OCI Petroleum Lease Marketplace, Part III
The Strategy Interface
What People, Ideas & Objects is undertaking in developing the Preliminary Specification is the simple process of moving the compliance and governance frameworks of the innovative oil and gas producer into alignment with the Joint Operating Committees legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks. This discussion will deal with the strategic framework and how the Petroleum Lease Marketplaces “Strategy Interface” works to communicate the unique strategic direction of each of the Joint Operating Committees the producer has an interest in. In addition, the business model provided to an innovative and profitable oil and gas producer using the Preliminary Specification will be discussed.
In each property, earth sciences and engineering are required. Producers' ability to apply generic corporate strategies to all of their properties is quickly expiring. A unique strategy for each property must be developed to address each property's unique characteristics. Each property's unique strategy will be the result of collaborations among the Joint Operating Committee participants and will be subject to change from time to time. A key determinant, or business model, is optimizing reserve value profitably consistently over the project's life. The model must be transparent, and flexible enough to adapt to changing commodity prices. It must also be tailored to the financial goals of the project, with an emphasis on maximizing efficiency and minimizing risk. Finally, it must be designed to be a long-term, sustainable strategy that will ensure the profitability of the project.
Placing the Strategy Interface in the Petroleum Lease Marketplace is the logical location for this information. Along with the agreements, leases, AFE’s, and other partner related information that shares several things in common with the “Strategy Interface.” Those common threads are the collaborative nature of the development of the documents, and the access privileges that will be used to access the information. Each producer has read / write access to each property that they have an interest in. Where they can collaborate within the partnership on the overall strategy and tactical direction of the property. Where individuals who are authorized to work within the Joint Operating Committee through the Security & Access Control module, and who are authorized with read access to the Strategy Interface are able to determine whether their actions are in line with the strategic intent of the property. Additionally, the Strategy Interface provides a platform for the producer to communicate and collaborate with other partners in the property. Allowing each partner to share their thoughts and ideas in order to reach a consensus and move forward with the overall strategy. The Security & Access Control module ensures that only authorized personnel have access to the Strategy Interface.
From the producers perspective they have a database of strategic documents unique to each property. They can determine quickly what the strategy is for any property and engage the specific people responsible for further information. Although each property follows its own proprietary strategy, the producer firm is not without its input. It can quickly determine the key strategic direction of the property.
We have now documented the “Strategy Interface” of the Petroleum Lease Marketplace module of the Preliminary Specification. This being a simple collaborative interface that documents the unique strategy of each and every Joint Operating Committee the producer has an interest in. This further discussion will deal with the positive attributes of the Strategy Interface, the application of the business model and the difficulties it will impose on bureaucracies unwilling to consider individual property strategies.
Natural gas is experiencing an exceptional situation with the prolific nature of shale gas discoveries. And oil continues to experience high global demand and prices with nominal supply growth. Providing energy for today's markets requires more complex earth science and engineering than in the past. The land and asset base of an innovative and profitable oil and gas producer is the basis for competition. For producers, now is the time to adopt a profitable and performance-driven business model. People, Ideas & Objects Preliminary Specification provides that updated business model for the industry. One that is based on the decentralized production model that sees the producer firm reduced to C class executives, earth science and engineering resources, some legal and support staff. The remaining administrative, accounting and overhead resources are reorganized into service providers focused on the industry-wide process. Processes like lease rental payments, production, revenue and royalty accounting, etc. Our business model enables the producer firm to focus on its core business of exploration and production. And converts overhead costs into variable characteristics, based on profitable production. It is therefore most profitable when only profitable production is produced to ensure oil & gas replacement value is earned.
In this manner, when the service providers provide production accounting services, they can bill the Joint Operating Committee for production accounting services. Note: They bill the Joint Operating Committee and not the producer. The property may be shut in if it fails to meet its marginal cost and moved to the producer's work-in-progress inventory. This allows innovative work to be undertaken to return it to profitable production as soon as possible. While shut-in all of the administrative, accounting and overhead costs that are typically incurred by the service providers will not be incurred and therefore will not be charged. Causing the property to report a null operation and saving the reserves for a time when they can be produced profitably. This will achieve our business model objective of removing surplus commodities from the marketplace and putting a floor under the commodity prices. Shutting in the property is a short-term solution to balancing supply and demand. In the long-term, there needs to be a plan to increase the property's innovativeness, so it can remain profitable and competitive in the marketplace. And ensure consumers have affordable, abundant and independently sourced oil & gas.
The combination of the Strategy Interface with the People, Ideas & Objects Preliminary Specifications business model for innovative and profitable producers. Gives the producer the tools to optimize the value they can achieve from their reserves. This is the way producers can compete in the complex energy era.
Exploration and exploitation of oil and gas reserves have been and always will be a function of technology based on science. This is undeniable, and is also likely to contribute to the short-term life cycle that many believe will continue. This reserve size and deliverability is paralleled in Professor Giovanni Dosi’s discussion of how innovations in industrial companies have been diluted by demand prediction and lower production volumes. Generic corporate strategies impede the value realization of petroleum and natural gas reserves. An innovative approach will also bring about different strategies in terms of investment timing. Professor Dosi notes;
Finally, empirical studies often show the coexistence, within the same industry and for identical environmental incentives, of widely different strategies related to innovation, pricing, R & D, investment and so on. Specifically with regard to innovation one notices a range of strategies concerning whether or not to undertake R & D; being an inventor or an early imitator, or “wait and see”; the amount of investment in R & D; the choice between “incremental; and risky projects, and so on (see Charles Carter and Bruce Williams 1957; Freeman 1982 and the bibliography cited therein). Call these differences behavioral diversity. p. 1157
Changing the innovative behavior of one producer carries a scope of change that is as broad and as diverse as is contemplated in the business world. Change at this scale often cannot be managed within an organization. Instead, it needs to be managed through creative destruction in the general economy. A time of dynamic change driven by organizational changes focused around the innovative Joint Operating Committee. How can a firm that has been developed in an era of cost control transform themselves into an innovative, dynamic, earth science and engineering focused producer? In many cases the will to do so might exist. However, with the speed and unforgiving nature of the business cycle, not much time will be provided to those attempting the transformation. Since the financial crisis of 2008, we've seen many interesting phenomena in the capital markets. To suggest any trend or definitive result from these would be premature. It's just a different world for oil and gas CEOs than it was before 2008. However I am sure we can all agree that continued production of shale gas reserves at a loss would be the continuation of the destruction component of creative destruction. CEOs need to be aware of the risks associated with overproduction and be prepared to adjust their strategies accordingly. It's worthwhile to remember that creative destruction is not just about destruction; it also involves creating something better in its place. Such a transformation will require an innovative approach such as the Preliminary Specification which capitalizes on shale gas reserves opportunities.
The Marginal Production Threshold Interface
Within the Preliminary Specification the producer can scale back their production in the face of poor commodity prices. This is part of the business model that allows the innovative and profitable oil and gas producers to optimize their reserves. In the Resource Marketplace module we discussed the implications shutting-in production has on production and overhead costs. That is by moving to the “decentralized production model” from the “high throughput production” model it turns the producers' fixed costs of overhead, administration and accounting, into the variable costs of overhead, administration and accounting of the Joint Operating Committee. Therefore all Joint Operating Committee costs decline in line with revenues. With no production there are no revenues, however there are no other costs other than capital costs. Leaving the property, or Joint Operating Committee with no loss, or a null operation during periods of shut-in production. It is in the Petroleum Lease Marketplace module that the capability to reduce production is acquired through the Marginal Production Threshold Interface. This is the subject of this discussion.
The operational decision making authority lies with the Joint Operating Committee. And we have discussed throughout the Preliminary Specification how the decision may be made to shut-in production to mitigate the losses on the property and to help return the commodity markets to profitable prices across the industry. Ultimately removing the bust from the oil & gas boom / bust economy. With the Preliminary Specifications move to the “decentralized production model,” where all costs are variable and recorded in the Joint Operating Committee. Therefore costs are suspended with the decision to shut-in production when triggered through the Marginal Production Threshold Interface.
The Marginal Production Threshold Interface would provide the collaborative means by which the Joint Operating Committee would agree to the criteria for suspension of production. We see today with natural gas prices in North America, a situation where no one makes money. When prices meet the criteria the partnership has agreed to, i.e. the marginal costs, the decision to curtail production can be carried out. Whether that is manually issuing the order to shut-in production, or if the systems are automated, the system is triggered at the beginning of the month when the criteria is met.
The Joint Operating Committee has the ability to collaborate and agree among the partnership. Having all of the Joint Operating Committees that producers have an interest in located within the Marginal Production Threshold Interface in the Petroleum Lease Marketplace. This will provide producers with an understanding of their production profile at various price scenarios. Recall within the Partnership Accounting module detailed, actual, factual accounting financial statements are prepared each month to determine the performance and profitability of each Joint Operating Committee. This can be subsequently analyzed through a “what if” scenario page within the interface.
Every marginal property within the industry would be shut-in and therefore have a null operation if each producer managed its production this way. Reserves would be saved for a time when production was profitable. Production and storage costs would be reduced to zero when reserves remained unproduced. Those reserves would not have to retrieve incremental profits to cover unprofitable production periods. Commodity prices would have fewer and less impactful downside swings due to less overproduction. Or unprofitable production as we've described it. As a result, these prices would apply across the producer's production profile, providing the much-needed replacement value. The current method of managing prices by limiting capital spending, or “capital discipline,” is a very blunt instrument that leads to over and under production at the extremes. Creating a boom-bust economy. People, Ideas & Objects Preliminary Specifications business model, with our user communities service provider organizations, enables producers to stop producing marginal production. This enables producers to employ the only fair and reasonable method of production discipline across North America. Producers, the service industry and all those associated with oil & gas will participate in a dynamic, innovative and robust economy. Providing producers with a wide range of markets for goods and services. And consumers will be assured of a sustainable industry providing affordable, abundant and independently sourced energy. A bit of faith in the markets is all that is required.
Focusing on Capabilities
Discussion begins on the boundary of the firm and markets in the Petroleum Lease Marketplace in the Preliminary Specification. In this section we focus on capabilities. And the question should be what capabilities are we seeking from the Petroleum Lease Marketplace? And why is there a need to transition to this organization model, a marketplace? We begin with a quote from Professor Richard Langlois’ paper “Capabilities and Governance: The Rebirth of Production in the Theory of Economic Organization.”
The organizational question is whether new capabilities are best acquired through the market, through internal learning, or through some hybrid organizational form. And the answer will depend on (A) the already existing structure of capabilities and (B) the nature of the economic change involved. p. 21
What we currently have are a number of departments; Land, Legal, Land Administration, Production and Exploration Administration and Accounting, which will become elements of the Petroleum Lease Marketplace. These departments will transition to various roles, some in newly formed service provider firms, where they will be part of a marketplace environment. It will be within the marketplace that they will provide their capabilities to those producers and Joint Operating Committees that need their services.
If a profit opportunity requires a configuration of capabilities different from what already exists in the economy, the Schumpeterian process of creative destruction may be set in motion. p.21
It's a marketplace, not a department within a bureaucracy. A marketplace within the dynamic, entrepreneurial and innovative oil and gas industry. A place where buying and selling leases or interests in properties, making deals or building producers can and will be done.
Seldom if ever have economists of organization considered that knowledge may be imperfect in the realm of production, and that institutional forms may play the role not (only) of constraining unproductive rent seeking behavior but (also) of creating the possibilities for productive rent-seeking behavior in the first place. To put it another way, economists have neglected the benefit side of alternative organizational structures; for reasons of history and technique, they have allocated most of their resources to the cost side. p. 6
It is interesting that one of the roles of the firm, in this revised boundary of the firm and market, is the enhanced role that coordination undertakes. This next quote states explicitly the need to improve coordination through routines and capabilities.
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
Since contracts are one of the key end products of the Petroleum Lease Marketplace module activities. It is these incomplete contracts that will continue to demand the services of those employed in the marketplace and the firm. "Routines and capabilities as coordinating devices." Making the "marketplace" a key interface of the Petroleum Lease Marketplace module.
We have noted that the ability to build a company was one of the things done while working within the Petroleum Lease Marketplace. Implying that the marketplace was an area where the active state of affairs was to create something instead of filling file cabinets with agreements. This is the key reason why the Petroleum Lease Marketplace must be a marketplace. It must reflect the personality of the people who build their firm. From Professor Langlois’ Competition through Institutional Form: the Case of Cluster Tool Standards.
Industrial economists tend to think of competition as occurring between atomic units called "firms." Theorists of organization tend to think about the choice among various kinds of organization structures - what Langlois and Robertson (1995) call "business institutions.” But few have thought about the choice of business institution as a competitive weapon. p. 1
The “Marketplace Interface” of the Petroleum Lease Marketplace module of the People, Ideas & Objects system provides innovative oil and gas producers with the competitive weapon they need to build their firm.
On the other side of the ledger, an open modular system can more effectively direct capabilities toward improving the modules themselves (Langlois and Robertson 1992). Such a system harnesses the division of labor and the division of knowledge, allowing organizational units to focus narrowly and thus deeply; at the same time, it magnifies the number of potential module innovators, and thus can often take advantage of capabilities well beyond those even a large unitary organization could marshal. p. 19
The modular nature of the Preliminary Specification provides this ability to focus on the critical attributes within the module. The Petroleum Lease and Resource Marketplaces are different just as the Financial Marketplace, Research & Capabilities and Accounting Voucher modules are unique. Each has a unique set of individuals and activities. All of these factors work together in support of the oil and gas company's innovative approach. From Professor Richard Langlois’ Organizing the Electronic Century.
A complex systems product is underlain by an architecture: a set of parts and a way of fitting those parts together. An integral architecture is one in which the parts depend on one another in complex and often unpredictable ways: the system is a tangle of spaghetti. By contrast, a modular architecture is one that regularizes the dependencies among the parts, forcing them to interact only in relatively formalized and predictable ways (Langlois 2002b) p. 6
The point that I am struggling to get across is the interface in which users will access this marketplace in the Petroleum Lease Marketplace. It is the "Marketplace Interface" that I am highlighting in this discussion as an oil and gas concern's value proposition. It is through the reorganization of the industry based on implementing People, Ideas & Objects et al's Cloud Administration & Accounting for Oil & Gas. And through this software representation of the marketplace, much value will be gained.