The Opportunity Costs of Natural Gas Prices

In this post we want to compare the two business models, the bureaucracies muddling along vs People, Ideas & Objects Preliminary Specification, in terms of the opportunity costs that are incurred by not having the Preliminary Specification operational. This calculation will be to determine what the opportunity costs would be for North American natural gas revenues assuming that producers were able to reduce production by ten percent and therefore raise the price of gas to $5.50 per MCF. Recall that the Preliminary Specification enables producers to shut-in production of marginal gas without incurring the penalty of production or overhead costs.

Currently natural gas production in North America is 78 Billion Cubic Feet (BCF) Per Day. That’s 78 x 365 days = 28.47 Trillion Cubic Feet (TCF) of gas for the year. We need to reduce this volume by ten percent to 25.88 TCF. With an estimated price of gas at $5.50, less an estimated average $3.00 realized per Thousand Cubic Feet (MCF) for 2012 leaves $2.50 of unrealized opportunity costs. Therefore the opportunity costs of 2012 natural gas prices is $2.50 x 25.88 TCF = $64.7 billion. A number larger than the costs to fund the Preliminary Specification.

The bureaucracy doesn’t need this money as they are adequately funded by the oil prices. However, the investors are entitled to this value nonetheless. It will require some work and effort, both to build and make the changes in the industry as a result of the Preliminary Specification. Work that the bureaucracy is not oriented towards. It’s not that the type of work is different to the work that the bureaucracy is familiar to, its that the bureaucracy is not that familiar to work itself. This situation has been with us now for a number of years. There is no proposed solution to its resolution. With the high costs of shale gas, and natural gas in general, this is not a situation that can continue. Yet the bureaucracy continues with no discussion of any possible resolution or even identification that this is an issue.

The fact of the matter is that the Preliminary Specification is new and not that well known in the marketplace, yet. The bureaucracy are not challenged by it as it is not seen by the marketplace as an alternative due to its relative newness. As we progress the bureaucracy will have a more difficult time in continuing on with their status quo do nothingness. I don’t expect that any solution to the over production will come about as a result of the bureaucracies handling of the situation in the next few years. There just not that smart and they are leaderless.

What the Preliminary Specification does is adopt the Decentralized Production Model. By doing so, all of the overhead costs are incurred by service providers who are organized based on a specialization and division of labor across the industry. That way they can organize their service offering based on the most efficient and effective process possible. These service providers then charge the Joint Operating Committee directly for their costs of production, revenue, royalty accounting or lease rental expenses, etc. Then when production is shut-in there is no service offering to be billed for the month and the overhead costs for the shut-in production doesn’t exist. Eliminating the High Throughput Production Model that the industry operates under today. Shut-in production therefore has no production costs or overhead costs incurred and therefore only the costs of capital are uncovered during periods when the production is shut-in. A producer can shut-in any production that does not meet the marginal costs and save those reserves for when the prices provide a return on investment. A much more rational way to approach the oil and gas industry during times when the shale formations are as prolific as they are. During times when production is shut-in producers can innovate and bring their costs down in their non-producing properties to bring those reserves back on production.

The irrational way in which the bureaucracy is producing oil and gas today is going to be looked upon as foolish in the near future. With so much potential reserves the bureaucracy seems to think that means it can be wasted. I think we should take the responsibility for producing those reserves out of the hands of the bureaucracy and put it in the hands of the investors and have it done profitably and responsibly through the Preliminary Specification.

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.

2012 Earnings Season

We are at the beginning of the 2012 earnings season. I am hoping this will be a crucial point in People, Ideas & Objects history. A time when our ability to demonstrate our business model’s value meets with the investors demand for greater earnings from the producer firms. If, as I suspect, that 2012 was a bad year for the oil and gas producers. Maybe this will be the point that the investors will begin to look for answers to the problems of the producers poor performance.

We have been running a balance of those producers who have announced their 2012 earnings. To date we have recorded only Encana’s spectacular loss of $2.79 billion. We have two other firms to add to that total and they are ARC Resource earnings of $139.2 million and Marathon Oil earnings of $1.582 billion. This gives a net total for the industry of $1.07 billion of losses for 2012.

The next two weeks we will see the balance of the firms report results. As I said, I hope that it is a turning point in the attitudes of the investment community towards the bureaucracies lack of performance. And our opportunity to demonstrate the differences between People, Ideas & Objects Preliminary Specification and the status quo.

The Preliminary Specification provides the oil and gas producer with the most profitable means of oil and gas operations. 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 are the Results of Innovations

Now that we have finished reviewing the Research & Capabilities module we are going to take a short break from reviewing the Preliminary Specification to cover off some of the other aspects of this blogs discussion. I want to leave the Research & Capabilities with this last thought based on this quotation from Professor Richard Langlois.

The first, and most obvious, point is that it was an outside individual, not an organization, who was responsible for the reorganization of the industry. Lazonick is right in saying that genuine innovation involves reorganizing or planning (which may not be the same thing) the horizontal and vertical division of labor. But it was not in this case “organizational capabilities” that brought the reorganization about. It was an individual and not at all a “collective” vision, one that, however carefully thought out, was a cognitive leap beyond the existing paradigm. If SMH came to possess organizational capabilities, as it surely did, those capabilities were the result, not the cause, of the innovation. p. 46

It is that last sentence that stands out for me. That the information contained within the Dynamic Capabilities Interface would be the result of the innovations that were developed by the producer. Certainly there will be other capabilities that are listed within the interface but the key capabilities will be those that are developed as a result of the innovations that are developed by the firm.

The Preliminary Specification is designed to define and support the innovative oil and gas producer. It is an inherent part of the business model that People, Ideas & Objects are offering the oil and gas industry. A business model that provides the oil and gas producer with the most profitable and innovative means of oil and gas operations. Based on the Joint Operating Committee, the legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks of the industry.

Contrast our business model with the one that the current bureaucracy are providing. One in which muddling along is the manner in which we approach the operational concerns. Is this how we address the future of the industry in this difficult energy era we are approaching? Our first step to addressing the future is to organize for it. And the first step in this advanced society is to build the software to define that organization. That is the objective here at People, Ideas & Objects and the Preliminary Specification is the design for the innovative and profitable 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.

Two Primary Processes of Innovation

We have been discussing the coordination of operations and how that is organized in the People, Ideas & Objects Research & Capabilities module. Coordination of operations is only one of the things that is carried out in the module, innovation is another. To refresh our memory, the primary process in which innovation is carried out in the Preliminary Specification is as follows.

The producer firm through its interactions with the service industry develops new and innovative capabilities that are captured and documented in the “Dynamic Capabilities Interface.” The interactions with the service industry are through a variety of interfaces in both the Research & Capabilities and Resource Marketplace modules. Using the football analogy this is the practice field where the team is developing new and innovative plays to be worked on and perfected before game day. Game day is when the capabilities are published in the “Dynamic Capabilities Interface” which enables them to be seen in all of the pertinent Joint Operating Committees that the producer has an interest in. This process enables the producer firm to eliminate the unnecessary “trial and error” learning from being repeated in each and every Joint Operating Committee. The learning can be done once, and therefore limit the cost of the innovation by reducing the unnecessary experimentation. As I stated this is the primary process of innovation.

If there was a secondary or optional process of innovation in the Research & Capabilities module it would be based on the following. This is from Professor Richard Langlois’ paper “Innovation Process and Industrial Districts.”

Innovation is based on the generation, diffusion, and use of new knowledge. p. 1

Opportunities do occur at times and in places that are not planned for. Innovation is something that frequently falls within this description.

While it is possible to conceive of a firm that is so hermetic in its use of knowledge that all stages of innovation, including the combination of old and new knowledge, rely exclusively on internal sources, in practice most innovations involving products or processes of even modest complexity entail combining knowledge that derives, directly or indirectly, from several sources. Knowledge generation, therefore, must be accompanied by effective mechanisms for knowledge diffusion and for "indigenizing" knowledge originally developed in other contexts and for other purposes so that it meets a new need. p. 1

To preclude the opportunities for these types of discoveries to be acted upon would leave the spontaneity out of the oil and gas industry. When faced with the knowledge that is provided to the user of the “Dynamic Capabilities Interface” some things may become obvious that were not so before. Serendipity is a word that is used in economics quite frequently. We should adopt it here to ensure that a dynamic and innovative nature of the industry is the result.

But there is more that we are doing in this secondary process then we have done in the first process. We are building on the already well established capabilities of the producer firms of the Joint Operating Committees, and, we are exposing the collective knowledge to the broader community of earth scientists and engineers of the Joint Operating Committee. This broadening of the scope of users is at the same time there is limiting of the focus to just that Joint Operating Committee. Professor Langlois notes.

When accompanied by close social relationships, tight geographical proximity may affect innovation in ways that are less common in more highly dispersed environments. For example, an awareness of common problems can encourage several firms, or their suppliers and customers, to seek solutions, leading to multiple results that can be tested competitively in the market. pp. 1- 2

and

Relationships within industrial districts therefore lead to diffusion but also to the creation of new knowledge through shared preoccupations. Because many people or firms can work on a problem simultaneously, a number of different solutions may be found (Bellandi, 2003b). The results is a larger and stronger "gene pool" within the sector (Loasby, 1990, 117), with the further advantage that solutions that are originally regarded as competing may turn out to be complementary and well-suited to different niches within the district.  p. 7

What is therefore needed is a means to capture innovations that arise from this secondary process. Turn them into the primary innovation process so that they can be further populated throughout the various Joint Operating Committees that the firm participates in. That will limit the amount of trial and error learning costs that might occur if each Joint Operating Committee were to field test their own innovations based on the ideas they heard from so and so.

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.

Management and the Former Soviet Union

In the Preliminary Research Report (2004) I suggested that the oil and gas industry was not fundamentally different than the former Soviet Union in terms of its ways and means. Going through the motions and determining “best practices” shows a state of stagnation that is very close to death, in my opinion. We see the natural gas prices that everyone watches but no one does anything about. Everyone complains about the service industry, but no one does anything about it. The market system hasn’t existed in the oil and gas industry for so long, no one even knows what it would look like. From Professor Richard Langlois book “The Dynamics of Industrial Capitalism” chapter 1.

The question, then, is clear: why did managerial coordination supersede the price system? Why did “managerial capitalism” supersede “market capitalism” in many important sectors of the American economy beginning in the late nineteenth century? p. 9

To reinstate the market and the dynamism of the market system in the oil and gas industry will require new systems to identify and support innovative producers, suppliers and Joint Operating Committees. The Research & Capabilities module is designed to enable the systemic thinking that is necessary for the earth science and engineering capabilities of the producer and Joint Operating Committees to act in dynamic, innovative and market fashion.

The parallel of the current system to the former Soviet Union is striking when you realize the pervasiveness of the non-thinking environment. From Professor Langlois’ “Economic Institutions and the Boundaries of the Firm: The Case of Business Groups.”

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.” ... Accompanying these advantages are shortcomings, inherent in the nature of the system. When the system pursues a few priority objectives, regardless of sacrifices or losses in lower priority areas, those ultimately responsible cannot know whether the success was worth achieving. The central authorities lack the information and physical capability to monitor all important costs—in particular opportunity costs—yet they are the only ones, given the logic of the system, with a true interest in knowing such costs. (Ericson, 1991, p. 21).

The opportunity costs realized in the natural gas business are horrendous. It is well within the scope of understanding of everyone within the natural gas business as to what the difficulties are, yet no solutions are discussed. If not for the Preliminary Specification there would be no solutions whatsoever. Including the market orientation into all aspects of the oil & gas and service industries are key components of the Preliminary Specification.

And in terms of the status quo that management continue to pursue. This is the one culture of the industry that we are moving against. It is also the most powerful. Management control the budget and have exercised it by not supporting People, Ideas & Objects. Show me an ERP system with the depth of research into oil and gas that the Preliminary Specification has, well there are none. They all get financed on relationships with maintaining the status-quo with management. The fact that there has been no funding proves that management are too conflicted to do the right thing in this regard. Therefore the decision to proceed will have to be taken out of management’s hands and put in the hands of the investors and the C class executives to make the decision to fund People, Ideas & Objects. After all they have some concerns with management as well.

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.

Technologies Role in Societies Demand for Energy

Lets go back a bit to look at the “Dynamic Capabilities Interface”of the Research & Capabilities module from a different perspective. One in which we are looking more high level at the attributes of what we are attempting to achieve. With this perspective it should be possible to see how the Preliminary Specification relies on the dynamic marketplace of the service industry, and defines and supports the framework to execute field operations with military precision. This seemingly inherent contradiction is anything but. The two are fundamentally different with the field operations being a temporary snapshot of the marketplace’s offerings. Once that operation is complete, that temporary organizational construct developed for the field operations and its capabilities will never exist again. That is not to suggest that the capabilities are deleted from the “Dynamic Capabilities Interface,” it's just that they do not exist in the organization that was used for that specific field operation.

We want to maintain all of the elements of a dynamic and innovative service industry. The Preliminary Specification has set out to provide for this by ensuring the service industry receives strong support from the oil and gas industry. This is also necessary for the energy industry to ensure that the demands of society, in terms of energy, are met. Once this financial marketplace recession is over the demand for energy will resume a steady pace. We have discussed Professors Anthony Giddens and Wanda Orlikowski theory of Structuration and model of Structuration. That people, society and organizations must move together or there will be failure. It should be asked if these societal demands for energy can be met by the current oil and gas organizations? Technology can have a role in this. From Professor Orlikowski’s paper.

Interaction with technology influences the institutional property of an organization, and this influence is more likely to be reinforcing rather than a transforming one. (p. 235 The Duality of Technology: Rethinking the Concept of Technology in Organization). 

In order to achieve the organizational performance necessary to meet society's demands, it will require the technologies to be put in place first. This was one of the key findings of the Preliminary Research Report. This same theme is picked up by Professor Richard Langlois in his paper “The Vanishing Hand: The Changing Dynamics of Industrial Capitalism.”

The basic argument - the vanishing hand hypothesis - is as follows. Driven by increases in population and income and by the reduction of technological and legal barriers to trade, the Smithian process of the division of labor always tends to lead to finer specialization of function and increased coordination through markets, much as Allyn Young (1928) claimed long ago. But the components of that process - technology, organization, and institutions - change at different rates. p. 3

So where are we? The People, Ideas & Objects Preliminary Specification is designed to support innovative and dynamic markets that will enable the oil and gas industry to meet the surging demand for energy. But neither the surging demand nor the software exists. 12 million cars were sold in China last year. Probably the same number will be sold this year. The point is that the markets for energy are developing and the demand will grow. The question will be who will be the first to volunteer to keep their economy stagnant due to a lack of energy? And just as the markets for energy develop the software too needs to be developed.

As in Chandler, secular changes in relative prices attendant on "globalization" (driven by technology or politics) affect economic organization not only directly but also, and perhaps more importantly, indirectly through changes in technology. Production costs matter as much as transaction costs (Langlois and Foss 1999). Moreover, the kind of transaction costs that matter in history are often not those of the Williamson kind but those I have labeled dynamic transaction costs (Langlois 1992b). Costs of coordinating through markets may be high simply because existing markets - or more correctly, existing market-supporting institutions - are inadequate to the needs of new technology and of new profit opportunities. But when markets are given time and a larger extent, they tend to "catch up," and it starts to pay to delegate more and more activities rather than to direct them administratively within a corporate structure. p. 5

There will be significant changes made to the markets during the times we are developing the People, Ideas & Objects software. Changes that will need to be captured in the software. There is never a best time in which to approach these changes, however, now might be a good time.

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.

What is a Capability

In today’s post we try to answer the question what is a capability? It is in the “Dynamic Capabilities Interface” of the Research & Capabilities module that we are seeking to document the “what” and “how” of the operation the Joint Operating Committee will undertake. It is very important to note at this point that the tacit knowledge that makes up that operation can not be documented. It will however be invoked through the orders in the Job Order system. The depth of “knowledge, skills and experience” that is documented in the “Dynamic Capabilities Interface” includes the members of the Joint Operating Committee, their roles and responsibilities, and the field operations personnel. Detailing what and how they need to do their jobs in order to attain the objective of the operation. In a paper entitled “Transaction Costs in Real Time” Professor Langlois notes:

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.

That’s an effective way to state what it is that we are trying to achieve here. The “Dynamic Capabilities Interface” is a how-to database of capabilities the firm has for getting things done. Or;

'Routines,' write Nelson and Winter (1982, p. 124), 'are the skills of an organization.' p. 106

Now here is the point where we need to pay attention. Both figuratively and literally. In this discussion as well as in any and all oil and gas field operations. The ability to do any of these tasks on autopilot doesn’t exist. And the implications of the next quotation is far reaching.

Such tacit knowledge is fundamentally empirical: it is gained through imitation and repetition not through conscious analysis or explicit instruction. This certainly does not mean that humans are incapable of innovation; but it does mean that there are limits to what conscious attention can accomplish. It is only because much of life is a matter of tacit knowledge and unconscious rules that conscious attention can produce as much as it does. p. 106

It will need to be the explicit instruction contained within the “Dynamic Capabilities Interface” that guides the field operation. The conscious attention necessary to follow the program is a necessity.

In a metaphoric sense, at least, the capabilities or the organization are more than the sum (whatever that means) of the 'skill' of the firm's physical capital, there is also the matter of organization. How the firm is organized - how the routines of the humans and machines are linked together - is also part of a firm's capabilities. Indeed, 'skills, organization, and technology are intimately intertwined in a functioning routine, and it is difficult to say exactly where one aspect ends and another begins' (Nelson and Winter, 1982, p. 104). p. 106

One thing I can say for certain is that the technology begins with People, Ideas & Objects. By developing the Preliminary Specification the producers will be able to attain the level of innovativeness and operational control that is described here.

It has been a long and difficult process to detail what it is exactly that we are capturing in this interface. Capabilities are a difficult concept to quantify and qualify. Add to that difficulty is the need to keep innovation at the forefront of the producers and Joint Operating Committees capability, and the challenge ahead is well defined.

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.

Operational Control Part II

In terms of operational control the “Dynamic Capabilities Interface” of the Research & Capabilities module provides a means to have everyone on the team operating from the same hymn sheet. Everyone knows what the plan is and everyone knows what everyone else is doing. Now we need a means in which to execute the plan. A way in which to deploy the tacit knowledge held by the team. In the “Planning & Deployment Interface” as well as in some other interfaces users will have access to the “Job Order System” of the People, Ideas & Objects Preliminary Specification. This will provide the ability for a member of the operational team, with the operational authority as designated in the Military Command & Control Metaphor, to issue a Job Order to execute a certain operation. Simply nothing is done during the field operation without the Job Order being issued.

And there is the budget. The AFE that was raised and approved for the operation is also at the hands of those that are in control of the operation. As has been mentioned many times throughout the Preliminary Specification. Within any interface certain aspects of the People, Ideas & Objects Preliminary Specification can be obtained by right clicking within the interface to pull up a contextual menu of items that enable certain actions. One of those actions could be the ability to approve an additional aspect of the operation for completion in the AFE.

The Work Order system will also be operational during these times. It will be providing the means in which to control the costs of the internal resources as those people charge their time to the AFE. The Work Order and Job Order are two separate and distinct systems. The Work Order aggregates the time that people are working on a specific project and bills them to the specific AFE or Work Order that is set up. It also works closely with the Military Command & Control Metaphor to layer a means to execute authority and responsibility within the resources that are committed to the project. These resources may be from different participants who are members of the Joint Operating Committee.

This next quote might be confusing without some discussion. It is from a Berkeley study and is dated in 1989, a time when the Japanese and the Americans were fighting over dominance in the microchip manufacturing industries. Apparently the two industries were configured quite differently, as Berkeley notes below. And it is the Americans that grew to dominate the industry at the Japanese almost total capitulation. The organizational structure of these industries is interesting to see some twenty three years later.

In one of the few contemporary academic examinations of this industry, a study by the Berkeley Roundtable on the International Economy concluded that; ... with regard to both the generation of learning in production and the appropriation of economic returns from such learning, the U.S. semiconductor equipment and device industries are structurally disadvantaged relative to the Japanese. The Japanese have evolved an industrial model that combines higher levels of concentration of both chip and equipment suppliers with quasi-integration between them. whereas the American industry is characterized by levels of concentration that, by comparison, are too low and [by] excessive vertical disintegration (that is, an absence of mechanisms to coordinate their learning and investment processes) (Stowsky, 1989) p. 3

My point in highlighting this is that we are relying heavily on the decentralized marketplace in the service industry to provide the oil and gas industry with the products and services it needs. We are however, also providing the Joint Operating Committee with high levels of coordination of the operation during the times it is employing the service industry. This is not a contradiction, one is a market, the other is an operation. The oil and gas industry depends on a highly innovative service industry and this will be expected from the marketplace. It also demands precision from the field operations that it conducts. Innovation will arise from both.

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.

Operational Control Part I

One aspect of innovation is tight operational control. Just because the firm is innovative doesn’t mean that it has a loose handle on operations. Apple is very innovative and is tightly controlled. These two attributes are not mutually exclusive. One aspect of the Research & Capabilities module is the ability to attain tight operational control during any field operation.

Reading of this next quotation shows that we have a job to do here in the “Dynamic Capabilities Interface” of the Research & Capabilities module. That is we need to replace this critical function that was done by the “firm” in the previous organization. As much as I want to criticize the current management they are doing the job to a certain level. And to not respect that level would be a failure on our part. What we need to do is to capture what the firm does now by “lowering the costs of qualitative coordination (or tight operational control) in a world of uncertainty.”

A close reading of this passage suggests that Coase's explanation for the emergence of the firm is ultimately a coordination one: the firm is an institution that lowers the costs of qualitative coordination in a world of uncertainty. p. 11

It would be People, Ideas & Objects assertion that the current bureaucracy are motivating the service industry through incentive clauses in their contracts. Lets put in context the conflict between the service industry and the oil and gas producers. They have been in disagreement for a number of years as to the pricing of the services for field operations. Read this next quotation with this in mind.

All recognize that knowledge is imperfect and that most economically interesting contracts are, as a consequence, incomplete. But most of the literature considers seriously as coordinating devices only contracts and the incentives they embody. It thus neglects the role- the potentially far more important role - of routines and capabilities as coordinating devices. Moreover, the assumption that production costs are distinct from transaction costs and that production costs can and should always be held constant obscures the way productive knowledge is generated and transmitted in the economy. p. 14

Professor Langlois is 100% correct. The producers are relying on contracts to incentivize the contractors and its not working. What is required is better coordination. And that begins with systems like the People, Ideas & Objects Research & Capabilities module that details the capabilities of the producers and field staff in a manner that constructively deals with the problems of a scientific based business.

What could only be described as a breakthrough, how we documented the Preliminary Specifications coordination of capabilities or tight operational control through the “Dynamic Capabilities Interface” of the Research & Capabilities module. This relieving the incentives problem that contracting of the service industry is presenting to the oil and gas industry. As we learned, coordination will provide oil and gas producers with the control over field operations. Coordination through the “Dynamic Capabilities Interface” provides the alternative means in which to ensure the science of the oil and gas business is effectively controlled as opposed to motivating the service industry through incentive clauses in the contracts. We will continue with this concept of the “incentive problem” and test it further with Professor Richard Langlois paper “Capabilities and Governance: the Rebirth of Production in the Theory of Economic Organization.”

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.

It is through the producers documentation of the capabilities in the “Dynamic Capabilities Interface” of the Research & Capabilities module that the “knowledge, experience and skills” are captured. From the engineers and geologists that are part of the Joint Operating Committee to those that are in the field, each should have an understanding of what is required of them from the capability that is listed in the “Dynamic Capabilities Interface.” Recall that in the Knowledge & Learning module these capabilities are called like plays in the football analogy. Everyone on the team knowing what is happening and what their role and task is. That is what needs to be documented in the “Dynamic Capabilities Interface” for each of these roles, for each of the capabilities that are captured there.

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

And that becomes obvious when we consider that the capabilities that are available to each Joint Operating Committee, and the Military Command & Control Metaphor that is used, is going to be unique to each situation it is applied to. Using the same team to apply the same capability over and over again however should yield the same results. Therefore, if you were running a ten well drilling program then the consistency of the capabilities and the MCCM would provide the same precision and the same results.

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.

Who Does the Innovation

Its important to remember that the people who are operating in the Joint Operating Committee are not experimental lab rats. That to leave a capability that was untested and untried for them to sort out is counter to the purpose of the “Dynamic Capabilities Interface,” the Knowledge & Learning module and the Joint Operating Committee. They are there for execution and not for the purpose of developing concepts or experimenting. To use the football analogy, the Joint Operating Committee is game day, and what the research and study area needs is a metaphorical practice field. One in which the opportunity to explore failure is welcome and where a producer can attain a learning experience to the ultimate solution or capability.

The question becomes who in the industry should be conducting the innovations. Some might assume that the majority of the innovation in the oil and gas industry is developed within the large producers. However, I think that is generally considered to be untrue. The small and start up oil and gas firms along with the intermediate producers are probably responsible for the majority of the innovations in the last 20 - 30 years. Professor Giovanni Dosi’s reference to the Schumpeterian hypothesis, “that bigness is relatively more conducive to innovation, that concentration and market power affect the propensity to innovate” and his rejection of that premise is evident in his paper’s following three points.

• First, although “there appears to be roughly a log linear relation within industries between firm size and R & D expenditures,” upon closer investigation, “estimates show roughly non-decreasing return of innovative process to firm size.” This is probably attributable to the fact that very large and very small firms conduct most R & D. p. 1151
• Second, although the expenditures in R & D incurred by large firms are impressive from a total expenditure perspective, the aggregate expenditures of small firms on a global basis becomes far greater in aggregate than the large business. p. 1151
• Third, money is not necessarily a good indicator of innovativeness. Large variances within industries can clearly be identified irrespective of firm size. p. 1152

Therefore “bigness” is not necessarily an element that enhances innovation. This might be intuitively understood by the small oil and gas producers ability to punch above their weight. In the software development business, SAP may do significant generic research in the software development arena. However, they do very little in terms of specific oil and gas research. On the other end of the scale People, Ideas & Objects have completed substantial oil and gas specific research and have commenced the development of oil and gas specific software with the publication of the Preliminary Specification. And I can assure you that at this time we are a very small firm, proving Professor Dosi’s first point.

If we look at Professor Dosi’s second and third point together. It is clear that money is not necessarily a determining factor in innovation. Although large firms spend impressively on R&D, that does not produce a number of usable innovations. And it may be the lack of financial resources that motivate the smaller firms to innovative problem solving on the other end.

Professor Dosi (1988) provides three caveats to the three differences noted.

• Statistical proxies cannot capture aspects of technical change based on informal learning. p. 1152
• Secondly, “differences in businesses and business lines (and business or product life cycles) may provide discrepancies in comparison of “like” firms. p. 1152
• Thirdly, many firms are expending significant research dollars in keeping up with other firms innovations.  p. 1152

Or in summary, proof that money is not necessarily a determinant of innovative success and that all producers need to be represented in an innovative oil and gas industry. There is a determining paradox for the ability to innovate based on imitation or on the basis of strict Research and Development. Companies can copy others innovations in industries with minimal asymmetry, (where competitors are all the same). Whereas industries that are asymmetric (like oil and gas) or have large variances in their capabilities are best served by differentiating themselves by pursuit of Research and Development.

This is why the focus on the capabilities is critical to the success of the oil and gas concern. They are able to differentiate themselves by research and development and the focusing on capabilities. Passing these capabilities on to the Joint Operating Committee through the Knowledge & Learning module allows the producer to initiate these capabilities “just in time” and where they are needed. This can be done without the concern that they are exposed or risked to potential competitors through the Joint Operating Committee. It should be clear through this analysis that those that would attempt to copy others capabilities will be expending extensive resources to do so, as much or even more then it would cost to develop the capabilities on their own, however, those that chose to copy will remain static within their competitive position within the industry. Its just not that easy to copy someone else, and it's not that valuable to their firm. When markets such as oil and gas are asymmetric, Research & Development are the ways in which to differentiate capabilities and build an 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.