Unconventional Oil and Gas Reserves

The Oil and Gas Journal reports the following unconventional reserves information.

BP’s latest energy outlook, which it released on Jan. 16 in London, said that worldwide, there are an estimated 240 billion bbl of technically recoverable tight oil resources and 200 trillion cu m (tcm) of shale gas. Asia’s resources total an estimated 50 billion bbl of tight oil and 57 tcm of shale gas, compared with North America’s 70 billion bbl of tight oil and 47 tcm of shale gas, it indicated.

That is certainly a lot of oil and gas. Add the 70 billion bbl of tight oil to the 170 billion bbl in oil sands and North America has adequate supplies to meet its needs. Conversion of the North American gas reserves brings in 1,659 tcf of gas which is mind numbing. To give some context, the amount of estimated conventional gas reserves for all of Canada was at one time around 153 tcf with cummulative production of approximately 80 tcf, leaving 73 tcf remaining. The amount of remaining U.S. gas reserves is estimated at 317.6 tcf. What these numbers show is the value of the shale revolution in meeting the demands of the energy consumer.

What is also apparent is these reserves will not be produced inexpensively. If anything the discussion around the Preliminary Specification in terms of the relationship with the service industry and the profitability of the oil and gas producer are or should be the primary concern of the industry. Approaching the development of these reserves should be the topic of discussion, but it isn’t. The way we approach the development of these reserves should be based on the new organizational and market basis as presented in the Preliminary Specification. This is the first step in developing these reserves.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

Our Value Proposition

It is People, Ideas & Objects claim that we provide the most profitable means of oil and gas operations. And we do. This is through a variety of means and we’ll detail them here in the next few blog posts. The first aspect of our claim is that our Revenue Model provides the lowest cost of obtaining an ERP system in the industry. And that is by charging for the costs of software development, plus an element of profit as our fee structure. Therefore the industry is only paying for the one time costs of software development. A fundamentally more efficient value proposition than any of our competitors.

We can do this because we are not focused on the traditional software company concerns of code and customers, but are oriented to the changing business dynamics of an innovative oil & gas, and service industries. This difference determines the motivation of the software developer over the long term. In People, Ideas & Objects instance we generate revenues on the basis of the changes that industry desires. Our motivation becomes the constant improvement of the software. In the traditional software vendor’s case they are motivated by their code and customer bases. The larger their code base the more difficult it becomes to change, which coincidentally does not generate revenue. And the larger the customer base the more costly the changes that need to made to each customer. Which coincidentally these changes to the customer software do not generate any revenues. What you have is a contrast in the dynamic nature of the software itself. In terms of its cost to the industry and the motivation behind the developer.

Within our Revenue Model we have an annual fee and penalty structure for those who have not participated on a timely basis. Isn’t the penalty, when paid, a benefit to the software developer above their regular fees? No, it is not. The penalty structure is designed so that each producer pays an equal share of the total costs of all of the development. There are no free riders in this program. If a producer were to wait until the fifth year to start to participate in the user community and use the software that was built by others; then they would have to pay the fees for those past five years plus the associated penalties as well. These fees and penalties would then be used to offset the following years costs before the calculation of the next years fee assessment. So the next years fees would be proportionally less the amount of any fees and penalties that were paid by producers who decided to join the community and use the software. We call this the participation bonus.

When we aggregate the fees across the industry. The revenues for People, Ideas & Objects fall within the scope of what is necessary to undertake the kind of work that is described in the Preliminary Specification. These fees remain incidental to each producer on a comparative basis to the total costs of the software purchased from other ERP vendors. Producers / investors will be receiving an application that was developed with the full budget of the project. These costs, which will include the cloud computing infrastructure, will be a small percentage of those Information Technology costs that it replace. And as we will detail in the next few blog posts, these costs paid to People, Ideas & Objects will provide one of the elements of our claim that we provide the most profitable means of oil and gas operations.

Each year we specify the amount that each producer's share of costs will be. These will be on the basis of estimates of our understanding of what is required to maintain and develop the software to meet its competitive advantage of providing the most profitable means of oil and gas operations. So there is an inherent level of trust in the work that is done through the community, and the financial support that is provided. The research and software development necessary to make this happen can be significant and needs to be undertaken in a timely fashion. With today’s tools it can be done in a commercial fashion with remarkable speed. The real inhibition will be the communities ability to think fast enough. The producers are a critical part of the community. What can not happen is to have the funding for this development terminated as a result of a lack or fading interest by the producers. It is therefore inherent upon me to provide a compelling reason for that not to happen and that is through the fact that we provide the most profitable means of oil and gas operations.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

Authority and Responsibility in Oil and Gas

One area that we have not discussed in terms of capabilities in the Resource Marketplace module of the Preliminary Specification. Is where the authority and responsibility for any field operations falls as a result of the revised boundaries of the firm and market. If we have dynamic markets providing innovative products and services to the producers and Joint Operating Committees. How does this affect the authority and responsibilities that are established in the business today.

The clearest example to provide direction to this issue is the BP Gulf of Mexico well blowout. The findings established that BP was 100% responsible for the cause of the well blowout, and that clearly is the way that the business is run. The earth science and engineering resources are within the producer firms, and Joint Operating Committees, to design and engineer the operations to meet the safe and profitable operations of the oil and gas facilities. Without an appropriate engineering design there is little that a vendor can do in the field with a program that is destined to fail. With the changes being made in the Preliminary Specification, where reliance on an innovative Resource Marketplace for the service industry products and services, nothing will change in terms of this responsibility. The engineering staff at the oil and gas producer or Joint Operating Committee will have more choice in terms of products and services in terms of what they can do in the field. A second point on this discussion, is also the changes within the producer firm in terms of the reduction in the bureaucracy. From Professor Richard Langlois book “The Dynamics of Industrial Capitalism.”

History is never kind to historicists, of course; and the facts of the last quarter century have made life uncomfortable for those who would project the Schumpeter-Chandler model into the present. It has become exceedingly clear that the late twentieth (and now early twenty-first) centuries are witnessing a revolution at least as important as, but quite different from, the one Berle and Means decried and Schumpeter and Chandler extolled. Strikingly, the animating principle of this new revolution is precisely an unmaking of the corporate revolution. Rather than seeing the continued dominance of multi-unit firms in which managerial control spans a large number of vertical stages, we are seeing a dramatic increase in vertical specialization — a thoroughgoing “de-verticalization” that is affecting traditional industries as much as the high-tech firms of the late twentieth century. In this respect, the visible hand, understood as managerial coordination of multiple stages of production within a corporate framework, is fading into a ghostly translucence. p. 7

Management having less influence in the day to day of an oil and gas producer does not affect the authority or responsibility either. The engineers are qualified and regulated in terms of their qualifications and certifications. If they are signing their programs then they have their career on the line which to me is worth substantially more than the controls a manager may have established.

In highly developed economies, moreover, a wide variety of capabilities is already available for purchase on ordinary markets, in the form of either contract inputs or finished products. When markets are thick and market-supporting institutions plentiful, even systemic change may proceed in large measure through market coordination. At the same time, it may also come to pass that the existing network of capabilities that must be creatively destroyed (at least in part) by entrepreneurial change is not in the hands of decentralized input suppliers but is in fact concentrated in existing large firms. p. 14

Substantial change, creative destruction and innovation throughout the service and oil and gas industries. That is what is required to resolve the problems of the day. It's important to remember that doing so is as Professor Langlois states “Economic growth is about the evolution of a complex structure (Langlois 2001).” p. 6. For the last number of posts we have been discussing the desired changes in the makeup of the various marketplaces that provide services to the innovative oil and gas producers. These changes are necessary and ongoing throughout these industries. It is imperative that the oil and gas producer build the market supporting institutions, of which People, Ideas & Objects Preliminary Specification are part of, to identify and support these service industries. What is also necessary, and what will be detailed in the Research & Capabilities and Knowledge & Learning modules is that there is a time for change and there is a time when things need to remain static. Such as during specific field operations. And that is provided in those two module through the tools that are provided there for operational control. We won’t get into them now, I only want to mention that a changing marketplace is desired to configure innovative solutions for the oil and gas industry. And there is the need for tight operational control which is provided in the Preliminary Specification. What we have learned in our research is that an innovative footing is not inconsistent with tight operational control. In fact it is difficult to have one without the other. Using the Preliminary Specification provides that innovative footing and tight operating control, and therefore is the appropriate model for the innovative oil and gas producer.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

A Transition From Banking To Science

One of the conclusions in the Preliminary Research Report (2004) was that the oil and gas industry was transitioning from a “banking” mentality of earning guaranteed returns on investments, one that was based on the cheap energy era where financial survival was the key to success. To a scientifically based industry where innovating on the earth science and engineering disciplines would become the determining factors in a producer's survival and success. Today those two cultures are clashing as the relics of the cheap energy era attempt to restructure to compete in the scientific frontier. Adding to this transition is the bureaucracies last ditch attempt to assert its purpose in life. Is it any wonder that a producer reports losses on their operation?

We have been discussing the capabilities of the producer, the Joint Operating Committee and the service industry and how the Resource Marketplace module of the Preliminary Specification works to coordinate these marketplaces. We have put the responsibility for the service industries market supporting institutions squarely on the producers. The reasons for that are for the obvious ones in that they are the primary benefactors, and they are the primary industry that collects the revenues that ultimately will be used to support the service industry. It is therefore necessary that the oil and gas producers use this money to encourage this market to grow and develop as thick and as responsive as possible. The oil and gas producers are the ones who will benefit from the innovative and competitive service industry. What is known about the future of the oil and gas producer is there are high levels of uncertainty. Developing thick markets in the service industry will mitigate some of this uncertainty. From Professor Richard Langlois paper “Economic Institutions and the Boundaries of the Firm: The Case of Business Groups.”

The second hypothesis, which has resonances at least as far back as Gerschenkron’s famous “backwardness” thesis (Gerschenkron 1962), is that the way an economy responds to the problems of coordinating economic development depends not only on its own institutions and capabilities but also on institutions and capabilities elsewhere. It depends not only on an economy’s own history but on the history of other economies as well. The force of this observation is that an economy at the frontier of economic development (however we care to define that) is likely to respond to the coordination problem differently than an economy lagging behind that frontier. Specifically, an economy at the frontier is arguably more likely to rely on decentralized modes of coordination. This is so because uncertainty is greater at the frontier — uncertainty about technology, organizational form, market direction. p. 18

And what we need are people thinking their way through the uncertainty. I have been a strong critic of the “best practices” phenomenon that has developed over the past few years. Copying others “best practices” reminds me of this quote from Professor Langlois paper.

Indeed, traditional command-style economies, such as that of the former USSR, appear to be able only to mimic those tasks that market economies have performed before; they are unable to set up and execute original tasks. The [Soviet] system has been particularly effective when the central priorities involve catching up, for then the problems of knowing what to do, when and how to do it, and whether it was properly done, are solved by reference to a working model, by exploiting what Gerschenkron . . . called the “advantage of backwardness.” (Ericson, 1991, p. 21).

Best practices reflect the staleness of the methods of the bureaucracy. If not for the increase in commodity prices over the past few years, you wonder what these bureaucracies would have relied upon for earnings. Financially driven operational strategies will not provide value for the shareholders. Focusing on the earth science and engineering capabilities of the firm, and leveraging those in new and innovative ways will be the way in which value is generated. Follow on strategies will be as effective as the former Soviet Union’s economic performance. Producers and Joint Operating Committees need to configure themselves for innovation by adopting the Preliminary Specification and building the software it defines.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

Dynamic Transaction Costs

We have been discussing the way in which the innovative oil and gas producer and the Joint Operating Committee will source the capabilities they need from the marketplace. The last few blog posts have discussed how the marketplace has to be the source of those capabilities, and that modularity provides a means to deal with the changes that occur throughout the marketplace. It is important to remember that when we are discussing the marketplace what is pertinent to the Resource Marketplace module of the Preliminary Specification. Any and all resources that are available from the marketplace are accessed through the Resource Marketplace module by the producer or Joint Operating Committee. A simple definition would include the field, administrative, and other services they might use.

Today’s topic of discussion is Dynamic Transaction Costs. Dynamic Transaction Costs are somewhat of a unique area of research for Professor Richard Langlois. That is to say I think he is the leading researcher on the topic. It is a topic that affects the oil and gas industry significantly as we operate in an environment where change is the one constant that we can rely on. Langlois’ definition of Dynamic Transaction Costs from “Transaction Cost Economics In Real Time” is as follows.

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-verse. 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

It is therefore reasonable to assume that an innovative oil and gas industry will be incurring dynamic transaction costs. As we move to a more defined marketplace for our capabilities, and as those capabilities continually evolve, dynamic transaction costs will be incurred. Recall we are looking for “thicker” markets to develop as the Joint Operating Committees look to the market for all of its capabilities. Let's recall what capabilities are with a quote from Langlois’ paper, and the phrase from Harvard Professor Carliss Baldwin of “Knowledge begets capabilities, and capabilities beget action.” And then add to that this quote from Pablo Picasso "Action is the foundational key to all success."

Although one can find versions of the idea in Smith, Marshall, and elsewhere, the modern discussion of the capabilities of organization probably begins with Edith Penrose (1959), who suggested viewing the firm as a 'pool of resources'. Among the writers who have used and developed this idea are G.B. Richardson (1972), Richard Nelson and Sidney Winter (1982), and David Teece (1980, 1982). To all these authors, the firm is a pool not of tangible but of intangible resources. Capabilities, in the end, are a matter of knowledge. Because of the nature of specialization and the limits to cognition, organizations as well as individuals are limited in what they know how to do effectively. Put the other way, organizations possess a pool of more-or-less embodied 'how to' knowledge useful for particular classes of activities. pp. 105 - 106.

And it is with that definition of capabilities that we begin to understand the role of the producer firm and Joint Operating Committee in coordinating the marketplace. It is not the ownership and operation of the machinery in the field operations, or the ability to file the appropriate production accounting reports that provides the value to the producer or Joint Operating Committee. It is the ownership of the appropriate mineral lease and knowledge of the earth science and engineering disciplines. Dependence on the marketplace to make up for the other areas, where value is not earned, can be coordinated by the producer and Joint Operating Committee. Applying some tools and knowledge towards the makeup of those marketplaces is what the Preliminary Specification has done. Tools such as automation through Information Technology, specialization and the division of labor, modularity, capabilities definition and dynamic transaction costs make for an innovative and dynamic Joint Operating Committee and oil and gas industry.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

Modularity in Software and Organizational Design

Among the many areas of research that went into the Preliminary Specification is Professor Richard Langlois’ modularity. Modularity builds on the boundaries between the firm and markets and is the reason that the Preliminary Specification has eleven modules. The primary advantage gained by using modularity is the ability to manage change. By isolating the impact of any change to one module, the impact of the changes are manageable.

Modularity is a very general set of principles for managing complexity. By breaking up a complex system into discrete pieces - which can then communicate with one another only through standardized interfaces within a standardized architecture - one can eliminate what would otherwise be an unmanageable spaghetti tangle of systemic interconnections. p. 1

People, Ideas & Objects impact is beyond just the software that is proposed to be developed. Organizations such as the producer firm, the Joint Operating Committee and the service industries participants are all impacted as a result of the modules in the Preliminary Specification. Dynamic change within each area is a desired characteristic that is necessary for the innovative oil and gas industry.

What is new is the application of the idea of modularity not only to technological design but also to organizational design. Sanchez and Mahoney (1996) go so far as to assert that modularity in the design of products leads to - or at least ought to lead to modularity in the design of the organizations that produce such products. p. 1

and

Why are some (modular) social units governed by the architecture of the organization and some governed by the larger architecture of the market? p. 2

It is in the Revenue Model that People, Ideas & Objects assert that our software developments are not just for the oil and gas producers. They are for individuals, society, and the service industry as well. To focus only on the producers misses some of the “who” we are developing these systems for.

The set of design rules that guide social interaction are what we can generally call social institutions (Langlois 1986). These rules determine (among other things) the extent to which, and the way in which a society is a modular system. The desirability of modular design is a theme with a long history in the theory of social institutions. Adam Smith long ago proposed a decentralization scheme based on what he called "the obvious and simple system of natural liberty," by which he meant a system of private property regulated by common law and subject to minimal central administrative intervention. On the economic level, this approach would lead, he believed, to economic growth spurred by innovation, learning, and an ever increasing division of labor. pp. 14 - 15

and

if we can agree that the economic problem of society is mainly one of rapid adaptation to changes in the particular circumstances of time and place," he wrote, "it would seem to follow that the ultimate decisions must be left to the people who are familiar with these circumstances, who know directly of the relevant changes and of the resources immediately available to meet them. We cannot expect that this problem will be solved by first communicating all this knowledge to a central board which, after integrating all knowledge, issues its order. We must solve it by some form of decentralization" (Hayek 1945, p. 524). p. 15

Change is the one constant throughout the Preliminary Specification. Modularity in the software, and the organizational design of the oil & gas, and service industries is a means in which to deal with change. By moving the compliance and governance frameworks of the hierarchy into alignment with the legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks of the Joint Operating Committee. We set in place significant levels of change where producers, service industry providers and individuals all move closer to the cultural, or natural way of the oil and gas industry. Around the Joint Operating Committee. Adopting modularity within our software and our organizational structures will provide us with the appropriate architecture to deal with change.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

Capabilities From Thicker Markets.

One of the areas that we conducted significant research for the Preliminary Specification was in the area of capabilities. Capabilities in the sense that the earth science and engineering capabilities of the innovative oil and gas firm were one of its key competitive advantages. And capabilities in terms of how the producer firm acquired field operations capabilities from the marketplace, or service industry. Today’s topic is about the acquisition of capabilities from the marketplace and specifically the boundaries between the producer firm and the marketplace. Now when we discuss the producer firm we of course include the Joint Operating Committee as it is the source of all operations in the oil and gas industry. And it is natural that the Preliminary Specification places special reliance on the marketplace to provide for the Joint Operating Committees field operations.

To conduct these field operations internally has never been a choice, so for the Preliminary Specification to choose the boundary of the firm and market in this manner is not contrary to the culture of the industry. What we are attempting to do is to apply Professor Langlois’ theories to the culture of the oil and gas industry and determine the appropriate way forward. I think however, that the conceptual model of transaction cost economics considers that there will be “thicker” markets and a greater volume of transactions contemplated between the producer firms or Joint Operating Committees, and the marketplace. Thicker markets then what is represented in the current industry configuration. The Preliminary Specifications Resource Marketplace module considers these “thicker” markets would develop as a result of the changes in producers actions from using People, Ideas & Objects software.

The conflict that currently exists between the producers and the service industry is at a very high level. We have documented how the producers have been dissatisfied with the costs of field operations, how they have not sponsored new and innovative ideas and firms, and as a result, been left with a somewhat static service industry offering. These issues have been addressed in the Preliminary Specification and the point that I want to make today is that it is for the innovative Joint Operating Committee to rely more heavily on the marketplace for their field operations in the future and to remedy these issues through participation in the Preliminary Specification. Remedies such as purchasing and operating drilling rigs and other field level operations will not help the oil and gas industry to mitigate the issues that we are discussing here. Participation in the marketplace is the only solution. Focusing on the core competitive advantages of the innovative oil and gas producer; of their land and asset base, and earth science and engineering capabilities are where the value is earned. Not in replicating the marketplace offerings. From Professor Richard Langlois.

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 capabilities view is to understand what is distinctive about firms as unitary, historical organizations of co-operating individuals. p. 17

Of note and interest, having access to the same thick marketplaces as other Joint Operating Committees does not provide for the same costs or the same results. To achieve the same results one must replicate the competitive advantages in the earth sciences and engineering disciplines that others used. Coordination of markets is another area where there are distinct advantages that can be gained by the Joint Operating Committee. For further information on how the Preliminary Specification aids in the coordination of markets, please see the Accounting Voucher and Resource Marketplace modules ability to “design transactions.”

In a world of tacit and distributed knowledge - that is, of differential capabilities - having the same blueprints [or software] as one's competitors is unlikely to translate into having the same costs of production. Generally, in such a world, firms will not confront the same production costs for the same type of productive activity. p. 18

The end result of these thick marketplaces is what the innovative oil and gas producer must attain. To extend their capabilities in a manner far greater than what is possible through the current management's capabilities.

Moreover, by taking advantage of a range of capabilities far wider than the boundaries of what even the largest firm can encompass, a network of specialist suppliers and competitors is better able to exploit the value of a complex and potentially modular product architecture.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

Software Development Capabilities

One of the key capabilities that the innovative oil and gas producers will gain through participation in People, Ideas & Objects is its software development capability. In the 21st Century the need to meet changing conditions requires that your organization adapt. The problem with software is that it defines and supports an organization The software therefore has to make these changes before the organization can change. When you employ applications such as SAP you have little opportunity for changes in the software, and therefore have an unchanging organization. People, Ideas & Objects is a software development capability that is focused on change, that supports a dynamic and innovative oil and gas industry.

If we look at the business model of the various software providers we see a fundamental difference in the People, Ideas & Objects business model. SAP and others provide a software sale and support type of business model that has the producer pay for the majority of the software up front. Each year they pay a maintenance fee to keep the software up to date. This model does not provide for any change in the business. The SAP software application is the same that is sold to businesses around the world. It is a poor system for oil and gas. Any changes to accommodate the needs of the oil and gas industry have to be customized by the individual producer at their additional costs to the license fees. Software is not a key competitive advantage of the innovative oil and gas producer. SAP is also not oriented to change in their code as a result of their code structure and their customer base. Any changes to their code require extensive testing and engineering and redeployment to thousands of their customers. A costly undertaking that does not generate any revenue above what is already contracted for under the license agreement. This business model is what is considered the most successful in the oil and gas industry, from a producer's point of view.

People, Ideas & Objects business model is focused on change. Producers subscribe to the community and participate by paying the annual fees defined in the Revenue Model. Software development costs, because they are oriented to the oil and gas industry, are amortized over the entire People, Ideas & Objects subscribing participant producers. These fees support the software development, hardware infrastructure and user communities on an annual basis. The software is provided as a free service to the user community. Only producers who are subscribing participants will have accounts. This business model is focused on change within the oil and gas producer organization as defined in the Preliminary Specification. An integrated oil and gas solution built for the 21st Century.

Having this software development capability as an overall industry capability will be necessary for the dynamic and innovative oil and gas producer. As the producers organizations evolve the software will need to evolve first, because organizational change is more deliberate now that we are so dependent on software. If we don’t take control over the means of software’s production, then we can’t take control over the means of the production of oil and gas. Software play’s that important of a role in our lives today. From defining and supporting a more sophisticated specialization and division of labor, to enhancing greater collaborations. Software such as that defined in the Preliminary Specification is necessary for the industry to evolve.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

The Issues With Natural Gas Storage Part II

Yesterday we began discussing the steps necessary for the innovative oil and gas producer to establish natural gas prices that ensured profitable operations. The issue was the natural gas storage business and how it affected natural gas prices. The first step was to ensure that no natural gas was sold below the marginal costs. That it needed to become culturally unacceptable for producers to sell oil or gas below its marginal cost. The solution for that was for the producers to subscribe to People, Ideas & Objects Preliminary Specification. The second step was for the producers to take indirect control of the natural gas storage marketplace and that is the topic of today’s post.

The issue that the natural gas storage owners take advantage of is the seasonal nature of the natural gas business. The lower demand summer seasons can have a significant impact on the price of natural gas and the storage owners take full advantage of this opportunity to fill their capacity with the lower cost natural gas. This leaves them with a lower cost product that they in turn can sell in to the higher priced market in the winter. Having the additional effect of dampening the upper limit on the prices during the peak season. The storage providers are able to take the lower prices during peak demand due to the fact that their costs, the natural gas that they purchased last summer, are low. Therefore it is imperative that the the innovative oil and gas producer begin to manage the storage providers costs and ensure that they carry market costs for the gas they keep in storage instead of the discounted costs they have traditionally kept.

Managing the storage providers costs can be easily handled if the innovative oil and gas producers ensures that they sell no gas below the marginal cost at any time during the year. The production discipline will be difficult to implement initially and will have to become culturally unacceptable. However the effect on the storage providers costs will have a significant impact on their behavior in the marketplace when selling in the peak and low demand times. Managing the storage providers costs in this fashion will limit the operational gains made on the seasonal variances in the natural gas prices. This may have been the major aspect of their operating profit. By eliminating this component of their operating profit the producers may be able to limit the effect of storage in the natural gas marketplace in the short to long term.

The reason there is a drop in prices in the summer months is due to the lack of demand and the producers have traditionally kept at full production. The storage providers made up the difference in the marketplace. What will now be required is the production discipline to shut-in marginal production and keep the prices in the range where they were all year, or at least above the marginal cost. This will affect the operational costs of the storage provider and their behavior so that their impact in the marketplace will be negligible.

The costs to the producer of not adhering to this production discipline is that they will incur operational losses on their properties. This will have the effect of incurring losses on the reserves that remain. These reserves will then have to provide a return on the remainder of the capital costs plus the losses that were incurred. Quite probably making the field or property uneconomic as a result of producing the well below the marginal cost.

Recall in our discussion yesterday that by shutting in the well we are suspending the overhead and production costs. To the point where most of the costs that remain are only the capital costs that are uncovered. This is a preferable situation compared to incurring a financial loss, and a loss of the physical gas reserves. It is a real strategy as opposed to just hoping for a cold winter. Producers will have it within their domain of operations to maintain profitable operations. There would be no need to report losses on any operations in this environment where the marginal cost was a threshold for production. Investors would need to hold the producers accountable for any losses on operations that meet this criteria and deal with them accordingly. That is the future of the innovative oil and gas industry.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.

The Issues With Natural Gas Storage Part I

How much of today’s natural gas price decline is attributable to the record storage volumes. In the past, to aid in deliverability of natural gas during peak demand, producers invested in storage to aid in the delivery of natural gas. This was to offset the risk of not being able to meet the demand for natural gas on those cold winter days. With so much electricity being generated by natural gas, shortages would lead to critical electrical energy shortages. In the beginning, and with the cyclical nature of natural gas, producers found that natural gas storage was a good business to be in. Buy the product in the summer at low prices and sell it during peak demand in the winter at higher prices. Soon thereafter there was a boom in building natural gas storage facilities. And with all booms the inevitable fallout in terms of the potential earnings. The producers, who were the initial investors eventually sold their interests in the natural gas storage facilities to what become a new sub-industry of providers, the natural gas storage providers. Today we live with the legacy of these transactions. And I think the natural gas storage issues are the real source of the natural gas pricing issues. The first step to correct this is for the producers to be able to shut-in their marginal production, and the second is for the producer's to take indirect control over the natural gas storage marketplace.

In order for the innovative oil and gas producer to take the first step as described above. They would need to subscribe to People, Ideas & Objects and build the Preliminary Specification. It is within the Preliminary Specification that we enable all producers to use what is called the “decentralized production” model and discard the “high throughput production” model that is currently used. The decentralized production model is defined by Professor Richard Langlois in his book The Dynamics of Industrial Capitalism as.

In a world of decentralized production, most costs are variable costs; so, when variations or interruptions in product flow interfere with output, costs decline more or less in line with revenues. But when high-throughput production is accomplished by means of high-fixed-cost machinery and organization, variations and interruptions leave significant overheads uncovered. p. 58

What the Preliminary Specification does is move the production and overhead costs from the producer firm to the Joint Operating Committees. This then provides the opportunity to reorganize these tasks and processes, and focus them on their specialization and division of labor across the industry. So that production accounting, royalty accounting, and lease rentals etc can be focused on the most efficient and effective process and be billed directly to the Joint Operating Committee for the fees for these services. Where production accounting is focused on the specific region for the gas plant. Or royalty accounting is specialized on the unique characteristics of one royalty jurisdiction. Or the lease rental process is the most efficient and effective due to its scale and scope across the industry. How this then affects the decentralized production model is that during times of shut-in production, due to low natural gas prices, because these charges are billed directly to the Joint Operating Committee, the costs of production and royalty accounting are not incurred or billed to the joint account. Achieving the decentralized production models objective of making most costs variable and only the costs of capital uncovered during times when production was marginal and shut-in.

If all of the innovative oil and gas producers were able to take the marginal production off of the marketplace by following the decentralized production model in the Preliminary Specification. Then they would have completed the first step in obtaining control of the natural gas prices. But this will not be enough until they deal with the inventory in storage and that will be the topic of tomorrow's post. This first step is critical in the prolific era of shale technologies. With the ability to flood the marketplace with oil or gas with high deliverability fields. The need to invoke production discipline across the industry is a must. The marginal cost must become the floor at which any and all fields can be sold at. Selling below the marginal cost must become culturally unacceptable in the innovative oil and gas industry.

The Preliminary Specification provides the oil and gas investor with the business model for profitable exploration and production. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy.