Understanding technology drivers in O&G

How and why do oil and gas producers make operational decisions at production levels? With such a large and complex industry, can we make sense of it all?

By Peter Welander February 4, 2015

This is part of a series of articles.

Imagine this scenario: In a refinery in some part of the world, an engineer struggles with an old and worn-out mechanical flowmeter. The rotor bearings are shot, and it’s giving erratic readings. He asks himself, "With a company of this size, with all the money flowing through here, why can’t we do some basic instrumentation upgrades?" The questions of why companies spend money the way they do and how they make investment decisions are complex in virtually any company context, but they seem particularly opaque when working in as large and diversified an industry like oil and gas.

Why are companies the way they are in this business, and are there keys for working within them?It’s complicated.A fully integrated company in this industry has to deal with everything from finding oil and getting it out of the ground to putting it in your car. Names like BP, Shell, ExxonMobil, and others encompass the entire range. Others are more selective and may only choose certain parts of the process such as drilling or refining. There are similar situations in natural gas production. 

As CFE Media launches this new publication dedicated to a very large and complex industry, let us pause for a moment and consider some of the elements that make it all tick. These are interesting times for the industry as oil markets today seem particularly mixed up and many producers find themselves in a difficult financial situation, at least for the moment. This article is the first of a series that will examine the industry in general, and then various segments one by one. We’ll look at what producers are doing and how they are undertaking projects to improve efficiencies and keep up with a changing regulatory landscape. We’ll consider what technologies are being adopted, where, and how proponents make a compelling business case.

In many respects, oil and gas production and refining gave birth to process industries as we know them. Turning bulk quantities of crude oil into kerosene and eventually gasoline, diesel, and other products, set the pattern for chemical and petrochemical industries to come. Refineries are among the oldest process plants we have, and the entire production and distribution chain from well head to your home’s gas meter or filling station is arguably the most efficient and optimized activity on earth. The fact that it has all developed to such a colossal scale around the globe over the last 150 years makes it particularly impressive. At the same time, growth in demand for the industry has effectively stopped in many developed markets such as North America and Europe. Depending on which reports one believes, demand in China has likewise slowed or stopped, although actual numbers vary. Saudi Arabian production policies to manipulate pricing notwithstanding, demand slowdowns have had a major impact on all markets.

Whatever comes out of the current situation, it’s safe to predict the picture of how oil moves around the globe will be different going forward.The fundamental things applyOil and gas companies, like all rational, profit-driven companies, are investor owned and therefore all about making money. They want to be able to sell their products for more than they cost to produce. (There are national companies in various parts of the world motivated by politics, but those are a different animal.) When profit-driven companies consider making investments in any part of the production chain, they do it with an expected return on investment or because they are compelled by some type of regulation. 

The things that make decisions so complicated in this context relate to scale and the number of choices.So how do managers make investment decisions? Nicole Decker is an energy sector strategist at UBS Wealth Management and started her career working at Texaco. In her thinking, the big companies dominating the industry today got that way because they generally made good choices. "Companies do have to focus on the business," she said. "They also have to keep shareholders happy. The one goal that the company and shareholders all benefit from is a return-oriented model where an oil company will take a look at its portfolio, see how it fits into the competitive landscape, and act accordingly. But they also have to ask how projects within the portfolio compete with one another."The business decisions as to where to invest in one project or another, are driven by which will yield the highest return. When they can generate cash flow, they can return that to the shareholders through dividends and share buy-backs," she said. "You see that now with a lot of the large-cap majors. There isn’t a lot of growth going on, but the dividends continue to increase and some of them are buying back substantial numbers of shares."Growing without growthWhile it may sound ironic, many companies in this industry don’t want to grow in the traditional sense.

Every barrel of oil or cubic foot of gas has to come out of the ground somewhere, which makes reserves hugely important. Where will it be coming from next week or five years from now? When production is growing every year, it puts more pressure on finding new reserves and that can be a very complex picture. If traditional sources begin to decline, a company may have to make difficult decisions about finding new ones.Of course, companies in industries that are not growing still need to improve profitability to keep shareholders happy and support their stock price.

Strategies include diversification, squeezing more out of existing assets, and divesting less profitable parts. Major integrated producers in this industry have frequently taken the path of divestiture when it comes to refining assets. We will look at refining in greater detail in future installments, but for the moment let’s consider where it fits in the larger picture.Decker adds,"Refining is a notoriously low-margin business, and it’s very cyclical. That’s the reason why many of the large companies want to shed refining assets. They aren’t the highest return assets in the portfolio. Upstream operations generate much higher rates of return."The role of technology over the last five to 10 years, the oil and gas industry has seen many technological changes ranging from drilling and production (e.g., fracking, new offshore drilling techniques, tar sands exploitation, etc.) to refining and distribution. The most dramatic changes have been upstream, and new sources of oil and gas have drastically changed the overall production landscape.

Recent oil price changes have disrupted these markets drastically. Some companies carry on with the assumption that these conditions are temporary and will return to more typical levels. Others have optimized production to the point that they can still earn a profit even with prices as they are now.Whichever view one takes, it is clear that growth of unconventional oil and gas production has been driven by technologies that have drastically reduced the cost and time necessary to drill new wells and get them into production. Improvements in well management have increased the amount taken from each, extending well life and production.So how do companies make decisions?

Let’s return to our hypothetical engineer mentioned at the beginning. What are his prospects for seeing any improvements in that facility? What would make the company decide to undertake an instrumentation improvement program, or any other investment opportunity?Lee Swindler, oil and gas program manager for Maverick Technologies, suggests the drivers aren’t all that hard to figure out: "A certain group of projects is safety driven. Another group is regulatory driven, such as environmental controls. Then there’s a third group of projects driven by profit. In lean years, your budget is completely spent on just safety and regulatory projects, so you don’t even get to the profit improvement stuff. In good years you still have to do the safety and regulatory, but you have a little extra money to do some profitability projects. Those are usually pretty easy to rank based on your expected rate of return."Paul Bonner, vertical market leader for oil and gas for Honeywell Process Solutions, sees the overall flow of capital influencing decisions on a very practical level. "When margins are very tight and people aren’t investing capital, a lot of companies will take on smaller improvement projects. That’s when we see advanced process control or MES projects to increase yields or improve energy efficiency. But those tie up the available engineering resources."So when capital is available and a company is spending $1 billion on a new process unit, they have to find people, and they want the best and brightest, so they often reassign all the engineers who would have been working on those optimization projects," Bonner said. "If you look at any business that supports both advanced solutions and capital projects, you find those are counter-cyclical. When there are big capital projects, there aren’t smaller optimization projects, and vice versa. For a refinery, those resource decisions are generally made within the fence, not at higher levels."Those points are important to understand, but how does a company make decisions on choosing one area of investment over another within its portfolio? Does all the money go to upstream ventures because that’s where management sees the greatest profit potential? Bonner said that isn’t how it works in practice.

"If you look into how an integrated oil company is structured, I think they have a higher degree of separation than people realize," he said. "Their upstream operations are almost completely different companies than their downstream. Moving capital or moving people from one to the other is like moving to a different company. They’re different cost centers, they have different vice presidents, so when they’re making investment decisions, which are based on ROI, they’re being made at the highest corporate level. They aren’t made by some guy at the production level who said, ‘Let’s not drill a well today; let’s work on the crude unit.’"Sometimes the answer is "no" to a project that seems like a sure thing. Swindler saw that himself earlier in his career working in the chemical industry. "There are times within a company when you look at a project, and maybe there’s a six-month payback, but you don’t have the money so you don’t do it," he said. "Plant personnel who are trying to operate and maintain the assets may consider it a stupid decision, and that can be a major frustration. In my experience, it seemed like there were lots of good projects that never got done."Other forms of investment so far we’ve discussed investment in the form of hardware and software. But there are other elements to the picture: the human side. Throwing technology at a problem is rarely a solution in and of itself.

The human capital side is a major element and can make a huge difference to a company’s success. Swindler sees that kind of thing routinely in his travels as an integrator. "Refineries operate with a lot of outdated equipment, probably more so than any other type of plant because of the age of their assets," he notes. "But work processes are a mix. I’ve seen plants with old equipment make impressive productivity gains by applying better work practices. Where people make a commitment, operational excellence can exist in some difficult environments."The ability to get people working toward common goals may be the biggest key to success. "You need everybody on board to create the efficiencies that these companies realize," said UBS’s Decker. "It’s a function of the human capital you give to it, not necessarily the money you throw at it. Most of the large companies will tell you that. They emphasize the importance and contribution of each individual."

Peter Welander is a contributing content specialist for Oil & Gas Engineering.

Coming in April: Refining-Making money the hard way.

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