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ROLE OF R&D AS DRIVING FORCE FOR FUTURE E&P

Donald L. Paul Abdulaziz U. Al-Kaabi ChevronTexaco King Fahd University of Petroleum & Minerals Despite the volatility in oil prices and the continuously changing business environment over the last two decades, the exploration and production (E&P) industry continues to increase production volumes and improve economic performance. Research and technology advances are recognized as a key driver of this success. Future E&P performance may be even more dependent on continued technological advances and the R&D system. Responding to a powerful combination of the changing business climate and major scientific and technological advances, new models and trends for industrial R&D have emerged. In this paper, we explore consequences of these trends in view of future business and technological challenges facing the oil and gas industry. The E&P industry has always been successful in adapting new technology trends, most notably information technology. Exponential growth in computation, global network connectivity and automation technologies are expected to continue to be incorporated into E&P technologies to raise business performance. How will trends in these key technologies impact applications for E&P? In this paper, we will discuss these major technology trends and examine possible impacts on both the E&P technology base and the industrys R&D system. The research environment in universities and government research organizations are also facing major changes and challenges. Will new expectations from industrial organizations significantly change their key contribution to long-term basic research and graduate education? In this paper we examine some important trends that are affecting the role of universities in research as related to E&P. We will conclude with an examination of the pathways and potential business models to continue the role of R&D as a driving force for future E&P.

ABSTRACT

Business drivers and trends:

It is deemed that the demand for oil and gas will continue to rise due to the increase in world population and the spread of economic and technological prosperity in regions considered less developed. It is estimated that over the next 25 years the world population will increase by about two billion citizens. In 2020, oil and gas is expected to provide more than 66% of total global energy needs. The biggest challenge facing the oil and gas industry is to meet the future world demand for energy at an affordable price. The oil companies were, so far, able to meet the challenge of securing the supply for energy despite the severe instability of oil prices. In January 1997, the price for oil was about US $23/bbl, less than two years later the price plunged to about US $10/bbl and in February 2000, it reached close to US $30/bbl in response to planned production cuts. Currently, and due to economic slowdown, oil prices are below US $20/bbl. This is more than 70% lower when adjusted for inflation than it was fifteen years ago [1]. Prior to the 1986 oil price collapse, the average cost of exploration by major oil companies was about US $ 7 per barrel of reserve. In 1995, the average cost for finding new oil by seven major oil companies was reported to be about US $ 2 per barrel. World oil reserves increased by about 60%

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from 1986 to 1996, a period during which the cost of field development experienced decline. In the North Sea for instance, the development cost declined from about US $ 9 per barrel in 1988 to about US $ 4 per barrel in 1996. In the USA and Canada, the development cost is estimated at about US $ 3.5 per barrel and in Russia it is about US $ 2.3 per barrel. The cost of field development in the Middle East is less than one US dollar per barrel. The reported operation/ production cost by major oil companies declined from about US $ 4 per barrel in 1991 to about US $ 3.4 per barrel by 1995. Most of the major oil companies reported an increase in their reserves between 1992 and 1995 [2]. Such a significant improvement in cost structure can be attributed to implementation of new technologies, such as 3D seismic and horizontal and multi-lateral drilling, and better project management practices [3] [4]. However, the expenditure on R&D by major oil companies did not match the considerable performance improvements along their entire value chain over the past decade [5].

Impacts on the E&P R&D Environment:

Despite the decline in R&D expenditure since 1984, there is no evidence of a negative impact on the performance and innovation of major oil companies [5] [6]. The declining trend is stronger in the US, which alone accounts for about 40% of global energy R&D expenditure [7]. However, the situation is different for large service companies (e.g., Schlumberger and Halliburton), which continue to play an increasing role in R&D in the upstream oil & gas industry. Schlumberger and Halliburtons expenditure on R&D as a percent of sales, accounts for about 5.6 and 1.9, respectively [8]. Table 1 summarizes current R&D investment for major international oil and service companies [8]. Company TotalFinaElf ExxonMobil Schlumberger BP Shell Halliburton ENI Chevron (now ChevronTexaco) Petroleo Brasiliero Baker Hughes Texaco (now ChevronTexaco) Norsk Hydro Nippon Mitsibishi Repsol YPF Chinese Petroleum 2000/2001 R&D Investment ($000) 619,560 542,555 520,138 417,497 374,209 222,216 211,338 164,498 129,892 113,513 103,894 979,59 95,776 87,335 81,420 R&D % of sales 0.6 0.3 5.6 0.3 0.3 1.9 0.5 0.3 0.5 2.3 0.3 0.6 0.3 0.2 0.6 R&D per employee 3.5 3.8 6 3 2.7 1.7 2.1 3.3 2.3 3.2 3.8 1.8 4.2 1.7 3.3

Table 1: R&D Investment by Major Oil and Service Companies [8]

The Role of R&D in Despite the volatility in oil prices and the continuously changing business environment over the last E&P Business two decades, the exploration and production (E&P) industry continues to increase production Performance volumes and improve economic performance. The research and technology advances are
recognized as a key driver of this success. Future E&P performance may rely even more on continued technological advances and the R&D system. Current Trends in Industrial R&D The oil and gas industry, with its critical weight in the world economy, has never accounted for more than a small fraction (about 1.4%) of total international industrial R&D expenditure, yet it is one of the most technologically intensive industries. Other industries such as Information

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Technology, Automotive, and Pharmaceutical sectors constitute 27.3%, 17.7% and 15.7%, respectively, of industrial R&D. Comparisons of R&D expenditure rates across industries need to account for the structural differences of each sector. The most common measure reported is that of R&D expenditures as a fraction of total revenues or sales. While easy to calculate from published financial reports, this measure ignores the significant differences in the capital and investment structure across industries. As an example, contrast information technology, with very short profit lifetimes for physical and intellectual capital, with oil and gas production, where the largest assets can literally operate profitably for many decades. The differences in the resulting R&D support structure are therefore not surprising. Another key to correctly interpreting the R&D intensity for E&P stems from the application of an appropriate definition for R&D itself. For example, in the context of most industries, what our industry would define as the business of exploration would be viewed as an R&D process. The characteristics match up well: investments which are high-risk, high-reward and front-end loaded; business processes which are sophisticated, science-based and directed at acquiring new geological knowledge and models. What we would define as technical service, such as major reservoir simulation study, would be classified as R&D in laboratories of many other industries. Significant changes to the E&P R&D structure have taken place, including an absolute reduction in the expenditure intensity, however, direct comparisons need to be carefully drawn. Ross et al. [5] lists several reasons to explain the decline in R&D expenditure in the oil and gas industry. These included: (1) Cost cutting, (2) Advances are produced by other industries, (3) Reliance on technology suppliers, (4) Realizing that value is derived from clever application- rather than invention or ownership- of technology, and (5) Difficulty in recognizing benefits from proprietary intellectual capital. In a recent study, Creusen and Minne [6] conclude that decline in R&D cannot be explained by availability of internal funds and creditworthiness. They further explain that the decline could be due to an R&D race and common expectations among oil companies who view their markets as mature, with few new technical opportunities. Oil companies tend to drop their R&D budget and wait until a new dominant technology emerges. They find subsidizing research of promising new technologies at universities more cost effective than doing it internally. The relative decline in R&D expenditures by the global majors also reflects the large growth in joint venture ownership of producing assets and the increased application of risk-based decision-making and portfolio management. This diversification strategy, coupled with enormous capital demands in large new field developments, leads to an increase in the sharing of technology between companies striving together to optimize asset performance and return on invested capital. This business structure then drives upstream into the R&D portfolio, which are re-framed to be much more selective in the proprietary components and much more leveraged into joint R&D programs. The net effect is to reduce the aggregate R&D spend across the industry. Wellington and Islam [9] concludes that the oil & gas industry is preoccupied with cost cutting and gaining economies of scale and consolidation through mergers and buy-outs. Oil & gas companies preferred sharing resources with other parties such as service companies to taking the whole responsibility for field development. This approach has reduced the desire of oil companies to fund R&D. Based on current trend, a decline in upstream R&D by major oil companies is anticipated. On the other hand, service oil companies are expected to fill the gap and take the lead in the future. Several oil companies have replaced their corporate funded research (old model) with customerdriven research (new model). The R&D units were replaced with technology groups that were treated as business units. The main motivation of the new model was to move away from unfocussed, high risk, low return R&D, to R&D projects that are tailored to the customers needs [10][11].

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A number of major oil companies have reported that the new model has created more interest in R&D between business units. They reported that more interaction has been created between technology groups and operations groups through this new arrangement, and success has been achieved through short-term projects. Certain other major oil companies have identified serious disadvantages. These include (1) Researchers or technologists are preoccupied with finding funding irrespective of type and value of the work to the company, (2) Priority of research to be conducted is decided by customers from business units who are less informed, (3) Researchers started to loose their expertise since their research focus is continually shifted by the interest of the customers, (4) Oil companies have lost the technical expertise to evaluate the work done by others (e.g., service companies, outside consultants and independent research organizations) [10]. Based on the new model, it is expected that major oil companies tend not to do fundamental research that will lead to technological breakthroughs. Their technology groups will concentrate more on short-term problem solving research that can be classified as engineering design or technical services. They are expected to substitute long-term research with technical cooperation with service companies and R&D organizations. Most of the innovative research will come from R&D carried out by large service companies. Service companies find it feasible to justify expenditure on long-term R&D since they can market and sell results to numerous customers [9]. Oil companies help this trend by providing service companies with the opportunity to test their new technology without restriction on the ownership of the resulting intellectual property [12]. As part of an important trend in industrial R&D, E&P is witnessing significant growth in the population of start-up or emerging technology companies. Through both formal venture capital processes and joint venture private ownership structures, the major producer and service companies are adding this new dimension to create more options for their R&D portfolio. The driving force to grow this form of R&D are essentially the same as observed in other industries: 1. 2. 3. A perceived better risk-reward balance for their investments; Shorter cycle times and more effective pathways to commercialization; Increased flexibility for entry and exit (specifically if structured as classical venture capital equity investments), and 4. Entre to a wider range of science and technology options (without committing relatively permanent in-house resources). Successful technology companies in this venue can follow several options including, becoming independent technology providers, being acquired and internalized by a producer or service company, or being operated essentially as a cooperative on behalf of the investor / owner companies. The net effect of this emerging alternative can be to draw investment resources away from traditional internal R&D programs. Industry/University Relation Despite the downsizing or restructuring of corporate R&D and the outsourcing trend by major oil companies, the funding level of university research did not see considerable change [11]. Moreover, the type of research that is funded at universities by oil companies is customer-driven which limits innovation and research that can lead to technological breakthroughs. Realizing the importance of links between industry and academia, a numbers of major oil companies and leading service companies have established research centers in the vicinity or in science parks of major universities in different regions around the world. Such facilities are independent and are fully owned and operated by the parent company. Universities tend to benefit from such arrangement

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indirectly through interaction between researchers, faculty members and students. Contract research could be initiated in areas of common interest. Contract Research Organizations Contract Research Organizations (CRO) that represent a bridge between academia and industrial organizations, are becoming common [13]. The role of CRO is to conduct research and development under contract for a fee. They tend to specialize in certain fields and are cost-effective to fulfill the needs of corporations and government agencies. Several clients, without having to setup their own research units, share the services provided by CRO. Some CROs operate under a university umbrella with semi-independent status. Since CROs are mostly driven by the contracts they receive from the industry, their research and development programs tend to be short-term and suffer from the same shortcomings as those of the customer-driven R&D conducted by technology groups of major oil companies under the new research model. Information Technology Information technology has become integral and essential to every industrial enterprise. In no industrial application, however, is the role or intensity of information technology more important than in the upstream oil and gas business. E&P invests more capital and operating expense in information technology per professional than any other industrial sector. Advanced scientific and engineering computing, collection and management of enormous digital datasets, state-of-the-art visualization technology, and sophisticated sensor and measurement systems all drive to make E&P the most digitally-intensive of industries. The co-evolution of E&P technology and information technology has lead to enormous increases in productivity (the oil and gas production per E&P professional has more than doubled since the early 1980s). This productivity increase has materialized in many segments of R&D as well, providing an additional downward bias to funding levels and simultaneously accelerating the opportunity to utilize external R&D sources. It is interesting to observe that while the R&D expenditures for E&P have steadily declined since the mid-1980s, the sum of R&D plus information technology expenditures has remained relatively constant for many companies. Like many fast moving industries, the oil and gas industry has significantly benefited from advances in information and communications technology [10][14][15]. The impact on R&D is represented in several ways. Advances in data management and visualization systems have tremendously increased efficiency in gaining access to valuable information. The Internet has reduced barriers and opened doors for new types of cooperation and alliances between R&D players. Virtual research teams that work in different organizations and geographical locations are becoming common. Web-based software has facilitated dissemination of knowledge and training programs on a global scale. This is particularly important for large corporations with a diverse business culture. Artificial Intelligence (AI) technology (expert systems and neural networks) continues to see more use for data mining, diagnostic and interpretation. Despite the huge investment by oil & gas companies in integrating information and communications technology in their operations, serious challenges remain to be tackled. This includes attracting new recruits who understand and appreciate the value and potential of the new technology for the upstream oil and gas industry. Accordingly, Petroleum Engineering and Earth Sciences departments are already revising their programs in view of this challenge to graduate engineers and scientists who could be able to utilize the advances in information and communications technology to solve problems and create new opportunities for their organizations. Another challenge is related to the declining knowledge base. Advances in information and communications technology have been very effective in generating a wealth of information, but very limited in providing knowledge that can be used effectively for decision-making. Knowledge

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technology will become increasingly important for oil companies to elicit knowledge and expertise from an aging workforce and to expedite training of their new recruits [9],[16].

Current Trends in University and government research was the source of many important technologies that had a University and significant impact on the upstream oil and gas industry. However, the current situation is not very Government encouraging. A report [17] about universities in OECD countries raises several concerns about the Research:
role of universities research and identifies several trends. Due to decline in government R&D funding and pressure from higher student enrolments (except in Petroleum Engineering), universities are finding it difficult to maintain their contribution to longterm basic research. Universities are becoming more oriented towards the industry needs, which are more focused on short-term applied research. Such an environment does not promote the innovative technology that is usually expected to come from university research. Moreover, the issue of freedom to publish and ownership of intellectual property remains a limiting factor for reliance on university research. Owing to the cyclical business environment in the oil and gas industry, talented students are attracted to other fields, and enrolment in petroleum engineering is generally declining. In the USA, from 1982 to 1999, the total enrolment in petroleum engineering declined from about 11,000 to about 1600 students and the number of petroleum engineers declined from about 12000 to less than 7000 [18]. This situation is alarming not only due to its serious effect on university and government upstream R&D, but also due to its negative effect on all sectors of the upstream oil and gas industry. Finding skilled and talented personnel is one of the most crucial future challenges that the upstream R&D will be facing. As usual, universities will continue with their leading role in providing engineers and scientists to the oil and gas industry. In order for their graduates to successfully serve their organizations in the new business environment, emphasis should be placed on providing them with skills that promote multidisciplinary teamwork, investigative and value engineering, leadership, and innovative and creative problem-solving [9][18]. Graduates need to have understanding of the impact of new technologies, especially of information and knowledge technology on the success of their organizations. Departments in related disciplines, for example petroleum engineering and earth sciences, should work together in closing the traditional gap between petroleum engineers and geologists. Integrated courses and research programs that bridge between petroleum engineering and earth sciences are becoming common in leading universities [18]. Future research and technology directions in the upstream oil and gas industry will be determined by the needs related to strong issues such as: (1) Cost and risk reduction, (2) Replacement of produced reserves, (3) Productivity enhancement, (4) Environment-motivated issues, and (5) Technological alliance and partnership between major oil companies, service companies, and universities [1][3] [10][19]. It is expected that long-term research and technological innovation will be conducted outside major oil & gas companies. Leading service companies and independent R&D organizations will increasingly continue to play a major role in advancing upstream oil & gas R&D [20]. Partnerships between oil companies and service companies will be the driving force for technological advancements in the upstream oil & gas industry. It is possible to identify several large-scale technology trends that are expected to have significant impacts on the oil and gas industry over the next 5 to 10 years. Deep-water Technology Deep offshore exploration represents a huge potential for the oil & gas industry. It is estimated that 55 million km2 of sedimentary basins, about four times the conventional offshore surface area, are

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found in water depths larger than 200 m of water. In less than 24 years, offshore technology has advanced from drilling in waters less than 300 m in 1978 to about 1800 m in 2001. The next target depth is 3000 m. To combat challenges that result from extreme conditions of high pressure and near-freezing temperatures associated with deep-water environments, new innovations need to be achieved. These include new materials, advanced sensors, and new technologies like dual-gradient drilling and wet-tree wellhead systems. Enormous R&D investment through industry-wide collaborative efforts (e.g., Deepstar) will need to be committed in order to meet the deep-water technology challenge in the next 5 to 10 years [1][21][22]. Reservoir Monitoring and Fluid Imaging Tracking fluid fronts in actively depleted reservoirs is very critical for the industry. Cost reduction technology, such as 3D seismic, played a major role in helping the oil & gas industry face the difficulties following the collapse of oil prices in the 1980s. Similarly, reservoir monitoring using 4D seismic will play an important role in future decision-making and cost reduction. Several related technologies will need to be developed, including data acquisition technology to reduce acquisition cycle and improve quality, resolution, and new data interpretation techniques to compute rock and fluid properties [10]. Reservoir characterization is expected to benefit significantly from advances in three-dimensional multicomponent (3D, 3C) reflection seismology [23]. Emerging methods for fluids tracking that are based on using wells equipped with permanent sensors (e.g., sensors to measure resistivity, rate, pressure, etc.) which are enhanced by advances in distributed fiber optics will witness new developments and applications [24][23]. Such techniques are expected to be invaluable in on-shore fields where 4D seismic data are not yet proven reliable due to heterogeneous surface cover. Information and Knowledge Technology Knowledge will be the differentiating factor in the information age. Companies that have access to the right knowledge will have the competitive edge. The challenge is how oil & gas companies will retain their management and operations knowledge as they continue to cut their workforce. Moreover, the average age of current oil and gas personnel is in the mid forties and getting higher [15][18]. To counteract this, oil companies will be looking more into information and knowledge technology for efficient data management, training, e-business solutions [25], portals [16][26], data integration and visualization techniques to allow for real-time modeling and virtual project teams. Computer Power and Modeling Methods Computer power, and new algorithms and modeling techniques have allowed for significant developments in the handling of complex and giant oil and gas reservoirs. Fast (hours rather than days) multimillion cell simulation studies using low cost parallel computers are now possible [27][28]. At the current rate of technology growth, it is very difficult to predict what computer power will be in the future; however, one can expect to see significant improvement that will have a great impact on the speed and efficiency of reservoir modeling. Data interpretation methods using AI techniques and artificial neural networks (ANN) will continue to see more applications and acceptance in the upstream oil and gas industry. Automation of well test interpretation [29] and computing of rock and fluid properties utilizing multi-seismic attributes are some examples where AI and ANN can be effective.

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Cost Reduction A number of technologies are expected to have an impact on cost reduction in the foreseeable future. These include down-hole equipment for down-hole fluid separation, and water shut-off, to minimize cost of water handling at the surface and reduce environmental impact, long-life electric submersible pumps to reduce replacement and maintenance cost, lighter and cheaper materials, remote-wireless measurement devices, automated control systems and smart wells that enable remote control of zones with excessive water or gas production, slim holes with less waste material to handle, and lighter equipment.[10][19][30][31][32][33]. Cleaner Energy Demand for natural gas is rising steadily due to growing concerns about climate change and other environment-motivated issues related to emissions from fossil fuel combustion [34]. Natural gas is increasingly considered as a more attractive energy source since it has significantly less combustion emission problems than oil. Accordingly, more emphasis is expected to be placed on R&D and technology applications related to development of natural gas resources and natural gas utilization [35]. Current technological trends like hydrogen fuel cells, combined-cycle power plants, acid-gas reinjection, and gas to liquid technology will continue to see increasing development [21] [34] [36].

Future Pathways and Business Models for E&P R&D

E&P R&D is the first to be affected by the fluctuation characterizing the oil & gas business environment. In the past, corporate research was the basis of many technological advances that contributed significantly to the growth and survival of the oil and gas industry. Oil companies cannot rely solely on R&D conducted by service companies or outside vendors. Successful companies should have strong R&D efforts that contribute to the growth and technical competence of the organization. A strong balance between basic and applied research that leads to product and process improvement is very important. Recent studies revealed that, in successful R&D organizations, basic research is a strong influencing factor [37]. Analysis of the research models of successful R&D organizations also indicates that the composition (i.e., basic research, applied research, technical services, and product and process development) of R&D is important. Expenditure increase on R&D alone is not enough of an indicator for the R&D strength of an organization. The current notion of customer-driven short-term research tends to promote technical services at the expense of more strategic research and long-term competitive advantage. It is important to realize that the technical services of today are the result of corporate funded longterm research of the past [11]. To remain technologically competent, oil & gas companies need to supplement their R&D efforts with outside alliance and cooperation with service companies and technology vendors. The success will depend, to a great extent, on both sides being technically competent. Measurement of R&D performance is essential in order to effectively evaluate the success and impact of research on overall growth of the organization [38]. Lack of research evaluation was one of the pitfalls of past E&P R&D [11]. Finally, technology strategy needs to be an integral part of business strategy [39]. Effective integration of business strategy and technology strategy is crucial for the long-term success of major oil companies. In the past, and due to lack of integration, a moderate slowdown in the business environment was seen as a major threat for the R&D and technology strategy of major oil companies.

Acknowledgement The second co-author would like to acknowledge the support received from King Fahd University
of Petroleum & Minerals. He is also thankful for the review and contribution received from Drs. G. Parry-Jones, Habib Menouar, Nabil Akbar, Saleh Bakhrebah, and Saud Al-Semari.

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