Aug 2009 : 08 : Achieving Hand-off Between Project Teams and FinanceDigital Crude - Why the Oil Business Needs Portfolio Managementby Dr. Calvin B. Cobb

Success in the oil and gas business becomes harder with every passing year. Gone are the days when oil operators could seemingly drive out to the middle of the desert, punch a hole in the ground, and have black gold spurt up. International oil companies don't own the most important ingredient of their business - the oil itself - and new sources for that ingredient are increasingly found only in high-cost, deep-water locations in the Gulf of Mexico, off the west coast of Africa, in Brazil, and Indonesia, or in expensive-to-extract sand soils such as those found in Alberta, Canada.

To advance their operations and produce returns for investors, executives in the oil business have come to understand the need for an exponential increase in performance - not just with production but also with exploration and development. This performance encompasses a complex list of goals:

• Achieving sustained differentiation in a highly competitive environment.
• Improving "resource" productivity (reservoirs, equipment, people, and information).
• Managing portfolio risk.
• Sustaining and increasing benefits of integrated value chains.
• Evolving worker performance in remote areas.
• Recruiting, retaining, affording, and protecting experts in remote areas.
• Increasing safety performance.
• Addressing important business and scientific characteristics, such as heavy oil; tight reservoirs; enhanced oil recovery; deep, remote, marginal, and complex fields; mixed gas/oil systems; carbon dioxide and hydrogen sulfide emissions; and health, safety, and environmental constraints.
• Managing oil and gas price variability.

The upstream oil industry has responded to these challenges by developing strategies that radically transform the way the oil business is done - strategies known in the business as "digital oilfields," "smart fields," "ifields," or "fields of the future."

Better Decisions with Data

When the concept of the digital oilfield was coined about a decade ago in a joint study by Ernst & Young and Cambridge Energy Research Associates, it started a slow but steadily growing acceptance of the view that better information could help an oil company compete in what is a commodity industry. That idea is that each phase of the business - exploration, development, and production - generates data that can be analyzed, modeled, and manipulated to make better, faster decisions. Also, that data can be transferred to the next phase to drive smarter decisions throughout the process.

Here are a couple of examples.

First, imagine that you're in the upstream oil business - that part of operations that take place up to the point of refining the oil into gasoline. Oil production often involves working in very cold temperatures underground, low enough that ice can form. If enough ice forms, it can plug the pipe, which will stop the pumping of the oil to the surface. That used to be discovered after the fact : "Oh, oh. We have trouble here..." With the digital oilfield, you can take physical characteristics of the oil field that's below the surface and measure and model that to tell people what's happening so that they can make better decisions : to warm the pipeline, inject chemicals into the ground, or some other solution. In other words, you can make decisions that keep the production online vs. getting into a crisis mode where you have to shut down.

Second, now that oil platforms have given way to FPSOs, floating production storage operations - huge ships that sit out in deep water - it's important to know how much oil you're producing and pouring into that ship, how fast production is moving, how fast its tanks will be full of oil, and when it will have to offload to a tanker. With this data, you can take a reservoir model and do projections that will help you plan and schedule when the oil will be taken to market.

So the digital oilfield is the concept of gathering data from multiple sources and phases, analyzing it, and being able to transmit information to the people who need it - production engineers, reservoir engineers, operators of facilities, and management or supervisory people.

Management Challenges

But even given the smart application of the digital oilfield with its requisite streams of data, upstream oil companies still face the age-old challenge : determining just what projects to pursue. This is nothing new to the oil industry, of course. Upstream companies have some of the best asset managers in the world. They've spent careers learning how to invest their firms' money. But there's always room for improvement - and it's that edge that increasingly defines leadership positions.

The new business case is how to allocate the company's resources optimally to select the best projects that meet the company's objectives.

Poor portfolio management in any industry takes many forms:

• Managing too many of the wrong projects.
• An inability to prioritize critical projects or kill unnecessary projects.
• A lack of defined processes for reviewing ideas or business cases.
• Attempting too many projects simultaneously.
• A lack of visibility of risks, issues, and conflicts.
• An inability to proactively manage the portfolio.
• Lack of senior sponsorship.

But the oil business has three defining characteristics that make portfolio management even tougher : complexity, scale, and the business model.

First, oil is highly complex business. The company can't see the asset it's working on. Upstream oil operations must gather data, use math representations, try to understand what's below the surface of earth, which can't be touched, felt, or seen. In the effort to get better at this, the oil business has created an astonishing rate of technological advancement, especially when compared to other types of manufacturing operations. What other industry can boast an advance such the ability to send pipes down two miles underwater, then turn them and take them horizontally across great parts of an oil field?

Second, most businesses don't have to grapple with the kind of scale that's commonplace in the oil business. Consider this : In the United States, oil demand is nearly 20 million barrels a day. That equates to about 300 billion gallons of oil every year. The amount is about four times larger when you look at worldwide demand. That means the largest upstream oil companies have to find billion-barrel oil fields on a regular basis to maintain significance in the overall supply.

Third, the economic business model is challenging because an oil company has to invest most of the money upfront long before it starts getting a revenue stream. It starts with the lease sale, then the investment of hundreds of millions of dollars to shoot seismic images and drill wells. If a source of oil is found, the company must then invest several hundreds of millions (or billions) of dollars to put in facilities to produce that oil - all before it generates a dime in sales.

Adding Process to Portfolio Optimization

And that gets back to why it's critical to get these projects in the right order of priority. A company wants to spend its money in the very best places. That in turn requires a continuous rebalancing of the projects in the portfolio.

Traditionally, this rebalancing has been done based on financial return. Decisions regarding other selection criteria are often made in a disjointed and less-than-optimal fashion. Few oil companies have a formal portfolio optimization process. That can leave senior management struggling to assess the strategic value of a particular mix of projects. Forget about achieving alignment between strategy and operations in the capital expenditure planning process.

In one company I'm familiar with where portfolio optimization was applied, senior management received enhanced information on business cases and benefits of all capital projects. This information was provided in the format of a view of strategic health of capital projects, along with a drill-down capability to view background details. The company established a structured approach for using capital planning to make strategy operational, based on the definition of business drivers and appropriate metrics to assess the strategic alignment of capital projects. The solution resulted in more transparent decision-making and a massive savings in capital investment.

The game-changing digital oilfield has offered up multiple opportunities for success by delivering data to people and systems when they need it most. Portfolio optimization plays into this scheme of data-driven decision-making by providing a way to assess both the strategic alignment and financial return of projects in that pipeline.

Calvin Cobb, an advisor to Pcubed, holds a bachelor's degree, master's degree, and PhD in chemical engineering. He has spent over 35 years consulting to executives in the oil and chemical industries. Contact Calvin at calvin.cobb@pcubed.com.