Petroleum Industry Overview


2. Upstream

Upstream activities are composed of exploration, appraisal, determination of commerciality or relinquishment and development/production stages. Once the lease is obtained, exploration takes place to search for oil and gas. If it is found, the discovery necessitates development. The drilling and extraction activities make up the production in the long term. Each petroleum-rich country has their own regime for the bidding and contracting process and rules and regulations to govern exploration, development and production.

A well is only developed if the resources can be commercially produced given current technological advances that allow the recovery of the cost of production and guarantees investor profit. While the companies will strive for profit maximisation, the host state will want to ensure that the maximum revenue is generated from its resources. Usually, there is therefore tension in balancing profitability for the companies and revenue/royalties/taxes for the host states. The profitability of the resources will differ depending on the geology and available technology, as well as the commodity price.

Process of bidding and tendering

The greater the perceived or proved hydrocarbon endowment of a host country, the more likely that a process of bidding and tendering will be followed. This process varies among host countries but typically includes:

  • Opening for tenders

  • International competitive bidding

  • Bidding factors and award procedures, pre-qualification of bidders

  • Data purchase

  • Negotiable bid factors/terms, seismic option

  • Invitation to bid, direct negotiations, and possible re-tender

The lower the perception of host country proceptivity, the more likely it is that the country will elect to invite tenderers to bid and then follow a process of direct negotiations.

Time-frame

The exploration period can last five to seven years. Development and appraisal process can be up to two years, sometimes overlapping the exploration phase. Production periods can be 20-30 years, with possibilities of 5-10 years’ extensions if commercial production remains possible. Finally, the best practice in abandonment is to have contractor create an ongoing reserve during commercial production to cover its ultimate costs, noting that offshore operations are far more expensive to abandon than onshore operations.

Conventional vs. unconventional resources

It is important to highlight the difference between conventional and unconventional oil resources. Shale oil and gas is the greatest technological advance in over a century. It bypasses traditional drilling for oil in deposits and traps and goes directly to the source of the petroleum's generation, in what the Industry calls "the kitchen". While shale oil and gas are both cost and resource (water) intensive, they have the potential to increase the world's petroleum resources exponentially. Indeed, countries with no discovered conventional oil resources may yet have significant shale oil and gas resources.

Shale oil and gas production can be a game changer. However, it also has its risks, such as that of early failure, need for continuous drilling, multi stage hydraulic fracturing (making the cost of finding oil significantly higher than conventional reserve exploration and exploitation), greater risk of environmental damage and pollution of potable aquifer water and expensive production methods that drive up the base cost of finding and producing. Shale production is much more subject to 'boom or bust" conditions as the volatile price of crude oil varies.

Exploration

Exploration of oil and gas is led by petroleum geologists and geophysicists, usually in companies operating internationally. It is a high-risk and high-cost activity. The key decision for the oil companies is where to search for oil and gas: in which continent, whether onshore or offshore, and using which technology (assuming that government content and data can be obtained).

Rapid and thorough exploration is important for a host country to achieve maximum benefits from petroleum development. It is therefore usual for host states to impose time limits and minimum performance guarantees in petroleum contracts. These would include having: minimum obligatory exploration work programmes; performance guarantees during exploration (usually corporate guarantees or bank letters of credit) and relinquishment or surrender of contract areas after a set number of years. Petroleum agreements will also provide for terms for appraisal of a discovery, and determination of commerciality.

The exploration process can be divided into various stages, including the declaration of commerciality, for example from seismic studies, and the establishment of rigs and types of exploration wells. Most governments in emerging petroleum producing states generally opt for carried interest at the exploration stage due to the probability of success given exploration is a high-risk activity which increases with water depth. This means that the State does not pay anything when it comes to costs at exploration (and development) but pays for its share of the costs when oil production starts.

A summary of exploration methods

 

Exploration methods

Development: appraisal and determination of commerciality

This stage of upstream sector activity in the petroleum value chain concerns the project development process. The risks and gains are evaluated and valued so that the producer can make an informed decision on whether to develop the discovered reserves. Qualitative and quantitative assessments to measure project feasibility are commonly undertaken during the development stage and these include:

Project development stage

Key elements of a successful project development

A successful project development would require these assessments and checks to be carried out and managed throughout the entire project life cycle. Key elements for a successful project development include:

  • Having formalised and achievable project phases and checkpoints in place;

  • Identifying accountabilities within the project implementation team;

  • Continuous control of costs;

  • Risk monitoring.

The objectives of the development strategy for the host state should also focus on maximisation of commercial discoveries; meeting national demand for petroleum sector to stimulate industry and employment; and maximising reservoir recovery.

For efficiency in gains and the environment, gas flaring should be prevented and where associated gas is recovered this should be processed to replace oil use (where possible –such as in heating) and used to help oil recovery.

The issues at stake may be different when it comes to offshore production. Considerations such as environmental concerns and local settlement are more prevalent in onshore development.

See, for example the case study, Niger delta issues in Nigeria.

Production

The production stage, following successful discovery of petroleum resources, can last up to 40 years or beyond, and is often 20-30 years with up to two mutually agreed extensions of five years each. But it can also be indefinite, expressed as, “for as long as commercial production remains possible". However, states do not favour this later formulation, as it creates the perception among citizens that they have given away their national petroleum patrimony completely and for too long.

All of this is circumscribed, though, by the requirement that the contractor always uses best available oilfield practices and adheres to Maximum Efficient Production protocols.  The producer would have to take a decision between fast production within a shorter productivity timeline or sustainability of production and lengthening the producing life of the field. The urge to cut dependence on oil and gas imports, often a huge burden on the state budget, may lead a newly resource developing country to conclude a deal in which they do not have control of operations.

The decision determining the preferred pace of extraction is important particularly to avoid a resource curse scenario. For instance, following the discovery of commercial reserves in Norway the government’s policy adopted a cautious approach to the speed of drilling operations. They concluded that a moderate pace of production would allow the host country to gain expertise and adopt appropriate policies and legislation to govern the sector in a way most beneficial to its citizens.

Reservoir management

Once the production has begun, the next challenge is to enhance production. There are a number of activities that can be performed to fulfil this task.

Stages of oil recovery

Cost management

As the price of oil and gas commodities is driven by global market forces outside the control of the producers, productions costs define the competitive edge of industry players in the sector. Depending on the size of the project, there are many factors which have an impact of cost of production and efficient management of each of these items has a potential for cost reduction.

 

Factors influencing production costs

Additional information relating to production processes and costs is contained in the topic material:

Petroleum Engineering and Standards