Microsoft Word - Oena 8433 Tutorial Three Due Date 21st May 2010

8/8/2019 Microsoft Word - Oena 8433 Tutorial Three Due Date 21st May 2010

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OENA 8433 TUTORIAL THREE

Peter Smith – Student No 20724513

Economics:

(1) “Price is the best allocator of resources, particularly between generations”. Explain this statement with reference to Hotelling’s rule (lecture 4.2 slide 13), detailing the underlying mechanism for a situation where oil price is rising (say to the levels of 2008).Make sure you state all assumptions required to generate this result. [20 marks]

Hotelling’s rule is defined as “a rule that the present value of a natural resource must be

the same whenever the resource is exploited, because the developer of the resource has to

choose between the increasing value of the resource if left unexploited and its currentvalue if extracted and sold” (6)

Oil prices rise at a rate beyond the cost of production (including cost of money – i.e.interest) because in part speculators assuming future consumption will exceed demand.

This future demand is priced into today’s prices. Oil prices also rise however because ofthe efforts of the cartels (i.e. OPEC) to attempt to charge what “the market will bear”, inorder to maximize economic rent.

The owner of a natural non renewable resource has a conundrum – choosing betweenexploiting the resource quickly (and hence depressing the price) or releasing theresource at a rate that satisfies the revenue desired. The difference between these twoprices becomes the resource rent – i.e. the difference between the extraction costs andthe final price the resource can be sold for.

It would be a mistake to understate the value of resource rent – the cost of extraction ofoil in Saudi Arabia was estimated at USD5/BBL by the Wall Street Journal in 2005 (7).

The resource rent in this case is over $60/BBL at todays oil prices!

Thus – given the original question – we have two drivers for the price of oil. Theresource rent which is derived from the oil suppliers desire to maximize return for a nonrenewable resource, and the speculator who prices in future demand into today’s prices.Both of these drivers cause the ‘PV’ (present value) of oil to take into account the ‘FV’(future value) of oil. Thus price – ultimately control demand which controls the rate ofrelease of an non renewable resources excluding any conservation legislation that maybe in place.

(2) Write short notes on TWO of the following:

(a) Dutch Disease;

The definition from “InvestorWords.com” is The deindustrialization of a nation's economythat occurs when the discovery of a natural resource raises the value of that nation'scurrency, making manufactured goods less competitive with other nations, increasingimports and decreasing exports. The term originated in Holland after the discovery ofNorth Sea gas.” (1). It can also be called the “resource curse” or the “paradox ofplenty” (2).



Countries that have followed this trend are those that have had large mineral wealthdeposits exploited and exported – this drives up their exchange rate which reduces thecompetitiveness of their internal manufacturing (for exports). The problem is aggravatedby the stage of development that a country is going through – developing countriessuffer the worst as generally no internal manufacturing development can take place due

to the exaggerated exchange rate whereas a developed country may be able to takesome steps to preserve the status quo.

Australia suffers somewhat from the same phenomena although Oil and Gas are not theprime resources driving current currency inflation but rather other minerals such as IronOre, Bauxite, Uranium etc. (2). Some economies (such as Australia until the ‘1980’s)attempt to protect against this problem with tariff barriers to protect domesticmanufacturing industries – however membership of the WTO and trade agreementshave removed a lot of tariff barriers.

In extreme cases countries are poor because of their mineral wealth; “Far from an

anomaly, Venezuela is a classic example of what economists call the "natural resource curse." A

1995 analysis of developing countries by Jeffrey Sachs and Andrew Warner found that the morean economy relied on mineral wealth, the lower its growth rate. Venezuela isn't poor despite its

oil riches--it's poor because of them. (9).

The opposite of “Dutch Disease” is a situation where a country poor in natural resourcesuffers currency devaluation due to the inability to export either manufactured goods orthere are no resources to export.

(b) Venezuela’s contribution to the formation of OPEC;

“The Organization of the Petroleum Exporting Countries (OPEC) is a permanent,

intergovernmental Organization, created at the Baghdad Conference on September 10–14, 1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela.” (4)

Pérez Alfonzo (Venezuelan Minister of Mines and Hydrocarbons during theadministration of Rómulo Betancourt) is described as the “other father” of OPEC (3) andalso as the co founder of OPEN (9). His actions – based on his studies of the TexaxRailroad Commission led to his ideas of forming a cartel of oil producers to push up theprices oil producers received from the IOC’s. He was introduced via Wanda Jablonski areknown oil journalist) to Abdullah Tariki (The first Saudi oil minister appointed by KingSaud) in 1959. Both men agreed that they should convene a meeting of other majorexporters- they formed a gentlemen’s agreement to establish an oil cartel in 1059. Theagreement became a common front towards the IOCs. Alfonzo’s ideas in creating

OPEC, were about conservation and stabilization of petroleum production and thedefense of oil prices.

The impetus for the formation of OPEC was unilateral oil price discounts brought in bythe IOC’s which reduced the revenue to the oil producing nations under the 50/50 rule inplace. Abdullah Tariki and Perez Alfonzo brought the Cairo Gentlemen’s Agreementpartners in Bagdad on 14 September 1960 together following this (5). OPEC at the



founding was the source of 80% of the world’s crude oil exports (3 – Page 523). WithoutVenezuela OPEC would not have achieved such a large amount of oil reserve control.

On 15-20 January 1961 Opec, meeting in Caracas, adopts a charter with three aims: toraise the incomes of member countries to fund development; to seize an increasing levelof control over oil production from the international companies; and to unify production

policies. Opec raises the royalties paid by the companies, by changing the basis uponwhich they are calculated, and levies them on top of the tax paid by the multinationals.(5)

(c) the employment multiplier citing the case of the Australian oil and gas industry. [10 marks for total of 20 marks]

Not answered.

The Role of Technology in the Oil and Gas Industry The 1990s have been one of the most productive eras in the oil and gas industry. It has been dubbed the technological age, as advances in technology have contributed greatly

to increased productivity, particularly from increased offshore productivity (Bohi 1998). In particular three significant technologies have contributed to this increased productivity.

Write short notes on the development of each, highlighting the role of research and development expenditures, and the major contributing factors, (such as importing existing technologies, major sponsorship) that contributed to the evolution of these technologies. [20 marks each technology*3=60 marks in total]

These are:

(1) 3D Seismology

“3D reflection seismic data provide interpreters with the ability to map structures andstratigraphic features in 3D detail to a resolution of a few tens of metres over thousands of square

kilometres. It is a geological 'Hubble', whose resolving power has already yielded some

fascinating (and surprising) insights and will continue to provide a major stimulus for research

into geological processes and products for many decades to come.” (7)

The above statement ties in with Krol et al (from lecture notes) who states;

“Historically, 3D seismic technology has been the most important technological breakthrough for

the continued hydrocarbon exploration and exploitation in the North Sea”

Reginald Aubrey Fessenden (October 6, 1866 – July 22, 1932) was a Canadian inventor

who patented the basic ideas for reflection seismology.

John Clarence Karcher (April 15, 1894 – July 13, 1978) was an American geophysicistand businessman. He invented and eventually commercialized the reflectionseismograph – the “core” component of 3D seismology.

Computer software and technology has been a key part of 3D seismology – movingaway from paper based “recording” systems to modeling systems that are able to evenreprocess older seismic records.



The commercialization of seismology has been primarily a private enterprise effort – notable companies include GSI and Western Geophysical. Some service companiesnow include CGGVeritas, ION Geophysical, and Petroleum Geo-Services.

HDHR Seismic Imaging improved resolution aids in subsurface characterization –

reduced uncertainty and improves development planning. This becomes an input intocomputer modeling of the reservoirs – a field called “Reservoir Simulation”.

Wood, 1993: “reservoir simulation has played an important role in the development of almost all

the major North Sea fields and has contributed to increasing reserves and optimal recoverystrategies” (From the lecture notes).

The economic aspect of all this is that these tools assist in capturing uncertainties duringexploration, appraisal and development and hence reduce capex risk to all partiesinvolved in the field development.

(2) Horizontal Drilling

The value in Horizontal Drilling (AKA “Directional Drilling”) is that it allows expansion wellbeyond the platform foot print for a pure vertical well. This allows exploitation of blocksnot accessible with older drill methods.

It also allows production from different reservoir layers. The author has experience withBrunei Shell who plan to drill 170 wells (100 producers) into a field to remove the “attic”oil trapped in formations – this is only possibly from a single platform with DD (directionaldrilling).

Offshore completions are far too expensive to “waste” on no value added top sections.

Krol et al., 1999: “In mature areas such as the North Sea, ERD allows explorationand production of marginal prospects around a central platform which may not be

commercialized by higher cost mobile rig drilling coupled with the expense of subsea tieback

lines”. (From the lecture notes).

The development of directional drilling was aided by the application of a gyroscope tothe drilling assembly (a joint effort between Sperry and Sun Oil), mud motors to allowchange of direction of the drilling bit, measurement while drilling techniques and veryclever telemetry systems that allows the data to be sent to the surface while drilling(logging while drilling – aka “LWD”). Most of the major effort appears to be have beenprivately driven with the companies being aided by the IOC’s.



(3) Deep Water or Offshore Production Systems.

Offshore drilling and production systems started from platforms built on piles in the freshwaters of the Grand Lake St. Marys in 1891.

By rig type, the most numerous rigs today are jackups (478), followed by semi-submersibles (210), drillships (56), drill barges (48), tenders (29), and submersibles (7)(taken from Ref 11).

A lot of development occurred directly out of private producers (i.e. Barnsdall Oil & Gas)as well out of partnerships of sponsorships between producers and engineeringcompanies (i.e. Alden J. “Doc” Laborde and Murphy Oil developing the first open watersubmersible rig). (11)

In1954, several new marine drilling contractors incorporated developed jackup bargesequipped specifically for drilling. (11)

Brown and Root (Engineering Company) was a key partner in developing early offshoreplatforms and production systems.

In the final evolution shipyards took over the design and fabrication – today for examplein Singapore – Sembawang Shipyards is a prime fabricator of Jack-Up andSemisubmersible rigs.

Today the epoch of design is in “floating liquefied natural gas vessels” – a subset ofFPSO (floating production/storage offshore vessels) (12). Although these are yet areality they are attracting investment from Shell for example (for the prelude field).

The OPEC price shock in 1973 helped pushed the economics of the North Sea oil field

developments to an affordable position.

Subsea production systems (trees, tiebacks, pipelines, instrumentation, separators) area key part of the deeper water developments – it’s not feasible to bring the oil to surfacein some deeper waters.

Subsea systems are now widely accepted field development and the technology can beregarded as mature rather than emerging With subsea systems there are economicadvantages such as;

Use of existing infrastructure - Existing facilities can be used to develop new fieldsproviding a lower investment, shorter project time and earlier production time. Subsea

structures and control systems allow decreased environmental impacts, a flexibility toadapt changing condition and ultimately lower operating costs.

The risks to the environment and personnel are very high however – witness the mostrecent accident with the “Deepwater Horizon” sinking in the Gulf of Mexico. TheEconomoist (10) points out that while offshore drilling may be temporarily unpopular thereality is that is where the oil is and that better technology is allowing exploration in everdeeper waters. The Gulf of Mexico accounts for almost a third of America’s oilproduction. Lexington in The Economist (11) points out that regulators, oil firms (and oil



service companies) will from this incident learn useful lessons.



References;

1. http://www.investorwords.com/1604/dutch_disease.html - retrieved 5 May 20102. http://www.theage.com.au/news/business/mining-boom-could-bust-

us/2007/11/10/1194329562546.html - retrieved 14 May 20103. The Prize – Daniel Yergin, 1991, Free Press New York.

4. http://www.opec.org/opec_web/en/24.htm (History of OPEC) - retrieved 14 May2010

5. http://mondediplo.com/2006/05/07timeline (OPEC timeline) - retrieved 14 May2010

6. http://www.economics-dictionary.com/definition/Hotellings-rule.html - retrieved 14May 2010

7. http://www.opinionjournal.com/extra/?id=110006228 – retrieved 14 May 20108. Joe Cartwright and Mads Huuse, 3DLab, School of Earth, Ocean and Planetary

Sciences, Cardiff University, Cardiff, Wales, UK9. http://money.cnn.com/magazines/fortune/fortune_archive/2003/02/03/336434/ -

retrieved 15 May 2010. “The Devlis Excrement”, Fortune Magazine, Jerry UseemFebruary 3, 2003

10. “Deep Trouble”, The Economist May 8th 201011. http://www.offshore-mag.com/index/article-

display/307364/articles/offshore/volume-67/issue-9/supplement/modern-offshore-fleet-comprised-of-same-rig-types-as-in-the-1950s.html - retrieved 15 May 2010

12. The Wall Street Journal – “The Journal Report: Energy”, May 10, 2010

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Microsoft Word - Oena 8433 Tutorial Three Due Date 21st May 2010