OCI Compliance & Governance, Part IV

 Governance Over the Value Add

The level of innovation within the oil & gas producer will become more challenging as the earth sciences and engineering disciplines continue their steep trajectories. With high levels of activity in this area, and the implications being so broad and far reaching there will be areas where substantial value might be left uncultivated by the producer. These could be in the scientific or business areas and the question becomes who is responsible for capturing this value? This discussion will detail how the Compliance & Governance module of the Preliminary Specification deals with this situation. 

With our look at technological paradigms and the effect they have on scientific and innovative trajectories in oil & gas. When discussing these points about innovation, it is pertinent to remember that the sciences, the trajectories they are on, and the opportunities they generate for a producer, are accelerating and will continue to do so. With this in mind, we note that Professor Giovanni Dosi suggests two separate phenomena are observed:

First, new technological paradigms have continuously brought forward new opportunities for product development and productivity increases. 

Secondly “A rather uniform characteristic of the observed technological trajectories is their wide scope for mechanization, specialization and division of labor within and among plants and industries.” p. 1138.

Specifically, these new opportunities will be in the firm's business and technological areas. There will be opportunities that are within the scope of the oil & gas company's competitive advantage of its land & asset base, as well as its expertise in earth science & engineering. However, much of it will also be generated outside of its core area, in the service industry. This is through further automation, division of labor and specialization. It will also be generated in non-related business areas that are new and not well served by existing businesses. Most of this business value will be easily captured. That however does not necessarily mean it should be pursued. At these times, the governance model must ensure that the firm sticks to its knitting and pursues its primary competitive advantages. That to move outside of its core competitive advantages, to pick up some of these low lying fruits would distract it from the real job at hand. This is the job of those who ensure the governance model is upheld. At the same time, any value in the core competitive advantage that is not realized must be captured and steps taken to systemically realize the value from that point forward.  

To ensure that the firm remains within its competitive advantages there will be one interface developed with two different elements to it. This will be called the “Capabilities & Deployment Additions Interface.” The first element will be a summary of the additions to the “Dynamic Capabilities Interface.” By reviewing the current additions, i.e. all of the text added in the last quarter, to the interface. The user will be able to determine if the firm can maintain its overall focus on developing its capabilities in line with its goals and objectives. If it sees that it is suddenly researching the development of drill bits, it has wandered in an inappropriate direction. The second element is similar in its characteristics but uses the “Planning & Deployment Interface.” With the deployment of its capabilities it can see that the firm deployed its resources in a manner that is consistent with its objectives and goals. That no capabilities were deployed to commission drilling rigs or similar unrelated activities during the quarter. 

In the same way that the capabilities and deployment of them can be evaluated, the AFE and Work Orders can be reviewed for the quarter. These will provide an understanding of what the firm conducts in partnership through its Joint Operating Committees and with other producers in the industry. After reviewing these activities the user of the “Capabilities & Deployment Additions Interface'' will be able to ensure that the producer's focus remains consistent with its objectives. Any potential deviations could be dealt with through discussions with management and corrective actions taken. 

Focusing on where it can generate the greatest value is the firm's only concern. Pursuing the value available in other areas is a distraction that should be ignored. However, understanding that at the same time there is new value being generated as a result of the steep trajectories that the relevant and core strategic science is on. That this new value may be reflected in other areas of the firm, and needs to be captured is part of the “Capabilities & Deployment Additions Interface” of the Compliance & Governance module.

Governance Over the Capabilities Revenues

Through our discussion of the Preliminary Specification we have noted that the innovative and profitable oil & gas producer will have two distinct sources of revenue. The first is oil & gas production, and the second is the value added process of the specialized capabilities they provide to the various Joint Operating Committees, working groups they participate in, and other producers who may hire them for their specialized capabilities. This discussion deals with governance over these capabilities to ensure that revenues are recovered from the appropriate partners. 

With the increasing volume of work required for each barrel of oil produced, the demand for earth science & engineering resources continues to grow. The supply of these resources is constrained as increasing them in the short, mid and long term is difficult. People, Ideas & Objects approached the supply of these technical resources by developing software that defines and supports increased automation, divisions of labor and specialization throughout the industry. We have also identified that the “operator” designation inappropriately requires that their capabilities be developed to handle any and all contingencies within the producer firm. The operator designation creates unused and unusable surplus capacity of earth science & engineering resources trapped within each producer firm. By pooling the technical resources available from the Joint Operating Committee partners. This pooling will take the available capabilities of each producer and match them to the needs of the property. This will ensure the requirements are fulfilled. Additional capabilities can be acquired from the marketplace if necessary. Eliminating the otherwise trapped unused and unusable surplus capacity of these earth science & engineering resources in each producer firm. Capabilities provided in this fashion will be cost to the joint account at an industry standard cost based on the producers' revenue per employee factor. 

Revenues from the provisioning of engineering and geological capabilities to the Joint Operating Committee are necessary for the oil & gas business. Replacing the current operator overhead charges. With the expansion in the volume of work required for each barrel of oil produced there is commensurate difficulty in securing these capabilities in-house. There is also increased difficulty just maintaining the capabilities. The need for producers to build specialized capabilities becomes an issue of how to develop them if they cannot source a dedicated revenue stream to support them. By having a dedicated revenue stream to support the engineering and geological expenditures, the producer can better manage their operation, and build their capabilities. There is a further issue when we apply specialization and division of labor. The scope and scale of an oil & gas earth science & engineering capable operation, without the pooling concept being applied, becomes so broad as to render it completely uncommercial. 

In terms of governance the Preliminary Specification will provide the “Capabilities Revenues & Support Interface” in the Compliance & Governance module. This will provide a summary of all of the charges to the various joint accounts and working groups for any engineering and geological resources. This will be done during the period the user's request. This interface will also have targets for departments to achieve in terms of percentage cost recoveries and budgeted incomes. Individual joint accounts should be able to meet these targets. 

These net revenues should be displayed in the proper context on the “Capabilities Revenues & Support Interface.” That is to say they should be presented in a pro-forma income statement showing the costs of these resources, which would include resource costs and the various other costs of rent, technical support, equipment etc. This would show progress in how the firm met its targets. 

Governance Over Coordination Without Incentives

With our review of Professor Richard Langlois' writings we can see there will be an element of the Preliminary Specifications Compliance & Governance module that will be devoted to what we would call “operational governance.” We want to discuss the incentives vs. coordination issue of any operation that a Joint Operating Committee undertakes. This deals with the conflict between producers and service industry representatives and the high costs associated with field operations. Producers feel field costs are out of control and impose cost controls to better manage them. People, Ideas & Objects believes that coordination of field operations and improved communications will control costs. This will also improve outcomes. The coordination and communication comes through the modules in the Preliminary Specification, specifically Research & Capabilities and Knowledge & Learning modules. In his paper “Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization” Professor Richard Langlois states. 

More generally, we are worried that conceptualizing all problems of economic organization as problems of aligning incentives not only misrepresents important phenomena but also hinders understanding other phenomena, such as the role of production costs in determining the boundaries of the firm. As we will argue, in fact, it may well pay off intellectually to pursue a research strategy that is essentially the flip-side of the coin, namely to assume that all incentive problems can be eliminated by assumption and concentrate on coordination (including communication) and production cost issues only. p.12.

Let's assume that People, Ideas & Objects Preliminary Specification is operational in your firm. You have the Industrial Command & Control, the Planning & Deployment Interface, the AFE and Job Order systems operational as expected however your results continue to disappoint and the cost overruns are tragic. How do we ensure that performance expectations are met and these poor performing situations are identified quickly and dealt with?

Either way it boils down to the same common-sense recognition, namely that individuals - and organizations - are necessarily limited in what they know how to do well. Indeed, the main interest of the capabilities view is to understand what is distinctive about firms as unitary, historical organizations of cooperating individuals. p. 17.

We should have an interface in the Compliance & Governance module that provides a user with the ability to oversee the operations being conducted in the Research & Capabilities and Knowledge & Learning modules. This interface should be called the “Operational Review & Governance Interface” which gives its users access to the operational information being reviewed. There they can interact, if desired, and supervise or mentor the project manager. This will ensure that objectives are met and costs are maintained. All with an understanding of how these objectives can be achieved, through enhanced coordination and communication, not through incentives. 

In saying this, it's more about governance than supervision. When things go wrong, you need to be able to fix them effectively, but you also don't want to interrupt the day-to-day operations unnecessarily.

Governance Over the Deployment of Capabilities

We are discussing the operational governance of the firm and Joint Operating Committee. A significant element of this discussion is the capabilities these organizations have access to. Earth science & engineering capabilities are documented in the Research & Capabilities and Knowledge & Learning modules of the Preliminary Specification. An innovative and profitable oil & gas producer has two key competitive advantages. Consequently, from the perspective of governance, these capabilities should be protected and kept for your firm only. Nothing could be further from the truth. Any usage of these capabilities will leak to member firms of the producer's Joint Operating Committees. That is an inevitable fact. And it is imperative that the firm consider as their priority the use of their capabilities as having the right information deployed to the right people at the right time. Governance must be concerned with the appropriate use of its capabilities, rather than information hoarding. From Professor Richard Langlois' “Modularity in Technology, Organization and Society.” 

This is the basic modularization of the market economy. It accords well with the modularization G. B. Richardson (1972) suggested in offering the concept of economic capabilities. By capabilities Richardson means "knowledge, experience, and skills" (1972, p. 888), a notion related to what Jensen and Meckling (1992) call "specific" knowledge and to what Hayek (1945) called "knowledge of the particular circumstances of time and place." For the most part, Richardson argues, firms will tend to specialize in activities requiring similar capabilities, that is, "in activities for which their capabilities offer some comparative advantage" (Richardson 1972, p. 888). p. 27.

What are we trying to achieve by employing these capabilities? It is to generate value. But more importantly to generate value for the owners represented on the Joint Operating Committee. In economic terms this value is called “externalities.” After the operation, after the deployment of the necessary capabilities at the right time by the right people the value should have been gained by the members of the Joint Operating Committee. 

So why don't we observe everywhere a perfectly atomistic modularization according to comparative advantage in capabilities - with no organizations of any significance, just workers wielding tools and trading in anonymous markets? We have already seen the outlines of several answers. The older property rights literature, we saw, would insist that the reason is externalities, notably the externalities of team work arising from the nature of the technology of production itself. The mainstream economics of organization is fixated on another possibility: because of highly specific assets, parties can threaten one another with pecuniary externalities ex post in a way that has real ex ante effects on efficiency (Klein, Crawford, and Alchian 1978; Williamson 1985). Richardson offers a somewhat different, and perhaps more fertile, alternative. Firms seek to specialize in activities for which their capabilities are similar: but production requires the coordination of complementary activities. Especially in a world of change, such coordination requires the transmission of information beyond what can be sent through the interface of the price system. As a consequence, qualitative coordination is necessary, and that need brings with it not only the organizational structure called the firm but also a variety of inter-firm relationships and interconnections as well." pp. 27 - 28.

If the Joint Operating Committee coordinates these capabilities in the appropriate way, the externalities will flow to the producers represented there. That is what the operation's governance is most concerned about. That there may be leakage of some explicit knowledge of these capabilities during the operation is immaterial to the firm's externalities and competitive position. Recall our review of Professor Giovanni Dosi for the Preliminary Specification. His research showed that it took equal and sometimes increased effort to copy another firm's capabilities than to generate them themselves. It is therefore more effective for a firm to focus on their key competitive advantages, their land & asset base, and their earth science & engineering capabilities. And the effective and efficient deployment of these competitive advantages on a “just in time” basis. 

We have asserted and I am certain that the oil & gas industry is moving towards its scientific basis as its primary competitive advantage. The days when financiers or lawyers could build viable producers based on their skills are numbered if not nonexistent. There is also a perception developed through the Preliminary Specification that the producer is a firm that maintains financial interests in a variety of Joint Operating Committees. That the producer will deploy their capabilities to these assets when and where they are needed and as they are developed. These capabilities deployment processes are under constant change and innovation. This level of change and innovation causes “Dynamic Transaction Costs” to be incurred, and people question the direction of the changes. What is needed is a method of governance in the Compliance & Governance module over the overall change process to ensure that the ship maintains its course and the costs remain in line. Quotations are from Professor Richard Langlois' “Transaction Costs in Real Time” paper. 

Over time, capabilities change as firms and markets learn, which implies a kind of information or knowledge cost - the cost of transferring the firm's capabilities to the market or vice-versa. These "dynamic" governance costs are the costs of persuading, negotiating and coordinating with, and teaching others. They arise in the face of change, notably technological and organizational innovation. In effect, they are the costs of not having the capabilities you need when you need them. p. 99.

We introduced the “Operational Review & Governance Interface" and we will now continue its discussion. In our previous discussion, we discussed the ability to mentor the Project Manager and oversee or supervise the operation if required. What we need to discuss now is broader and more global in scope. An interface that encapsulates the entire firm's operations. This is so that the user can see that the firm's direction in terms of capabilities development is being optimized in its Joint Operating Committees, etc. It would be of questionable value if the firm expended valuable resources on developing its capabilities for multilateral fracing in shale formations. This is when none of its Joint Operating Committees were deploying, or able to deploy the technologies. 

With the “Operational Review & Governance Interface” the user can review the entire operation as it happens. From the “Dynamic Capabilities Interface” to the “Planning & Deployment Interface,” AFE, Job Order and “Lessons Learned Interface," review all of the actions taken and the documentation generated during the operation to determine what was the critical cause of the success or failure of the operation. This could be done in fine detail or in summary form to oversee the many operations conducted. 

Another variable captured by the Preliminary Specification is the Dynamic Transaction Costs. These are the costs associated with change and innovation. When people run into these charges, they will be able to tag them with the Dynamic Transaction Costs tag for further review. This will be a red flag in the “Operation Review & Governance Interface” for the user to trigger. When they see high levels of “Dynamic Transaction Costs" they know the operation has run into high levels of change and / or innovation. Therefore they will be able to see the implications of these costs in the knowledge and information at the interface. And know that some significant change or innovation will follow.

OCI Compliance & Governance, Part III

 Governance Over the Process of Innovation

One of the areas that we covered in our previous discussion in the Compliance & Governance module of the Preliminary Specification. Is that effective governance and innovation are not necessarily mutually exclusive. We want to discuss the “Lessons Learned Interface" initiated in the Knowledge & Learning module of each Joint Operating Committee. These lessons learned are aggregated in the Compliance & Governance module of the Preliminary Specification in an interface called “The Innovation Library.”

What we know about innovation can be summarized by Professor Giovanni Dosi. He states,

In very general terms, technological innovation involves or is the solution to problems.” p. 1125.

Dosi defines this as,

In other words, an innovative solution to a certain problem involves “discovery” (of the problem) and “creation” since no general algorithm can be derived from the information about the problem that generates its solution "automatically." Certainly the "solution" to technological problems involves the use of information derived from experience and formal knowledge. It also involves specific and uncodified capabilities on the part of the inventors. p. 1126.

With the demands for more earth science & engineering for each barrel of oil & gas produced, and the need to keep up with the steep trajectory of those sciences over the coming years, the oil & gas firm, and the individual Joint Operating Committees will learn substantial volumes of new and valuable information about the business. The innovative oil & gas producer will be able to take advantage of these developments and expand the knowledge of both the organization as well as the science. Keeping proper governance over these processes would seem counterproductive, however, it doesn’t have to be.

One of the first things we can do to provide effective governance is to ensure that the same mistakes are not made over and over. Having the lessons learned populated from each Joint Operating Committee, up to each participant producer firm. Where each producer firm will have the aggregated lessons learned from each Joint Operating Committee they have an interest in. Then they can apply any lessons learned from any of the Joint Operating Committee’s to other Joint Operating Committee’s as may be required. 

Another thing we can do in the governance section of this module is provide a strong understanding of the innovation process. By compiling and assimilating innovation processes into an understandable business process, those charged with responsible governance will understand what innovation is, and what unsuccessful innovation is. Having a library of the science of innovation, some written by Professors Dosi and Langlois, would alleviate the guesswork and concern that some of the activities occurring in the firm were moving the firm down the wrong direction, when in fact they were successful innovations. We know that innovation can be reduced to a quantifiable and replicable process. Therefore it should be governed on the same basis. However, that governance needs to be done in a manner that understands what successful innovation consists of. That successful governance is a responsibility to understand the innovation process just as much as innovators. Let's call this interface “The Innovation Library" of the Compliance & Governance module. Professor Dosi notes in his paper, Sources, Procedures and Microeconomic Effects of Innovation.

In general the uncertainty associated with innovative activities is much stronger than that with which familiar economic model deals. It involves not only lack of knowledge of the precise cost and outcomes of different alternatives, but often also lack of knowledge of what the alternatives are (see Freeman 1982; Nelson 1981a; Nelson and Winter 1982). p. 1134.

This is not what corporate governance wants to hear. What will please them is that we have the “Research Budget Allocation Interface” in the Research & Capabilities module. Remember that this interface documents the information that the firm is involved in. It summarizes the activities currently ongoing and the costs are budgeted. If a Work Order involves research or innovation being carried out, it will be listed on the interface. If an AFE includes some of these activities, they will also be listed on the interface. Within the Research Budget Allocation Interface the ability of its users to review all ongoing activities within the organization is possible. The risk of duplications would be discovered and the budget allocation for research and innovation costs would be prioritized and given some corporate direction. 

Additionally there is the Industrial Command & Control (ICC) providing governance over the innovation process. The ICC is developed to pool technical resources in the Joint Operating Committee, however it has just as much application in the producer firm. By using the ICC for innovative activities within the Research & Capabilities module, a firm can keep tight control over who is involved in innovation activities. By imposing a chain of command and control over the people seconded from different departments in the firm, the ICC helps to provide appropriate governance over innovation in the firm.

We know there is more to innovation than this. Sometimes it is the un-qualifiable and the unquantifiable that we seek. Professor Dosi notes. 

In fact, let us distinguish between (a) the notion of uncertainty familiar to economic analysis defined in terms of imperfect information about the occurrence of a known list of events and (b) what we could call strong uncertainty whereby the list of possible events is unknown and one does not know either the consequences of particular actions for any given event (more on this in Dosi and Egidi 1987).  p. 1134.

And

I suggest that, in general, innovative search is characterized by strong uncertainty. This applies, in primis to those phases of technical change that could be called pre-paradigmatic: During these highly exploratory periods one faces a double uncertainty regarding both the practical outcomes of the innovative search and also the scientific and technological principles and the problem-solving procedures on which technological advances could be based. When a technological paradigm is established, it brings with it a reduction of uncertainty, in the sense that it focuses the directions of search and forms the grounds for formatting technological and market expectations more surely. (In this respect, technological trajectories are not only the ex post description of the patterns of technical change, but also, as mentioned, the basis of heuristics asking “where do we go from here?”) p. 1134.

This will become the nature of the oil & gas business. An effective governance over the innovation process will have to limit its involvement so that innovations can develop. At the same time this does not preclude the oversight mentioned at the beginning of this module's description. And there may be substantially more “good governance” that our user community can determine when their involvement in these developments is unleashed. 

Continuing our discussion of corporate governance over innovation uncertainty. And how the firm's governance will seek to moderate investments in innovation and attempt to make it a routine aspect of the firm's activities. We have noted that innovation is a quantifiable and replicable process. It is, however, anything but routine. We want to ensure that innovations remain within the commercial sphere and do not become science projects. At the same time I want to reiterate that innovation and sound governance are not mutually exclusive. And with that jumble of contradictions let's continue. 

Writing the Preliminary Specification is an innovation of People, Ideas & Objects. It is something significant and will happen only once. It is not something that happens every day and it is unusual for it to be undertaken. These are characteristics of innovation. When a firm undertakes to do something innovative it is usually something that is original and significant to their firm. It involves some risk and implies a high level of uncertainty. Professor Giovanni Dosi notes. 

However, even in the case of “normal” technical search (as opposed to the “extraordinary” exploration associated with the quest for new paradigms) strong uncertainty is present. Even when the fundamental knowledge base and the expected directions of advance are fairly well known, it is still often the case that one must first engage in exploratory research, development, and design before knowing what the outcome will be (what the properties of a new chemical compound will be, what an effective design will look like, etc.) and what some manageable results will cost, or, indeed, whether very useful results will emerge. (Mansfield et al. 1977) p. 1135.

Unfortunately this is the state of the oil & gas business as it stands today. That every well drilled is literally the result of someone's theory as to what the existence of oil & gas is. Anything classified as exploratory, and much of the development work, would meet this innovation criteria. 

As a result, firms tend to work with relatively general and event-independent routines (with rules of the kind “... spend x% of sales on R & D,” ... distribute your research activity between basic research, risky projects, incremental innovations according to some routine shares ...” and sometimes meta-rules of the kind “with high interest rates or low profits cut basic research,” etc.). This finding is corroborated by ample managerial evidence and also by recent more rigorous econometric tests; see Griliches and Ariel Pakes (1986) who find that “the pattern of R & D investment within a firm is essentially a random walk with a relatively low error variance” (pp. 10 - 11). p. 1134.

Reverting back to People, Ideas & Objects. Writing the Preliminary Specification is not routine, however, it is in a long line of routine research and development projects undertaken by our firm to explore the development of user driven software for innovative oil & gas producers, based on using the Joint Operating Committee. 

In this sense, Schumpeter’s hypothesis about the routinization of innovation (Joseph Schumpeter 1942) and the persistence of innovation-related uncertainty must not be in conflict but may well complement each other. As suggested by the “late” Schumpeter, one may conjecture that large-scale corporate research has become the prevailing form of organization of innovation because it is most effective in exploiting and internalizing the tacit and cumulative features of technological knowledge (Mowery 1980; Pavitt 1986). Moreover, companies tend to adopt steady policies (rules), because they face complex and unpredictable environments where they cannot forecast future states of the world, or even “map” notional events into actions, and outcomes (Dosi and Orsenigo 1986; Heiner 1983, 1988). Internalized corporate search exploits the cumulativeness and complexity of technological knowledge. Together with steady rules, firms try to reduce the uncertainty of innovative search, without, however, eliminating it. pp. 1134 - 1135.

This is where corporate governance does not necessarily conflict with innovation. Priorities and budgets need to be set and established. Corporate focus is needed. Innovative oil & gas producers will benefit from a good corporate governance model. Otherwise the firm's pursuit would be an out of control science experiment. I think the governance mechanisms mentioned to date, the “Research Budget Allocation Interface” and the Industrial Command & Control provide the beginnings of effective governance. I want to stress again that our user communities' input into the Preliminary Specification will be of substantial value in this area.

Governance Over the Firm’s Collaborations

We want to discuss the governance of the firm and collaborations between the Joint Operating Committees. It is these collaborations between the industry participants and the service industry that will provide the fuel for the producer and Joint Operating Committee innovations. A proper governance over these collaborations is also necessary to ensure that the firm's capabilities are not unnecessarily leaked to areas where they are not required. We have stated throughout the Preliminary Specification that these capabilities are as difficult to copy as to generate within the firm. Copying another firm is as costly as developing them. This discussion is about good governance.  

We begin by discussing Professor Giovanni Dosi’s definition of technological trajectory. The definition of a technological trajectory is the activity of technological process along the economic and technological trade offs defined by a paradigm. Dosi (1988) states “Trade-offs are the compromise, and the technical capabilities that define horsepower, gross takeoff weight, cruise speed, wing load and cruise range in civilian and military aircraft.” People, Ideas & Objects assumes the technical trade-off in oil & gas is accurately reflected in commodity pricing. Higher commodity prices finance enhanced innovation. 

These trade-offs facilitate industries' innovation on changing technical and scientific paradigms. Crucial to the facilitation of these trade-offs is a fundamental component that spurs change and is usually abundant and available at low costs. For innovation to occur in oil & gas, People, Ideas & Objects would assert that the ability to seek and find knowledge, and to collaborate are two “commodities” that are abundant today. With their inherent low direct costs, knowledge and collaboration are the triggers for a number of technical paradigms that will provide companies with fundamental innovations.

Throughout the Preliminary Specification enhanced collaboration between the producer and other members of the various Joint Operating Committees the producer is partnered with. This included industry members, service industry participants and the general industry at large. These collaborations are for the expressed purpose of developing the firm's technology and understanding. Enhancing its innovativeness and capabilities. There are however limits to this exposure. For a variety of legal, proprietary, and other reasons certain things may not be able to be discussed openly. There is also the case that information regarding a certain capability will only be discussed with partners with an interest in that property. That releasing it to other partners would not be in the firm's interest. How is collaboration governance managed?

The capabilities within the “Dynamic Capabilities Interface” of the Research & Capabilities and Knowledge & Learning modules are restricted to those situations in which they are authorized. However, does that solve the problem? The issue comes down to collaboration itself. Does the information slip out in the discussion between the individual and their counterpart at company B? What can be done once a collaboration leaks the data? Is limited and that is the issue that the governance will deal with. 

One of the first things we can do is centralize the publication of collaborations in one area. There they can be approved for content before publication. If any collaboration is deemed too revealing, it can be returned for editing, and further review before publication. This would slow the process of collaborations however that is a minor issue compared to the loss of critical information. Secondly, the review before publication could be handled only by those familiar with corporate secrets. The problem with either of these situations is that it would take someone very senior within the organization. To do this would require that we have a centralized “Collaboration Interface” that aggregates the firm's collaborations into one central area. Therefore we will build this interface within the governance area of the Compliance & Governance module should any producer desire to use it.

OCI Compliance & Governance, Part II

 Automation of the Compliance Frameworks

The question is, with the future of work becoming more self-directed and motivated through performance. At the same time with computers automating more of the lower level work, how does compliance and governance fit into this vision?

We may be successful in building the software described in the Preliminary Specification. And yet have a real mess on our hands in terms of compliance and governance. This is if we don’t have an answer to this question built into that software. That is not what we do at People, Ideas & Objects. As much as everyone would like to ignore this difficult area of the business world it is a very necessary part of the business. And by saying that I know I have offended those people who are truly passionate about compliance and governance. And it's those people who will know how to implement these frameworks in the manner that solves the problem we're discussing. As for every problem there are people who have a passion that drives them to solve it. Such is the nature of user-driven software developments.

I know enough about the topic that this can be done in a manner that makes the user aware of the compliance and governance requirements of their actions. Even so, don't mindlessly remind them every ten minutes. Where decisions can be informed of compliance and governance implications before they are taken, rather than after the fact. Where information can be contextually provided without research. The point of the matter is that the user interface should be a rich environment where the underlying intelligence of the system should operate and provide for all of these requirements. That is if we purposely build it here in the Compliance & Governance module of the Preliminary Specification.

One of the other areas we discussed in the Compliance & Governance module was the scope of regulations that producer firms are now exposed to. A producer must meet quite a few different jurisdictions for a variety of different requirements. Staying on top of these requirements is a full time job for many within their organizations. If the trend is for more regulations then the demand for more people will increase, or alternatively, automation of compliance and governance frameworks will become a necessity.

Compliance & Governance of an Innovative Oil & Gas Producer

Throughout our discussion of the Preliminary Specification there’s been a spirit of cooperation between the producers that participate in the Joint Operating Committee and the vendors in the service industry. Oil and gas remains and will always be a very competitive industry and this spirit does not detract from it. The individual producer is ultimately focused on developing their land & asset base, and expanding their earth science & engineering capabilities. This is for their shareholders' financial gain. Control of the corporation, and hence its competitiveness, should be through the governance interface of the Compliance & Governance module.

This emphasis on governance needs to consider innovation's role in the market economy. It assumes companies in a free market are willing to invest in science & technology to advance their firm's competitive nature. Some may see governance and innovation as two opposing forces on the same scale. That may be the case, but I don’t think they conflict. You can have effective governance and remain highly innovative and competitive. For instance, look at Apple. No one doubts they run a tight ship. I would suggest that it would be difficult to see an innovative corporate mindset come about from a poorly governed process.

One of the research questions in the Preliminary Research Report was “can the scope and understanding of the innovation process be reduced to a quantifiable and replicable process?” The answer to that is difficult to quantify. First you need an appropriate organization, such as the Joint Operating Committee, to be supported by the aligned frameworks of the Joint Operating Committee. Then you need a service industry that collaborates with producers to develop the science & engineering products and services necessary to develop the industry. So with that, that makes the answer to the research question an unqualified yes.

Having everything in place is no guarantee of innovation. People are necessary elements of the process. The ideal thing a producer can do is to provide an environment that enables and enhances innovation, and that is what the People, Ideas & Objects Preliminary Specification is designed to do. In terms of governance of that process I think we have given the producer some unique tools to maintain control over their firm and the Joint Operating Committees that they participate in. These tools include Industrial Command & Control, the Work-Order system, the Purchase-Order system, etc.

Governance of the Joint Operating Committee

Throughout our discussion of the Preliminary Specification we have described two distinct organizational structures. The producer firm and the Joint Operating Committee. Up until now we have focused the Compliance & Governance modules discussion on the producer firm. The Joint Operating Committee is operated through the People, Ideas & Objects software application modules to identify and support the seven frameworks the Joint Operating Committee defines. The question therefore becomes how does the producer firm maintain governance over the producers' working interest share of the Joint Operating Committee?

First we have Industrial Command & Control that is adopted across the organization. This is so that producers within a Joint Operating Committee can pool their human resources, and impose a chain of command, control and governance over those resources. This pooling is done to offset the shortage of technical resources in the earth science & engineering fields that we have discussed. Since the pooling is composed of resources from multiple producer firms, governance over those resources in the Joint Operating Committee is deferred to the Committee itself.

Each Joint Operating Committee is governed by their own agreement, operating and accounting procedure in most instances. These are the documents that provide operational means for decisions, policies and procedures. The influence of one producer to skew the results of these decisions, policies and procedures may occur if they have a high percentage of voting rights during the establishment of the agreement. Other than that the Joint Operating Committee will be left to operate based on the parameters set and will have minimal need for voting on these points in subsequent years. Where they will be active is in the budgets and the decisions as to what and where the facilities should be developed. For this there are mechanisms to deal with the (non) participation of other producers and these will be documented by the Joint Operating Committee.

As we can see the voting rights of the producer in the Joint Operating Committee is the extent of their influence in the day to day business. Other than their determination of the amount of capital they will spend. The Joint Operating Committee will operate completely autonomously based on the parameters agreed to by the founding producers. There are voting rights and those may be significant in terms of influence on the outcome. However, the producer organization and the Joint Operating Committee are two separate organizations for all intents and purposes.

Nonetheless, there is the need to ensure that the governance of the operations of the Joint Operating Committee is within the normal scope of operations. This is a responsibility of the management of each producer firm. How then can the producer's governance be extended over the Joint Operating Committee in a manner that meets this criteria. This respects that each producer on the Joint Operating Committee will have similar concerns?

When a producer adds up the number of Joint Operating Committees they have an interest in, it could easily number in the hundreds. Management of hundreds of properties operating semi-autonomously presents its own issues and opportunities. Documenting all Joint Operating Committee activities is not an issue. This would involve putting an interface over the various data elements and presenting that within the governance section of the Compliance & Governance module. I think we have to get more sophisticated than that and start capturing the activities and actions within the Joint Operating Committees. Every time there is a vote the results are reported through the governance interface to each partner. Every time there is an election, non-participation, capital expenditure decision, etc., it's reported through the governance interface to each partner. Then the users of the data have a summary of the actions in those Joint Operating Committees. They can determine if any actions require further attention. I am sure our user community will have substantially more needs than these few requirements. And that is why users have such a prominent role in this software development.

Governance Over Lessons Learned

The innovative oil & gas producer is supported through the People, Ideas & Objects application modules. Their innovativeness is what the system is designed to achieve. This is based on the fundamental belief that higher commodity prices finance increased innovation and the most efficient producers will be the most profitable. However, as we know with innovation there is failure that is a natural part of the process. Therefore with greater innovative success there will be greater failure in the process of achieving that success. This deals with the governance of failure within the Joint Operating Committee and how it is handled in the Compliance & Governance module of the Preliminary Specification.

The first thing we should do is define these failures in their proper context and call them lessons learned. These will be documented in an area within the governance section of the Compliance & Governance module for review by others. As we have discussed, a producer may have hundreds or thousands of interests in Joint Operating Committees located worldwide. The ability to know what works and what doesn’t work, where lessons are learned daily, would be a valuable resource for a firm. Recall that in the Knowledge & Learning module these lessons learned are captured in each Joint Operating Committee. What the Compliance & Governance module does is aggregate these lessons learned from each of the Joint Operating Committees the producers have an interest in. It presents them in a database with all of the other Joint Operating Committees they have an interest in.

This is to avoid repeating the same mistakes and expecting different results. If the firm knows a certain operation is ineffective, it should cease conducting it. With each producer within a Joint Operating Committee having access to the lessons learned the less they might occur. In spite of the fact that these lessons were learned much after the fact, it is still worthwhile to be aware of the information so that others will be able to avoid a similar situation in the future. Lessons learned may also show the way to success. Firms should require their designates to the Joint Operating Committee to report all material deviations through the lessons learned interface. This would update the Knowledge & Learning modules for the specific Joint Operating Committee and the Compliance & Governance modules for each producer firm so that learning could be spread as far and as quickly as possible.

Our research discovered a fascinating anomaly. Do these collaborations within the Joint Operating Committee create leakage of proprietary knowledge and capability from one producer to the other? The question therefore becomes how is this proprietary information and capability deployed on an as-needed basis? Professor Giovanni Dosi notes that “although the free movement of information has occurred in industries for many years, yet has never been easily transferable to other companies within those industries. The ability to replicate a competitive advantage from one company to another is not as easy, and may indeed be not worthwhile doing.” Dosi (1988) goes one step further and states, “even with technology license agreements, they do not stand as an all or nothing substitute for in-house search.” A firm needs to develop “substantial in-house capacity in order to recognize, evaluate, negotiate and finally adapt the technology potentially available from others.” Therefore why not focus on the need to increase the company's own unique and distinct sources and directions of competitive advantage? This also implies that the free flow of information between producers through collaborations in the Joint Operating Committee would increase knowledge, yet not expose anyone of the specific organizations to any specific losses of key knowledge, proprietary information or capability.

Within a Joint Operating Committee each producer is entitled to this information irrespective of its origins. What is needed is the means to mitigate losses caused by repeating the same mistakes corporately. The ability to learn from its mistakes should be a strong part of any corporate governance module and that is why it is included here in the People, Ideas & Objects Compliance & Governance module.

Compliance & Governance Opportunity

When will the demand for more information from regulators end? Maybe a more constructive question would be to think about how we can get ahead of this situation permanently? Part of the answer to that question is software. We approach the development of comprehensive software for the innovative oil & gas producer with People, Ideas & Objects. This should be seen as an opportunity to rethink the producer firm's compliance and governance. To begin the implementation of software that will solve compliance and governance issues on an ongoing basis. And by that I mean from the point of view of using software, automation, the division of labor and specialization as solutions to the problem. 

Assuming that each producer needs to comply with regulatory requirements from a to z, that’s 26 jurisdictions. That’s 26 unique talents they would need on staff to meet regulatory requirements within each producer firm. Now in aggregate, the industry will have those same 26 jurisdictions. Why would we not break this down into 26 teams who specialize in one jurisdiction each on behalf of all producers? Using software designed to meet the needs of that jurisdiction, they could do the necessary work on behalf of each producer in the industry. They could apply their services to small start-up firms and Exxon Mobil. The specialized nature of the staff at each service provider would be more efficient and less costly than having in-house staff at each producer firm. Add to that the costs of developing specific software to meet compliance needs being amortized over the entire industry, instead of incurred at each firm. The costs of compliance are lower with better service. 

In Professor Giovanni Dosi's three key factors of innovation, regulation is part of the third. Clearly it is currently a drag on innovation. And what we have here is an opportunity to reduce regulatory drag on industry innovation.

Additional issues include the conditions controlling occupational and geographical mobility and or consumer promptness / resistance to change, market conditions, financial facilities and capabilities and the criteria used to allocate funds. Microeconomic trends in the effects on changes in relative prices of inputs and outputs, including public policy. (regulation, tax codes, patent and trademark laws and public procurement.) p. 1121.

At some point the volume of regulations will become economically impractical for each producer to maintain on their own. I think that time may have passed and these compliance costs degrade industry profitability. It should be at this point that the regulations should force producers to look at other means to meet these requirements. In today’s marketplace that includes software, automation, the division of labor and specialization. And see a shift away from individual producers' compliance and governance capabilities to industry wide compliance and governance capabilities. That is the opportunity presented here in the People, Ideas & Objects Preliminary Specification.

OCI Compliance & Governance, Part I

 Introduction

Compliance & Governance, the module everyone loves to hate. It is my hypothesis that everything went wrong here, at compliance and governance. What I mean by that is in the 1960’s when computers were introduced to oil & gas companies. The question arises: what will we do with them? And of course the answer is accounting. As they became ever more powerful and successful, they added more tasks to their duties and added the natural follow-on concerns of tax, royalty and compliance. Soon the culture became focused on those “compliance” requirements of the “firm” and the Joint Operating Committee developed into something that is used there. Soon after this engineers and geologists began speaking a different language to "business" types. Divisions grew and the corporation focused on the need to file the necessary paperwork with the appropriate agency in the required time frame on the appropriate colored form.

Anyway the real business of the business, the Joint Operating Committee somehow survived. When we align the compliance and governance frameworks of the hierarchy to the Joint Operating Committees legal, financial, operational decision making, cultural, communication, strategic and innovation frameworks everyone can start speaking the same language as the engineers and geologists and get some real business done. And as People, Ideas & Objects research shows this would provide the oil and gas producer with heightened speed, innovation, accountability and profitability.

Compliance & Governance is the eleventh module in the fourteen module Preliminary Specification. It’s also no accident that I added Compliance & Governance last, as the question that should be asked is this one. How are we able to ensure compliance with all the regulations for all the module specifications we've discussed so far? And I would assert that this is why these are user-based developments. One thing governments seem to like today is regulations on oil & gas companies. Information Technology enables various governments to issue technical business rules, technical specifications, XBRL syntax and other technological frameworks for these regulations. The ability to write these "frameworks" has only encouraged governments to write more regulations. The larger point is that these frameworks provide software developers with distinct advantages in enabling regulations within software.

Earlier, we indicated that the scope of People, Ideas & Objects was determined by our user communities. Part of that scope determination will include which regulations it must comply with. With so many jurisdictions requiring compliance, each transaction may need to be assured of compliance with multiple jurisdictions. In addition, a transaction may be generated through a Joint Operating Committee owned by a variety of producers. Who may come from an international background and the Compliance & Governance module gains importance.

From the point of view of a producer, maintaining the database and applications for all of the compliance frameworks producers have to worry about is a difficult task. The number of people you need to keep your applications up to date is significant. However, with People, Ideas & Objects, as one software developer acting on behalf of the industry as a whole, the job becomes much more specialized and manageable. Then again if we were building these applications to serve an industry we would use the division of labor and specialization to manage these tasks in a way that would significantly lower the costs of compliance, and increase the quality of the producers' compliance.

These applications must comply with dozens of different jurisdictions in terms of royalty compliance. Approaching this from a software engineering point of view as a sole producer is not cost effective. When these costs are replicated within each producer organization, we begin to see the costs of compliance escalating to the levels that they are today. There is another way, and that is we move away from individual producer compliance and governance capabilities and rely on industry wide capabilities. That is what is proposed here in People, Ideas & Objects. In addition, we are proposing many other innovative ways to deal with oil & gas industry issues.

Automation, Specialization and the Division of Labor

We noted the opportunity of centralizing software development costs and efforts for Compliance & Governance frameworks under one roof. That is to say that instead of each producer building the in-house capacity to keep software and compliance up-to-date, it is preferable to have it organized and managed through People, Ideas & Objects. I want to take that concept a bit further and break down another element of the cost of compliance. I want to discuss how that element could also be done in a centralized manner. That element is of course the accounting and administrative costs incurred in meeting the regulations requirements. The costs of which are incurred in the human resources and associated overhead. These costs are an area where specialization and the division of labor could be applied and build real value for the producer firms.

It comes down to the question of where is the compliance work done, at the Joint Operating Committee, or at the firm? It needs to be done at the firm as all the variables are unique to each producer. Within the Preliminary Specification we use the decentralized production model. This sees the prototypical producer firm reduced to C class executives, earth science & engineering resources, some land, legal and support staff. In the case of compliance and governance resources they are provided to the producer firms through industry-based service providers. This moves the producer's compliance and governance to be relied upon through the industries compliance and governance capabilities of service providers. 

If we approached accounting and compliance reporting requirements on an industry wide basis and used specialization and division of labor we could add significant value to the industry. Taking the organization of accounting across the industry and building compliance and governance needs for all producers would provide value at lower costs and better service. This is because of the advantages of the division of labor and specialization. Where the accounting and administration service providers specialize in one and only one compliance requirement. Particularly in the area of compliance reporting, especially royalties, where the knowledge of the people employed in the compliance service would be so specialized that they could ensure that their clients' royalty obligations are the lowest possible. With royalties being the largest cost component of a producer this would certainly be of value but there are greater efficiencies than these available. There would also be the ability to manage the process with the most efficient team available.

These are two elements of compliance costs. As we mentioned earlier, maintaining compliance with the regulations is expensive. And two, accounting and administration done to keep the firm up to date by service providers. If the software can be maintained on a global basis on behalf of the industry by People, Ideas & Objects then the one-time costs of the software can be amortized over the industry as a whole. And if accounting and administration costs can be managed through the centralization of the accounting and administration function within an industry wide capability within service providers, then automation, specialization and the division of labor come into play. And the industry benefits by reducing their costs by reducing the two largest components of compliance costs in the most cost effective way. Yet, they have also done so in the manner where their compliance quality is high.

Another element of quality also comes into play due to the proposal from People, Ideas & Objects. That element is time. If the timeliness of the information is within the guidelines, or earlier, the quality of that information is much higher. It seems that the high levels of automation, specialization, and division of labor contained here will ensure that the information we are building is timely and will exceed the regulatory deadlines. This timeliness doesn't come at the expense of accuracy.

Lastly when we discuss moving the compliance and governance frameworks of the hierarchy into alignment with the Joint Operating Committees legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks. We state that this provides increased speed, innovativeness, accountability and profitability. When you align compliance and governance with operational decision making, accountability results.

Compliance for Everyone

In a capital intensive business such as oil & gas, access to capital is a critical capability producers need to develop within their operations. In order to have access to capital you must meet the regulatory requirements and compliance needs of the capital markets. Therefore the Compliance & Governance module of the Preliminary Specification is a critical capability for all those dedicated to building an innovative oil & gas producer. This principle applies equally to ExxonMobil as to the startup oil & gas company.

And ExxonMobil should be concerned that the start-up oil & gas operation maintains its compliance and governance in good shape. Why? You can’t pick your neighbors and all of your partners. Sometimes you have to deal with partners with a history you're unfamiliar with. You want to make sure that they can operate in a fashion that is consistent with standard industry practices. It is those standard industry practices that include high levels of compliance and governance in today’s oil & gas industry operations. What about tomorrow’s environment?

As we've discussed, regulators' expectations with respect to compliance are high. It appears that no relief will be forthcoming. On the contrary, we should expect requirements to grow. This is the only reasonable expectation. However, I would ask, have we implemented these compliance frameworks correctly? Have the regulations submitted in technical frameworks been integrated into the ERP system, or just attached?

We can see the answer to that question when we find that no current ERP system calculates the Gas Cost Allowance for royalty calculations. To conduct these types of calculations you would need to integrate the royalty frameworks deeply within the ERP systems, and that’s not been done. So when it comes to the automation of the compliance frameworks, which is the objective of the regulators in publishing these technical frameworks, nothing’s been done from the industry side.

I have argued that there are two ways to approach oil & gas problems. One is to automate processes. This requires the high capital costs of software development such as what People, Ideas & Objects have proposed. Or, you can employ human resources to maintain compliance requirements manually. This is the method the industry chose to pursue. I would ask when;

The cost of capital remains historically low.

• The demand for human resources is somewhat constrained.
• Regulators have published technical frameworks.
• Why wouldn't oil & gas producers develop the People, Ideas & Objects applications? 

Automation of the compliance frameworks within the People, Ideas & Objects applications would provide many benefits to the innovative oil & gas producer. The costs of this engineering work are amortized over the entire producer population. Making these highly engineered software solutions incidental in terms of actual cost to each producer. Access to these systems would benefit all producers in the industry. Providing each producer with the capability to meet or exceed the minimum industry standards. In a world of increasing demands, your partner's capabilities could become a critical issue for your operation. There is a compelling argument here about the compliance aspects of the Compliance & Governance module. 

Governance of Self-Organizing Groups

The manner in which much of the work is done in the People, Ideas & Objects Preliminary Specification resonates with the ideas of how work will be done in the future. Direct supervision is replaced by self-organizing groups motivated and directed by their property's performance. This creates the environment that people aspire to work in; and the governance issues that this creates for the firm. This discussion deals with governance issues and how the governance areas of the Compliance & Governance module reels in the vision of self-organizing groups to something that is more workable and sensible in the commercial environment.

Firstly, Industrial Command & Control isn't just for Joint Operating Committees. Although we have discussed it in terms of just the Joint Operating Committee, there is nothing stopping the firm from using the organizational overlay within the firm. This also applies to the Work Order system. These two tools would provide the firm with the ability to make sure that tasks were assigned and completed as budgeted. In addition, execution was consistent with firm expectations. With the use of these systems, it is understood that no other work is undertaken without the ability to charge time or costs for a Work Order. Assuring that no unauthorized projects are undertaken. The Work Order system would also provide the internal control necessary to ensure that the appropriate people necessary to achieve governance are assigned to approved projects. These people are capable of meeting the tasks requirements. When “things” turn out wrong it’s usually at the beginning and having that “governance” information available is the objective of this capability.

Internal controls of firms and Joint Operating Committees seem to be a lost art in the toolkit of today's executives. The ability to set up a control to trigger a warning that something is happening that is inconsistent with normal policies may have been implemented more in the past than today. The power of technology seems to work hand in hand with internal controls. I think they provide a strong governance method that should be built into the People, Ideas & Objects governance area of the Compliance & Governance module. That there needs to be a section devoted to building database “triggers” and “stored procedures” that are used by the firm to monitor areas of the firm's activities. These of course are available to those individuals with the appropriate authority to access the data and information necessary to run queries, and to fully appreciate the art and science of internal controls.

Governance in the Service Industry

Discussion of the governance of one of the capabilities processes documented in the Research & Capabilities and Knowledge & Learning modules. The specific process takes the ideas generated throughout the oil & gas and service industries. It funds them, develops commercial products and services, develops the producers capabilities, transfers those capabilities to the Joint Operating Committee and learns through their application. As we can see this is a long term process with many open ended elements that could be lost in the shuffle. In addition, there are aspects of the process that are too tempting.

It's advisable to take a step back and discuss why we are implementing this process in the Preliminary Specification. Simply put, we have two choices for providing producer firms with service industry products and services. We can let the market provide all of the products and services, or we can have the producers conduct all of the work. This includes manufacturing drill bits to produce oil. We currently have a situation where producers are dissatisfied with the service industry and micromanage that industry through control of the market. Today the service industry has been fundamentally destroyed. Access to capital is unavailable, and may be for a generation or more owing to oil & gas producers' actions. A comprehensive and involved rebuilding of the service industry by oil & gas producers on a philanthropic basis will be the only way forward.

It is here within this “capabilities” process that the firm's governance must enforce the firm's boundaries. The division between the market and the firm, and where that division lies, needs to be enforced within this process. The producer firm is only concerned with their land & asset base and earth science & engineering capabilities. Everything else must be provided by the marketplace. The producer's role is to provide vision and leadership to the marketplace and seed that market with funding. In a paper written by Professors Richard Langlois and Nicholas J. Foss entitled “Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization," they note.

The organizational question is whether new capabilities are best acquired through the market, through internal learning, or through some hybrid organizational form. And the answer will depend on (A) the already existing structure of capabilities and (B) the nature of the economic change involved. p. 20.

The economic change the producer is facing is commodity prices reward the innovative producer. Focusing on purchasing more drilling rigs is not where producers generate value. Governance by the producer must maintain the focus on where the producer can generate the greatest value, on finding and developing oil & gas reserves, otherwise...

If by contrast, the old configuration of capabilities lies within large vertically integrated organizations, creative destruction may well take the form of markets superseding firms. History offers many examples of both. p. 20.

To ensure focus and governance on this process, the producer should rely on the Work Order and Industrial Command & Control of the Preliminary Specification. Distraction away from the producer firm's objective is possible when dealing with marketplace noise. The Work Order will ensure that no work is done on unauthorized projects and that a chain of command is implemented in the administration of each project. This will help to ensure that each project is ultimately focused on providing the producer with the highest returns on oil & gas reserves discovery, enhancement and production.

This discussion may seem like a fundamental contradiction regarding producer involvement in the service industry. I am critical of the way producers have involved themselves in the service industry. The producers' dissatisfaction with the costs, products and services provided to them by the service industry is due to the high levels of involvement of the producers in the service industries business. Micro-managing, cost control and direct ownership of things like drilling rigs are counter to the producers' interests. At the same time there needs to be stronger representation made by the producers in focusing and leading the service industry marketplace. Leadership is lacking and missed. My argument is that we need to remove the direct manipulation of the service industry marketplace by the producers and replace it with a more constructive leadership role so that the service industry marketplace can better respond to the needs of innovative and profitable oil & gas producers. 

OCI Blockchain, Part V

 Research & Capabilities

We have discussed the current producers' capacity to deal with issues constrained by the ERP systems in use today. That we see a repetitive inability, or lack of capacity to deal with the existing issues of the industry. As a result, we seem to be reliving the 1990's issues around takeaway capacity and commodity pricing. Furthermore, industry finds it difficult to address new issues, such as the commercial development of shale reserves and the relationship with its service industry. I have suggested that the industry seems to be in a never ending cycle it cannot exit from. The ERP systems that exist today operate on a day-to-day basis and cannot deal with the long term perspective.

This cycle of day-to-day existence damages the industry. The ability to deal with this issue is by adopting the Preliminary Specification and acquiring the software development capability proposed by People, Ideas & Objects. Then the innovative and profitable oil & gas producer will be able to break the cycle of system dependency. This will enable them to effectively plan and execute the business of the business. Until we do this, it's best to become familiar with the various elements of the scenery we're in. And that primarily refers to losses from operations in North America and its overall destruction. 

Does anyone believe that proceeding along this same course that we’ve traveled for the past number of decades, and with the passage of even more time, will change the industry's profitability? The scenery is the same as in 1986 and only officers and directors have benefited. The Research & Capabilities module provides an exit from this endless cycle. How the firm breaks away from what it’s done before and develops its capabilities to enhance its business in the long term is detailed here. There are a number of things we do in this module that make that happen in the Research & Capabilities module.

Research & Capabilities is a producer-driven module, while Knowledge & Learning is a Joint Operating Committee-based module. Based on the research conducted prior to writing the Preliminary Specification we determined many things that are detailed specifically in those two modules' specifications. Items such as the producer should be the ones developing innovations for their deployment in the Joint Operating Committee. Then they’ll make the inevitable mistakes made during the development of the innovations once and only once. Then when the innovation is developed and implemented successfully it can be released from the Research & Capabilities module to the Knowledge & Learning module representing the producers' interests in their Joint Operating Committees as a capability available for its use. Making any process development mistakes once in the producer firm, not repeatedly in each Joint Operating Committee, is a key to the dynamic, innovative, accountable and profitable oil & gas producer. To develop an innovative oil and gas industry, these two modules are essential. Much of Professors Giovanni Dosi and Richard Langlois' research was implemented in these modules. Enabling the innovations and capabilities of the firm and Joint Operating Committee, which are unquestionably the key competitive advantages of the producer firm, their focus and priority. 

How this is implemented in the Research & Capabilities module is through a collaborative textual interface called the Dynamic Capabilities Interface. This captures the research or capability or explicit knowledge of the firm. The key attribute of blockchain implementation in the Research & Capabilities module will be within this Dynamic Capabilities Interface. This documents the processes of the producer. As time passes elements of each process are amended and improved upon. Our Dynamic Capabilities Interface will highlight the changes since the reader last read that “page” of the interface. By using the blockchain, changes to individual processes are written to subsequent blocks of the blockchain. Therefore each of the blocks concerning that capability will provide the reader with a history of the process's development. The latest block represents the latest text addition for the current version of the capability. A comparison will be made to the previous version number read by the user. Any changes since then will be highlighted in different colors. It will enable them to quickly and easily learn of those changes. A similar interface in the Knowledge & Learning module called the Planning & Deployment Interface will operate in the same manner.

The Research & Capabilities module documents the producer's capabilities. Those procedures that they can replicate consistently. Capabilities that have been made available to the various Joint Operating Committees they have interests in. The dynamic, innovative, accountable, and profitable oil & gas producer also has a second revenue stream. That is the sale of these capabilities to the Joint Operating Committees under the pooling concept discussed earlier in this module. There is also the opportunity to sell these capabilities to other producers directly. The documentation of these capabilities forms the foundation of the producer firm's Intellectual Property. Having these capabilities documented and published across the larger population of producers represented on their Joint Operating Committees through the Knowledge & Learning module secures their copyright. Having these captured on the blockchain will document the time and place these capabilities were developed. This will ensure that the producer can defend them against claims that they violated other producers' capabilities. The key competitive advantage of the producer is the deployment of their earth science and engineering tacit knowledge. 

Knowledge & Learning

Access to the various capabilities of the participating producers in the Joint Operating Committee is made through the Knowledge & Learning Planning & Deployment Interface. Blockchain makes access secure. Using the private / public key encryption of the blockchain only those producers who are members of the specific Joint Operating Committee will have access to those details. It will be necessary that each Joint Operating Committee has an individual key that is also shared by users who are interested. Then the data and information can be encrypted by the private key and reviewed by the shared public keys held by each producer. What we see with these two modules of the Preliminary Specification is the development, deployment and controlled access to the research and capabilities of the producers involved in the Joint Operating Committee. By implementing blockchain technology, we are able to deliver this solution to producers for their needs in this area. 

There are many other elements of these two modules that will benefit from the blockchain. The need to include a discussion at this point would be moot. Understanding these two features will help determine how blockchain is ultimately implemented. It is these two modules that provide a distinct advantage through blockchain technologies. The one advantage I'm particularly pleased with is the clear vision of how these features can now be developed. Before, without the blockchain these processes and functionality were not necessarily the easiest parts of the Preliminary Specification to build.  

I would like to highlight the reason the Research & Capabilities and Knowledge & Learning modules are structured this way. It’s a point that needs to be understood why we’re doing it and the reason for this is captured in the Research & Capabilities module. The quotation below is from Professor Richard Langlois’ Modularity in Technology and Organization. I discussed how I've interpreted this understanding and applied it to oil & gas.

The question then becomes: why are capabilities sometimes organized within firms, sometimes decentralized in markets, and sometimes coordinated by a myriad contractual and ownership arrangements like joint ventures, franchisees, and networks? Explicitly echoing Hayek, Jensen and Meckling (1992, p.251) who point out that economic organization must solve two different kinds of problems: "the rights assignment problem (determining who should exercise a decision right) and the control or agency problem (how to ensure that self-interested decision agents exercise their rights in a way that contributes to the organizational objective)." There are basically two ways to ensure such a "collocation" of knowledge and decision making: "One is by moving the knowledge to those with the decision rights; the other is by moving the decision rights to those with the knowledge." (Jensen and Meckling 1992 p. 253). p. 27.

To be specific, what we’re doing in the Research & Capabilities module is “moving the knowledge to those with decision rights.” And this is where the alignment under People, Ideas & Objects begins. What the current producers are trying to do is to “move the decision rights to those with the knowledge.” And that is where the conflict is being created. The Joint Operating Committee has the operational decision making framework and there is little to change that. The knowledge is held within the participating producer firms designated operator. It is therefore necessary to create a process that sees knowledge flow from producer firms to the appropriate Joint Operating Committees and that is what the Research & Capabilities module's Dynamic Capabilities Interface does. 

Analytics & Statistics and Performance Evaluation

Another dual use set of modules as the Analytics & Statistics module deals with the producer firm and the Performance Evaluation module deals with the Joint Operating Committee. Moreover, these modules are designed to contain algorithms of analysis that determine specific performance criteria. And then provide the user with ad-hoc analytical reporting. There is not much I know about what blockchain technologies can provide here. Blockchain is concerned with the recording, securing and reporting of data on distributed ledgers. The Analytics & Statistics and Performance Evaluation modules are not involved in the generation of data. Instead, they manipulate data acquired through other modules and outside of the industry.

Compliance & Governance

It’s difficult for me to see a substantial role for the Blockchain module in the Preliminary Specifications Compliance & Governance module. In the Partnership Accounting and Accounting Voucher section of this Blockchain module discussion, we noted what role blockchain technologies could be used. This lack of vision in terms of its use in Compliance & Governance doesn’t preclude our user community from developing creative and innovative ways to ensure compliance and governance is attained through blockchain technologies. What I am finding is that the extension that blockchain will provide everything to everyone gets to the silly stage when talking about compliance and governance issues and opportunities. Articles such as this one from Oxford Academic which state that blockchain will eliminate the need for public accounting firms and annual audits are not fully understanding the role of these audits in business. 

3.7.a. Accountants and financial intermediaries

In a world with real-time accounting, consumers of financial statement information would not need to rely on the judgment of auditors and the integrity of managers. Instead, they could trust with certainty the data on the blockchain and impose their own accounting judgment to make their own non-cash adjustments such as depreciation or inventory revaluation. The potential US savings equals the total revenue of the accounting industry, which exceeds $50 billion per year. This sum represents the social cost for third-party validation of the accuracy of company accounts, or more simply, the social cost of mistrust of corporate managers. Instead of relying on the auditing industry, which itself has been subject to moral hazard and agency problems (Cunningham, 2006; Ronen, 2010), each user could costlessly create their own financial statements from the blockchain’s data, for whatever time period they wished. Users could access the firm’s raw data and make their own decisions about depreciation schedules, marking assets to fair market value, and recognizing non-cash accruals to earnings. To survive, accountants would need to reinvent themselves as interpreters of raw financial data, and given the large size and complexity of many companies, market demand for their services would probably continue in some form.

As a former auditor, prior to my days in the software business, these are ridiculous assertions. Just because a transaction has been recorded on a blockchain does not imply that the transaction's integrity is beyond question. Auditors do not just verify that transactions have been recorded in the system correctly, but rather that those transactions are the legitimate revenues and expenses of the business. Misappropriation of corporate assets can and will occur no matter what technologies are used. People who are bent in that manner will always find a way to circumvent the systems put in place. That is the same for blockchain technologies. Elimination of the audit function from the role of public accountants is never going to happen. Not with blockchain or any other technology. 

It is the oil & gas business issues and opportunities that drive the fourteen modules of the Preliminary Specification. We are not technologically focused on oil & gas industry solutions. People, Ideas & Objects are solving business issues and exploiting opportunities for the oil & gas producer through the application of Information Technology. We provide the most profitable means of oil & gas operations, everywhere and always. No amount of declarative referential integrity in a database will solve oil & gas producers' business issues. Holding up blockchain as the be all and end all solution to business problems is a part of the myth around this technology. We’ll remain focused on the business issues and opportunities of the North American oil & gas producers and address those through innovative means. We'll work on the business solutions and implement them appropriately in our software. That is our business offering and we’ll continue to differentiate ourselves from those that sell the latest technological widgets for oil & gas. 

The concerns that we’ve expressed in the development of the Preliminary Specification and the implementation of blockchain technologies are the same concerns expressed by PriceWaterhouseCoopers in their PwC Blockchain Validation Solution. These concerns are addressed in our budget where we allocated to the public accounting firms for their work in assuring the oil & gas producers that the developments made under the Preliminary Specification are consistent with Generally Accepted Accounting Principles and the appropriate business practices. These public accounting firm reviews of People, Ideas & Objects developments, and our user community, will be part of the continuous developments undertaken as part of our permanent software development capability we provide the oil & gas industry. Our second concern is that there is a consistent tendency to believe that blockchain can somehow eliminate audits. Nothing could be further from the truth. 

It is with this mindset that PriceWaterhouse is now offering software and services based on the blockchain. This will aid in auditing their client firms. Entirely consistent with People, Ideas & Objects thinking of what is required in terms of the Compliance & Governance module of the Preliminary Specification. This module is consistent with the needs of a dynamic, innovative, accountable and profitable oil & gas producer. It would only be necessary to specify PwC’s software within the Preliminary Specifications Blockchain module. I would however make one suggestion that I think is relevant to People, Ideas & Objects. Our budget is to be distributed to all public accounting participants. By pooling their resources, they can ensure that all of the oil and gas producers they represent are included in their work with us. I would also prefer to see all public accounting firms pool their blockchain software and services into one offering. There are too many conflicts when one firm chooses KPMG to conduct the audit of a firm that has implemented PwC’s Blockchain Validation Solution. 

The reason I see this pooling of accounting firms' resources as necessary is that the future is different. PwC is, in the right way, approaching all industries and companies with blockchain software. Attempting to create a substantial competitive advantage for their firm. Which is not incorrect and should be commended. However they are also locking in those clients to their other services to get the full meal deal and the best of breed solution. If the blockchain software is pooled with other accounting firms then their clients and shareholders can select any audit firm they want.

We had in the late 1990’s issues with audit firms owning ERP software used by producers in the industry. It created conflicts and public accounting firms divested those assets. I think the reasoning for those divestments is stronger today than ever. Conversely the type of software and service that PwC is offering in its Blockchain Validation Solution is an extension of their statutory requirements to producer firms. This could be argued as the future of the public accounting firm. There is no way we can put the genie back in the bottle now that the idea has been presented. Therefore the pooling of public accounting firms to offer a generic solution in the audit capabilities of blockchain technologies is in my opinion a necessity. The software and services associated with these products are in their infancy and will develop to include more and more compliance frameworks. Creating a demand for the product to grow in terms of its function and process capabilities. This is to the point where it becomes, I would suggest, too large for one of the large audit firms to undertake and manage on their own. Secondly it would be too much of a burden for the producer firms and firms in other industries to carry the costs of up to ten of these same software development initiatives being undertaken by public accounting firms. One for each industry. Sharing the burden as a non-rival cost under Professor Paul Romer's "Endogenous Technical Change" theory may be a solution.

People, Ideas & Objects have developed our pooling concept in many ways for the oil & gas industry. First in the sense that all producers pool their IT budgets into one ERP system development. Avoiding the demands of each producer developing inhouse capabilities to build and support an ERP system. Doing so does not provide them with any competitive advantage whatsoever. By pooling the producers' budgets, we can save substantial sums for each individual producer. We can also focus on the needed developments of the industry with the larger aggregated budget to do so. The pooling of earth science and engineering resources in the Joint Operating Committee is also provided as a solution to the expansion of the division of labor and specialization of those professions. An expansion that would soon move the scope and scale of those producers' capabilities, and key competitive advantages, outside of what a commercial operations budget can sustain. And will provide a means to deal with the anticipated shortfall in those technical resources as a result of pending retirements and lack of new university intakes. 

By pooling the public accounting firms resources on one software solution they will be able to access the budget that will be necessary to build the kind of solution that this will eventually be. An ominous and comprehensive solution for the audit profession. To avoid lock-in, which I would suggest, is necessary. If an accounting firm used their blockchain and audit software to lead their sales effort and lock-in their services, that would be contrary to everyone's interests. However if they were able to share in the revenues of the blockchain and audit software and compete based on the quality of the audit services that they can provide above and beyond their competitors, then that would be the most ideal solution for everyone concerned. The choice for shareholders will then be based on the most qualified auditors available for the job. 

People, Ideas & Objects Blockchain module is provided as a significant enhancement to the other thirteen modules of the Preliminary Specification. Including this technology eases many of our needs to resolve some of the difficult technical questions we raise. This is due to the complexity of our solutions. That is where I see blockchain technology being most valuable to oil & gas businesses. I will continue to update and develop the Blockchain module, as with all modules in the Preliminary Specification, as situations arise.

People, Ideas & Objects Preliminary Specification is eleven years old. During the time we discussed the specification, our user community and service providers and all the other elements needed for dynamic, innovative, accountable and profitable oil & gas producers. There were no changes to the specification, establishing it as a baseline for our user community. Today we begin the definition of our 12th module of the Preliminary Specification. After researching the topic and grasping an understanding of the Information Technology that underlies the blockchain, today we can begin the integration of that technology into all aspects of the other thirteen modules of the Preliminary Specification. 

The most effective video I found describing what blockchain provides is from its biggest proponent, Don Tapscott, author of the book “Blockchain Revolution.” This video has a number of interesting catch phrases that I think help people understand the technology.