Tony Hayword, the CEO of BP, has a Ph.D. in Geology from Edinburgh University. He is a very smart guy, so his recent indications that BP is refocusing on its core skills of finding, producing, refining and selling oil and gas are to be taken very seriously. Looks like the era of ‘Beyond Petroleum’ is at least temporarily derailed. Whether that is the right move for major international oil companies in this economic climate is not a question of this essay. Rather I would like to focus on the “Computer-Aided Lean Management” alternative to such refocusing-on-the-principals events in the Energy Industry. The Lean solution would be to keep as real options all future possibilities for diversification by continuing investment in as many alternatives for selling into an unpredictable and dynamic market into the future as possible. As new and unexpected world changes become realities, it is always a threat to any company’s sustainability that their market will change out from under them. We all know of companies that were defeated in the marketplace not by competitors, but by the marketplace changes. A Lean company in the oil and gas business would always be looking to sell its core products in as diverse a way as possible. Real Options are the mathematical formulation of the projected worth to the company of keeping such options open. To give a specific example, oil and gas production can always be converted into electricity directly at the site of production. We do it all the time to drive generators to power our offshore and remote drilling rigs. To do it at a sufficient scale to sell enough to capture price anomalies among oil, gas and electricity in reachable markets requires estimates of the maximum and minimum real option value of those investments from “cradle-to-grave.” Arbitrage among varying prices in as many markets as profitable is a fundamental advantage to any company. Specific to oil, gas and electricity, the oil price has recently been way out of kilter with it’s equivalent BTU value of 7:1 versus natural gas (barrel to mcf), mostly because of hedge fund speculation in the market. If you don’t believe that, look at the precipitous drop in NYMEX price this last week from >$70 to <$60 because of threats to regulate and make transparent such speculation in the U.S. and Europe. Adding price variability from gas affected as always by the cost of long-distance transportation, and from electricity’s transmission congestion makes for a compelling case for evaluating the real option of conversion of oil and gas to electricity for every giant oil discovery in the world at the moment (that is not in the Middle East, that is). Yet, no oil company that I know of (with the possible exception of PetroBras) is currently computing such 3-way, oil-gas-electricity real options. Anyone out there know of others? Beyond Petroleum was my biggest hope.
