The "Fifth" constraint.

The oil and gas producers are having a difficult time in keeping up with the demands for energy. I have attributed this problem to the organizational structure and named the hierarchy as the culprit. The resource constraints are serious and include human, technological, scientific, financial and lets name the fifth constraint "speed".

The problem as I see it is a deliverability one. The next ten years will see the productive capacity of the industry slowly adapt to the market demands. The time lines and capabilities are not in the supply of energies favor. Time is necessary to formulate scientific concepts, purchase land, drill and produce the oil or gas. This process is usually around ten years in terms of the beginning to production, especially for offshore and oilsands.

In terms of where the attitude and mindshare of the bureaucracies is at, it's 1996. When there were no such energy demands and a productive surplus of around 10 million barrels per day. None of the issues of the supply demand imbalance of today. Oil in 1996 is trading at around $20 per barrel and the capital budget of the large company is based on these criteria. These are the resources and production that are being brought to market today.

If you hear the large companies talk they fear a price drop to the 1996 levels. That there is no energy shortage and a sense of urgency doesn't exist. Why are they so calm? You have literally two billion plus people joining the industrial revolution and the large companies just blink at you in a stunned state of confusion.

The larger companies are experiencing information overload in addition to the lack of understanding of their market. They are completely engulfed in a paper world that has so confused them that they have no idea what year it is.

As these large companies will not be in existence in 10 years we should let them off the hook and let them die in peace. Anyone that would suggest the hierarchy will rise up to this challenge and solve it are being sarcastic at best. The effort necessary needs to be organized first, that is what this blog is about, defining the joint operating committee as the central organizational focus of the oil and gas producer.

This new organization needs to have the systems built to operate the new producer in the manner that the individual users need. Just as SAP defines the bureaucracy, this blog's developments will define the innovative producer, user and investor. So for those that have seen that blank stare of the large companies, join us here and help out where you can.

Web 2.0 based value propositions.

Google reported their quarterly earnings yesterday, boosting their market capitalization to $136 billion. This brings to mind the value proposition of Google, and for that manner, any and all Web 2.0 services. Not many people can say they ever paid any money to Google, I for one have never, even though I use all of their services.

Earning small advertisement revenues from the firms asking for exposure of their product on Google's sites doesn't sound like a great business. However, when the value generated produces multi billion dollar earnings for a ten year old company, this makes for interesting times.

Web Service companies that are Web 2.0 are able to aggregate users easily and share the costs and the load over far larger bases of customers. This site subscribes to this wisdom. If the usage of this Web Service (when built) charged as little as $1 / barrel of oil equivalent per year, the costs of systems to fuel the energy industry would collapse to the level that would parallel the value proposition of Google's.

Where we are...

It has been a long road to this point. I am not aware if the Calgary Herald will run a story regarding my criticisms of Petro Canada. I hope that they do as it would be a solid beginning for this blog to become the area of focus for our prototypical users, the people who earn their living in oil and gas.

This blog introduces a very disruptive innovation from the point of view of how organization's should be formed. To suggest that the hierarchy has failed is generally concurred with by most people, and feared at the same time. This has been a risky and controversial suggestion from the start. And that is the point, change is upon us, we either get with the changes or get out. I choose to challenge the old with the new.

There is a saying by George Bernard Shaw...

"The reasonable man adapts himself to the world; the unreasonable one persists to adapt the world to himself. Therefore all progress depends on the unreasonable man."

I am an unreasonable man.

Jonathon Schwartz and James Gosling in Brazil

[Technology]

I had the opportunity to attend a speech of Dr. James Gosling in Calgary. Firstly I am a big fan, and secondly, as both of us are Calgarians we share similar attitudes towards the large producers. The attitude being the oil and gas producers are not getting the new technologies, and are indeed resisting them.

Dr. Gosling stated some very interesting points regarding the status of the technologies employed in North America. Calling them third world due to the constraints of the legacy infrastructure. Noting that all Brazilians had cell phones which were used to access government services. And the high quality of the broadband in Asian countries.

The President of Sun was in Brazil with Dr. Gosling, and filed this entry on his blog. (Click on the title of this entry for the link to this article.) Reading this entry should concern those that reside in North America who think we are advanced in these technologies, we need to get with the program or we'll be left behind.

A summary for the press.

[Marketing]

I recently submitted a comprehensive summary of this blogs activity to the Calgary Herald and wanted to highlight what the point is / was. Firstly I would like to think that this blog provides a strong opportunity for anyone interested in innovation in oil and gas to actively participate in building the future. A Herald article would be very valuable for this blog and those readers.

Another point is that I wanted to show that the major oil and gas companies are now jeopardizing the future of the industry and the people that rely on it. This is quantified and qualified in the example I have made of Petro Canada. In summary this shows the following:

• Inability to find economic replacement reserves.
• Fudging the replacement reserves with;
• longer amortization on heavy oil assets
• restating as economic, formerly uneconomic reserves based on today's prices.
• Employing questionable independent and objective review of all reserves.
  
• Have participated in "lottery" style compensation of its managers.
  
• I'm all for rewards for performance, but have to ask where is the performance?
• Skewed earnings by not recognizing the costs of those reserves.

These managers have handsomely rewarded themselves for what can only be described as comprehensive failures. Covering up the problems with rosy numbers that don't correlate with the truth. This failure extends beyond the control of management to all those that were party to releasing the financial statements. So here are some questions.

• Mr. Brennaman did exercise 180,000 shares in 2005, but how many of the 4+ million shares options did he receive? For that matter what was the distribution of those share options?
• What are the actual reserves based on an independent review? Why did the company find only 26 million barrels of oil after spending over $2.4 billion? (Independent implies they did not receive share options.)
  
• What are the actual costs of the depletion, depreciation and amortization? If Petro Canada drew down 12% of its reserves, why recognize only 6% of property plant and equipment as the costs of those reserves?

The old hierarchical way isn't working, and that is clear to me. The only manner in which the industry can continue is through participation here and reorganization to new organizational models. These are more or less my words in 2004, and those that are now being echoed by Harvard, McKinsey and Strategy & Business. The justification to proceed and reorganize is there.

To continue will be the managers vain attempt to maintain the hierarchy and their stock options. These organizations will continue to function as they always have until the failure is admitted by them in bankruptcy court. I only hope that there is time as this system will need several years of development.

It is my hope that the Calgary Herald takes the opportunity to ask these questions of Petro Canada's management before their annual meeting on April 25, 2006. If so we will see the beginnings of the replacement to the hierarchical organizations.

Genesys' GUI technical definition.

I want to mention that there are a few unique characteristics of the Genesys system, particularly from the user interface point of view. First as discussed in the previous entries regarding the technical infrastructure and partnership accounting, the global scope of the core application, in my opinion, demands the strong "typing" offered by the Java Programming Language.

The system needs to be reliable and predictable. It is predictability that is particularly difficult to attain in the browser / Ajax world. When we consider the number of potential users and the exponential number of interactions between those users. Reliable and predictable can only be attained by taking the strict approach to how the systems will be built.

To define the user elements of the system, the following tools will be added to the technical architecture of the Genesys system. (For a more detailed description select the following links to Wikipedia.)

• Java Web Start
• Java Applets
• Java Swing
  

These Java components and tools make the development more difficult, however, in exchange, developers have greater control over the development of the system. These component's provide an unlimited tool kit in terms of what the developers and users can think of. But most important of all the reliability and predictability of the system will be what the users and developers need. Therefore we need to specify these as basic requirements for all components of the system and include the reliability and predictability with the other Java foundations of security etc.

The new energy economics...

[Energy]

A few housekeeping items that I wanted to comment on. These provide a bit of a common thread I'll summarize at the end.

Firstly, the price of gasoline continues to rise due to the seasonal consumer demands and the overall global demand for oil. (Click on the title for an interesting gas price summary in the New York Times.) Understanding energy is the fuel of the economy, we have seen that India and China have been able to sustain a labor based energy advantage in the globalized economy. This labor advantage has many countries concerned for their long term ability to compete. The U.S. has significant competitive advantages to sustain their economy in the face of these challenges, their key advantage may be the low gasoline prices their consumers enjoy.

With Europe's small population base, their ability to compete with China and India are limited. Europe also has a poor ability to compete in the horsepower, or industrial economy, due to the high taxes they assess on gasoline. The U.S., I think, has it right. By limiting the amount of taxes on gasoline provides the U.S. with an overall lower cost associated in generating horsepower.

I expect to see this will become a competitive advantage that most western governments will realize they are hurting their industrial infrastructure by assessing gasoline taxes. The gasoline tax cuts would be attributable to a further increase in demand for oil, hence further oil price increases. Could this thinking become the manner in which labor and energy is valued? Where the 8 hour shift of one man in China being the basis of the same value of one gallon of gas? Therefore to generate 1 horsepower for 2 hours (the cost of gas) vs 8 hours manual labor (the cost of food, tools, training, etc) being approximately the same.

Secondly, I wanted to create a new analogy to the saying that "If a tree falls in the forest...". And revise this to read, "If a natural gas compressor detonates in the field, will the commodities traders in Chicago hear it?"

Third point to make today is Einstein's calculation of E=MC2. This may be the most profound innovation in the oil and gas industry. If the mass of one atom is multiplied by the square of the speed of light, then one atom of C (Carbon) has the potential to power one person's needs, maybe for a lifetime. The source of the energy issues that we have today could be mitigated by the acceleration of our ability to more efficiently use each molecule of energy.

Since the 1960's we have seen how we produced 200 bhp for the average "Pony" car, and today provide the same 200 bhp in the family car that is longer lasting, more fuel efficient, and much smaller in displacement and pollutants. Does the aggressive exploitation of E=MC2 provide real competitive, and structural advantages for the North American automobile manufacturer?

Finally, this past weeks death of Casper Wienberger has started a variety of reflections of the 1980's energy pricing policies. Long lines of consumers at the gas pumps in the 1970's was quickly replaced by collapsed oil prices in the 1980's. Casper Wienberger was defense Secretary in the Reagan administration. History shows that he and Reagan were successful in breaking the Soviet Unions back by bankrupting it through spending for the alleged "Star Wars" initiative. At the same time the administration was dealing with the Saudi's who willingly flooded the market with oil and orchestrated the collapse in prices during the mid eighties.

The Soviets needed hard foreign currency to fuel their "Star Wars" level defense. Initially this was easily attained through the abundance of energy of the Former Soviet Union (FSU). However, when the energy prices collapsed, so did the bankrupt and corrupt communist regime of the Former Soviet Union. The Saudi's went along with the plan because they were in direct energy competition with the FSU. The house of Saud was also concerned with Iran and Iraq being supported by the FSU and the Saudi's wanted them out of the region.

Lastly putting these disparate threads together, by having producers drill more wells is the mindless (Petro Canada) solution to our energy problems. Energy problems that have been with us since the 1970's and are far worse as a result of the unintended consequences of the aggressive removal of the FSU. Don't get me wrong, I am as pleased as punch the FSU is gone.

We are however, behind the eight ball in terms of where the energy market should be, and the next decade will deal with these issues in remarkable ways. I certainly am doing my part here for the producers that need appropriate software built for these new market realities. I for one hope that Petro Canada's management can stop lining their pockets with shareholders money and start dealing with these issues as a responsible and practical organization. But don't get me wrong here either, I doubt the management can. Like the FSU in the 1980's their days are numbered.

Capturing the technology...

[Technology]

The title of this blog entry will lead you to an article in today's New York Times. This article captures the state of the technology marketplace today and should create a sense of urgency for all users. Users, particularly business' should heed the warnings contained within the article. The technology revolution is here and very capable.

To argue that this is the same as the technology bubble that burst in 2000 is fundamentally incorrect. These technologies are able to automate human thought and therefore provide real value. The only solution, in my opinion, is to fully immerse oneself in the technology in order to ride this very fast and extremely complicated trend.

Dr. Giovanni Dosi, Sources Part IV, A

[Dosi]

Part IV Opportunities incentives and the intersectoral patterns of innovation.

Dr. Dosi notes that the purpose to involve an industry in innovative activities is based on incentives and opportunities. Noting this Dosi starts his analysis with the key question.

"Are the observed intersectoral differences in innovative investment the outcome of different incentive structures, different opportunities or both."

A. Technological opportunities: Exogenous Science and Specific Learning.

To state the oil and gas industry is heavily dependent on the sciences is an obvious comment. The issue that I am raising is not so much the use of science but industries ability to keep pace with the changes in the current and prospective earth sciences and engineering disciplines. Scientific changes will be the fuel of innovative producers in the near to long term. Producers that are able to interpret these scientific findings will be rewarded with higher levels of revenue and earnings. A difficult statement to support, yet something that is well understood and generally agreed to in the industry.

How can a bureaucracy, built on the basis of command and control, keep up with the changes in the sciences that are developing exponentially faster? I suggest they can't and have suggested a new method of organization needs to be adopted. An organizational structure who's focus is the industry standard joint operating committee. The severity of this innovativeness capability in oil and gas is leading to a substantial failure in the supply of energy to the market. A serious and detrimental issue for one of, and possibly the most important primary industries, energy.

Dosi asserts two important qualifications to this discussion. That technology is a derivative of science and science is dependent directly upon the technology that defines it. We first discussed the theory of communicative action with Dr. Jurgen Habermas. Dr. Habermas theories were first published in the 60's and Dosi is tacitly reflecting these as pertinent to the science and technology in general. The best way to state this simply may be to impute a symbiotic relationship between science and technology.

Dosi notes an important point as well. That science usually spawns "a widening pool of potential technological paradigms." p. 1136.

Based on this information, Dosi then draws an extremely pertinent point about the science and technologies associated within an industry. The point arises out of the fact that the organizational structure has a limited or defined capacity of knowledge and understanding of both science and technology.

Dosi states the following;

"the idea that technological opportunities are paradigm-bound is also consistent with the historical evidence and interpretive conjectures... stemming from the gradual exhaustion of technological opportunities along particular trajectories." p.1137.

and,

"New paradigms reshape the patterns of opportunities of technical progress in terms of both the scope of potential innovations, and the ease with which they are achieved." p. 1138.

It is my assertion here the failure of the oil and gas firms to manage their technology and keep pace with the changes in science are now organizationally and paradigm constrained. They can not keep up to any of these changes.

What can only be described as a failure of industry is glossed over with the immediate response that their is lots of oil remaining. Well if that is the case then provide the market with its demands! There is plenty of oil left for the remainder of the century, however, at fundamentally different economic values then they are willing to acknowledge publicly. These economic values require that new scientific and technological paradigms be introduced to enhance the capacity of the industry. Why has this not happened?

It is my opinion that the management of these firms require time for their pensions and stock options to vest before they will even begin to address these issues. This is the failure that I attribute to the organizational mess that they have created. They are well aware of the problems, they just don't have solutions and are in no urgent financial need to get to work on these issues.

This latter point is evidenced in the fact that since 1997 the companies based in Calgary have tripled their annual capacity to drill wells. Despite this tripling of wells drilled, the provinces overall deliverability is down from 2003. Evidencing, in my opinion, that the level of creative thinking in finding more oil and gas is equal to the number of wells drilled. An industry that has no capacity to think outside of this capability due to the organizational constraints discussed.

As I visualize the industry, I see a large rat running ever faster in the wheel in anticipation that the faster it runs the quicker it will get there. The ability of the industry to stop and think, as opposed to do, is zero due to this level of activity. And as with the rat in a wheel ultimately meets its demise, a similar fate awaits Petro Canada.

Partnership accounting Part III.

[Partnership accounting] [Java programming language]

In previous entries, located here and here, we discussed some of the accounting related issues of using the joint operating committee as the organizational focus. In Part I we discussed the ability for each partner to contribute time, effort, intellectual property, and capital in disproportionate amounts compared to their interest. In Part II discussion of the specific issues regarding billing was raised. This involved an enhanced method of equalization, or capacity utilization to be calculated individually for each producer on a frequent basis.

In Part III I want to expand the scope of the discussion to include a few characteristics that bring additional programming issues to deal with, and they are:

• Penalties, Casing point elections, Before and after payout. (Points in time when the working interests of the producer changes, and therefore, imposition of an accounting cutoff.)
• Accounting for the traditional concept of "accounting" month and "production" month.

The number of possible scenarios that a property may have is unlimited. There are many established traditions and cultural influences in oil and gas that are systemic the world over. These relate to not only working interest owners but also to royalty interest owners and lease holders. When we combine the additional layer of complexity of the accounting for interests over top of the discussion in Part I and II we begin to see another level of complexity. I want to reiterate the innovative producer will use more creative means to structure a deal and the need to have these complexities mirrored within the system adds a dimension that we have discussed elsewhere.

The second element that I want to discuss in this entry is the traditional accounting and production months and the differences in the timing of certain costs and revenues. In Canada, and specifically Alberta, the reporting process for reporting volumes requires that a long lead time is necessary to ensure the accuracy of the production data. The marketing process may also take some time. These lead to the deferment of the actual production month reporting for a later time in the accounting system. This lag in timing has to be dealt with in the system and the appropriate production reported in the appropriate month requires that there be an accounting month and a production month.

Of course I would be remiss at this point if I did not state the numerous amendments to the recording of the actual data may go through many iterations. These changes are created through a myriad of different justifications that are systemic through the industry and have to be addressed. Revised pricing, allocations, nominations and distributions are not uncommon.

What these two additional criteria for accounting in oil and gas do is complicate the calculation and reporting for this data. To model the possible outcomes of what may or may not happen in a specific property becomes conceptually difficult. The ability of the Java programming language is designed to deal with this level and style of complexity. I frequently think that Java can model data in up to ten different dimensions, and therefore Java provides the capability to address these type of programming problem easily. For this I have strong opinions as to how they should be managed, however, I will leave the technical decisions to the developers when they join. Needless to say I can see how the Java environment, based on the technical environment I stated here, can deal with this level of complexity.

I will close the discussion at this point and pick it up again in Partnership Accounting Part IV.

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