World Petroleum Congress

Identifying value creation channels through e-business implementation in the oil industry MAZIGHI AHMED, Energy Specialist SONATRACH, Algiers, ALGERIA Abstract :
The main purpose of this communication is to identify and assess five potential channels of value creation through e-business implementation. The first channel, which is somewhat ambiguous, is the existence of positive externalities in the industries using networks. The capacity of the network increases at a rate equal to

C n2+1 C n2

when the number of subscribers on the network (n) increases and hence, gives oil markets for procurement, old materials and final products more liquidity and more transparency. But, in the same time, information becomes more abundant on the network requiring highly skilled people and new technologies to process the information. The second channel is the decreasing cost of telecommunication in term of bandwidth, data storing and the increasing capacity of information processing (Moores law) which allow oil companies to converge toward zero paper in the value chain with a payback between 9 and twelve months. The third channel is the decreasing of the logistic costs mainly in the retail. The fourth channel is the modification of the traditional channels of distribution. An oil company can for instance sell electricity if she has a client oriented website that gives consumer the amount of his bill at any time. The last channel is the portfolio diversification through the investment in an electronic exchange. This channel does not add value directly but gives the opportunity to process the information of the e-market and publish statistical data and forecasts on the web. Special attention will be given to oil and gas companies.

1) INTRODUCTION
In october 1999, Texaco created a new position of Vice president of e-business. In the same time, BP created a corporate team to explore e-procurement opportunities, while Shell established with Commerce One an e-marketplace for the energy and chemicals industries. Nobody can really reject the idea that e-business has became one of the new fashions of our old oil and gas industry. The e-business has created such new opportunities that some specialists (Oil & gas Journal, August 2001) have imagined a kind of ready made process of e-transformation for the oil and gas companies. Our objective is not to deal with the e-transformation of the oil and gas companies, but to assess some sources of value creation through e-business implementation. However, before going deeply into those sources of value creation, we need to highlight the challenging aspect of the e-business for the oil and gas companies.

2) WHAT WILL BE THE REAL GROWTH OF THE OIL AND GAS INDUSTRY DURING THE COMING YEAR ?
The answer to this question is obviously very easy. The real growth of the oil and gas industry during the future years will be less then the real growth of the world GDP. Indeed, we need to take into account the energy efficiency which has became less than one in all the major fossill energy consuming countries. In the same time, we may also include the share of fossil energies in the global energy balance. The value creation in the oil and gas industry will not be driven by the world economic growth. So, were can we find new sources of value creation? One can may be suggest the price of fossil fuel. Un fortunately, the real price (year base = 1990) of oil seems to be very flat since 1986, while the nominal one is still very volatile. Even the price of gas with the emergence of the spot market is supposed to become more and more volatile. A risky averse investor cannot consider the price of fossil energies as sources of value. Another one can suggest to develop the downstream in order to create value. But the industry seems to have excess capacity in this segment. We can develop the marketing of the petro chemistry products also, but sooner or later the margins will decrease. The real sources of value creation in the oil and gas industry must be found in the efficiency of this industry. One way to reach this objective is to merge in order to benefit from scale effects. All the Majors tried this solution during the last decade. Another way to reach efficiency is to digitise our operations where it is possible. In this sense the switching to e-business is something irreversible. By the way, how to define e-business?

3) DEFINITION OF E-BUSINESS
The best definition we can give to e-business is certainly the one of IBM : [e-business is]The process of using Web technology to help businesses streamline processes, improve productivity and increase efficiencies. Enables companies to easily communicate with partners, vendors and customers, connect back-end data systems and transact commerce in a secure manner. (see www-3.ibm.com/e-business/glossary) This definition is very clear because it shows us that e-business is not a re-invention of business nor the New economy is the re-invention of the law of supply and demand. e-business is only capturing value by digitising our processes and exchanging data through computer mediated networks. ebusiness doesnt need necessarily Internet, but since Internet is the widest network making e-business implies using the web and its technologies.

4) POSITIVE EXTERNALITIES AS A SOURCE OF INFORMATION COSTS REDUCTION

The main advantage of networks (Economides, forthcoming bibliography) is that they provide positive externalities to the subscribers. Imagine a simple telecom network with 4 subscribers. On this network, A can phone to B, B to Cand, vice versa each time. Finally, we have we add a marginal subscriber, we will have

2C 42 = 12

economic goods. If

2C

2 4 +1

= 20 economic

goods. The supply capacity

increases when the demand increases, while both are supposed to be independent.

Now, imagine two incompatibles networks with N1 and N2 subscribers. In case of connectivity or extensibility, the supply capacity will not be the sum of the two supplies, but it will be is much more higher than

2(C

2 N1

+C

2 N2

).

2 2C N 1+ N 2

which

What does this mean in term of e-business for the oil and gas industry? First of all, it means a decreasing cost of transaction. To understand this, lets compare an old labour intensive procurement system to an e-procurement system : Infrastructure Paper Order Labour intensive system 1 person for the procurement, another one for the stock management Stocks files, order forms, clients files Via phone or fax e-procurement 1 person + a computer system No paper

Procurement function Mistakes

Cost of negotiation

Via e-mails, extranet, emarketplaces, which allows us to send several kilobytes at small rates Needs the examination of Can be solved through an excel several order forms, faxes which sheet. is time consuming. The order mistakes on paper No mistakes represent 25% of the total of orders regarding AMR Research. Are reduced between 20%

(IBM) and 25% (McKinsey) The e-procurement system reduces paper consumption and order mistakes to zero as well as it reduces negotiation costs and personnel. Considering Forrester Research Survey of 50 large companies, the purchases via Internet (e-mails, extranet, e-markets) will increase, while the share of Electronic Data Interchange (EDI) and faxes will decrease. 2000 7 5 1 59 28 2002 6 28 17 28 21

e-mail Extranet e-markets Fax/phone EDI Source : Forrester Research

Secondly, for National Oil Companies, using Internet for the procurement means switching to a transparent system with a convergence toward zero corruption when the network become very wide. This second point is somewhat neglected by the literature while it is very important for the national oil companies that are trying to switch to a private management. Thirdly, accessing to more furnishers means and increased competition between them and a decrease of procurement costs. In the same time, we must keep in mind that for the integrated oil and gas companies this is not really a channel of value creation. Indeed, the reduction of costs due to the eprocurement is offset by the reduction of prices and negotiation power once the oil company has to sell its products through the Net. In this sense, for the integrated oil and gas companies, the sources of value creation should be found elsewhere.

5) TIME SAVING AND MORE LIQUIDITY AS A FIRST CHANNEL OF VALUE CREATION

Making e-business is basically designing and implementing electronic management processes using Internet technology. Hence, the cost of making e-business is the cost of the required technology (computer, fibre optic, satellites, ISP services, security, advisory..) plus the cost of highly skilled people. As shown below, the cost of technology is exponentially decreasing. Moreover, because of an increasing competition, the tariffs of ISP and advisors will decrease. There is also a good chance that the cost of telecommunication will be neglectable in the 10 coming years. Indeed, because of the increasing capacity of telecommunication in term of bandwidth, some operators will set up a monthly or yearly pricing system with unlimited communications rather than a communication duration based pricing system. SOME FIGURES ABOUT THE COST OF e-BUSINESS INFRASTRUCTURE 1970 Cost of processing 1 Mhz of power 7.6$ Number of transistors by 8008 microprocessor Cost of transferring 1000 billion of 150$ bits Cost of storing 1 Mega bit 5.25$ Source : Federal Bank of Saint Louis 1999 0.17$ 10 000 000 0.12$ 0.17$

Even with those extraordinary reductions, the real source of value creation will be time saving and market liquidity.

6) TWO ADVANTAGES FROM THE MODIFICATION OF THE CHANNELS OF DISTRIBUTION

In a classical channel of distribution the product is somewhat pushed to the client. With the setting up of an interactive web site the product will be tailored to the client. Moreover, the web site can allow the oil company to optimise its logistics costs. The best example here is the one of the retail in the oil and gas industry where we can imagine a client buying his gasoline on line. After payment, the web site of the company gives the client a secret code which enables him to fill his car reservoir in a certain moment and in a certain retail station. This way of buying gasoline obviously allows the retail to optimise stocks and, the gains resulting from this optimisation can be shared between clients an retailers. That is, indeed, a real channel of value creation.

Arthur Little Energy Practice in its famous Virtual Oil Company proposed a kind of ready made process to switch from a classical downstream oil company to a virtual oil company. The first step consists in setting up a client oriented web site. The second one is the online commerce of fuels and lubricants. during this step the company should make its best to have the client loyalty. Once the client 'fidelised', the company can propose to him new products such as electricity. In this last step indeed, the web site of our old downstream company is supposed to be enough developed to allow our client to know the amount of his electricity bill at any moment. In this sense, through e-business, downstream oil and gas companies can 're-capture' the segment of electricity to the residential. In order to avoid a 'war' between the traditional electricity sellers and the oil companies, electricity sellers have already started to invest huge amounts in the web site designing.

ONLINE TRADE OF POWER 1999 2000 1 6.3 Source : Forrester Research Billions of $ 2001 13.1 2002 26.7 2003 2004 53.2 100.5

7) THE CHANNEL OF PORTFOLIO DIVERSIFICATION

A lot of things have been said about diversification, but when we look at the works of Tobin and Markovitz, we can see that diversification is not a source of value creation in itself. It is only a way of reducing risk through a reduction of the variance of our portfolio. In this sense, investing in an emarketplace or an e-exchange can be compared to an investment in the mobile or cell phone for an oil and gas company.

Every one knows that the difference between oil and gas development is a difference in term of payback and development opportunities. The payback for oil is smaller than the one for gas, because gas is more capital intensive than oil ; but gas gives the opportunity to invest in power plant, methanol and so on. That's why gas continue to procure value even after a long time. What about investing in an e-exchange or an e-marketplace? Obviously the investment is less capital intensive and, once the investment recovered, we obtain a kind of perpetuity. If the competition in the sector of e-marketplaces is high, the tariffs of the e-marketplace services will be low giving small increments of NPV once the investment is recovered. If there is no competition and/or if the dot com is innovative, then we will have a potential of value creation - case 1 on the figure above. In the oil and gas industry, indeed, we must keep in mind that investing in an e-marketplace is not only giving access to data rooms or electronic auctions, it is also processing data, elaborating market studies and selling them to the subscribers. The value creation is not due to the diversification in itself, but to the opportunities offered by the investment in the e-market place. We can imagine an oil company investing in an e-marketplace in a first step and operating in the consultancy and advisory market in a second stage.

CONCLUSION
Someone can say that for an integrated oil and gas company the value creation potential of ebusiness cannot be compared to the value creation due to an increase of 4 or 5 Dollars in the yearly average of oil price. That's true indeed, but we cannot either compare one Dollar of management and processes improvement to one Dollar of windfall. The success of an industry must be also measured through its managerial performance. If we give a retrospective look to our industry, we can see that we have made only three progress during the last ten years : 1 New techniques in the seismic 2 New drilling technologies 3 Scales effects through M&A activity May be e-business will be the new field of cost reduction.