Efficient frontier or wild west?

The leitmotif of the MBA/economist brigade is that the current low returns provided by the upstream must be improved if industry is to survive. PDM editor Neil McNaughton wonders if, with oil at $30, such self flagellation is still really necessary.

It is no coincidence that the major application vendors both are fronting their new strategy with hi-falutin’ MBA economics. Both major vendors are prefacing the rush to integrate financial and technical information with the claim that E&P return on investment (ROI) is pitifully small at 5-7%. Indeed both go as far as to suggest that with better portfolio analysis, by high-grading assets using the new and magical Efficient Frontier Analysis (EFA), then all will be well and ROI will rocket back to levels that will satisfy the investment community. While it is hard to imagine that innovative software will put quite so much onto the bottom line, the task of attempting to put an ‘objective’ value on an prospect, or on the aggregation of prospects that is a portfolio, is a fascinating exercise indeed, which brings together geology, psychology and OK, a little economics.
It would be nice to imagine that projects - like people - are all created equal and all have merit in the right portfolio. But the reality is as any old timer will tell you, that there are “eating sardines“ and “selling sardines”. That some prospects are good and some are dogs, unworthy of a position in any portfolio. Choosing which is which is the expert job of the geoscientist and engineers. If your corporate aim is to do better than the dreaded 5% ROI, you are going to have to get rid of some of the dogs. So you farm them out. Or rather you try to farm them out. If it was possible to farm out anything, as was the case in the early 1980’s, and if all prospects are subsequently drilled by other companies then the industry-at-large ROI will be unchanged. For a given world-wide pool of prospects, an improvement of industry-wide ROI must be achieved at the expense of a reduction in investment, by eliminating the dogs and only drilling the prime prospects. One wonders if the implications of a such a reduction of investment in exploration has been thought through by those who are touting the new economics. What reduction in the service sector spend would be necessary to bring oil and gas ROI into line with the dot coms?
Of course today, not only you cannot farm out so easily, you may even find it hard to finance the prospects that you do want to drill. Expenditure is totally focused on development or low risk opportunities, so far has the sentiment turned against the explorationist. And the sentiment of the investment community is what is key here. We have worked on the science, and on the economics, but seem to have overlooked something. Perhaps if we stopped flagellating ourselves with the poor ROI story, we might have time to reconsider the very real change that 3D seismics brought to the E&P business. I know that was the big story of the 90’s when the oil price collapse stopped us in our tracks. But technological breakthrough is an even bigger story today, as visualization technology catches up with acquisition.
Finally, to return to the ROI debate or should that be debacle? The MBA’s and holier-than though cost-cutters have indeed talked the industry into a big hole, and they are still digging. I Rationalizing structural change in the service sector is all very well, but it is perplexing to see it being done with such enthusiasm by the very companies who are at such risk from it. I would submit that more of the communications firepower should be devoted extolling risk reduction technology rather pretending that this can be achieved by analysis. Efficient Frontier Analysis is only snake oil after all, but it’s the wrong snake oil! We need to get those Chicago dentists back with their tax dollars! We need economics run at a $30 barrel – yee haw!

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