'ACREAGE FACTORY' MANAGES UPSTREAM WORK

Ray Hutchinson
BHP Petroleum
Melbourne, Australia

Thirty-four years ago I went to work in the upstream end of the oil and gas industry. It seemed very easy at the time. I first experienced the meteoric rise of Venezuela production in Lake Maracaibo, then the rise of the Niger Delta, and 10 years later the growth of Bass Strait in Australia.

While none of these discoveries was due to my diligent efforts, I was at least there to share in the excitement. It all seemed so easy: Large reserves were discovered, and the upstream end of the business made all the profits. We used to wonder what sort of people there were in the downstream business.

Then came the mid-1980s and the crash in oil prices. Large discoveries became fewer and further between. Profitability of the upstream business sank below that of the downstream business, and we were scraping for profits and cost savings in every corner.

About this time I turned back to the management books that I had read or scanned over the previous 19 years. Everything I read seemed to apply to a manufacturing plant or a sales distribution network. Nothing seemed to apply to high-risk upstream exploration and development activities.

Granted, statistical methods were used to analyze and manage risk. I studied a number of the more well known texts to see if any of these could be applied to the upstream oil business.

I finally landed on Michael Porter's value chain as demonstrated in his book "Competitive Advantage." Porter analyzes the flow of semifinished goods through a factory from input logistics through manufacture, output logistics, marketing, and service.

Porter overlays this process with a continual input of management, personnel, purchasing, and technology (Fig. 1).

ACREAGE FACTORY

I visualized our industry in terms of manufacturing, where our exploration, development, and production techniques are applied to acreage in a factory.

The major step was to visualize the land flowing through the factory with the various processes of geophysics, drilling, development, and production being applied to the acreage much like an assembly plant.

Once I had envisaged this idea, it was easier to see the acreage flowing into the factory with inward logistics and out the end of the factory with outward logistics and marketing. Obviously, the outward logistics of this flow of crude oil, or products, and natural gas are more important than the outflow of acreage itself.

I now had an acreage factory to which I could apply most of the management techniques that I had learned in earlier years. The only major difference between the acreage factory and another manufacturing outlet is that in our case, the factory goes to the raw material, instead of the raw material coming to the factory (Fig. 2).

HOW IT WORKS

The first and perhaps the most important activity is then the acquisition of the oiliest or gassiest acreage on the most favorable inward logistics terms in the right quantity and at the right time.

To ensure that we acquire the best acreage under the best terms, we set up search organizations in our business units. Typically, a search group consists of geologists, geophysicists, and landmen, working as a team.

Their task is to find the future of the company without worrying about the day-today exploration and production from our existing portfolio of acreage. We are interested in areas with multiple targets and significant potential to increase the shareholder value of the company.

The inward logistics of bringing acreage into our factory include the negotiation of the best terms with the land and/or mineral owner or host government, with the lowest commitment. We also look for appropriate joint venturers and analyze the prospects for a promote.

It is important at this stage to determine whether we operate or allow others to operate.

This decision determines whether the acreage will pass through our factory or somebody else's. If the tools needed to extract the most economic level of oil and gas from this acreage are owned by another company, then it may be better to joint-venture with that company and allow it to be operator.

OPERATING ECONOMICALLY

Once the acreage enters our factory it is then up to us to explore, discover, and extract the economically optimum quantities of oil and gas from that acreage,

To do this we employ modern geophysical techniques, directional drilling, early production systems for offshore fields, reservoir management techniques, secondary and tertiary recovery, etc.

While doing this we try to drive down costs and overheads. Once discovered, oil in particular and gas to a lesser extent should be produced at the maximum economic rate. Discovered oil in the ground is like cans of beans on the grocery store shelf-expensive inventory that needs to be moved to the customer as soon as possible, at the best price.

The factory may be extended into the downstream with gas processing plants, crude oil refineries, or petrochemical plants. The need for outward logistics and marketing becomes more obvious the further downstream one goes.

Nonetheless, the outward logistics of crude oil and natural gas are every bit as important. Offtake may be by pipeline, sea tanker, or rail or road haulage.

The optimum combination of transportation and storage requires careful design.

Crude oil and natural gas are not the only products of our factory. We also produce mature acreage. At least in the U.S. there is a ready market for such mature acreage.

The final step in the value chain is that of marketing. Often we are price takers when selling oil; however, it is possible through careful marketing to add several cents per barrel.

In the mature natural gas markets one can choose between selling into a pipeline or transporting through a pipeline system to a local distribution company, an industrial user, a power generation plant, or a petrochemical plant.

PURCHASING, MARKETING

The two concepts of purchasing (acquisition) and marketing (selling) apply throughout the value chain. It is vital that the search team acquire sufficient acreage to keep our factory running at 100% capacity.

It is not necessary that we acquire only virgin acreage. We can also acquire acreage which has existing discoveries or even existing production.

The most obvious example of this today is the rush to Eastern Europe and the republics of the U.S.S.R. to acquire proven oil and gas deposits for development. We are in fact buying semifinished products into our factory.

Likewise, we can sell any of our semifinished products from unexplored acreage through to mature acreage at any time through the manufacturing process. This can include the promotion of a concept in acreage which we have yet to drill, or the farmout of an exploration area which we have partially tested, or the sale of producing acreage.

It is as important to us to manage the flow of acreage into and out of our factory as it is to manage the flow of produced oil and gas out of our factory. If we do not do this then the mature acreage can pile up in our factory, adding unnecessarily to the complexity of our operation.

ADVANTAGES

For me the most immediate advantage of looking at upstream oil and gas activities as an acreage factory is an increased emphasis on the acquisition and inward logistics of the right quantity of acreage, in the right quality, on the best terms, at the right time.

I also find it very comforting to be able to apply the lessons of my managerial textbooks directly to my industry. I tend to draw strongly from Michael Porter and his value chain.

The reader may have his or her preferred management theories. Whatever they are, perhaps the concept of the acreage factory can help to apply those theories to the everyday problems of the strategies, structures, and results of an upstream oil and gas business.

Copyright 1991 Oil & Gas Journal. All Rights Reserved.