Oil Industry Challenges and Changes
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By TMFRoZany
July 2, 2007

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Rite of Spring at the Gas Pump:

This a continuation of Rite of Spring at the Gas Pump with a focus on oil industry challenges and changes. The purpose of this post is to explore the oil and gas industry in a somewhat limited scope and depth to identify constraints and challenges that are very real and that can be obscure in some instances for the analyst. In my view and that of some others, the number one challenge facing the U.S. and the world is climate change and energy security, then conservation and energy efficiency, something the oil industry will not quickly embrace. Geopolitical energy security is big business for the Pentagon these days as it is for the oil industry.

Crude oil and petroleum products are global products, their prices are determined by supply and demand factors on a worldwide basis reflected in the interactions of thousands of buyers
and sellers to include future and other contracts. Since the type of crude oil has a bearing on refining yields, different types fetch different prices (crack spread).

The heavier and more sour the crude, the more difficult and expensive it is to turn into usable refined products. Markets still determine prices of oil, Brent in London and a lighter crude at West Texas Intermediate (WTI) in Cushing, Oklahoma, an oil trading hub. New York Mercantile Exchange feeds into WTI. People study the WTI-Brent spread and make heavy bets on the crude commodity against another benchmark, Dubai prices. Trade focuses on wild movements between crude benchmarks.

Interestingly, Cushing is also the primary crude oil storage and distribution point for crude in middle America that has caused some bottlenecks this year, reflected in crude prices. Oil flows in from the Gulf and North out of Cushing, it cannot do the reverse. New pipelines are called for, no immediate action in sight. Is this something quite acceptable to the oil industry?

This continuation of Rite of Spring focuses on the oil industry forces, challenges, changes, strategic choices and skills that create value. Unlike discrete manufacturing, petroleum manufacturing does not start with a bill of materials. The main reason for upstream inefficiency is an inability to address realistic reservoir complexity - the reason for the question of peak oil.

The world as we know it has gotten hooked on oil products. Since 1985, U.S. domestic crude oil production has been declining while oil product consumption has been increasing, resulting in a growing reliance on imports, especially gasoline as refinery building is viewed as too expensive. Oil moguls still quiver when the thought of previous oil shocks arise.

Increasing energy demand, increasing oil prices with increasingly limited supplies of hydrocarbons found in more unconventional sources, complexity of high tension geopolitics make a huge impact on the performance and M&A activity in the oil industry. There are new forces in play alongside the traditional corporate drivers of reserve replacement and portfolio balance as we shall see. Private equity and National Oil Companies (NOCs) are now major contenders.

Are there market inefficiencies? In other words can companies exploit market inefficiencies? The commercial groups that do the trading and hedging are not in very close communication with the exploration groups that make the drilling decisions. There have been recent legal cases where energy companies have actually created the inefficiency in the first place but they are very difficult to quantify.

The take home thought here is that of risk. Businesses operating in the petroleum, natural gas, and electricity industries are particularly susceptible to market risk--or more specifically, price risk--as a consequence of the extreme volatility of energy commodity prices according to the
Energy Information Administration (EIA). Price volatility is caused by shifts in the supply and demand for a commodity. The other general risk categories are, credit/default risk, operational risk (equipment failure, fraud); liquidity risk (inability to buy or sell commodities at quoted prices); and political risk.

Behind the scenes, it is said that oil and gas trade more on perceptions and imperfect information than reality.

EIA weekly report
The energy complex (specifically upstream oil and gas) is mind boggling in terms of 'tricks of the trade' that have evolved among stock traders, oil tankers in the Gulf, refineries, and the price at the pump. I read somewhere that crude supplies for the U.S. are at their highest level in nine years (cough, cough).

In this weeks inventory report, the U.S. Energy Department's Energy Information Administration (EIA) said gasoline inventories dropped by 700,000 barrels in the week ended June 22. Crude oil supplies rose by 1.6 million barrels to 350.9 million barrels last week, above the average estimate of a 1 million barrel increase. Refinery utilization increased 1.8 percentage points to 89.4 percent (that is nowhere near the 95% normal range).

The real issue is product inventory levels (measure of the balance, or imbalance, between petroleum production and demand) and not the refinery operating rate said Citigroup Global Markets analyst Tim Evans. Gasoline imports, which had propped up supplies the previous week, dropped by 300,000 barrels last week

What a surprise, gas pump prices are on the rise Wednesday, up a dime in my neighborhood, as we go forward to another holiday weekend. Gasoline prices in the short term are very inelastic related to supply and demand. The big three determinants of price elasticity all point toward a low number (consumption is insensitive to price changes in the short run). This is why, when the world supply of petroleum changes, a very large change in price is usually needed to bring supply and demand into balance. Demand stays strong with $3.00 gasoline.

U.S. refineries churned out 89.4 percent of the gasoline they are capable of producing last week, while gasoline imports declined. Although gasoline prices have fallen recently, Energy Information Administration (EIA) analysts have said they expect prices to increase this summer.

Whinery at the refinery continues as the bogeyman of biofuel and increased mileage specs for autos and SUVs threatens the industry so some contend. That impinges on decisions to build more refineries. Not in my back yard and regulations along with increased output are cited as other reasons not to build. This looses sight of the fact refineries are not particularly profitable.

Downstream gasoline refineries are a subject that requires further examination in the value chain and value creation. Upstarts like QuickTrip (full-service c-store providers), Racetrac Petroleum Inc. (buyers of distressed spot fuel), and Wal-Mart Stores Inc., Albertsons Inc. (and other grocers), penetrated the supply chain as the moat was skimpy.

Crude for sale in the Gulf of Mexico parked in VLCCS
Very Large Crude Carriers (VLCC) are used to hedge against Nigerian supply disruptions or Gulf of Mexico hurricanes writes John Dizard commenting in a Federal Times article. Crude oil is stored in these vessels awaiting purchase, then transferred ashore. Stored offshore crude is owned by trading houses, rather than the oil companies, although some could be owned by entities in Gulf producing states. Shipbroker rates for storage are in the range of $47,500 a day to more than $60,000 a day.

Institutional money is crowding into the trade between the spot price and prices a month or two out, meaning that investors are paid to store oil. That's right, the oil companies don't own the oil in those VLCCs parked full in the Gulf of Mexico. The main regional benchmark for the Americas is the New York Mercantile Exchange's (NYMEX) futures contract for light crude oil, against which physical delivery can be made at the pricing hub of Cushing, Oklahoma. Changes in refinery outages and the Cushing system makes the benchmark more open to manipulation.

Morgan Stanley will be the first investment bank to lease a fuel oil floating storage unit (FSU) in Asia, as it vies with major players for the Chinese and marine fuels markets, the point is understanding supply of crude is complicated.

Major oil companies reserves not replaced
The headline Sunday (June 24) read, "Major oil companies replace less than 100% of their reserves" in a report that says costs to find and produce oil continue to rise in 2006 and reflects a general failure of major oil companies to replace reserves for the third straight year.

Jeff Tillery noted that companies such as ExxonMobil Corp, Royal Dutch Shell PLC and other majors produce a small portion of the world's oil and gas compared with government-controlled national oil companies. More later on National Oil Companies.

Venezuela's nationalization
Venezuela's Hugo Chavez flexes his nationalization efforts and finds Exxon and ConocoPhilips in retreat. They refused to sign a government proposal for a memorandum of understanding that commits them to remaining in the projects with a smaller stake. Four other companies -- Chevron Corp., Norway's Statoil, Britain's BP Plc and France's Total -- plan to sign an accord that will keep them in the massive Orinoco oil reserve projects, a government official said.

Exxon and ConocoPhilips may work out an eleventh hour deal. Venezuela remains the fourth-leading supplier of imported crude and refined petroleum products to the United States. Geopolitical risk of oil supply is difficult to predict as we hear more problems from Nigeria.

Resource stewardship
Simply put, what we have to do is reduce reliance on oil, not just foreign oil. This is a matter of stewardship of a resource - conservation. This thinking is controversial in the oil industry and to many consumers. "A push from Congress and the White House for huge increases in biofuels such as ethanol is prompting the oil industry to scale back its plans to expand refineries." (

Lots of kibitzing in the U.S. over biofuels, especially ethanol, fuel cells/hydrogen and efforts to get automakers to build more fuel-efficient cars and sport utility vehicles. Pundits say ethanol raises the cost of food and that fuel-efficient car standards will be the end of the U.S. auto industry.

Major factors affecting the infancy biofuel industry's profitability--feedstock costs, regulation, and technologies-- all are in flux. Cellulosic technology could lower production costs. The oil industry is not rushing to incorporate alternative fuel from a competitive commodity into markets that have failed to invest in sufficient refining capacity to alleviate the tight conditions in the gasoline market.

However, ConocoPhilips linked up with Tyson for "clean fat" biodiesel from quality products. Syntroleum also linked up with Tyson for lower grade "dirty fat" product for an alternative fuel for jets. Tyson and ConocoPhilips have lobbied hard in Washington in recent months to ensure that their renewable diesel will qualify for a $1-a-gallon federal tax break

Diesel clouds of pollution
The big-rigs that haul goods across the country every day belch clouds of exhaust and get diesel mileage that makes SUVs look good. Some burn a gallon of diesel an hour while parked at night left running for creature comforts of a cab or refrigeration. Some steps are being taken to reduce those numbers.

The question du jour, which produces more air pollution: a cow or a Mack truck? Federal officials are trying to figure that out and spending big bucks ($14.6 million) for the researched answer. (shaking head, the answer is out there, cattle are the winner). ""Livestock are responsible for 18 percent of greenhouse-gas emissions as measured in carbon dioxide equivalent, reports the FAO. This includes 9 percent of all CO2 emissions, 37 percent of methane, and 65 percent of nitrous oxide. Altogether, that's more than the emissions caused by transportation." Christian Science Monitor

Remember the contaminated spinach scare was from cattle pooh (E.coli and friends) in water and the methane from cattle (cow farts) has a greater effect on global warming than burning diesel. Now I am trying to picture how you capture that methane emitted from cattle for a study.

Don't mess with my comfort zone
It is a truism, the American way of life is not negotiable. Oil and gas are commodities of utility, they are a source to meet my creature comfort and travel needs. Check out that food chain, the tractor used to raise and harvest crops, notwithstanding getting that food from the field to my plate, or at least to the Golden Arches for pick up or to my favorite grocery store. Most agree that the oil and gas industry in the long haul fuels the economy.

Sifting through what might impact energy needs a somewhat hidden market emerges. Think of the housing market and the size that Toll Brothers builds as footage of houses increases with higher ceilings and the need for climate control heating and air conditioning. And the petro- chemicals in the products in that house from plastic to carpeting. Add to that market, new buildings.

Russia plans great expansion of nuclear power plants while the U.S. hesitates. Nuclear power plants prevent air pollution and climate change because they don't burn anything. Nuclear, pollutes in a different way with radiation emissions and heat and to a different degree.

Richard W. Dortch, The Clarion-Ledger, writes citing another point of view related to oil industry profits. "Over the last few years, Big Oil has demonstrated that it does not reap its biggest profits in times of peace and prosperity. Big Oil reaps its biggest profits in times of economic hardship: during wars, natural disasters, terrorist attacks and worse. The more unstable the U.S. economy, the less secure we are in the world, the more profitable Big Oil becomes."

Energy policies of most nations are still evolving, regulation is perhaps the greatest uncertainty of all. Remember, regulation is what brought down Standard. The primary purpose of the antitrust laws is to foster free and unrestrained competition on the assumption that such competition will produce the best result for consumers

Cambridge Energy Research Associates (CERA) estimates the worldwide cost to produce oil and natural gas (labor and equipment) has risen 53% since 2004. In some cases, the rising costs have led oil producers to scrap exploration.

Former Motley Fool analyst Tom Jacob writes, "The oil and gas industry is a messy business that fluctuates wildly. That means much inefficiency to exploit." That is something that leads me to an examination of the value chain mostly and a pass through on the supply chain, in the end focused on something called Strategic Market Position facing strategic choices in analysis of an oil and gas company. Value creation is a key factor in security analysis.

Oil industry strategy and value analysis focus
An overview follows on the oil and gas industry in the end followed by stressing a focused strategy, value creation, and competitive advantage applied to a business as discussed by Alfred Rappaport and Michael Mauboussin in Expectations Investing and Stuart E. Jackson in Where Value Hides: A New Way to Uncover Profitable Growth for Your Business.

Value chain analysis has as a premise that competitive advantage cannot be understood by looking at the firm as a whole, thus a chain framework. There are those who say the oil industry is non-competitive related to the merger and acquisition factor.

Value here is a strategic concept.

Competitive Strategy is the title of a book by Michael Porter. Three categories are important in assessing an industry: cost leadership, differentiation, and focus. Of the three, most investors prefer a focused strategy and that includes me. Using Michael Porter's industry framework, what changes and challenges are occurring in the industry to guide a focused strategy?

The oil and gas industry businesses are filled with silos that in themselves contain information silos, something to crack other than the crude to produce value in a very mature industry. The global nature of the industry means that businesses can no longer afford to work in silos created by vertical integration. Along the way innovation, disruption theory and the proposition that 'information rules' will be emphasized.

The oil and gas supply chain is quite unlike any other, costs, schedules, processes distribution and many other factors are subject to constant change, and the materials within it can be bought and sold many times over during transit. The end result is massive potential for inefficiency and value leakage.

Conventional analytics tools use linear mathematics while refineries and processing plants operate with what are essentially non-linear processes notes There is no straight forward raw material in-finished product out paradigm. Instead there are countless different ways of processing the same raw material to arrive at the same end product.

Companies with multiple facilities and employees in different locations may find it cheaper initially to maintain separate quality systems, but the inefficiency of systems that are not connected can cost a lot in terms of man-hours. One of the big problems is lack of IT integration.

Inefficiency also results from inability for real-time oil and gas reservoir management and real time drilling issues. Geotechnical software has extended well test analysis to more accurately reflect reservoir geology. Well testing is a key technical function within the oil and gas industry - an application that information rules. The ultimate goal is profitability.

In the oil business we have something called monopolistic competition, competition among a few, like-minded firms. The industry has many sellers producing products that are close substitutes for one another. Why not oligopoly? I say it has to do with the lack of a high barrier to entry. QuickTrip and and Racetrack took it to the downstream market retail and kicked butt.
monopolistic competition elasticity

It has been said that to analyze stocks in an industry first know about the industry. Expanding Warren Buffett's admonition, stay within your circle of competence, knowing about an industry in my view, enhances a circle of competence. I would suggest that analysis of a business is strongly related to an analysis of an industry.

Santa Fe(SFI) scientist W. Brian Arthur said in an interview with Michael Mauboussin that re-architecting of the economy is going on everywhere, in every industry, at all scales. "Oil drilling, oil exploration, oil refining and production--all these are becoming digitized, and bringing in new possibilities as this happens."

Take this important statement to heart, the easy oil has already been found and in the future technology will be the driving force for exploration and production, manned by competent people that are now in short demand. The U.S. upstream oil and gas industry has cut an astounding 1.1 million jobs, boomers are retiring, experienced geophysical engineers are decreasing in numbers.

Currently British Petroleum faces an inability to tackle technological challenges and has had a forced delay in pumping from one of its brightest prospects for the future, BP's massive Thunder Horse platform in the Gulf of Mexico.

Questions to ponder
What is the 21st century's greatest challenge? (hint: it has to do with energy)

There is significant controversy over the size of global oil reserves and whether they have passed their peak, but what is the real issue? Gas and oil are not renewable, someday they will run out.

Have you come across the surprising 'quiet crisis' in the oil and gas industry?

What is the new 'geography' of energy distribution in the world?

Should oil and gas firms accept arguments in favor of deconstruction and break up into focused entities, and would this actually add value? It is becoming fashionable to question the vertically integrated structure of the super majors and to argue that value would be unlocked if they were to be reconstituted as independently focused entities.

Oil companies also need to recognize the fact that they operate in an industry that is capital intensive with long term asset lives. As a result published accounts are a fairly worthless measure of profitability and they do not accurately reflect the underlying value of the asset base. . . Internal rates of return based on more realistic assessments of underlying asset values are, as would be expected, close to the cost of capital. (

Has the thought of Clayton Christensen's disruption theory crossed your mind with application to the three segments of the oil and gas value chain: retail, refining, and exploration and production?

Disruption and value migration could undermine the dominance of today's leading firms says Joseph A. Stanislaw of Deloitte and Touche. Disruptive forces are found in changing geopolitics, market conditions, and technologies.

The changing landscape
From the Cambridge Energy Research Associates (CERA): "Periods of great uncertainty produce winners and losers; we are in such a period today. We are living in a world of heightened anxiety about the future of energy. The concern is not just over oil, but over nearly every aspect of the energy value chain."

The U.S. petroleum industry is entirely decoupled with significant players existing at each stage of the value chain. A revisit is required from investors as the competitive landscape has changed. Executives face the challenge of continued growth and high levels of profit; they have information overload at hand but where is the value hiding in the competitive landscape, waiting to be discovered to increase shareholder value?

Every era in the history of energy has evolved into monumental change presenting challenges. The oil industry started in the Middle East by oil seeping up through the ground that was used in waterproofing boats and baskets and is five thousand years old. Whale oil was a source of light. Today rigs line land and offshore for exploration for the black gold that propels people and products around the world.

Petroleum is the second largest consumable on the planet, water gets first place. We depend on oil and gas for comfort and convenience. With oil and gas, there is the existence of the world's longest supply chain that is significantly more complex than any discrete supply chain.

The business involves many interdependent operations from searching for oil and gas extending to delivery of finished products. This is not made up of your ordinary discrete manufacturing silos now transitioning, these are interdependent whether upstream, midstream or downstream. The golden nugget of transformation of successful oil and gas businesses today is divestiture of unrelated business lines with return to a focused strategy.

The challenge is clear for the future as the U.S. is at a crossroads when it comes to energy. To sustain economic growth, we'll need energy - and we'll need a lot of it. The best way to do that is to increase and diversify our energy resources and to use these resources more efficiently with application of stewardship principles.

The challenges are many to meet near-term and future global oil demand. There are many geopolitical, technical, infra-structure, economic, capital and workforce challenges to meeting near-term and future global oil demand.

Impinging forces on the oil and gas industry
A world-view on a subject requires demographics. The majority of people who will inhabit the globe in 2030 have already been born and the overwhelming majority of people alive today will still be around in 2030 says CERA. That determines demand patterns that are habituated or becoming so. The technological changes that have most affected environmental conditions of our planet relate to energy use.

Not only is demand exceeding supply, the disruptive forces of changing market conditions, geopolitics, and technologies in energy are challenging the industry promoting more flexibility in strategy.

Some of the macro forces of change and challenge in the world impacting the oil and gas industry include environmental concerns, growth in demand and geography of oil, energy security, National Oil Companies, and technology and innovation.

1.Environmental concerns first stemmed from the very nature of drilling and transport of oil and that was the risk to the environment through contamination of the environment and safety of workers. Climate change from the by-products of burning oil and its products creates havoc with the environment. Society demanded environmental protection so environmental regulations evolved. And so did a sideline business of carbon credits that yield a few benefits, used by European governments and corporations to justify increases in emissions.

However, climate change as an environmental risk has Exxon and Royal Dutch/Shell at opposite climate change strategies. Environmental violators in the petroleum industry seem to continue to resolve claims with cash settlements.

Controversial problems such as global warming and acid rain came about. Some view the increasing pressure applied by oil industry leaders pushing for new drilling in sensitive and once-protected regions as a risk.

Competition for energy sources is increasing as demands for increased fuel efficiency rise. Biofuel and bioheat are not favored by the oil industry and they say biofuel will hurt at the pump as investment in refineries is at a stalemate and the U.S. raises import of gasoline. Somehow, Brazil, England and Europe have moved forward in production of biofuels.

Global Climate and Energy Project (GCEP) says we can't wean ourselves off of fossil fuels quickly and offers carbon capture and storage (carbon sequestration) that traps carbon dioxide after it is produced and injects it underground as one path for cutting emissions of carbon dioxide. Capturing carbon dioxide from small, mobile sources, such as cars, would be more difficult, Lynn Orr said. But with power plants comprising 40 percent of the world's fossil fuel-derived carbon emissions, he added, the potential for reductions is significant.

Engineers have more than three decades of experience putting carbon dioxide into oil reservoirs, where it increases oil production by making the oil expand and "thin out" such that it flows more easily. Critics of carbon sequestration argue that the technology will divert attention from research on long-term clean energy options, such as renewable power.

Environmental concerns increase the cost of production with regulatory issues. Figuring compliance risk for an oil and gas corporation falls here. Risk = Probability x Consequences

2. Growth in demand is increasing capital and workforce needs. The Asian Phoenix (China and India) contributes to energy consumption rising from 29 to 42 percent in 2030 (EIA) at the same time there is a gradual decline in the quality of crude oil both in terms of American Petroleum Industry (API) standards and sulfur level. The New York Times quotes oil companies as saying they can provide enough supplies -- which might eventually lead to lower oil and gasoline prices -- but that they see few alternatives to fossil fuels.

Counter forces to growth in U.S. demand is pressure for increased fuel efficiency standards and alternative fuels find the auto industry lobbyists scurrying the Representative as the Senate passed a mandate to increase CAF� standards (the first since 1975). But here is the nuts and bolts of the story, the Senate Democrats fell three votes short of the 60 needed to advance a tax package that would have levied $29 billion in new taxes on the oil industry to pay for developing renewable fuels and clean-energy programs. My read is that the lobbyists for oil won.

The issue is not will we run out of oil and gas but what will replace it to fuel the economy and security in the Age of Materialism? Cheap oil has kept transportation and agriculture productive, but petroleum derived chemicals are found in medicine, energy provides water services and treatment, and oil powers national defense. The Department of Defense is the largest single energy consumer in the country.

Food is transported on average 1500 mile to get to your table, massive quantities of oil are required for plastics, and it takes approximately 20 barrels of oil to construct an average car, According to the American Chemical Society, the construction of a single 32 megabye DRAM chip requires 3.5 pounds of fossil fuels in addition to 70.5 pounds of water.

The future of oil and gas is not in jeopardy. There is a school of thought that claims the American economy is simply not as dependent on oil as it has been in the past says Many manufacturing jobs have been outsourced which has greatly reduced oil demand. Fuel oil has been replaced by coal and natural gas for many industry needs. And while the argument can be made that SUVs are still eating up the gas, more and more hybrid cars and fuel efficient cars are being manufactured and sold, not a huge trend yet.
Oil company crisis

The geography of energy is undergoing a radical shift described by Deloitte and Touche in Energy in Flux: the 21st Century's Greatest Challenge." Whereas Saudi Arabia remains at the heart of production, the center of gravity has already begun to stretch north and east--the Saudi-Caspian-Siberia-Canada (SCSC) axis that will drive the "energy of geopolitics" in the 21st century. The Caspian fields are estimated to hold the world's third largest reserves as the first pipeline (one means of transportation) from this area with United States backing is viewed as a key to reducing the West's reliance on Middle East Oil.

The product mix has changed as well: The old "oil game" is becoming the "oil and gas game," and will become more of a "gas and oil game" before the next energy paradigm shift occurs. ( Philip Durell was prescient in his oil and gas selections for Inside Value. Rationale: location, location, location)

3. Energy security is an international issue that concerns exporters with security of demand and importers with security of supply. Intensity of global competition, geopolitical tension, and heightened concerns arise. Remember the burning oil rigs of the Gulf war as a burning testament to how the fight for control over oil has affected the global international dynamic. Oil is a factor in world peace, it is a political bargaining chip. Iran is sabre rattling next door to Iraq.

Energy is the key force in the global economy, as well as in global politics. In the meantime, there has been a gradual decline in the quality of crude oil over the years.

4. National Oil Companies (NOCs) control over three fourths of the word's oil and gas resources. Only 6 percent of world-wide reserves are now held by investor-owned oil and natural gas companies. Increasing power of state monopolies and the emerging partially privatized firms now have control of the lion's share of world oil. The EIA forecasts that 90 percent of production over the next 30 years will come from the developing world--that is, from National Oil Companies ( NOCs)

"Before the 1970s, major oil companies that were fully vertically integrated controlled the global network for supplying, pricing, and marketing crude oil. However, the structure of the world crude oil market has dramatically changed [bold italics mine] as a result of such factors as the nationalization of oil fields by oil-producing countries, the emergence of independent oil companies, and the evolution of futures and spot markets in the 1970s and 1980s. Since U.S. oil prices were deregulated in 1981, the price paid for crude oil in the United States has been largely determined in the world oil market, which is mostly influenced by global factors, especially supply decisions of the Organization of Petroleum Exporting Countries (OPEC) and world economic and political conditions." (From

In recent weeks, statements made by both OPEC and the International Energy Agency (IEA), the statistical arm of the Organization for Economic Co-operation and Development (OECD), have shown increased tension based on growing concerns of consumers about the oil supply situation.

Saudi Aramco's current state of upstream developments is still not fully understood. Based on growing research figures provided by independent analysts, it has been shown that current depletion of Saudi oil fields are increasingly above the normal 8% to be expected. Several authors have already shown that since beginning of 2006, current depletion is more likely between 10%-14%, which is very worrying. Some view the huge problem Saudi reserves are facing is one of reserve depletion.

Meanwhile, consolidation moves reflect both the evolution of the industry in America and Europe. In Europe, the case of Statoil and Norsk Hydro, a degree of defensive scaling-up in response to the increasing power of NOCs from other countries.

The Financial Times ranked the 'New Seven Sisters' on the basis of resource base, level of output, company's ambition, scale of their domestic market, and influence in the industry. In order of prominence, they are Saudi Aramco , Russia's Gazprom, CNPC of China, NIOC of Iran, Venezuela's PDVSA, Brazil's Petrobras and Petronas of Malaysia. The old 'Big Oil' companies are not so big anymore.

Russia has moved from a state-owned industry to almost totally privatized that are still structurally
short of refining capacity.

A dominant trend is a further strengthening and consolidation of the position of the NOCs. The pressure to consolidate has a long way to go in the future

5. Technology and innovation in the 21st century finds discoveries dependent upon sophisticated geophysical tools, elegant geologic models and highly technical drilling and production techniques that increase oil recovery. The issue at hand regarding petroleum reserves and exploration is not an economic issue but an issue of geology. This calls for geological engineering talent that is dwindling in numbers, the quiet crisis of the oil and gas industry.

Technology advances have made it possible to unlock more oil from old fields. Oil companies have been perfecting so-called secondary and tertiary recovery methods -- injecting all sorts of exotic gases and liquids into oil fields, including water and soap, natural gas, carbon dioxide and even hydrogen sulfide, a foul-smelling and poisonous gas as noted in the NYTimes article.

A second arm of innovative technology is found in off-shore design structures applied to hurricanes in the Gulf of Mexico that decreased damage to the infrastructure even though the disruption of production was extensive. This subsequently resulted in significant economic impacts that affected the entire nation.

A third arm has to do with information and communications technology. Out of date or incorrect data and information has and does render petroleum companies ineffective. Integration of IT is a priority with mergers. Integration is bottom line for decision-making in the IT journey.

WiMAX gives the oil and gas industry the ability to get much higher bandwidth without having to invest in underground infrastructure to transmit from oilfields. Alcatel-Lucent as signed by the Norwegian Oil Industry Association, to carry out a Universal WiMAX test in the North Sea to enhance communication.

Probably the most important application of innovative technology is in the area of conservation and energy efficiency, something the oil industry is not quick to wholeheartedly embrace. But the onus of conservation and energy efficiency also falls on most American consumers who so far are not impressed by the price at the pump or cost of heating homes to the point of mass behavior change toward conservation of the resource. Climate change and emissions are a concern as there is an increase in government regulation.

Talent and technology will be the driving forces of innovation and ingenuity that propel the oil and gas industry forward, writes Stuart R. McGill, Senior Vice President of Exxon Mobil Corporation.
A shortage of qualified personnel is a universal complaint within the oil and gas industry today.

So what does all of this mean? Growth will be slower, exploration and production costs will increase, and oil companies will pursue more joint ventures.

Why not include Peak Oil as a force?
Because there is so much disagreement, I view it as a conumdrum. Quoting Jeff Hatlen, an engineer at Chevron, that peak oil is a moving target, oil is always a function of price and technology. The rapid pace of change in the oil industry means that a view can appear controversial to one group/sector and at the same time acceptable to another because of inadequacies in reserve estimation.

Peak oil analysis doesn't take into account the role of development (vs. exploration) projects in expanding reserves while field production is propped up for short-term considerations. So true.

Oil and gas companies continue to struggle with the processes to estimate and disclose reserves. There is significant controversy over the size of global oil reserves the real issue is our current ability to access and produce the resources that have already been discovered.

Looking forward
The future for world oil and gas production over the next fifty years looks a lot more problematic than has been the case during the past one hundred years.

A forecast made in 2004, "By 2025, natural gas and renewable resources may provide more global energy than oil, today's dominant fuel, according to Philip Watt, chairman of Royal Dutch/Shell Group's managing directors." He distinguished himself among oil industry executives by speaking out in favor of developing renewable sources of energy. This is the guy who was challenged and was ousted about restatement of its oil and natural gas reserves, by 25%. The Justice Department had an inquiry into whether executives at the Royal Dutch/Shell Group violated any laws by failing to timely disclose a significant shortfall in proven oil reserves and "tried to manage its reserve figures to satisfy investors." Three were felled.

The manufacturing processes in the middle are complex. These processes are responsible for much of the 'whinery' at the refinery these days in a back ground characterized by tough competition, stricter environmental regulations using heavier, sourer and costly crude oils, accompanied by possible disruptions caused by various factors that companies cannot control.

The winners will be those that can deploy the newest technologies to boost their reserves markedly at a time when most rivals are fighting just to replace production said Barrons. Judson Jacobs, director of up stream technology at Cambridge Energy Research Associates said, "The big prize is the increased production that results from technology; it's very difficult to create a sustained competitive advantage through technology."

The competitive landscape in the oil industry has changed. New developments could begin upsetting the comparatively stable industry structure. Deloitte and Touche says the developments are emerging all along the industry's value chain - in distribution and retail, in refining, and in exploration and production (E&P). The mechanism of change that will challenge the industry is found in disruption theory. Successful companies understand where growth will build competitive strength and profitability and where it will not.

A critical issue emerges here: leadership needs to level with the American people. Lee Iococca, former CEO of Chrysler, says leadership is about managing change in his part rant book, Where have all the leaders gone? "Gasoline prices skyrocket and nobody in power has a coherent gas policy."

Has the recent performance of oil related stock prices and CEO pay been the result of skill of luck? The top executives of the second and third-largest oil companies on the planet--British Petroleum and Royal Dutch Shell--operate in the same global marketplace and face the same "huge responsibilities" as the top executives of U.S.-based oil industry giants. Yet CEOs at the top two oil companies in the United States made eight times more last year than their foreign counterparts from BP and Shell. (from the 13th annual CEO Compensation Survey)

More next time. Comments or corrections are welcome.

Selected References:
Previous posts:
Rite of Spring at the gas pump
Pump jumps and pixel power.

Oil price shocks and the macroeconomy: what has been learned since 1996
This week in petroleum
Understanding the petroleum market
Oil prices-this week in oil prices
Crude oil benchmarks go awry

Price elasticity of demand
Oil prices and gasoline inventory
Price elasticity of gasoline demand
Annual Energy Outlook 2007 with projections to 2030, EIA, often accused of erroneous assumptions.

Reserves, refinery projects, trading
"Major oil companies replace less than 100% of their reserves."
Venezuela takeover deal
Making money in oil
Big Oil a problem
Industry curtails refinery projects
Trade focuses on wild movements between crude benchmarks
WTI benchmark temporarily breaks down: is it really a big deal?

Crude oil, John Dizard
Crude oil benchmarks go awry
Pictures of the shipping industry, Port of Huston

"A commodity of utility"
Risky business. (Registration required)
Gasoline markets
Energy boost: managing the supply chain management

Dawn of a new age. CERA, a profit-making business that sells its consulting services.
Gasoline and American People 2007.
Learning Center Chevron
About Oil and Natural Gas
Carbon credits

Platts (leading global provider of energy and metals information)
International Energy Outlook
Peak Oil Review, June 2007
OPEC -"Oil and Arab Co-operation"
GAO energy markets.

"Researchers examine carbon capture and storage to combat global warming"
"Oil Innovations Pump New Life Into Old Wells"
Energy to construct a car
Microchip environmental implications

Oil Market Under Pressure, Supply Not Able to Counter Demand
O&G deals: 2006 [Excellent overview of trends]
The new seven sisters
The changing role of NOC's in international energy markets
Energy boost: managing supply chain
Oil company crisis
Knowledge low

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