into the marketplace for energy. I think the dynamics of the industry are accelerating at a pace that many of us, and certainly myself, are only now realizing how fast paced this environment is. One last link to Bloomberg shows them suing the Fed in order to determine if the Fed has made an unannounced change in their policies and are targeting inflation; to eliminate the deflation by flooding the market with "printed money." If we already have the recession, why doesn't the Fed invert the yield curve to force the market interest rates to rise. Throwing cash around in a panic is only making everyone nervous.

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Thursday, November 27, 2008

The three Applications of the Preliminary Specification.

I thought that I would mention the design of the three applications that will house the modules of the Preliminary Specification. These three Applications have been determined to be the applications that the users, the producers and the Joint Operating Committee's will access. Essentially different views of the data, different views of the modules and different application processing contained within each Application. Each Application will contain different perspectives of the different modules as defined in the recently completed Draft Specification.

This work of identifying the Applications needs to be done in the Preliminary Specification and is a critical part of the People, Ideas & Objects deliverables. I have left the design and development of these modules to the greater community, as it is the community who will be best able to design these applications. The remaining work that needs to be done is too comprehensive for one individual to comprehend, understand and implement. Recall the budget, which has not been finalized, may contain the B, as in Billion dollars of development costs.

My role, as I have mentioned before, is to remove myself from any further design and development of the applications and modules. This is for my own sanity and the fact that I could really end up getting in the way with a number of my own preconceived notions that don't have any bearing on the performance of the innovative oil and gas producers. I have committed myself to ensuring that the resources and needs of the community are provided for the business end of these software developments.

I have a sense, and I have not done any research in this area, that the design and implementation of these applications will need to have significant research and development of new and unknown attributes. Just identifying what these attributes are will be a difficult and exciting area of research. I am calling for 100 individuals to participate in the Preliminary Specification. Researching the Applications will be a critical area where I suspect much value can be added. Please, join me here.

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Wednesday, November 26, 2008

The next 30 years.

I frequently watch the video's from for the surprisingly good content contained on that website. Think of it as the YouTube for the thinking. It is a compilation of videos from a 115 governments, institutions, universities, and leading publications. One can be lost in the sites content for weeks.

I was watching an Australian Broadcast Corporation (ABC) broadcast of Rupert Murdoch, Chairman and Chief Executive Officer of News Corporation. His Boyer Lecture entitled "A Golden Age of Freedom." During the broadcast he states in the next 30 years the world will welcome an additional 2 - 3 billion people joining the ranks of the middle class.

I am an optimist, although my recent rants on the economy may make it seem that I am pessimistic, I can assure you that there is nothing further from the truth. As I mentioned yesterday, the future holds new disciplines, new opportunities, new ways of organizing and living in a far better world with a much higher quality and quantity of life.

I leave you with the thought as to what the world will be like in 30 years. With a design of the People, Ideas & Objects Application and Modules fully operational in the marketplace for many decades, how the energy industry will have developed. The work that is being done in physics, nanotechnology, computer sciences, bio-chemistry, robotics, space and many other areas. Conducted on a global basis with the greatest possible number of people living a middle class lifestyle.

Our one impediment to making this happen is the ways and means of how we have achieved what we have to date. The bureaucracy or its more antiseptic name the structured hierarchy is the reason we are being held back. Change is violent and upsets too many things to be undertaken in a constructive manner. We know we should have moved away from the bureaucracies many years ago. The reason that we didn't is that bureaucracies still provided enough value as to not attract the necessary attention to there inefficiencies.

Now we have entered a time in our lives where everything happens so quickly. Our organizations, which can not accommodate any change, especially at today's pace of change are failing. Failure is what eventually happens, and we see that failure happening in business today. And we should welcome this change and move to the new forms of organization that will optimize the next 30 years. Please join me here in designing and developing these applications.

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Tuesday, November 25, 2008

McKinsey Power Curves

This article discusses the distribution of an industry dynamics. An interesting topic that I have not studied too much of in the past. I think, as the author of the article asks, there are implications here that may need to be discovered.

In the Preliminary Research Report I discussed the performance of then laggards against those of higher performance oil and gas companies. I used Revenue Per Employee as the manner in which to determine these firms performance. I then discussed the ability of laggards to catch up to higher performing firms; and noted the ability to do so was almost impossible due to a the following two factors.

  • Influence of the firms asset performance based on its historical cost, infrastructure and industry distribution. Noting that putting lipstick on a pig makes no difference to the pig.

  • Secondly the ability to catch the leaders is difficult. Today I would suggest that the Chinese have a long and very hard climb to match the growth and performance of the U.S. economy. And that is the same type of difficulty that firms face in each industry.

It is possibly ironic that the high performing firm that I used in the Preliminary Research Reports analysis was none other then our stellar pig, Canadian Natural Resources Ltd. How times have changed. And it is in that example I think I have found that the dynamic of change is not so much in the hands of those that want to challenge the established leadership, but in the hands of the leadership to make the big mistakes. CNRL has proven they have the capacity to ruin what was considered a leader in the Canadian oil and gas industry.

The McKinsey author closes the discussion with the following quotation.
Unlike the laws of physics, power curves aren’t immutable. But their ubiquity and consistency suggest that companies are generally competing not only against one another but also against an industry structure that becomes progressively more unequal. For most companies, this possibility makes power curves an important piece of the strategic context. Senior executives must understand them and respect their implications.
Clarifying the nature of how industries change. And this is where I see this situation becoming doubly dangerous for those that are active in any industry. Your ability to compete has little to do with the competition. Focusing on the competition will provide you with products that look and perform very similar to what GM produces. The need to pursue your own strategy of how you will optimize the performance of your assets should be in the forefront of your companies focus. The risks are associated with the mitigation of tangible and intangible threats to your firm, and the upside is through optimization of your opportunities. But is this optimization and mitigation able to provide the firm with any ability to sustain a higher performance "Power Curve"? This question also takes on needed and important discussion about the role of re-organizing the oil and gas producer on the basis of the Joint Operating Committee (JOC).

The first implication that I see in applying Power Curves is that doing nothing becomes one of the most difficult and dangerous strategies. We have all used the do nothing alternative in most of our decision matrices and that is not what I am talking about here. But doing nothing from the point of view of not taking the enhanced risk in this high paced change business environment.

It may have been prudent to sit back and wait until the competition in your industry to explode and you reap all the rewards. However, that is not what I am thinking of in this discussion. What I am thinking is the pace of change will render a status-quo strategy to the dust bin in the quickest time frame. A company must be actively attempting to move up the Power Curve in order to ensure they are progressing.

If we think about the times that we live in today. It is easy to see that we are heading into a time period where man will progress the furthest and fastest. In the next 50 years, biology, physics, chemistry, bio-chemistry, molecular biology, economics, robots, computer performance, software capability will fundamentally change society. Not one of these scientific categories is outside the realm of the innovative oil and gas producer.

How can a firm sit and watch what is historic in terms of discovery, almost every day. Clearly the ones that will win in the future will be those that are able to match the demanding changes that society will dictate. Look closely at the environmental movement and I think we begin to see the societal demands of our organizations accelerating. Can China continue to asphyxiate their population in the long term? Of course not, but they appear to do very little about the problem. Therefore how long will China be able to compete?

I take great pleasure in highlighting the failures of the companies highlighted in the piggy series of blog entries. Considering the scope of the discussion in this entry so far, it is easy to see how the greed and satisfaction of oneself has become the prime focus of companies today. Is this sustainable? I'm not sure, either way. Should we wait and see if today is the time in which we should have acted? Of course not. You don't wait until you can determine if someone is going to get themselves out of a burning building. You do everything possible to get them out. And like Treasury Secretary Paulson's failed TARP program, without trying, you'll never know if it worked or not. This is a key discovery, just as if the TARP program would have worked beyond everyone's expectations.

These are the dynamics that we face in the business world today. I suggest we critically analyze the performance of the oil and gas industry based on these metrics. I fail to see how the structured hierarchy and their bureaucratically identifying and supporting relatives, SAP and Oracle, can be expected to exist in this future environment. Please join me here.

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Monday, November 24, 2008

Two groups who need People, Ideas & Objects.

AP is reporting that the large and small producers in the oil and gas industry are experiencing some systemic difficulties. The large producers are able to generate large cash flow, and indeed have large bank balances. However, recent declining and negative reserve trends are now causing their production to decline. These accelerating decline curves are a direct reflection on their ability to find and produce more oil and gas.

On the other end of the spectrum the small producer is challenged by the inability to generate or raise any cash to begin to address their growing needs. This of course is as a result of their small asset base and the current low oil and gas prices. On the positive side, reserves are able to be increased at will. The reverse of the situation of the larger strata of the industry. To me this is not news, but a reflection on the way things have operated in the industry for many decades. The scope and severity of the problem comes down to the large producers declining production profiles.

Another issue that the entire industry faces in the short term is the size of the asset write downs caused by the today's lower prices. Based on the prices of the commodities it is fair to assume that producers were able to capitalize 100% of their costs associated with exploration and production since 2004. These costs are now subject to the auditors testing of value, based on the reserves. Potentially we may see the industry reflect large losses on their write downs to fair value.

Over the past 20 years the small producer has struggled to keep the doors open. Just as many small enterprises in other industries experience. Testing the risk profiles of small producers would result in the conclusion they are at stratospheric levels. Leading to the skill and courage of the investors and management, just to survive. Small producers have the inability to provide any returns for their investors for many years. The simple act of building a producer has to consider the many millions of dollars needed to increase the production profile. Many of these millions go to the simple act of keeping the lights on. The overhead of the firms is notorious for getting in the way of the investors expectation of receiving some value from the firm. Granted their will always be the capital gains that the investor could make over the life of building the firm. But their capital gains are not that spectacular and they should expect and receive more of the value they provide.

I have always marveled at the discussions that are made around the companies reserve reports. Reports on the field activities that have no concept or consideration that those operations have to support the administrative and management of the firm. In a public company this discussion takes on a much larger concern as the overhead costs of a public firm push the administrative costs well beyond what is possible for the management of the firm from an engineering and earth science point of view. The Private Equity movement that began in the last decade is symptomatic of the huge compliance and governance costs that a small public producer has to offset before there is anything left for anyone else. Please review the Compliance & Governance module of the Draft Specification for further information in how the compliance and governance is handled.

How is it that People, Ideas & Objects can help in this area? From the perspective of a large producer I see the problem as an issue of focus. The firm needs to simplify their strategy to something that will make money for the shareholders. This blanket strategy may not be appropriate for all of the properties or Joint Operating Committee's (JOC's) they have an interest in. (I attribute this as the source of the firms lack of "focus.") To say that there is conflicting strategies of the producers representing the JOC is obvious, and one of the sources of how problems get resolved is through identifying and resolving these contradictions and conflicts.

One of the advantages of moving to the People, Ideas & Objects system is that the JOC is able to set the strategy irrespective of the individual producers "global" strategy. Enabling each and every JOC to be optimized for their best operating and performance strategies and tactics. Providing the much needed focus that the large producers can not find. This strategy optimization in the JOC is a direct benefit of aligning the legal, financial, operational decision making, cultural and communication frameworks with each of the producers compliance and governance frameworks.

The banks, investors and money markets may have an interest in the producer or the JOC itself. Securitization of the individual interests in oil and gas will be necessary to fully optimize the innovative stance and increasing reserves of the industry.

Therefore the mix of producers in the JOC will help to mitigate the producers size issues for the entire industry. The large producer can partner with the smaller producers to balance out the needs of the property. Recall that the Partnership Accounting module in the People, Ideas & Objects system is based on the contributions of the individual firms represented. If a firm has a specialty in a certain regional geography, it can then agree with the partnership that the costs of those specialties goes towards satisfying some of the commitment from the company to secure their interest. In other words. The small and large producers are able to earn their interest in the property through their contribution of capital, expertise and / or land position on an all in valuation basis. If a geologist were to prove their value in the marketplace by finding commercial volumes of reserves. Then their ability to secure elements of the interests in the producing assets he / she is directly involved in creating.

The last point of the previous paragraph violates the first order of all oil and gas managements oath of allegiance. (I'm trying to be funny.)  Recognizing Intellectual Property (IP) is the exact opposite of the situation that exists in the energy industry today. Particularly the large firms do not want anyone to hold any form of IP as it conflicts with their needs to find people to employ and is (incorrectly) believed to be a leakage of value from their organization.

This is the 21st Century. We have the manner of all economics being re-aligned on the basis of new and more effective organizational structures. Those that believe in the bureaucracy, of any industry, are effectively being cut down to nothing in this market. The current economic climate is the same situation that affected the Former Soviet Union in 1989. The methods of organization could no longer sustain the demands of the people and failure was the result. Our system of organization has reached its limits of growth based on the bureaucracies inefficient efficiencies.

So the sooner we say good bye and good riddance, the sooner we can achieve the multiples of our current standard of living. As Jonathon Schwartz at Sun Microsystems says, you have to stop to change direction. These points are addressed in the Resource Marketplace and Research & Capabilities modules. If we expect to deny people the rights they earn in thinking through the big problems of how we can solve the oil and gas industries problems, then we are eliminating ourselves from the entire economic equation of the future. Our choice, and those that don't want the People to hold the trademarks, patents and copyrights should research which way is the best for the oil and gas industry to continue. We're going this way.

This issue is also addressed in the People, Ideas & Objects system. The competitive advantage of a producer is their physical producing assets, land base and scientific and engineering capabilities and capacities. Ownership of the capabilities and capacities, (the current situation) I don't think provides the industry with the value they think they attain. Building huge, mutually exclusive capabilities in each and every producer has increased the level of redundancy in the industry to a ridiculous level. Note also the large producers effectiveness of using these capabilities and capacities in finding and producing oil and gas. People, Ideas & Objects is the better way.

The producer who researches, develops and manufacturers their own drill bits is at a distinct disadvantage to the other producers who have manufacturers providing drill bits based on a collective need across all producers. I don't see too much difference in this example from what a firm is doing today with their geological talent. The alternative is hiring from a pool of highly qualified and talented scientists for application to a specific issue in one JOC. This has advantages that are directly beneficial to the future oil and gas producer. Once the geologist has completed their work, there may be no more work from that JOC in that area for his specialty again. He will have to keep thinking of how better to get the oil or gas out of the ground, (his job) which will form the basis of his new, and far more valuable to him, IP. Why employ him for 35 years and promise a retirement benefit that Wall Street will only take away from him.

The most effective change that the People, Ideas & Objects system provides the industry is an alignment to the cultural basis of the business. The JOC is the business, and the business is the JOC. Recognizing these facts in the IT that identifies and supports the JOC is a necessary realignment of the industries interests. A realignment that will fuel the innovation and further development of the critical sciences that are underlying the business of oil and gas.

With respect to the large and small producers that I started in this post. The alignment removes the conflict that the industry has with the development and ownership of Intellectual Property. It enables the large producer to use their cash flow in a manner that is more consistent with the needs of their JOC's producing properties. And the small producer has the ability to sell more of the talent and capability that is a necessary part of the industry makeup to financiers and investors. Both sides appear to me to be winners.

From the investor point of view, the fact that the systems will be supported through the levying of a fee on the basis of $ / BOE / year means that the larger producers will be paying the largest part of the freight in terms of the People, Ideas & Objects software development costs. Producers that are small and have no production would be use the system for free and have the Community of Independent Service Providers, that are a key part of the People, Ideas & Objects community, available to help mitigate the large associated costs of running a start up oil and gas concern. Please see the Compliance & Governance module for further clarification of how this is implemented in the system. And recall, that ideally the investor is the one representing the ownership interest of his / her share at the virtual JOC table.

Now is the time for these ways and means of operating be adopted. What we are witnessing is economic history. Producers MUST become more efficient and begin the process of rebuilding the industry from a more efficient and effective means of organization. To say the industry is collapsing is best reflected in Canadian Natural Resources Ltd impending demise. Please join me here.

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Friday, November 21, 2008

The New Economics of Computing.

Professor Nicholas Carr is a Professor in the business faculty at Harvard. He is probably most famous for his controversial article "IT Doesn't Matter" and the follow on "Does IT Matter, an HBR Debate". June 2003. Since these publications he has written a few books on the topic of IT and writes a blog about the way he sees technology and technology trends influencing business.

He has been talking about the implications of "Cloud Computing" and what the paradigm change means to business, both technical and other businesses. In his recent post he makes some comments about the significance, and an example of how cloud computing does provide real value. (Recall the People, Ideas & Objects application will be accessed through the "Cloud Computing" method.)

My favorite example, which is about a year old now, is both simple and revealing. In late 2007, the New York Times faced a challenge. It wanted to make available over the web its entire archive of articles, 11 million in all, dating back to 1851. It had already scanned all the articles, producing a huge, four-terabyte pile of images in TIFF format. But because TIFFs are poorly suited to online distribution, and because a single article often comprised many TIFFs, the Times needed to translate that four-terabyte pile of TIFFs into more web-friendly PDF files. That's not a particularly complicated computing chore, but it's a large computing chore, requiring a whole lot of computer processing time.

Fortunately, a software programmer at the Times, Derek Gottfrid, had been playing around with Amazon Web Services for a number of months, and he realized that Amazon's new computing utility, Elastic Compute Cloud (EC2), might offer a solution. Working alone, he uploaded the four terabytes of TIFF data into Amazon's Simple Storage System (S3) utility, and he hacked together some code for EC2 that would, as he later described in a blog post, "pull all the parts that make up an article out of S3, generate a PDF from them and store the PDF back in S3." He then rented 100 virtual computers through EC2 and ran the data through them. In less than 24 hours, he had his 11,000 PDFs, all stored neatly in S3 and ready to be served up to visitors to the Times site.

The total cost for the computing job? Gottfrid told me that the entire EC2 bill came to $240. (That's 10 cents per computer-hour times 100 computers times 24 hours; there were no bandwidth charges since all the data transfers took place within Amazon's system - from S3 to EC2 and back.)
My experience with "Cloud Computing" has involved renting processors on Sun Microsystems and Amazon's Web Service offerings. You should set up an account on one of these services to understand the full scope of the power that is offered to the user. If you have a processing problem that can take 100 hours of processing on your computer, hoisting it up on one of these services will not only allow you to process the problem far more cost effectively as Professor Carr points out. But you would also recieve the results for this 100 hour job within a matter of minutes. To me this was the intoxicating aspect of cloud computing.

Go ahead and try one of these web services. If you need help figuring out what type of problem to solve, use this Princeton University book. (Download the first chapter, its free.)

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Thursday, November 20, 2008

Why at $3.27 it's a buy.

Sun Microsystem stock at today's prices represents the easiest and most cost effective manner in which to make money. At $2.42 billion (Friday November market cap, the company is trading below its cash value. And this post is to show how far they are ahead in providing the types of services applications such as People, Ideas & Objects need.

I have specified an architecture of Sun technologies for the People, Ideas & Objects applications to be run in. (See the July 2008 post here.) Sun has published a white paper that captures the extensibility and flexibility of their products in terms of how the can be configured. For those that are technically challenged I would skip this post now.

Downloading the .pdf is available to those with a Sun account. The configuration discussion talks about the performance and configuration advantages available for the deployment of GlassFish on Solaris. Making the post I made in July 2008 look like the optimal solution that Sun has to offer. This is why Sun will make money in the software future. No other vendor can provide our application with the support and low licence costs. Running GlassFish in some of the configurations using IBM and Oracle would be prohibitively expensive. Not so with Sun.

So their choice was to ensure the developer and user of their software services were able to operate their technologies in the optimal configuration without first having to bankrupt them. Taking the hit in current revenues for the long term. In today's myopic market of this quarter Sun doesn't fit in. In this go forward environment Sun and Apple are the only two companies that I can see making money in the future on technology.

The only change that I would make to the blog post in July is the need to build our own data centres. Using provides us with the resources of a service based offering of processors and support. Processing is too critical a resource not to be under our influence and control. With the majority of the support for our data centers remaining with Sun.

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Wednesday, November 19, 2008

"Almost" two down and two to go.

Management of the Piggies, our nickname for Encana, Canadian Natural Resources, Nexen and Petro Canada have had a really bad quarter. Since July of 2008 when they had $3.3 billion of "in the money" stock options, they've lost a bit.

First it was their options which quickly evaporated when the market meltdown started its Tsunami like roar. Now it seems to have turned more personal. First was Charlie Fisher to announce he is leaving Nexen as its CEO. Now the focus seems to be on Petro Canada.

Our local paper The Calgary Herald is reporting that the "Fort Hills" heavy oil project operator, Petro Canada is now "deferring development". But that's not the key point of the article. (If you listen carefully you can hear the ghosts of Arthur Anderson's staff using their shredders.) It seems some people who own Petro Canada are not particularly happy with the management, stating:

Part of the stock's downdraft Monday was due to oil prices falling to their lowest levels since January 2007, but another reason offered for the absence of market support was a lack of confidence in the company's management. The most-often asked question among the investment community of late-- behind closed doors, of course --has been around when the company's chief executive, Ron Brenneman, might be stepping aside.
So lets mark this one as a "half way" through the door. Careful guys don't let the door hit you on the way out. Leaving us with only Encana and Canadian Natural Resources. What's that saying about the bigger they are the harder they something or other. Lets predict that CNRL is the next to loose the top echelon of the firm. Remember, they thought strength in numbers would provide good cover when things got hot. But with 45 different individuals with Chief or President in their titles, it just might be best to get a forklift.

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Tuesday, November 18, 2008

And the transition begins.

Creative destruction in its purest form is beginning to operate in the oil and gas industry. I'll start with the destruction aspect of this phrase. The transition from the structured hierarchy to the new science based producers has begun. In Canada we have the majority of oil and gas companies failing. This will become more and more obvious in this next phase of the market meltdown. The preliminary symptoms of the transition are evident today. Here is the CEO of mid-sized producer Anderson Energy Ltd.

"We have seen significant, unprecedented changes in capital, equity, commodity and currency markets in the past few months and ongoing concerns about the global credit crunch," said president and chief executive Brian Dau in a note released with third-quarter results.
As a result of these events Anderson Energy is reducing its capital expenditures, and financing some of the remaining expenditures through the sale of some properties. Expect to hear a lot of companies beginning to do these types of things for the next two years. As these firms continue to slide in their organizational performance, aggravated by the decline in commodity prices, producers are faced with the ultimately difficult decision of what to sell to make the next quarter.

The creative part will come into play when the new and innovative science based producer will be able to purchase these assets at very large discounts. Comparing the metrics of the bureaucracy to the performance metrics of the innovative oil and gas producer will make the assets far more valuable in the hands of the innovative producer. Innovators will be able to purchase these assets based on the poor performance of the property. Turnaround the property and make the asset more valuable through applying new science and ideas to the property.

Recall the competitive advantage of the innovative, scientific based oil and gas producer is in their land base and their technical capabilities. Having anything more in terms of an in-house capability should be considered overhead. These firms are defined and supported through the software we should be building here to ensure this transition is conducted in the most positive manner.

Clearly I don't expect any existing producer will want to use this software to run their organization. They have made it clear they don't want anything to do with the changes that are implemented in this new way of operating the industry. Which is fine, theirs is a road that ends quickly in a brick wall. Nonetheless the ability for these firms to hang on by implementing this software I don't think is possible. Therefore they will cannibalize themselves in a very short and desperate process.

And in related news, Penn West Energy Trust also made news as it's the largest royalty trust organization of the Canadian industry. It too is having financial challenges that lead the management to state:
"With the number of opportunities that everybody anticipates coming up in the next little while, the key is going to be discipline and maintaining focus in terms of what our acquisition appetite looks like," Foulkes said.
Even having the CEO going out as far to say the following:
"I don't want to hang my hat on any number," chief executive Bill Andrew said during a conference call. "But we wouldn't continue to operate in a position where we were borrowing money from the bank to distribute to the shareholders."
I'm sure their shareholders are enlightened by their CEO's assurances. If these producers are in such need of capital. After several years of high prices, and are unable to survive without cannibalizing themselves, you know that the transition is near. Particularly when it is someone who has been able to successfully put together companies in the range of multi-billion market capitalization's such as J.C. Anderson has done in the past. Cutting at a critical time as this is obviously the wrong thing to be doing. You can not change the spots on a Leopard either.

If you find yourself in the position of being severely affected by the market meltdown. I would be pleased if you gave some thought to joining this project. I am looking for 100 people to take the Draft Specification and enhance it to the level of the Preliminary Specification. This is a ground floor opportunity for those that may find they have lost a lot, and don't know where to turn in the future.

I believe the only sustainable competitive advantage for an individual is to have some Intellectual Property owned or accessible. Such as this project is. This is the key value proposition that an individual has to offer a producer. I would encourage you to review this blog as much as you need, find an area where you are familiar and have some ideas on how to improve these areas in the application. Please join me here.

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Monday, November 17, 2008

Transparency & Accountability = Software

Reference readings to the BBC and the Wall Street Journal.

News from the President of the U.S., George W. Bush is that the G20 have made 50 recommendations to deal with the economic meltdown and make improvements. In a Wall Street Journal video he states:

Transparency is very important, so that the investors and regulators are able to know the truth.
And there you have the issue and the solution. In a related posting I suggested that accounting rules for "Mark to Market" should be maintained to ensure what transparency that had been achieved is maintained. As it stands I could not tell you the results are of those discussions in making those changes. A reflection on the the lack of understanding of the source of this issue.

How we get back to the point where the economy is able to function at the level that it was. Is difficult for me to see without the transparency and accountability necessary to ensure that trust is restored. Trust that has been eroded due to the global financial wizards with nothing better to do then invent new and deceitful ways of making money. As President Bush says transparency and accountability will enable the investors and regulators to know the truth.

So how do these two missing ingredients in the economy equal "software". And what does that mean for the oil and gas investor. Who I propose sits at the virtual Joint Operating Committee (JOC) table through the People, Ideas & Objects application modules?

For the oil and gas investor there is going to be the need to have a greater say in the day to day operations of what they own. As the industry transitions from the bureaucracy to the Joint Operating Committee, it is the investor that has a vested interest in making this software application the glue that holds the new oil and gas industry together. This has to be done in order for there to be a future in our societies. Oil and gas is too critical of a commodity to go without, and the software that identifies and supports the JOC needs to be as transparent and accountable to the investors and regulators.

This is done through the open source nature of this project. I don't want this to confuse anyone, the producers that will be using this software will be paying for it. This software is free, but not free in the monetary sense. Free in terms of it being open and available to anyone to review the Java code that the application is built from. And free like a puppy. Where the applications are free to wander and explore the necessary areas that are critical to getting right what is necessary in the industry. Where this wandering is not under the direction of one individual but the needs of the entire oil and gas industry.

Only then can the investor and regulator begin to be satisfied that the operations of the industry are as truthful as they appear. And that is why I will continue to pursue the investors and governments for financial support of these application modules.

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Friday, November 14, 2008

Carliss Baldwin - Mirroring Hypothesis

Carliss Baldwin - Mirroring Hypothesis

A series of 2008 Working Papers has been released by Harvard Professor Carliss Baldwin. (Click here to her page where all ten can be downloaded.) This first paper is "Exploring the Duality Between Product and Organizational Architectures: A Test of the Mirroring Hypothesis." This paper provides keen insight into many of the topics we need to better to understand in developing the People, Ideas & Objects application modules. As discussed in her paper we reviewed here, the mirroring hypothesis was a part of that paper, we now have the opportunity to review the mirroring hypothesis.

Before we begin I want to put forward the Cognitive & Motivational Paradoxes into the discussion as background for the discussion of the justification for radical change of the oil and gas industry, as considered in the Draft Specification. It is suggested in this paper that the rewriting of software applications from scratch has not been done. And I would suggest in the short period of time that software has been used in corporations limits the full scope of our understanding and experience of software. We have also not gone through a comprehensive market meltdown, as the one that we face today, an economic situation that I believe is the result of our inability to make the necessary, wholesale changes to organizations. And as such these changes are not only necessary for the economies to resume their positive attributes, but critical. If as I say in the above referenced blog entry, the constraints of code and customers are too large of a compromise in approaching this situation from an otherwise clean slate. These compromises are too significant to overcome the cognitive and motivational paradoxes. Now lets begin to review this very interesting paper. From a technology implementation point of view, the build up from a blank slate is the easiest approach to providing this value to the industry.
A variety of work has sought to examine the link between a product’s architecture and the characteristics of the organization that develops it. The roots of this work come from the field of organization theory, where it has long been recognized that organizations should be designed to reflect the nature of the tasks that they perform (Lawrence and Lorsch, 1967; Burns and Stalker, 1961). In a similar fashion, transaction cost theory predicts that different organizational forms are required to effectively solve the contractual challenges associated with tasks that possess different levels of uncertainty and interdependency (Williamson, 1985; Teece, 1986). To the degree that different product architectures require a different set of tasks to be performed, this work suggests that organizations and architectures must be aligned. p. 5
Alignment of the Joint Operating Committee's (JOC) legal, financial, operational decision making, communication and cultural frameworks with the compliance and governance which has been the sole domain of the bureaucracy, are what is achieved as a secondary benefit of this software development project. Our primary objective is to move the producer firm from a banking mentality to that which is based on the earth science and engineering disciplines; and to innovative off that base of knowledge. This is necessary in order to provide the energy consumer with the energy they demand. Referring back to the motivational & cognitive paradoxes, I would assert that the industry has been unable to meet the markets demands for energy, and almost all producers production profiles are in decline. This is further justification for the radical redesign of the oil and gas industry that is proposed in the Draft Specification.
While the studies above begin with the premise that a development organization must be designed to match the desired structure of a new product, a second stream of work adopts the opposite perspective. It assumes that a development organization’s structure is fixed in the short-medium term, and seeks to understand the impact on new product designs. This view was first articulated by Conway (1968) and is sometimes known as “Conway’s Law.” He states, “Any organization that designs a system will inevitable produce a design whose structure is a copy of the organization’s communication structure.” The dynamics of this law are best illustrated in Henderson and Clark’s (1990) study of the photolithography industry, in which they show that market leadership changed hands each time a new generation of equipment was introduced.
I italicized the quotation of Conway's Law to highlight the fact that communication in the oil and gas industry is through the JOC. As we have achieved this alignment in the Draft Specification with the JOC's communication structure, the alignment of the organization will be better able to serve the primary (enabling the earth science and engineering) and secondary reasons (the enhanced innovativeness and performance) from this alignment of the industry. This is a material change to the Draft Specification in that the Communication Structure will be added as the fifth framework that the JOC provides the innovative oil and gas producer.
These observations are traced to the successive failure of leading firms to respond effectively to architectural innovations, which involve significant changes in the way that components are linked together. Such innovations challenge incumbent firms given they destroy the usefulness of the architectural knowledge embedded in their organization structures and information-processing routines, which tend to reflect the existing dominant design (Utterback, 1996). When this design is no longer optimal, they find it difficult to adapt. pp. 5 - 6
Again I assert that the reason for the rewrite is that the bureaucracy is unable to make the necessary changes to ensure the producer firms remain innovative and profitable. The inability to adapt to the increased amount of earth science and engineering necessary for each barrel of oil, is the beginning of the end of these bureaucratic organizational structures. I can not see them surviving these changes in the greater economy. And I am certain that the economic meltdown we are currently experience will ensure their demise. That is why we must begin the process of developing the software as described in the Draft Specification.

2.1 Product Architecture and Measures of Modularity

We have purposely defined a modular design structure from the work of Professor Baldwin but more specifically through Professor Richard Langlois. These are accurately summarized as follows.
Modularity is a concept that helps us to characterize different product architectures. It refers to the way that a product design is decomposed into different parts or modules. While there are many definitions of modularity, authors tend to agree on the concepts that lie at its heart; the notion of interdependence within modules and independence between modules (Ulrich, 1995). The latter concept is referred to as “loose-coupling.” Modular designs are loosely-coupled in that changes made to one module have little impact on the others. Just as there are degrees of coupling, hence there are degrees of modularity. p. 6
There is a further rather profound reason for moving to a modular structure. The Java Programming Language is most efficient in a loosely coupled or modular fashion. These have been the design theories that make the language so useful to the business community. As is mentioned elsewhere the secondary advantage of a modular system is that developers are able to focus on one module, as opposed to having to know all of the aspects of the system. This compartmentalization helps the developers and users to deal with the complexity of the system.

6. Discussion

I am particularly proud of the size of this community. It has been many years in the building and each day I am pleasantly surprised by its scope and scale. The most important aspect of this community at this time is their vested interest in this system and particularly their understanding of the basic ideas and issues. When you have this many people following the ideas in this blog, it reflects that we are on the right track. One other important point that may be off topic a bit, but the size of this blog is well over 600,000 words and reflects the basic idea of using the Joint Operating Committee as the key organizational construct of the oil and gas industry. So many words for just one idea. I can not wait to see what this community does with these ideas when they get finished with it. In this next quote Professor Baldwin notes the products architecture is comprised of more then the functions. 
Our results make an important contribution to the academy in several ways. First, they reveal substantial differences in the levels of modularity between software systems of similar size and function. The pairs we examine vary by a factor of eight, in terms of the potential for a design change to propagate to other system components. This result has significant implications for those who must design such systems. It shows that a product’s architecture is not wholly determined by function, but is also influenced by a variety of other factors, including the characteristics of the organization within which development occurs. The space of possible designs within which solutions are sought appears to be constrained by the nature of the context within which search occurs. p. 20
This communities influence on the Draft Specification and the building of this system will be like no other we have seen to date.
We should note that the mirroring phenomenon is consistent with two rival causal mechanisms. The first is that designs evolve to reflect their development environments. In closed source projects, dedicated teams employed by a single firm and located at a single site develop the design. Problems are solved by face-to-face interaction, and performance “tweaked” by taking advantage of the access that module developers have to the information and solutions developed in other modules.

Even if not an explicit managerial choice, the design naturally becomes more tightly-coupled. By contrast, in open source products, a large and widely distributed team develops the design. Face-to-face communications are rare given most developers never meet, hence fewer connections between the modules are established. The architecture that evolves is more modular as a result of the inherent limitations on communication. p. 21
Once introduced to the ideas of this software development project people can begin to see how things fit in naturally. Using the JOC is a very natural way in which the industry operates. The technologies today provide the ability to mitigate the effects of location specific activities. The virtual JOC being the ultimate manifestation of the way in which oil and gas investors can manage their operations.
Alternatively, our observations may be a product of purposeful choices made by the system architects. For closed source products, the sole aim is to develop a product that maximizes performance at a point in time.

The benefits of modularity, given the competitive context, may not be viewed as significant. By contrast, for open source products, the benefits of modularity are far greater. Without a modular design, there is little hope that contributors can understand enough of a design to contribute to it, or develop new features and fix defects without affecting many other parts of the system.

Open source products therefore need to be modular to both attract a developer community and also to facilitate the work of this community. Our data can be explained by either of these causal mechanisms. In practice, both are likely to work in parallel. p. 21
By defining the modular specification we have what I consider the break from the "old way" of doing things. It is necessary for people to see how and where the system they are going to be involved in is going to be different. Without the overall vision of the Draft Specification we may have regressed into the "old ways" without thinking how this system could truly be different. I like to think that the design of the eleven modules makes it difficult to operate in the "old way" as its inefficiencies and frustrations are always in the way.
Our work suggests that managers of the innovation process must strive to understand the influences on their design choices that stem directly from the way they are organized. The challenge is that these influences are seldom explicit, but are a result of the complex interplay between a firm’s normal problem solving and information processing routines, and the space of designs that must be searched to arrive at a new solution. While a firm can look backwards and see what kinds of designs it is predisposed to produce, it is hard to look forward, and imagine what new designs might be possible. The commercial software managers we work with almost always think their designs are highly modular. When shown these results however, they realize how much more can be achieved. pp. 21 - 22
It should also be evident that the constraints (code and customers) and the motivational and cognitive paradoxes be eliminated from the mindset of the community. To do this I have established a very high bar in which participants in this community need to conduct. This does not preclude anyone from contributing, it only seeks to break the ties with the past so that the unencumbered and unconstrained methods of community involvement are optimized to the best solution. The up to 2,500 word essay expects the community member to apply their experience in the oil and gas industry to the specification in its current state. I believe that this is enough of an exercise to truly have the community optimize the solution. And for like minded individuals to find one another on the wiki. (Closed to the general public.)
Our findings have important implications for development organizations given the recent trend towards “open” innovation and the increased use of partners in R&D projects (Chesbrough, 2003; Iansiti and Levian, 2004; MacCormack et al, 2007). In particular, they imply that these new organizational arrangements will have a distinct impact on the nature of the designs they produce, and hence may affect product performance in unintended ways. In essence, our work suggests that R&D partnering choices, as well as the division of tasks that these choices imply, cannot be managed independently of the design process itself (von Hippel, 1990). Decisions taken in one realm will ultimately affect performance in the other. Managers must understand the implications of these organizational choices, in terms of the constraints they place on the solution space.
There is much to do and much to learn in this new project. I can't suggest strongly enough that the future does not include the structured hierarchy in any business operation. That is what is being eliminated in this market meltdown. Our first issue is related to the fact that new organizations are unable to form themselves in productive and efficient ways without the software being in place first. This is why the Baldwin, Lanlgois and others analysis is so necessary to find our way through this future.

Companies today have had the opportunity to change and build this system and they have chosen to ignore it. And that is the expected response. Bureaucracies do not change and it is foolhardy to think so. The change can not be implemented in the manner that is necessary without the complete destruction of the old. To change direction, you must first stop. Does anyone believe that the structured hierarchy will be used in 2025, what about 2015? I suggest it may be sooner then 2011 that we plan to have the retirement party of the last millennium in honor of the bureaucracy.
Our work opens up a number of areas for future study. With respect to methods, we show that dependency analysis provides a powerful lens with which to examine product architecture. While we focus on only a few types of dependency, our methods can be generalized to others, assuming that they can be identified from source code. With respect to studies of modularity, our work provides visibility of a phenomena which was previously hidden, and metrics with which to compare different products. This approach promises to facilitate the study of a variety of important research questions that have previously been answered only via purely descriptive or conceptual work. pp. 22 - 23
Professor Baldwin is on the right track here. Her analysis of transactions was the means in which the Accounting Voucher was developed. With the expressed intent to have transaction design be the area of real value generation in oil and gas. Transaction processing has developed to a reasonably high level such that the ability to differentiate ourselves based on transaction processing does not exist. It is a necessity, whereas using Baldwins analysis and tools provides the means in which to design transactions.

I close with two paragraphs of Professor Baldwin that put in perspective the context of this software development project. This is an opportunity that provides the community with significant ability to make the changes and increase the performance of the oil and gas industry.
Does greater modularity require trade-offs with other aspects of performance? Intriguingly, our work suggests that, in practice, many designs are not at the performance “frontier” where a trade-off exists, but lie below it due to architectural inefficiencies or “slack” (MacCormack et al, 2006). If this is true, there may be scope to improve a design along multiple dimensions without a performance penalty.

Exploring such issues via the measurement of architecture and product performance will help reveal managerial strategies for moving designs towards the frontier. And they will help us understand the trade-offs involved in moving along it. Herbert Simon (1962) was the first to argue for the systematic study of design more than 40 years ago, claiming, ‘…the proper study of mankind is the science of design.’ However, his ambitious vision for the field has proven elusive. The study of design has been constrained by, among other things, limited theory, methods and tools that can deal with the complexity of everyday designs, and more importantly, to make them visible, allowing us to compare their structures. The methods we have developed promise to open up a host of questions that, until now, were beyond our analytical capabilities. p. 23
Please, join me here.
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Thursday, November 13, 2008

McKinsey The Next Step in Innovation

The creation of knowledge, products, and services by online communities of companies and consumers is still in its earliest stages. Who knows where it will lead
Hey that's us! McKinsey have prepared another article that shows they are in the lead in terms of what the future holds for business. This is number 41 in a long line of excellent articles that we have reviewed, and comes as a result of a major redesign of McKinsey's website. Check it out
Distributed cocreation is too new for us to draw definitive conclusions about whether and how companies should implement it. But our research into these online communities and our work with a number of open-innovation pioneers show that it isn’t too soon for senior executives to start seriously examining the possibilities for distributed cocreation or to identify the challenges, such as the ownership of intellectual property and increased operational risk, they face in adopting it.
Too late. This community has locked up the Intellectual Property (IP) of using the Joint Operating Committee (JOC) as the key organizational structure of the innovative oil and gas producer. This is to the benefit of all those who provide services to the industry based on the People, Ideas & Objects software. This also takes the point of view that many within the oil and gas industry, oil and gas companies and their suppliers such as accounting firms, have a date with destiny. That much of the ownership of the producing assets and the work done in the service industries will pass to new and faster service providers. What the current market meltdown is saying is that the bureaucracies are no longer able to sustain our way of life and are uncompetitive. They therefore will be forced to liquidate in rapid fashion leaving the People, Ideas & Objects community to pick up the pieces. The users will be the ones providing the human resources and service business, the investors will be able to take ownership of the oil and gas facilities and they will all run on the software designed and developed by this community. At least that is the way I see it with these new rose colored glasses.
While distributed cocreation does seem promising, it isn’t entirely clear what capabilities companies will need (or how they will organize those capabilities) to make the most of it. Many of the answers will become clear as companies gain greater experience with various open-innovation approaches, including distributed cocreation. But a few challenges are already apparent.
  • Attracting and motivating co-creators.
We are seeing this challenge in many ways today. First its a chicken and egg problem. The financial resources are not in place to pay the people for their time. A critical issue, and one that has to be resolved for this first step. I have opened up the Preliminary Specification to 100 people who wish to contribute. These contributions will be critical in establishing these 100 people as the leaders in this community. A recognition that would provide substantial long term monetary value as their service offerings developed. The symbiotic relationship of everyone contributing to the IP under license, it aggregating in my hands, as I own the original ideas and their expression, and in turn license the whole of the IP back to those individuals who are members of this community. Those that are able to develop their ideas in this community will be able to prosper in their geographic region, no matter how large.
  • Structuring problems for participation.
I think to myself at times that I have 50,000 man years of work ahead of me. The sanity soon recovers when I realize I can do it all, or I can do none of it. Since I would only stand in the way I have chosen to leave the entire development in the hands of the community. This is the best place for it and I need to concentrate on securing the resources and needs of the community. The financial resources, the infrastructure etc.
  • Governance mechanisms to facilitate co-creation.
Communities are productive when they have clear rules, clear leadership, and transparent processes for setting goals and resolving conflicts among members. Sun Microsystems, for instance, developed its Solaris operating system, cocreated with a global community of software developers, in the early 1990s. The company established a board, including two Sun employees and a third member from the larger software community, charged with loosely overseeing the project’s progress. Even then, by the way, the community wanted Sun to relinquish more control.

The leadership must also maintain a cohesive vision, since there is always a risk that community members will “fork” intellectual property and use it to develop their own cocreated product or service. Mozilla, the online application suite distributed by the Mozilla Foundation, was cocreated by a software community. As the programs were being developed, two contributing engineers, dissatisfied with the project’s direction, used the Mozilla code to create the Firefox Web browser. Community leaders eventually made it the primary supported browser.
This needs to be dealt with as well. I am hesitant to suggest anything more then what has been stated in the Security & Access Control module. A governance structure will have to be built in order to make sure that the software product and the communities associated service offerings are developed in the best manner possible. This I think is a key area where McKinsey may be able to help in identifying the means and methods.
  • Maintaining quality.
More eyeballs has proven to be one of the best methods of ensuring the software code is operational as it should be. How do we ensure that the services that are provided by the community are of a high quality. Well we could spend a lot of time trying to figure that one out, but I think you'll agree that the community service provider is ultimately rewarded through quality service to the producers. It is the producers that will ultimately be responsible for making sure their operations are handled in the appropriate and optimal fashion. The only other key difference is that the time of a community member is best spent 50% with the software developers and 50% with the producer clients. This is an iterative software development project where the innovation of the producers is the key. Therefore we can never stop developing. McKinsey states the following.
Many cocreating online communities assume that “crowds” know more than individuals do and can therefore create better products; as the open-source-software expert Eric S. Raymond has said, “Given enough eyeballs, all bugs are shallow.” It is far too early to know with certainty if this idea holds true across all kinds of products, but a growing consensus maintains that in software development, at least, distributed cocreation is a ticket to quality. A study published in the European Journal of Information Systems in 2000, for instance, noted that “open-source software often attains quality that outperforms commercial proprietary” approaches. What’s more, a December 2005 study published in the scientific journal Nature concluded that Wikipedia’s entries on scientific subjects were generally as accurate as those in the Encyclop√¶dia Britannica. Still, some have questioned these conclusions and the accuracy or insights of the entries on which they were based.
I did mention that this was open source, but I don't think I stated why it is open source. The need for the producers to be able to ensure that their use of the application is as it seems. They need the ability to go to the code repository and review the actual code that does xyz for them to ensure that the software is done right. They cannot run the binary, only I can do that based on the license, the producer can only review the code.

Lessons from communities

Although it is still too early to develop useful frameworks for success with cocreation, they will no doubt emerge over the next few years. Meanwhile, some lessons about how to proceed are coming out of both the consumer and the professional online communities.
This area of communities and their development is new, and as a result of the Internet. How it develops and how to encourage that development will be something that we should consider taking on as a research project within the community. Just a suggestion. McKinsey has some interesting point of view in the following sections.
These numbers suggest that people are more and more willing to participate with companies online and that companies can tap into that willingness today.
Granted many people can contribute in the short term, but this is a long term permenant software development project. And the community itself will fill in the areas that are necessary for the producer to remain as profitable as can be. But the ability to sustain this in the long run is on the basis that the community is compensated for their time and effort in working with the developers and working with the producers. And I am on that job of raising the financial and other resources.
Even the most advanced businesses are just taking the first few steps on a long path toward distributed cocreation. Companies should experiment with this new approach to learn both how to use it successfully and more about its long-term significance. Pioneers may have ideas about opportunities to capture value from distributed cocreation, but fresh ones will appear. To benefit from them, companies should be flexible about all aspects of these experiments.

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Wednesday, November 12, 2008

International Energy Agency 2008 report.

The BBC is reporting the results of the International Energy Agency 2008 report contains a warning derived from the implications of the current credit crisis on investment in oil and gas,  and hence future production deliverables.

IEA is declaring the era of cheap oil is over. The cheaper prices we are experiencing today are attributable to the market meltdown as the world consumption of energy continues to tank. No one has any quality information as to the extent of the decline in demand, and as such is assuming the worst scenario and prices are collapsing. This is a temporary situation that may last for the full term of the markets meltdown, which may be the next five years.

The lack of investment is cited by the report as the reasons behind the warning. The geological aspects of peak oil, or declining production due to lack of reserves, is not the issue that the IEA is warning about. It is the lack of investment by the industry to ensure the market supply of energy is maintained. I would tend to agree with these assumptions that the lack of investment is a more dire and serious problem then peak oil.

This project does not have the financial resources to pay for the full report. However, the BBC coverage is providing us with the scope of the warning and the material information in the IEA's report.

But, they point out, field by field, declines in oil production are accelerating and more money will be needed in research and development to extract the oil there is.

While world oil supply will rise, the report's authors predict that massive investments in energy infrastructure will be needed - an eye-watering $26 trillion dollars up to 2030.

A significant amount of this money - $8.4 trillion - will need to be spent on oil and gas exploration and development.
Big numbers. I sarcastically assume that the structured hierarchy will be able to provide the industry with the appropriate organizational structure to 2030. It seems ridiculous to me to throw this type of money at the problem on the same basis as we have relied on in the past. Doing the same thing and expecting different results will be insane. The bureaucracy will fail, I would have 100% concurrence from those in the oil and gas industry and energy consumers in general. We need to begin the process of developing the software and building the organizations and systems necessary to undertake this critical task. A critical task that may materially affect our way and quality of life if we are not successful.

I suggest we develop the People, Ideas & Objects application based on the vision provided in the Draft Specification, please join me here.

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Tuesday, November 11, 2008

Times like these calls for...

In most business' the amount that management sell their products at is higher then its costs. In oil and gas we would only dream of such a concept as price management. In the Draft Specification I have included a price management capability on a fully automated basis.

The problem comes down to the designation of one producer as the operator. The operator has every motivation to keep the wells and fields producing to their fullest extent at all times. This is as a result of beliefs of competitive drainage, and the bank expecting their investment to perform. The fact of the matter is that the operator does not have the authority to shut in any production without the consent of the partners.

Recall that today, the Joint Operating Committee (JOC) meets on a relatively infrequent time frame and the majority of the reporting is standard fare statements and data. Any production volume reduction is not possible without the consent of the producers who hold x% as determined in the Operating Procedure.

Fast forward now to the day in which the People, Ideas & Objects system has been built and is commercially available. It is fair to assume that the volatility in the commodity prices remain and the variance in price is in the realm of + / - 20%, and somewhat determined by political factors and seasonality. This would make the majority of the production either very profitable, marginal or create a loss situation.

With the People, Ideas & Objects system we will have the ability to calculate the costs on a "live basis" based on the contributions of the partners involved in the JOC. This is the key change factor that enables the producers to use an algorithm to move production up or down based on the commodity prices and the actual costs of the operation. If at any time the required percentage of voting partners determine that the costs exceed the price received, production would be scaled back to 50% of the flow rate. If the loss exceeds 10% then another 50% of production would be reduced to the point where the production could be scaled back to the level that the partnership are satisfied the optimal reserves production and prices are optimized.

These operations are dependent on one factor, the collective decision of the producers representing the JOC. This is the type of capability that would be made available in People, Ideas & Objects. The standard bureaucracy can not make the decisions in fast enough time frames to make the decision valid. By the time the decision would be made, the prices may have risen dramatically just at the time the wells were being choked back.

After the decision from the JOC has been made. And this decision is based on the producers vote and desire to optimize the value of the reserves. This decision is therefore somewhat automatic in that each producer will be able to input their specific criteria that they would expect the changes in production to occur. The commodity prices fall below what the calculated actual costs are and if the production became marginal, the wells production would be reduced to the 50% I am using in this example. The prices subsequently, because their is a lack of production available for the consumer, increase and then the well can increase its production on any increment the JOC may have deemed appropriate for the reserves and their cost factors.

The ability to calculate the costs, determine the market prices, and the ability to slow the rate of production through telemetry. Are the technologies that are being implemented in this application. Please review the Technical Vision and specifically the IPv6 component. Other times during further price changes, the system would provide the opportunity to increase production for higher prices as well.

The interface to this capability would be the browser of those that are present virtually in the JOC. And I have suggested that these people are the actual oil and gas producer / investor / owners of the property. Imputing a reduction in the separation between management and investors is something that can be, and probably will occur in this current financial market meltdown.

Now I know that their are contractual commitments made to the firms that gather, deliver and market the commodities. The nomination process is how they monitor their business and these people will need to be involved in the decisions that are made at the JOC. That they have the right to demand gas production meet certain annual volumes could be accommodated by recognizing this price management capability and implementing it into their operation as well. I don't foresee an issue here, if there is it may be a simple matter that the producer declares Force majeure to reflect the operation is no longer commercial at current prices.

Irrespective of the ability to have these types of operations conducted I know two things. The bureaucracies are too slow to accommodate any price induced change in production. And the industry has to take responsibility for the prices that they need to realize. As we move the industry from a price taker to a price maker, the optimal use of the reserves and our endowment of oil and gas will be optimized, not only for the producer but also the energy consumer. This is achieved through the generally higher prices that will be realized, and hence the more financial resources that will be available for exploration and bringing on the more difficult production.

Please join me here.

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Monday, November 10, 2008

Canadian Natural Resources Questionable Financial Statements.

Here we go again, making representations that are not true. First of all CNRL's Third Quarter 2008 financial statements are designed to mislead so that reputable names like Forbes get the actual numbers wrong. This is intentional on the managements behalf and is a material issue in my opinion.

All one needs to do is look at page 17, 20, 21, 25, 40 of their financial statements and the "unaudited" revenues are qualified in the management discussion. Note (2) is appended to each instance of "Sales Price" and they have the following quote.

(2) Net of transportation and blending costs and excluding risk management activities.
So its, net of transportation and blending costs. And does not include risk management activities. Even written grammatically it leads the reader to confusion.

The problem comes down to the fact that the firm did not realize those sales prices. They hedged their production on a go forward basis. The real "market" prices for the commodities were what the firm sold them at, however they need to be discounted based on what the firm sold their production forward at.

This is how material of a misstatement this activity is.
    Reported Revenues = $4.583 billion.
    Risk(y) Management Activities = $1.715 billion (B as in billion)
    Real Revenues = $2.868 billion.

This is how the firm is able to report that earnings are $2.835 billion, and cash flow is $1.677 billion. Which doesn't make any sense does it. Particularly when the Changes in cash for the three months is a drain of $8 million. (M as in million).

On page 52, under Risk management, they come clean with the goods with the following comment.
The resulting fair value estimates may not necessarily be indicative of the amounts that could be realized or settled in a current market transaction and these differences may be material.
Why would a firm do these types of things. I think it is reflected in their third quarter announcement that they are reducing some of their capital expenditures. They stated that as a result of royalty changes in Alberta they were dropping their expenditures by 46%. This only shows that they have no money. Everything is being diverted to make sure that Horizon gets started. Well I predicted that Horizon start up was not going to happen in my post of August 25, 2008. And the prompting of my prediction was that the firm was $26 billion in debt with a $3.2 billion working capital deficiency and the...
Specifically I think that financial capital is in a state of seizure that is unlike anything we may have seen in the past. The impact of this credit crisis will be limited to those institutions that are involved in granting financial capital and those that need it. If you need financial capital don't bother knocking on the door, you won't know what the response will be.
That's correct the looming credit crisis did come, and I have to say that I underestimated it's size by a substantial margin. On page 59 I also find this tidbit interesting.
(2) Net expenditures for the Horizon Project also include capitalized interest and stock-based compensation.
Reflecting that the management have been reading some people's blogs! (Hi there.) And to be honest, making it to the top of the Piggies list in July 2008 must have been embarrassing. So why would they not hide these costs in their capital expenditures? I never would have thought that capitalized stock based compensation was legitimate!

On page 39 one could also discover that there are some legal troubles brewing with the contractors at the Horizon project.
The Company is defendant and plaintiff in a number of legal actions that arise in the normal course of business. In addition, the Company is subject to certain contractor construction claims related to the Horizon Project. The Company believes that any liabilities that might arise pertaining to any such matters would not have a material effect on its consolidated financial position.
I'll bet not, big project, big contracts, big contractors, nah that won't be material at all. Let me go out on a limb here and say that I think the project is in the middle of the process of being forced to close by the firms inability to pay the contractor.

I say we bring on Phase II of the market meltdown and clean these guys out, (oops these guys are already out of the money in their stock options), sorry folks I didn't mean to rub salt in those gaping wounds. Lets instead say, take them out of business. Take them out of their misery and let them get honest jobs. A sort of management rehabilitation exercise. I would suggest that it's 11:59 for this firm. And as a result most, if not all of management should will take the Charley Fisher (Former CEO of Nexen, another Piggie) route to redemption and quit.

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