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© 1994 Hart Publications, Inc. Printed with Permission. Published: Hart’s PetroSystems World, July/August 1994 p.


Executive Fundamentally, the petroleum

exploration and production industry

faces the classic buy-versus-build
decision. In its case, find-and-produce
petroleum instead of build. This is
nothing more or less than any other
industry faces and is a good opportunity
By Scott M. Shemwell to make use of decision support systems
(DSS), modeling tools, simulations,
expert systems (ES), and other
A Framework for the Strategic Cost Analysis of computer tools.
Information Technology in the Petroleum Industry: But this decision is not simple. Most
E&P companies find themselves -
Part 1. juggling a combination of find and buy
activities. Optimizing this mix is
probably the biggest challenge
Editor's note: The energy industry based services as well. Many argue that companies face as they try to increase
needs to streamline information computer-aided exploration techniques petroleum reserves. They must ensure
technology to remain competitive but are so successful that fundamental shifts longterm access to raw materials while
struggles with quantifying the results of or reengineering efforts are occurring in balancing current cash flow
these efforts. This is the first in a three- the way upstream business is requirements.
part series that examines methods for conducted.
determining the value of information If this is true, then this fact is IT's Role
technology strategies. Scott M. consistent with experiences in other
Shemwell is director of information The return on the investment in
industries, but an extensive IT program information technology has been
technology for Halliburton Energy cannot be successful alone. Rather, IT
Services. elusive. A 1992 study by Short &
is only one component of the overall re- Venkatraman exposes that most
The petroleum industry is big engineering of businesses that industries
business. All but the smallest companies have only automated
must undertake to remain competitive. existing business processes but have not
corporations are multi-million dollar
entities and many are multi-billion achieved desired results from their IT
dollar firms. Petroleum products are Strategic Impact investments. But isn't it likely that IT
critical to the national well-being and It is difficult to determine the could contribute to the competitiveness
national defense of the United States. strategic impact that information of companies in this unstable
In other words, this is an important technology has on a petroleum competitive environment?
industry; one that employs thousands of corporation. Most often, companies It is widely believed that technology
people and directly impacts the lives of evaluate IT projects using short-term can lower the microeconomics long run
millions more. It is also an industry that oriented financial models like net average total cost curve for a firm or
has faced enormous difficulties in present value. Furthermore, subjective industry. If this is correct then the
recent years. models are hard to quantify. Strategic appropriate use of information
Is the business of a petroleum cost management (SCM) is a technology can certainly contribute to a
company in the 1990's to explore and methodology that adds quantifiable firm's strategic drive to be the low cost
produce petroleum reserves, purchase modeling to the concept of competitive producer. In the March 5, 1994 edition
crude oil and natural gas for resale strategy and the value chain. Statistical of The Economist the article "Inside the
through retail channels, optimize techniques can also be used to develop empire of Exxon the unloved" explains
existing petroleum reserves, or and simulate a strategic cost analysis that Exxon's longterm approach to the
combinations thereof? Regardless of model for firms in the petroleum oil industry has been one of cost-
which scenario a petroleum company industry. control. It refers to a 1918 memo by
adheres to, it will no doubt be in a more Economic models and simulations Walter Teagle, the rescuer of Jersey
competitive environment due to drive the industry. Companies develop Standard after the Standard Oil Trust
increased regulation and the what-if scenarios constantly. For was broken up, which warns of poor
unpredictable nature of oil and natural example, in a 1993 study, Salomon prices and calls for more efficiency.
gas prices. Brothers estimated the level of E&P Since that time, Exxon's culture has
These companies are large users of spending at $24/barrel is 35% higher relied on the use of technology to
information technology (IT)—using than spending would be at $1 8/barrel. ensure that the company remained a low
computers of all types and sizes to One scenario implies that the cost producer Mr. Teagle's memo is as
evaluate and maximize oil and gas successful company will need to appropriate in 1994 as it was in 1918.
production. As George Baker showed in increase production while keeping its So, how can IT contribute, can it be
his 1993 study, all companies— both cost down, another suggests that if measured, and if it cannot be directly
domestic and international— study production is not increased, the measured can a business model and
geologic, engineering and economic company will need to purchase simulation be developed to support IT's
parameters when making business petroleum stocks to feed its refining contribution?
decisions. and/or distribution networks. While Next issue: Various models that are
Not only are hardware and soft-ware another scenario indicates that used to evaluate competitive strategy.
heavily used in the normal course of economic growth in the Far East will
exploration and production but in IT- drive the demand for petroleum the
remainder of the decade.
14 Petro Systems World
© 1994 Hart Publications, Inc. Printed with Permission. Published: Hart’s PetroSystems World, September/October 1994 p. 14

With this data in hand, these individuals

Executive develop various technical models and

recommend additional exploration,
development or production activities to

maximize the return on the corporation's
These technical models are
probabilistic by nature. Any business
decisions made on the basis of these
By Scott M. Shemwell models will involve an element of risk.
While even probabilistic technical
models can be approximated by
mathematical optimization models, the
A Framework for the Strategic Cost Analysis of socioeconomic or corporate planning
models are not so easily solved. The
Information Technology in the Petroleum Industry: systems dynamics of a petroleum
corporation's business model must take
Part II. into consideration the lag between initial
exploration, field development and
Editor's note: This is the second in a Business Value of Computers, that the refining to bring petroleum products to
three-part series that examines methods value of IT cannot be measured directly. market. The investment can be enormous
for determining the value of information Finally, the value-chain model takes and it can take years to pay it back, let
technology strategies. Scott M. Shemwell into consideration structural cost drivers alone to make an acceptable return. One
is director of information technology for like complexity, experience, capacity example is the North Sea, where
Halliburton Energy Services. utilization, and Total Quality Management development required billions of dollars of
(TQM). These drivers exist throughout the investment before returning a single dollar
In 1980, Mike Porter developed his value chain. As Shank and Gouindarajan in revenue.
classic model of industry driving forces, stated in 1992, technology is an important In this environment, economic and
which is one of the methodologies driver of cost at the critical junctures in the political considerations can and do
companies use to attempt to evaluate chain. Furthermore, technologies are severely impact a company's financial
investments in technological change. interrelated and different technologies can performance. These issues are difficult to
While this model is a good representation have a profound impact on the corporate predict or quantify, and contribute to the
of the relationship between technological system. probabilistic and non-linear relationship
change and competition, it lacks the ability Change is inevitable, and in the world between input and output in this industry.
to conduct a formal financial analysis of technology, change appears to be
within an industry.
One of the key strengths of this model
constant. Porter argues that the judicious
management of technological change will
Strategic Cost Management
Strategic Cost Management (SCM) is
is the concept that firms must either strive lower cost or enhance differentiation and
quantitative methodology grounded in
to become the low-cost producer or find a shift cost drivers in favor of a firm.
Porter's qualitative, structural strategic
way to differentiate their products and Models like Net Present Value (NPV)
thinking. This approach develops a model
services from others. Using technology to are insufficient when evaluating the long-
based on ValueChain Analysis, Cost-
reduce risk might be a way of reducing term ramifications of adopting significant
Driver Analysis and Competitive-
cost in the exploration and production technological change. They place too
Advantage Analysis. As a blend of these
industry. Additionally, quality and service much emphasis on short-term results, with
analyses it strongly suggest that without
can differentiate a firm's products and little importance applied to long-term
evaluating all three, the job is not
services in the market. Gasoline is strategic implications.
basically gasoline, but people will buy one Kaplan's model addresses the issue of
Critical to this analysis is the
brand or the other, and in fact appear to deterioration of the technical base if no
understanding that value is added
have brand loyalty. further investment is undertaken, as well
throughout the firm's value chain. This
Porter's 1985 concept of the Value as the tangible versus intangible benefits
implies that value obtained at the
Chain augments his original model. This of the investment in technology. He
beginning of the value chain can cascade
concept suggests that information recognizes that the early investment in
through the chain. This is particularly true
technology should be treated as part of the technology can have ramifications
in the petroleum exploration industry
corporate infrastructure. It is a thread that throughout the corporation. Criticisms of
where it has been shown that deterministic
weaves its way throughout the entire Kaplan's model center on the fact that the
inputs only obtain probabilistic outputs.—
corporation— inbound logistics, model is fundamentally an extension of the
operations, and outbound logistics as well NPV model, and although correct, it still In the next issue we use the Strategic Cost
as the company's marketing, sales and does not adequately address strategic Management model to evaluate technology
services efforts. This indicates that the issues. benefits at 227 of the largest energy companies
effects of IT might be cumulative. A small Prior to and after acquiring data in the world.
change in the input segment could have a through seismic, logging operations and
profound impact on later divisions of the other means, scientists and engineers must
Value Chain. This model also suggests, as organize, retrieve and analyze large
determined by Paul Strassman in The amounts of data quickly and efficiently.

14 Petro Systems World

© 1994 Hart Publications, Inc. Printed with Permission. Published: Hart’s PetroSystems World, November/December 1994 pp. 10-11

Executive Expenditures for IT. Additionally, the

assumption was made that only 25% of
that amount would be directly spent on
computer hardware and software, the

Vision By Scott M. Shemwell

remainder was for non-asset items, like
personnel, and various IT services like
maintenance and training. Under this
assumption, the Total Assets with IT
were only increased by 0.25%. It makes
no difference whether the firm owns the
A Framework for the Strategic Cost Analysis of IT assets or outsources IT capability.
Information Technology in the Petroleum Industry: The second assumption made is that
the Worldwide Liquids Production and
Part 111. Worldwide Natural Gas Production
would each increase 1% based on the
Editor's note: This is the third and apparent. Finally, IT plays a role in the additional 1% additional spending for
final installment in a series that firm's infrastructure throughout the IT. This assumption suggests that an
examines methods for determining the Value Chain. increased IT budget will increase overall
value of information technology A spreadsheet-based financial model production.
strategies. Scott M. Shemwell is director of the oil and gas industry was developed The third assumption is that the
of information technology for using data obtained from the Oil & Gas number of wells drilled will remain the
Halliburton Energy Services. Journal 300 database (1992). It contains same with the additional IT expenditure,
As stated last issue, Strategic Cost financial and other data for fiscal 1991 and the average price the company
Management attempts to integrate from the 300 largest oil and natural gas receives for its oil and natural gas
Porter's models with quantitative producers including: Total Assets, Total products remains constant. IT needs to
methodologies. The petroleum industry Revenue, Net Income, have a beneficial impact on the
appears to be an appropriate industry in Return On Assets, Capital and organization's cost drivers to have a
positive impact on
the firm's bottom
Industry ROA w-wo/IT Finally, the
model calculates
the Return On
Assets with IT and
the Difference in
Change in ROA

Return On Assets
without IT (Figure
1). Return On
Assets (ROA) was
chosen as the
output of the model
for two reasons:
1. It was mea-
surable based on
the available data.
2. This ratio
eliminates the
Petroleum Companies affects of the firm's
capital structure.
On the basis of
Figure 1. the above
assumptions, the
which to use SCM techniques. Exploration Expenditures, Worldwide model also calculated: Net Income with
The industry is very competitive, with Liquids Production, Worldwide Natural It, Increase Revenue Liquids with IT and
numerous firms attempting to secure Gas Production, Worldwide Net Wells Increase Revenue Natural Gas with IT.
competitive advantage, each with Drilled, Average Crude Price, and
different cost drivers. The buyers of the Average Natural Gas Price. Firms with Statistical Assumptions
firm's goods and services are in a strong incomplete or inconclusive data were
While input is deterministic, we
position—gasoline is a commodity. eliminated, and the final model consisted
Furthermore, many IT suppliers to the of complete data sets for 227 companies. make the case that the output of any
industry, such as computer hardware investment in this industry is proba-
firms, have other non-petroleum Assumptions bilistic. (See previous issue.) Input may
customers and are not wholly dependent vary and since the relationship between
The framework made the assumption
upon oil and gas customers. Likewise the input and output is non-linear, an input
that each firm in the industry added 1%
threat of substitution is real and
to their Capital & Exploration

10 · Petro Systems World

of less than one percent may generate an It will be necessary to run the model
output of greater than one percent. using data from more than one year,
For these reasons, both the input, adjusted for business cycle variables, to
Capital & Exploration Expenditures with ascertain whether or not increases in
IT, and the outputs, Liquids Production ROA are universal within the industry.
with IT and Natural Gas Production with Actual case studies would further test the
IT were treated as normal distributions validity of the framework.
with a standard deviation of one. Future
models may change the shape and Limitations
standard deviations of these curves, as Productivity and reduced risk are hard
well as input and output values. to measure. While these issues are
addressed in the SCM methodology, they
Computer Simulation are difficult to quantify. This implies that
Once the model was developed, it the impact of IT can never really be
needed to be tested. Implicit in any predicted, but as with other infrastructure
statistical model is the need to conduct a components of the firm, IT will simply
number of iterations to simulate the contribute to the overall performance of
expected value(s) of the model. The @ the firm's core business units.
Risk software package from Palisade, Also, this model and simulation can
1992, was used to perform this only be considered as a framework.
simulation. Individuals interested in the impact of IT
The simulation conducted 500 on a specific firm or segment of this
iterations using the Latin Hypercube industry may wish to conduct a more
stratified sampling technique. This indepth analysis on this firm or segment.
technique tends to force convergence, or Finally, the use of ROA as an indirect
stability, of a distribution using fewer measure of the effectiveness of IT may
samples than with Monte Carlo not be appropriate in some cases. As
sampling. firms in this industry continue to
The simulation generated detailed downsize, outsource, and otherwise
statistics for the following variables: divest themselves of assets other ratios
Total Revenue with IT, Net Income with may be more appropriate to investigate.
IT, ROA with IT, Capital & Exploration
Expenditures with IT, Worldwide Summary
Liquids Production with IT, and Given the strategic and infrastructure
Worldwide Natural Gas Production with nature of information technology, it is
IT. very difficult to measure the return on
Of specific interest is the ROA with the firm's investment in IT. Although
IT. This is the output of the model that is several models have been proposed, all
the best indicator of the change in are lacking in some regard.
financial performance based on IT SCM methodology appears to be a
expenditures. valid approach to this problem. This is
particularly appropriate to the petroleum
Conclusions industry today. This paper has presented
On the basis of the ROA with IT an SCM model and petroleum industry
measure, this model suggests that the simulation.
investment in IT is warranted in many The results of this simulation suggest
cases. Small increases in ROA are that properly deployed, IT can have a
significant in the large corporations significant impact on the bottom line of
evaluated. It is important to note firms within this industry. However, the
however, that if a company has a model further suggests that there are no
negative ROA before IT investment, it panaceas. A firm cannot strategically
most probably will have a negative ROA reverse a poor financial position in the
after IT investment. short term. IT is not a cure-all. It is only
The probable explanation of this another tool that a firm can utilize to
circumstance lies in the strategic nature help it secure strategic advantage.
of the SCM model. The data tested in There is a great deal of work to be
this paper represents one fiscal year. done in this area. The framework
Strategic investments will not necessarily presented here is only the outline of an
generate significant increases in the approach towards solving the problem
firm's financial statements immediately. on the strategic use of information tech
Most likely, the results of this investment nology in the petroleum industry.
will manifest themselves sometime in the