FUNDAMENTALS OF

OIL & GAS

MODULE ONE
Introducing Oil & Gas

AUTHOR
David A. Wood PhD
Principal, David Wood & Associates
A sample copy of Module 1 of the Fundamentals of Oil & Gas.

We hope you enjoy this extract and find it beneficial. Once you have read through the contents, if are
interested in completing the rest of the course you can apply online via the website:

www.ibc-academy.com/fog

Or if you have further questions about the course or need more information, please do not hesitate to
contact us on:

Tel: +44 (0)20 7017 7636

Email: ibc-academy.admin@informa.com

N.B. This trial is of the module contents only and you will not receive access to the interactive online
classroom, the tutorial discussions or end of module test.
CONTENTS
Introduction to the Course ............................................................................................................. 3
Structure of the course .................................................................................................................. 4
Studying the course ...................................................................................................................... 8
1. Introducing Oil & Gas ............................................................................................................. 9
1.1 Introduction ................................................................................................................... 9
1.2 What is Oil and Gas? And Where Does It Come From? ......................................................... 9
1.3 How is Oil and Gas Formed? ........................................................................................... 14
1.4 Concepts of Finite Resources and Limitations on Recovery .................................................. 16
1.5 Global Distribution of Oil and Gas ................................................................................... 17
1.6 Industry Overview and Segments .................................................................................... 21
1.7 Uses and Markets for Oil and Gas .................................................................................... 25
1.8 Role of Government and its Agencies in the Oil and Gas Industry ........................................ 26
1.9 Introduction to the Supply and Value Chains: Upstream to Downstream .............................. 27
1.10 Organizations Involved Along the Supply Chain ................................................................. 31
1.11 Key contributions made by specialist service providers, suppliers and construction contractors ... 32
1.12 Distinct Economic Issues for Oil and Gas Supply Chains ..................................................... 33
2. Summary & Conclusions ....................................................................................................... 34
2.1 The Next Module ................................................................................................................ 34
3. Further Research and Useful Websites .................................................................................... 35

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2
INTRODUCTION TO THE COURSE

Welcome

Oil and gas are amongst the most important resources we have. Apart from providing the majority of our
energy, petroleum is used to create countless products upon which we rely in every part of our lives. It is
not surprising, then, that the oil and gas industry is a principal driver of the global economy. The systems
and processes used to produce and commercialise oil and gas are complex, involving large amounts of
capital, state-of-the-art technology and vast numbers of skilled personnel serving supply chains that span
the globe.

There are many facets to the industry and a lot of information and angles to cover. In the six modules of
this distance learning course you will gain a comprehensive grounding in all aspects of the oil and gas
industry.

Welcome to the course and Module 1.

David Wood

Course Director

3
STRUCTURE OF THE COURSE

During the course we will explore the many facets to the industry in six modules, which are outlined
below.

Module 1: Introducing Oil and Gas

Providing a comprehensive overview, this module introduces the fundamentals of the oil and gas
industry, its history, structure and key terminologies.

The origins of oil and gas

Concepts of finite resources and limitations on recovery

Global distribution of fossil fuels

Industry overview and segments

Uses and markets for oil and gas

Role of government agencies in the oil and gas industry

Introduction to the supply and value chain: upstream to downstream

Organisations involved along the supply chain

Key contributions made by specialist service providers, suppliers and construction contractors

Distinct economic issues for oil and gas supply chains

Module 2: Finding Oil and Gas

This module introduces the fundamentals of geology and offers an understanding of the main exploration
techniques used to find oil and gas reserves. It then examines the frameworks used to negotiate access,
operation and ownership rights.

An introduction to petroleum geology

Defining and calculating reserves

Reservoir engineering

Conventional and non-conventional petroleum resources

Exploration and prospecting: broad surveying techniques

Seismic and other geophysical surveying techniques

Exploration and appraisal drilling

Remote detection methods

Types of exploration and production contracts and fiscal agreements

Accounting for risk: Expected Monetary Value

Economics of exploration: financing, fiscal regimes and time value

4
Module 3: Extracting and Processing Oil and Gas

By examining the different methods of production, this module gives an insight into the broad range of
options available to extract oil and gas in every kind of physical environment.

Well planning and design

Subsurface pressure and temperature

Hole sections and well trajectory

Types of drilling rigs, systems and equipment

Drilling procedures and problems

Production engineering

Production technologies

Marine operations

Fixed and floating production facilities (including FPSOs)

Subsea technologies

Well completion

Artificial Lift

Fracking and other forms of reservoir stimulation

Enhanced oil recovery (EOR) techniques including carbon capture and sequestration (CCS)

Typical timings and costs

Module 4: Oil Refining and Gas Treatment

This module presents the logistics involved in transporting and storing oil and gas. It then introduces the
basics of refining and distributing petrochemical products.

Crude oil evaluation and classification

Transporting and storing crude oil: pipelines, marine tankers, rail and road

Refining oil

Refinery configurations

Distilling, cracking, reforming, blending and treating

Petroleum products, supply and demand

Transporting and storing gas: pipelines and other methods

Refining gas and gas to liquids technologies

Dehydrating, sweetening, NGLs and LPG

Liquefied Natural Gas (LNG) Gas to power: combined cycle gas turbines (CCGT) and
combined heat and power (CHP)

5
 Distribution networks

Module 5: Selling Oil and Gas

The commercialisation of oil, gas and petrochemical products is the focus of this module, with an
overview of the business practices involved in selling, trading and regulation.

Global markets and key players

Market segments: wholesale, aviation, marine, LPG

Spot and term sales

Benchmark prices

Trading instruments: forwards, futures, swaps and options

Hedging from various supply chain perspectives

Risk management

Retail marketing

Network analysis

Pump process

Oil inventories and strategic stocks

Module 6: Managing Oil and Gas

This module examines global issues affecting the oil and gas industry, as well as internal and external
factors shaping its current state and future direction.

Geopolitical risks and opportunities

Techniques for quantifying political risks

Environmental and sustainability issues

Gas flaring, emissions and contamination

Prudent operators and best practice

Triple bottom line approach to decision making

Industry and regulatory bodies

Organization of Petroleum Exporting Countries (OPEC)

Gas Exporting Countries Forum (GECF)

International Energy Agency (IEA)

Legal concepts and contractual frameworks

Sole risk and non-consent

Farmout and joint venture arrangements

Dispute resolution and arbitration

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 Fiscal elements and designs

Production sharing and mineral interest systems

Cost recovery from government and producer perspectives

Future of energy: challenges and opportunities

Trends in uses of energy and per capita energy intensity

World primary energy mix and substitutes for oil and gas

Forecasts for fossil fuels and the primary energy balance to 2050

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STUDYING THE COURSE

We all have our preferred learning styles and tackle reading and learning activities in our own unique
way. As the author and tutor for this course it is my responsibility to keep you interested in the content
and to try and help you remain motivated to learn. This will be achieved in part by the text, which will
take you through a thorough introduction to the oil and gas industry, but you also have a responsibility
for your own learning? Your responsibility is to set aside sufficient time and a place where you can
undertake your study of the modules, be it at home, whilst you are travelling, or during quiet periods at
work. For optimal personal development though, you need to fully engage in the learning process part
of this is to apply your responsibility to work diligently through the materials, thinking about what you
read, reflecting on it, and no doubt at times challenging it.

We aim to thoroughly cover the subjects addressed in the course, but you may at times wish to consult
other sources on the internet, or maybe in a library, in order to delve deeper into an issue that
particularly interests you. Your responsibility for your learning also extends to making use of the online
course forum. Here you can post a question if there is something you dont understand, you can read
what others are asking or saying, you can add your comments in order to allow others to benefit from
particular knowledge you have, or you can share your own experiences of a particular issue. However
the course forum is what you make it. If you just enter it to read other peoples posts and do not
contribute yourself, it will be a lonely place. Please start by checking out the forum and introducing
yourself. You could post your name, where you are, who you work for and the reason you are interested
in the subject of this course. Have a go and try it out!

Hopefully you have taken the above on board? The worst thing you could do with this course is to just
read the content of each module, learn it parrot fashion and then move on, without further thought or
discussion with others.

A large degree of thought has gone into the chronology of the modules and their sections the running
order. The sections in these modules are akin to the chapters in a book or a story, in that they build
upon one another. We would respectfully encourage you to read them in order, so as to put you in the
strongest position to address and absorb the key messages. Naturally you will have your preferred pace
and you may choose to dip in and out of the text, which is your prerogative.

As a final note, a great idea that suits many people when studying by distance learning is to consider
writing their own brief summary of the key learning points being taken away at the end of each major
section which is sometimes called an Elevator Pitch. Where does the term Elevator Pitch come from?
Imagine you are travelling a few floors in an elevator with your boss and he/she asked you what did you
learn from that last chapter of your course I saw you reading ? Youve got the time the elevator travels those
few floors to succinctly tell them the main points you drew from the text. Have a go at drafting one.
Remember that whatever you produce will probably vary from others this is not a problem as you will
probably have a different priority or focus on what is important to you in the section. Additionally, the
disciplines of summarising and prioritising are very important for people to practice.

Enough of the preparation and guidance for this course, lets turn our focus to the first module which
provides a broad overview of the distribution of petroleum resources and the organisations that constitute
the industry.

8
1. INTRODUCING OIL & GAS

Providing a comprehensive overview, this module introduces the fundamentals of the oil and gas
industry, its history, structure and key terminologies.

The origins of oil and gas

Concepts of finite resources and limitations on recovery

Global distribution of fossil fuels

Industry overview and segments

Uses and markets for oil and gas

Role of government agencies in the oil and gas industry

Introduction to the supply and value chain: upstream to downstream

Organization involved along the supply chain

Distinct economic issues for oil and gas supply chains

Learning Outcomes:

On completing this module you will have an understanding of:

how oil and gas is formed and where it is located on Earth;

the factors that limit and impede its recovery to the surface;

the structure of the industry and its different segments;

roles for governments, its agencies and other entities along oil and gas supply
chains;

how oil and gas is used and the markets into which it and its products are traded;
and

the main economic drivers that distinguish the oil and gas industries.

1.1 Introduction

This module is designed to give an introduction and overview of the oil and gas industry. It provides
insight to some of the fundamental technical issues, such as how oil and gas is formed and where it is
located. It also outlines the structure of the industry, its different segments, markets and the
organizations that contribute to the functioning of its supply chains.

The industry, like many others, is permeated by specialist terms, jargon and abbreviations. These terms
are explained in the text as and when they are mentioned. A glossary of commonly used oil and gas
terms and abbreviations is available and can be downloaded at:

http://www.dwasolutions.com/images/DWA_Oil_Gas_Glossary.pdf

1.2 What is Oil and Gas? And Where Does It Come From?

Oil and gas are, respectively, liquid and gaseous hydrocarbons that occur as natural resources on Earth.

9
They may collectively be referred to as petroleum.

Hydrocarbons are chemical compounds made predominantly of the elements hydrogen and carbon. These
elements form key constituents in the building blocks of life on Earth and petroleum and other
hydrocarbon resources have their origin in the ancient and fossilized remains of living materials.

Oil and gas are not the only naturally occurring hydrocarbon resources on Earth. Coal is another very
important hydrocarbon resource. Collectively, oil, gas and coal are referred to as the fossil fuels; because
they are derived from fossilized living materials and they are consumed in large quantities to provide us
with fuel for heat, power and transportation.

Oil and gas occur in various forms and are loosely classified as conventional resources (i.e. those that are
easily flowed or pumped to the surface) and non-conventional resources (i.e. those that require specialist
techniques and/or additional energy to aid their extraction in commercial quantities). See Figure 1.1. The
unconventional resources of oil and gas have become much more important over the past decade as new
technologies have made it possible to produce more of them on a commercial basis.

Figure 1.1

Classification of Petroleum into Types. Larger In-place Resources are Associated with those
Petroleum Types Near the Base of the Triangle: Source: David Wood.

More specifically oil is further classified according to its density and specific gravity relative to water. The
scale commonly used to measure the specific gravity of crude oil is degrees of API (API stands for
American Petroleum Institute; the United States body responsible for establishing oil and gas standards).
Crude oils with specific gravity of greater than 31API equate to densities of less than 870 kg/m3 and are
termed light oil. Oils with specific gravity between 22API and 31API equate to densities from 910 to
870 kg/m3 and are termed medium-gravity oil. Oils with specific gravity of less than 22API equate to

10
densities of greater than 910 kg/m3 and are termed heavy oil. Oils with specific gravity of less than
10API equate to densities of greater than 975 kg/m3 and are termed ultra-heavy oil. Crude oils are,
except for some ultra-heavy oils, all less dense than water. Water has a density of 1,000 kg/m3 which
equates to about 7.5API.

There are many regional benchmark crude oils specified by name around the world and used for trading
purposes. The names that are most familiar, because they are used most widely and underpin trading
activity on exchanges, are Brent, West Texas Intermediate (WTI) and Dubai crude oils. In addition to
specific gravity (degrees API), it is the quantity of sulphur content and a specific crude oils abundance in
terms of proved reserves that determine its character and long-term significance (see Figure 1.2).

Crude oils are described as: sweet or low sulphur with less than 0.5% sulphur; intermediate with
between 0.5% and 2% sulphur; and, sour or high sulphur with greater than 2% sulphur.

The worlds remaining crude oil reserves are becoming heavier (lower API gravity) and sourer (higher in
sulphur). Most Middle East crude oils have sulphur contents of greater than 1% weight. This is an issue
for refiners trying to meet lower sulphur fuel specifications.

Figure 1.2

Some Important Crude Oils Distinguished by Specific Gravity and Sulphur Content. The Size of
the Bubbles Reflects the Magnitude of Remaining Proved Reserves. Note the Small Size of the
Bubbles for Brent and WTI Versus Arab Light and Other Crude Oils from the Middle East.
This Diagram was Published by David Wood, Petroleum Review, April 2007.

Oil and gas also contains additional constituents, usually in only trace quantities, of several other
elements. For the most part such minor constituents are contaminants that have to be removed to avoid
emissions when they are burned as fuels or transformed by refining and petrochemical processes into
non-fuel products, such as plastics, solvents, lubricants, etc. In the case of oil the contaminants can
include water, sulphur, metallic salts and heavy metals (e.g. nickel and vanadium). In the case of gas the
contaminants include water, hydrogen sulphide (and other sulphur compounds), carbon dioxide and
nitrogen. Natural gas also contains minor concentrations of the noble gases (i.e. helium, argon etc),
which can in some cases be separated and provide an additional minor revenue stream from natural gas
production. Indeed markets for noble gases are small but growing and these gases are generally in short
supply.

The specification of produced crude oil that most influence its market value are usually the density or API
gravity, the sulphur content (as explained above). However, the bottom sediment and water (BS&W)
content of specific cargoes of crude oil and, if it is being loaded on to a ship, the Reid Vapour Pressure
(RVP), which measures the quantity of volatiles in the crude also influence its value. Additionally wax
contents and pour points (related to viscosity) are also often specified as waxy and high pour point
crudes, which can be difficult to handle causing blockages in pipelines or solid deposits in storage tanks.
Those crude oils that contain substantial metallic salts, metals and organic acids, are of lower value to
refiners (i.e. they will command lower prices) unless those contaminants are removed or reduced below
acceptable threshold concentrations by the supplier.

11
Usually a producer is expected by a buyer to process its crude oil to a certain specification in order to
justify an agreed price relative to a specified benchmark quality. If a cargo is out of specification,
adversely from the buyers perspective, then a price adjustment is usually applied (e.g. a reduction for
additional water etc.) or perhaps a penalty incurred. If the crude is significantly out of specification then
the buyer is often within its rights under a purchase contract to refuse delivery, as to do so may lead to
them incurring costs or upsetting their process configurations.

Crude oil usually ends up with refiners who are interested in the hydrocarbon molecular compositions of
the crude. They consider the value of the crude in terms of the refinery (and petrochemical) processes
they have available to them, the molecular nature of the crude established by detailed chemical analyses,
termed an assay, of the crude and the market demand and prices for certain products in the markets
they are supplying. The hydrocarbon molecular structures that are important to refiners are discussed in
a later module. Buyers are usually interested in a much more detailed compositional analysis of a crude
oil than the seller. Although refiners commonly establish a buying price related to the density and sulphur
content of a crude oil they are interested in the quantity of high value products they can produce from
that crude oil in order to maximise their refinery margins.

Each grade of crude oil has its own specific basic quality and composition as well as being associated with
a specific geographic regional grade in many cases. Review assays for some of BPs crude oils at:

http://www.bp.com/modularhome.do?categoryId=6725&contentId=7020583

Prices at which crude oil can be bought and sold vary on a daily basis and the price differentials between
the major crude oil grades also vary over time. As oil, gas and petroleum product market movements in
the second half of 2014 testify, prices can change significantly on a day-to-day and week-by-week basis.
The main international crude oil benchmarks (Brent, West Texas Intermediate WTI and Dubai / Oman)
have their spot prices quoted daily (i.e. prices for delivery in the current month) and futures prices
quoted on exchanges (for settlement in future months). Some of these prices are quoted in the media
daily, for example see website:

http://www.bloomberg.com/energy

For more detailed daily oil pricing information used in contract pricing formulae it is necessary to
subscribe to price discovery agency reports, such as those produced Argus Media, ICIS and Platts:

http://www.argusmedia.com/

http://www.icis.com/about/heren/

http://www.platts.com/

Oil pricing and trading is discussed in more detail in later modules

Directed Learning:

For your country or region investigate the benchmark crude oils and try to obtain some
information about their quality (e.g. API gravity and sulphur content). Once you have
done this, publish your brief findings on the module forum on the Learning
Management System so we can share our findings and read what other participants
have discovered.

Petroleum resources are located in deposits, termed reservoirs, within the rock formations forming the
Earths crust. These reservoirs are usually not large cavernous void spaces filled with fluids, like vast
underground lakes. They are in fact made up of solid rocks with small porous volumes of void space,
disseminated between the mineral grain matrix making up the rock. That rock matrix in good quality
porous reservoirs is like a solid sponge with small but very numerous voids within it that can hold fluids
and allow them to flow through it, if the pores are connected to each other. The more connected the pore
space the more permeability a rock possesses and the easier fluids can flow through it. Good reservoirs
need both porosity (i.e., void space between the mineral grains) and permeability (i.e., connectivity of
the void spaces). The petroleum is accumulated (i.e. reservoired) together, in almost all cases, with
water in the pore space (see Figure 1.3).

12
 Figure 1.3

Oil and Gas Reservoirs are made up Mainly of Solid Rock and Mineral Grains with the
Petroleum Contained within the Pore Space Disseminated through the Rock. The Mineral
Grains are Usually Coated with a Layer of Water and the Petroleum is Located in the Centre of
the Pore Space Enabling it to Flow More Easily from the Reservoir. Source: David Wood.

Petroleum reservoirs may occur at or close to the Earths surface (e.g. tar sands, bitumens and gas
hydrates, which are solid ice-like structures with gas molecules contained within them) or, more usually,
at depths of several thousand metres below the Earths surface and, in extreme cases, as deep as 15
kilometres within the Earths crust.

The rocks containing petroleum reservoirs are in almost all cases sedimentary rocks or rocks occurring
within or immediately adjacent to sedimentary basins. Sedimentary basins are receiving areas on the
Earths crust where sediments laid down by seas, rivers and wind accumulate. Other types of rocks such
as those formed by volcanic processes (i.e. igneous rocks) and those formed at depth within the Earths
crust by deformation processes at high temperatures and pressures sustained for long periods (i.e.
metamorphic rocks) rarely contain petroleum reservoirs.

Crude oils vary in colour and consistency from a thick dark brown opaque liquid (i.e. most medium-
gravity and heavy crude oils) to a light brown, transparent easily-poured liquid (some of the very light
crude oils see Figure 1.4). Heavier crude oils tend to be more viscous than light crude oils, but high
viscosity is related to high wax content of the crude oils and it is possible to have light but waxy crude
oils.

Figure 1.4

Crude Oils Display a Wide Range of Colours and Viscosity, but most are Dark Brown
or Black and Opaque. Source: David Wood.

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1.3 How is Oil and Gas Formed?

Petroleum is formed from the decay of animal and vegetable matter over millions of years. These
organisms originally grew using energy derived from the sun. Heat and pressure sustained for long
periods of time transform, through a sustained cooking process, the decaying organic material into
petroleum. The petroleum is a store of energy, originally derived from the sun and locked up for millions
of years in the form of hydrocarbon molecules.

The organic material from which oil is derived is laid down in marine and lacustrine (i.e. lake) conditions
such that it is buried in anaerobic conditions (i.e. absence or very low concentrations of oxygen). This
enables the decaying organic material to be initially preserved for deep burial (see Figure 1.5). The main
sources of organic material by volume are microscopic plants and animals that live near the surface of
the oceans and lakes and sink into the sediments when they die. Macroscopic plants and animals make a
much smaller contribution over geologic time scales.

Figure 1.5

Diagrammatic Cross-section Illustrating how Organic Material is Deposited in a Sedimentary

Basin, Buried and Preserved as Organic-Rich Mud Layers to be Later Transformed at
Depth into Oil or Gas. Source: David Wood.

Different sources of organic material and depositional locations lead to different types of petroleum. It is
possible through organic chemistry to determine these sources. For example some oil source rocks with
organic material laid down in lakes have characteristic waxy qualities. Other source rocks with mainly
woody plant material tend to produce coal type deposits more likely to generate gas than oil.

As the organic material is progressively buried it becomes compressed and changes into organic
agglomerations within the sediments known as kerogen. The different types of kerogen, which vary
according to their organic precursors, will progressively generate different volumes and types of oil and
gas over different temperature ranges as they are heated up during the burial process.

In some sedimentary basins the flow of heat and rate of sedimentation and burial is more rapid than
others. This means that in certain conditions burial and cooking of the source rocks is rapid and
petroleum is generated in just a few million years. In other cases burial and heating can be much slower
and the petroleum generation may take hundreds of millions of years. Also the Earths crust is a very
dynamic environment and the burial process may occur in several stages, including some reversals where
sediments laid down are removed through erosion, bringing the organic-rich potential petroleum source
rocks closer to the surface and arresting the cooking process for long periods of time. Indeed some
organic-rich rocks although capable of generating petroleum never make it to the appropriate
temperature conditions. Either they are buried to insufficient depths or eroded and destroyed.

Geologists talk of kitchen areas and oil and gas windows, referring to the locations and conditions based
upon temperature and time where source rocks of certain types would generate and release their
petroleum. Part of the exploration process is locating and mapping such areas to establish that significant
and sufficient quantities of oil and gas have been generated in the basins being explored.

It is a combination of factors that must occur together (see Figure 1.6) in order for sufficient oil and gas
generation to occur. The key factors are: (1) organic-rich sediment layers of appropriate composition and

14
sufficient volume (petroleum source rocks) are buried and preserved; (2) certain temperature thresholds
are achieved; (3) the source rocks remain within certain temperature ranges (the oil and gas windows)
for adequate periods of time to enable oil and gas to be generated and expelled.

Figure 1.6

Heat and Pressure Sustained at Depth for Long Periods of Time Leads Organic-Rich
Sediments Generating and Releasing Petroleum. Source: David Wood.

If the source rocks pass through the oil window too quickly the initial oil generation will be overtaken at
higher temperatures and mainly gas will be produced or the oil will be cracked over time into mainly
gaseous petroleum. Hence the third factor of time in the appropriate oil window can determine whether a
particular area is more likely to have produced oil or gas.

The gas window extends to greater depths than the oil window (see Figure 1.7). This, and the occurrence
of some source rocks that are more gas-prone than oil-prone, means that petroleum source rocks over
geologic time are more likely to generate larger volumes of gas than oil. That is a primary reason why
greater volume resources of gas than oil have been discovered.

Figure 1.7

Oil and Gas are Generated in Specific Depth Windows that are Related to Temperature and
Pressure. Source: David Wood.

15
 Directed Learning:

Do you consider your country or region primarily oil-prone, gas-prone or both?

Investigate the ages and names of known source rocks in your region. Once you have
done this, publish your brief findings on the module forum on the Learning
Management System so we can share our findings and read what other participants
have discovered.

1.4 Concepts of Finite Resources and Limitations on Recovery

Petroleum takes millions and, in some situations, hundreds of millions of years to form, because of the
burial and cooking process. When we flow oil from sub-surface reservoirs we are in fact removing in a
few decades what has taken millions of years to form and move (migrate) from source rock to reservoir
rock.

There is a finite amount of petroleum that has been formed over the history of the Earth. This amount is
related to the amount of organic material buried, preserved and cooked in those specific conditions that
enable petroleum to be formed. Of the petroleum generated much of it has in fact been degraded or
destroyed over geologic time as it fails to be trapped in a reservoir and escapes to the Earths surface or
its reservoir is destroyed by erosion processes at work due to the mobile and dynamic nature of the
Earths crust (i.e. its outermost solid layer).

The more oil and gas we produce and recover from these ancient subsurface reservoirs the less there is
to produce in the future. Although there is much oil and gas remaining buried in the Earths crust yet to
be produced, and indeed yet to be found, the nature of fossil fuel (i.e. gas, oil and coal) resources is that
the ultimate volume of them that has been formed on Earth to date is a fixed and finite volume. We do
not know the exact values of those volumes, but we can estimate those (more about that in Module 2)
with some confidence. The point here is that once the current complement of each fossil fuel is produced
and consumed there will be no more available to produce and it will take long periods of geologic time to
replenish them.

The finite (i.e. non-renewable) nature of these resources is one of the major drawbacks for the fossil fuel
industries. In their current mode of operation they are not sustainable in terms of being able to meet
global demand for energy and non-energy petroleum products indefinitely in the future. We can rely upon
them for a few decades, but not for centuries. Therefore the energy industry has to continue to invest in
alternative forms of energy to fossil fuels to meet the long-term (i.e. 50 to 100 years into the future)
energy demand of the planet when fossil fuel resources are either substantially depleted or what remains
is too expensive to extract.

At the same time as the fossil fuel resources are progressively depleting, so global demand for energy
continues to grow, due to population growth and economic development leading an ever-more affluent
global population to demand and consume energy in more energy-intensive lifestyles. There are many
environmental groups and political initiatives to try and improve energy efficiency and reduce per capita
energy intensity. To date these initiatives have generally failed to reduce the relentless global per capita
increase in demand for energy. Global demand growth is currently being driven by developing nations,
particularly in Asia and the Middle East, whereas for much of the nineteenth and twentieth centuries that
growth in energy demand came from what we now refer to as the developed nations (i.e. those belonging
to the OECD Organisation of Economic Cooperation and Development). OECD nations now account for a
little less than 50% of global energy consumptions, but constitute a small fraction of global population.

Whereas the fossil fuels account for between 80% and 90% of global primary energy demand at the
current time, the recognition that this cannot be sustained indefinitely, together with concerns over
carbon emissions associated with combustion of fossil fuels is driving many of the largest energy-
consuming nations to seek renewable energy resources as alternatives to fossil fuels (e.g. hydro,
biomass, wind, solar, tidal, geothermal, and nuclear). Not all of these alternatives are indefinitely
renewable and sustainable, but they are substantially more so than fossil fuels. There challenge is that
they are in most instances more expensive to develop and deliver their energies in a less efficient and/or
less convenient way than the fossil fuels.

There is an additional point that needs to be made in the context of the continuously depleting nature of
fossil fuel resources. Even when we have found and developed an oil and gas field for production we are
unable to economically recover to the surface more than a fraction of the petroleum resources it holds.

16
The actual fraction recovered will depend on the nature of the reservoir and the technologies deployed. It
varies from about 5% at worst to about 70% at best for oil. For gas the recovery factors are usually
better and vary from about 60% to 90%. The industry has made great progress in the past decade with
technologies that can improve the ability of poor quality reservoirs to flow and release the fluids they
contain more easily to the surface. Such technologies are referred to under the title Enhanced Oil
Recovery or EOR and will be discussed in module 3. This means that recovery rates of in-place oil and
gas resources are showing signs of improvement as such technologies are more widely deployed. Indeed
many large reservoirs that were considered to be depleted using older technologies are now being re-
evaluated for further development and recovery.

To achieve 70% recovery for oil we have to work very hard and deploy the latest technologies to the best
reservoirs, i.e. those in which there is plenty of pore space (measured as porosity as a percentage of the
total rock volume) with good connectivity (measured as permeability). This means that the oil production
process tends to leave large amounts of residual oil in depleted reservoirs that cannot be easily recovered
by continued production efforts. For this reason when we talk of reserves we refer to those volumes that
can be economically recovered to the surface, not those volumes identified as present in the reservoir.

Directed Learning:

For your country, or another country of your choice, investigate the proved reserves of
oil and gas. You can search online, or may have access to other information sources.
The BP website (www.bp.com) has statistical review data that could help. Try to
establish the ratio of proved reserves to current annual production to come up with an
R/P ratio in years. Think about what this tells you about how long reserves are likely to
last.

1.5 Global Distribution of Oil and Gas

Oil and gas are found accumulated in commercial quantities in many sedimentary basins. As sedimentary
basins are found in every continental landmass on Earth and along many continental margins extending
into the deep ocean, it is not surprising that oil and gas occurrences are distributed widely around the
globe. As will be explained in Module 2 some sedimentary basins are more endowed than others with
large volumes of oil and gas resources (e.g. those of the Arabian Gulf).

Why sedimentary basins occur where they do is linked to the dynamic processes that have occurred over
the history of the Earth and continue today. The Earths crust, that outer solid layer which represents a
thin veneer to our planet, remains in constant motion.

The Earths crust is less than 10km thick at the mid-oceans where few sediments accumulate and is
made of hard dense and young rocks formed by volcanic activities, part of the driving mechanism of
crustal motion. Such rocks are not very promising for oil and gas formation due to their lack of
longstanding sedimentary accumulations. On the other hand the Earths crust on the continents and
continental margins can exceed 50km in thickness with vast thickness of sedimentary accumulations,
both young and old. These areas are much more promising in terms of their chances of forming and
preserving oil and gas accumulations.

17
 Figure 1.8

Diagrammatic Illustration of the Dynamic Nature of the Earths Crust and its Fragmentation
into Tectonic Plates that Determines how and where Sedimentary
Basins Form. Source: David Wood.

The Earths crust comprises 12 major tectonic plates. Each tectonic plate is a segment of the crust that
acts as a coherent mass moving in a single direction relative to the other plates. Some plates move more
quickly than others, but motions are measured at rates of less than 1 centimetre per year to several
centimetres per year (comparable to the rate at which human finger nails grow). Such rates over millions
of years lead to plates moving significant distances and resulting in large oceans opening and closing.
Some plates are moving away from each other (diverging) others are moving towards each other
(converging or colliding) and some are moving laterally (sliding past) each other.

Such constant motion of the tectonic plates making up the Earths crust explain its dynamic behaviour,
which sets up regions of high stress mainly at or near to the plate boundaries. These stresses can be
compressive, where plates collide and oceans can close and their sediments be folded and uplifted into
mountain ranges (e.g. the rocks now exposed by the Himalayan Mountains were, just a few tens of
millions of years ago, sediments on a sea bed). The stresses can also be tensional causing rift valleys to
open (e.g. the East African Rift Valley) some of which may ultimately form new oceans. The stresses can
be rotational and lateral causing uplift and subsidence in adjacent areas or large masses to slide past
each other forming great fracture zones (e.g. San Andreas Fault and many other faults in California).

These stresses and relative motions explain why the tectonic plates are permeated by fractures (faults or
breaks) and structures (folds in the sedimentary strata) distributed in the subsurface throughout the
Earths crust. The subsurface structures, particularly those in the sedimentary basins facilitate the
accumulation of petroleum. Without them oil and gas might be formed but could not so easily be moved
and trapped within economic reach of the Earths surface.

Understanding the big picture provided by the relative motions of the tectonic plates enables petroleum
geologists to explain how and when specific sedimentary basins were formed, when petroleum generation
occurred in their organic rich formations and whether that timing was optimal in terms of the presence of
traps able to contain and preserve those hydrocarbons.

There are more than one thousand sedimentary basins identified in the Earths crust. About one-third of
those are known to contain petroleum bearing systems, but not all of those have yet been found to
contain oil in commercial quantities. Some two hundred basins, distributed mainly around the plate
boundaries or in rift basins within them, have to date produced oil and or gas. However, of those only
about 50 basins have to date provided more than 5 billion barrels of ultimately recoverable oil and gas
reserves. These facts tell us that locating sedimentary basins is no guarantee that they will also contain
large commercial resources of petroleum.

18
In-place resource volumes globally for conventional oil are in excess of 10 trillion barrels. Of that about
1.33 trillion barrels are known with confidence to be proved as recoverable reserves remaining to be
produced (see Figure 1.9). Globally we have already to date produced similar volumes to those remaining
as proved reserves. Lower confidence resources that remain to be found, delineated and developed for
production are likely to be between 2.5 and 3.0 trillion barrels.

Some 10 countries hold about 80% of the proved oil resource and those same 10 countries are
responsible for some 51% of daily oil production. This highlights that although oil and gas are distributed
around the continents and their margins around the world the majority of it is concentrated within a few
sedimentary basins located in a few fortunate countries.

Figure 1.9

Distribution of the Worlds Proved Oil Reserves by Country. Data Source from BP Statistical
Review (June 2014), the countries shaded in this table are OPEC members. Ranking and
Interpretation by David Wood.

It should now be clear that not all sedimentary basins are prospective for finding oil and gas, especially in
large quantities. Oil and gas accumulations occur where and when source rocks, reservoir rocks, traps,
seals, structures and fluid movements occur in such a way, and with synchronized timing, that is
favourable to the generation and preservation of petroleum in accessible and findable locations. Module 2
will spend more time describing these key geological elements of petroleum systems.

Occurrence is limited to specific areas of the Earths crust petroleum-generating sedimentary basins.
Exploration to date has confirmed that petroleum systems are much more likely to occur in certain types
of sedimentary basins associated with specific plate tectonic configurations.

19
The countries of the Middle East, particularly those surrounding the Arabian Gulf (i.e. Saudi Arabia, Iran,
Iraq, Kuwait, Qatar and the United Arab Emirates) contain some 50% of proven oil reserves and some
40% of proven gas reserves. These countries constitute a key component of the Organization of the
Petroleum Exporting Countries (OPEC).

OPEC is an intergovernmental organization, created at the Baghdad Conference on 1014 September

1960, by Iran, Iraq, Kuwait, Saudi Arabia and Venezuela. The five Founding Members were later joined
by nine other Members: Qatar (1961); Indonesia (1962) suspended its membership from January
2009; Socialist Peoples Libyan Arab Jamahiriya (1962); United Arab Emirates (1967); Algeria (1969);
Nigeria (1971); Ecuador (1973) suspended its membership from December 1992 to October 2007;
Angola (2007); and Gabon (197594). OPEC has had its headquarters in Vienna, Austria since 1965.

OPEC states (www.opec.org) that its objective is to co-ordinate and unify petroleum policies among
member countries, in order to secure fair and stable prices for petroleum producers; an efficient,
economic and regular supply of petroleum to consuming nations; and a fair return on capital to those
investing in the industry. Many oil consuming nations view OPEC as a cartel focused on controlling global
oil supplies in order to boost prices. OPEC production is followed closely (see Figure 1.10).

Figure 1.10

OPEC Crude Oil Production in late 2014 by Member Country. Note Daily Production was Just
About 30 Million Barrels/Day in Dec 2014 whereas Capacity was Cited as about 34 Million
Barrels/Day Indicating Compliance with Targets Set to Reduce Supply and to
Bolster Prices. Source: IEA Oil Market Report, Jan 2015.

Some regions of the world remain relatively unexplored, mainly for reasons of their remote and
challenging locations, environments and political obstacles (e.g. Arctic Ocean continental margins and
regions of Antarctica). The deeper regions of the continental margins, e.g. in water depths in excess of
3,000 metres remain difficult to access from a production perspective even though the information
available suggests large petroleum resources exist there.

In other regions certain geologic conditions obscure the deeper regions of many basins from the remote
sensing technologies available to the industry and prevent prospective features from being delineated. Oil
and gas may be there but currently we are unable to locate it with precision. As technologies develop
some of these regions may well prove to be more prospective. The industry has a history of innovation
and has continued to develop exploration techniques and technologies that have revealed oil and gas in
areas where it had previously been obscured. The most recent example of this is in the so-called pre-salt
regions of the Santos basin offshore Brazil in the deepwater Atlantic Ocean, in which billions of barrels of
oil has been discovered due to breakthroughs in seismic technologies (more detail of this will be provided
in Module 2.

Oil and gas production at the field site is usually assiduously measured / metered and those

20
measurements and meters are also regularly audited by third party hydrocarbon accountants to ensure
that all production is accounted for. This is often motivated by the fiscal concerns of a government in
order to minimise tax avoidance and/or theft of such valuable products. Most oil and gas operations have
rigorous hydrocarbon accounting procedures in place to ensure that confidence does exist in the volumes
being produced and how they are being allocated to specific fields and reservoirs. Because most
governments enforce this for fiscal purposes there is reasonable confidence globally about the volumes of
oil being produced on a daily basis. In the case of natural gas, particularly where gas is being used as
fuel, re-injected or flared exact production figures can sometimes be inaccurately reported, either
through lack of precision or in order to avoid full disclosure of emissions.

Accurate and reliable reporting of reserves, particularly at the national level, poses a more significant
problem than reporting of production volumes. Whereas most oil and gas companies have their reserves
reports regularly audited or verified by independent specialists, most OPEC countries do not have
independent assessments of their reserves. This leads many analysts to question the accuracy of the
reserves values those countries report. Reserves are discussed in more detail in a later module.

Directed Learning:

Study Figure 1.10 to establish which OPEC country holds the most spare capacity?
Think about why spare capacity is important and how it could be used to exert control
on the worlds supply of oil and influence behaviour of other OPEC countries.

1.6 Industry Overview and Segments

The oil and gas industry has to deal with the distribution of resources that nature has dealt it. This means
that it has to operate in some geographically, environmentally and politically challenging locations. The
geological identification of petroleum resources is not clear cut and there is substantial risk that areas
that on preliminary evaluation appear prospective are found on drilling to be non-commercial or lack oil
and gas completely.

This means that the industry has to deploy on a risked basis large amounts of technical effort and
financial resource that often results in failure. It is amongst the riskiest of industries. Yet when success is
achieved it can be amongst the most financially lucrative industries for those prepared to take the risk
and for those nations fortunate enough to hold the sovereign rights to the resources found.

The industry, however, consists of much more than just finding and producing oil and gas, which is
challenging enough in itself. There are many other components to the industry which bring these
resources to their ultimate consumers. Remember, crude oil requires much treatment before it becomes
useful to consumers. When confronted with a barrel of crude oil you or I would be able to do little with it
in its natural state. Hence sections of the industry are focused on handling and treating oil and gas so
that it becomes more useable, valuable and marketable.

Many large oil and gas companies operate across the full spectrum of sectors that characterize the
industry. They are referred to as integrated oil and gas companies because they have the skills,
resources and infrastructure that enables them to provide all the activities necessary to find, produce,
process, handle, refine, store, market, trade and deliver petroleum products. The following paragraphs
describe the key sectors of the industry.

Exploration and production (also often abbreviated to E&P and referred to as the upstream sector of the
industry) is the sector focused on finding, producing and processing crude oil and gas to the point of
export from a single production facility or gathering plant aggregating production from several fields. The
E&P sector generally delivers its production to a terminal or export facility.

Oil and gas terminals, pipelines, tank farms (multiple tanks on a single site) and marine transportation
sectors are sometimes referred to as the midstream sector of the industry. They are concerned with
handling, storing and, most importantly moving oil and gas from production regions into the petroleum
markets. The local markets may be close to the production areas, but more frequently the markets lie in
other countries, continents or across oceans. This means long distance transportation is often required.

Refining and product storage is the first segment of the downstream sector of the oil industry. Refineries
are complex plants deploying a wide range of physical and chemical separation and conversion

21
techniques to produce a wide range of petroleum products ranging from gasoline, jet fuel, kerosene,
diesel fuel, fuel oils, lubricants and waxes. Each of these hydrocarbon products has a distinct
composition, use and market.

Oil products segments, wholesale and including retailing of transport fuels at gasoline stations is the
downstream segment of the oil industry closest to the ultimate consumer. Storage, terminals and
distribution logistics are key components of this sector.

Gas and power segments of the industry are commonly operated in close cooperation as much natural
gas is ultimately destined to be consumed in gas-fired power plants. Gas is usually delivered to power
plants by pipeline. However, gas may have to be moved long-distances, sometimes thousands of
kilometres from its production sites to the power plants and other markets in which it is consumed. It
may be temporarily stored in underground reservoirs closer to markets to meet seasonal demand
(underground gas storage, or UGS, is a component of the gas and power sector that is growing in
significance). Gas may also be moved and stored in very cold liquid form as liquefied natural gas (LNG)
which now accounts for almost one-third of all gas that is exported from its country of production.

Natural gas volumes are sometimes expressed in terms of barrels of oil equivalent (boe) in order to
enable oil and gas production and/or reserves to be quoted together using the same units. The
conversion most commonly used is 6000 cubic feet (or 170 cubic metres) per barrel, which is an
approximation. All gases have slightly different compositions which means on an energy equivalent basis
natural gases range at the well head from about 5600 cubic feet per barrel to 6000 cubic feet per barrel.
Note that a barrel of oil and a boe of gas have different value. This is because crude oil is more valuable
than natural gas in most markets, due to the fact that crude oil can be refined to produce a wider range
of more easily handled and transported products which are in higher demand than natural gas.

Directed Learning:

Is gas used to generate power in your country? Do you know the energy mix used for
power generation in your country (i.e. coal%, gas%, hydro%, oil%, nuclear%,
renewables%)? Try to find this out and publish your brief findings on the module forum
on the Learning Management System so we can share our findings and read what other
people have discovered.

Natural gas that is delivered to markets is usually predominantly methane (CH4) also referred to as C1
as it contains just one carbon atom in its molecule.

However, gas produced from the reservoir varies in composition and often contains significant quantities
of heavier hydrocarbon gases ethane (C2), propane (C3), butane (C4), the condensates (pentane and
heavier hydrocarbons commonly abbreviated to C5 plus or C5+) and other trace components (see Figure
1.11).

22
 Figure 1.11

Components that Constitute Natural Gas. Source: David Wood.

Condensate is a form of petroleum that is gaseous in the reservoir but condenses into liquid at the
surface temperatures and pressures. It has compositions similar to very light crude oils and is often light
brown in colour and transparent. Condensates and other liquids derived from natural gas production can
provide significant revenue streams for producers. Some gases, called wet gases, contain high
concentrations of condensate (i.e. up to 100 barrels condenses from each million cubic foot of gas),
whereas others, called dry gases, contain very low concentrations of condensate (i.e. less than 1 barrel
condenses from each million cubic foot of gas).

Gas plants are frequently built to separate and fractionate ethane and the heavier hydrocarbon gases or
natural gas liquids (NGLs) for their respective markets. The easily liquefied propane and butane
(collectively referred to in mixed combinations of various proportions as liquefied petroleum gas or LPG)
have multiple uses.

Most ethane is used in the petrochemical industry, and it can be handled and stored in both gaseous and
liquid forms. Ethane has a boiling point of minus 88.5oC, so requires cryogenic temperatures to liquefy it,
which typically is achieved using a turboexpander. NGL or gas processing plant are important facilities of
the gas industry somewhat analogous, but simpler, than the refineries of the oil industry.

Gas to liquids (GTL) plants are relatively rare facilities that use a range of evolving technologies to
transform natural gas into liquids similar to those produced from oil in refineries, e.g. diesel fuel, jet fuel
and lubricants. These plants are chemically complex but enable gas products to be traded into the
traditional and larger oil products markets.

Chemicals and petrochemicals is another downstream sector of the industry that transcends the oil and
gas industries. It takes some feedstocks from refineries, in particular LPG and Naphtha (the lighter
hydrocarbon fractions) and some feedstocks from the NGL plants, particularly ethane and some LPG. Its

23
products are the non-energy products such as plastics, solvents, inks and a wide range of other
materials.

Commodity trading is an important sector of the oil and gas industries, involving crude oil and natural gas
commodities as they are produced and the wide range of petroleum products from refineries and NGL
plants. This trading activity is associated with buyer and seller reaching short-term and long-term
agreements to exchange the physical commodities and also derivative trading frequently focused on
hedging objectives to lock in attractive prices looking forward in volatile and unpredictable markets.

Many oil and gas companies also exploit other energy
particularly the power sector. This includes a range of
more sustainable products in the future as fossil fuel
associated with emissions make fossil fuels more costly
alternatives.
resources and participate in related industries,
renewable energies with a view to establishing
resources deplete and environmental penalties
and potentially less competitive with renewable

Safety, environment, planning, community development and government relations and public health are
issues that cannot be ignored by oil and gas companies. Many are employed in these areas by the
industry and the performances of individual companies are frequently judged by their performance in
these areas.

Important stakeholders in most segments of the oil and gas industry are communities close to the
locations of facilities and plants serving the industry which provide those communities with employment
and the opportunity to develop. More specifically labour unions and non-governmental organizations
(NGOs) representing wider community interests also often play an important role in securing
employment, training and knowledge transfer from the international oil companies to the local
communities impacted by their operations.

Suppliers of equipment and services and the construction contractors, many with specialist technologies,
equipment and skills developed specifically for the industry make significant contributions to the success
of the industry. Indeed these organizations provide much of the skilled labour on which the oil and gas
operating companies depend.

The downstream sectors refineries, petrochemical plants and product distribution sectors are the
most labour-intensive sectors of the industry. For large oil and gas companies about three-quarters of
their work force is deployed in these sectors. However, these sectors for the most part are not the most
profitable. It is the upstream sector, except in times of extremely low oil and gas prices, that is the most
profitable sector. This is because the margins are slim in the downstream sectors. Unless government
monopolies apply there is frequently significant competition in those sectors at a local level. Government
subsidies or taxes also impact margins on transportation fuels. Moreover, supply and demand swings for
products make it difficult for companies to lock-in healthy margins for sustained periods.

Because the segments of the industry described above require massive investment in infrastructure and
operating activities, financing and financial services (raising and servicing equity and debt investments),
insurance etc. are also key activities for successful oil and gas companies. Oil and gas sectors and
products are taxed in a variety of ways, sometimes quite punitively. Tax planning for oil and gas
companies and fiscal design for governments are critical in securing positive investment decisions and
acceptable sharing of the economic rent generated by the different segments of the oil and gas industry.

The oil and gas industry conducts many of its operations as joint ventures (JVs) between companies of
various sizes, some publicly traded others state-owned. This approach has evolved to spread risk, to
share resources and to share knowledge and technologies. However, this JV relationship sometimes
results in disputes and both litigation in commercial courts and arbitration hearings to resolve contractual
and commercial disagreements. Sometimes disputes arise between government agencies and oil
companies, associated with increased government involvement verging on nationalization and
appropriation of assets. The role for legal and audit professionals is clear in such issues, but even with
their expertise resolutions of disputes can be difficult to find and impose. This is partly because of the
interplay of commercial and political factors are frequently responsible.

Arbitration cases with billions of dollars at stake are not uncommon and often hinge on the interpretation
of ambiguous wording in contracts written decades ago. Drafting and negotiating contracts with detailed
commercial and fiscal economic evaluations are the forerunning activities to investment contracts being
approved and signed in all segments of the industry. For the very large projects, particularly for those
involving midstream infrastructure, the contractual, commercial and fiscal negotiations can take years to
conclude. The role of lawyers, economists, tax experts and bankers in the success of such projects should
not be underestimated. It is the engineers that take the credit for designing and building the

24
infrastructure, but that infrastructure would not be put in place without a commercially and fiscally robust
contract first being agreed.

1.7 Uses and Markets for Oil and Gas

Oil and gas have a range of uses and products that trade in distinct markets. Both are used as energy
fuels in both power generation and transportation sectors. Oil products are used less for power
generation fuels today than in past, but distillates and fuel oils are still quite widely used particularly in
developing countries and markets unconnected to the supply chains of other fuels (e.g. remote islands).
When natural gas supplies are limited and/or prices are high some dual fuel power plant will for short
periods of time switch to fuel oil or distillate to reduce costs.

As transportation fuels, oil products trade and dominate the markets as road fuels (gasoline and diesel),
aviation fuels (Jet kerosene and aviation gasoline) and as marine bunkers (distillates and fuel oils). There
are few substitutes for these oil-derived fuel products that are as cheap to produce or are as efficient in
delivering their energy to transport engines. More than 50% of all oil produced is destined to be
consumed as a transportation fuel in one form or another.

Natural gas is used extensively for power generation, space heating and in energy-intensive industries
such as metal smelting, cement plants, glass manufacturers. It is used currently only in niche markets as
a transportation fuel in various forms: (1) under pressure in compressed form as compressed natural gas
CNG; (2) at very low temperatures in liquefied form as liquefied natural gas LNG; (3) as LPG
(propane and butane extracted from natural gas in NGL plants).

Natural gas vehicles (NGVs) require specially converted and tuned engines, which makes them more
suitable for commercial vehicles than private cars and adds a cost to the vehicle. On the other hand
many governments in attempts to promote gas as a cheaper and cleaner road transportation fuel offer
substantial tax incentives to consumers. Natural gas in its various forms is likely to take a larger share of
transportation fuels in the future. There are now several projects under consideration to use LNG to
power train locomotives, marine vessels in addition to expanded use of natural gas in compressed form
(CNG) and as LNG to power fleets of heavy goods / freight road vehicles.

In addition to their use as energy fuels oil and gas products are both used to manufacture many non-
energy products. The heavier oil products such as waxes and bitumens are used in foods, to surface
roads and provide waterproof seals. Some are used in polishes, lubricants and solvents.

The petrochemical industry, using both oil- and gas-derived feedstocks produces a wide range of
products trading into many manufacturing industries. Some of these are traded in bulk as commodities
purchased by manufacturers to make a wide range of consumer durable goods (e.g. olefins, polyolefins
and aromatics). Petrochemical plants also produce specialty products such as films, synthetic fibres,
elastomers, butyl rubber, adhesives polymers and solvents. These supply a wide range of industries from
plastic bottles and wrappings to detergents. Indeed many of the furnishings and fittings in the modern
home are derived at least in part from such petroleum-derived products.

Directed Learning:

Does your country manufacture or import its petrochemicals? Establish some

information about the level of consumption and imports of petrochemicals in your
country, and the feedstocks used for petrochemical manufacturing plants, if they exist
in your country.

The importance of the non-fuel products in supporting modern lifestyles should not be underestimated.
Finding substitute feedstocks for these products is currently more difficult than finding alternative (to
fossil fuel) transportation or power generation fuels.

Geographically there are three main markets that dominate oil, oil products and gas consumption
worldwide. These are North America, Europe and Asia (both OECD Asia Japan, South Korea and Taiwan
and China and India). Consumption in those three markets dwarfs that in other developing markets.

These three markets are all in the northern hemisphere, some with quite high latitude locations. The
significance of that point is that the market demand for most products is skewed towards the northern

25
hemisphere seasons. Hence, in the northern hemisphere winter there is greater demand for natural gas
for power generation and space heating than in the northern hemisphere summer. Natural gas markets
can be highly seasonal.

On the other hand transportation fuel consumption tends to peak in the northern hemisphere summer
(e.g. North Americas driving season represents a peak for global gasoline consumption). Seasonal and
regional fluctuations in demand influence prices in most oil and gas markets.

1.8 Role of Government and its Agencies in the Oil and Gas Industry

Oil is the largest commodity market in the world and a major source of revenue for many governments
from upstream, midstream and downstream sectors. It is not therefore surprising that oil is also the most
politicized of commodities and that most governments demonstrate an enthusiasm for controlling all
sectors of the industry within their sphere of influence.

Natural gas is not far behind oil in being highly politicized at a regional level.

The consequences of the high political profiles of oil and gas is that commonly in each country there are
many government agencies involved in regulating, owning, taxing and policing the industries. Most
countries have a government minister responsible for oil and gas. A key role for these senior government
officials is to set fiscal design and to conduct, among other things, strategy decisions concerned with
issues such as security of supplies and diversity of supplies for the main consuming countries. For the
main producing countries the issues are also often centred on fiscal design and frequently focused on
diversifying markets and customers and securing inward capital investment to help develop their
resources.

Sitting beneath the oil and gas or energy ministry level are several agencies addressing planning
approvals, regulation, health, safety and environmental compliance, emergency response, customs
(import and export controls) and establishing strategic stocks to supply their markets in times of crisis or
sudden supply shortfalls. The roles of some of these government agencies have been highlighted by the
aftermath to the blow-out of the Macondo-252 well located in a water depth of nearly 5,000 feet in the
United States Gulf of Mexico on 20 April 2010, which resulted in the tragic loss of life of crew aboard the
Deepwater Horizon drilling rig that ultimately sank on 22 April 2010. It took BP, the operator of that well
until 4 August 2010 to successfully shut-in that well, which in the interim had spilt millions of barrels of
oil into the Gulf of Mexico causing much environmental damage and industry disruption in the region. The
technical issues associated with this incident will be covered in Module 3 of this course when drilling is
addressed. The US Minerals Management Service (MMS), Department of Homeland Security, Department
of Interior, US Coast Guard, US Navy, US Environmental Protection Agency, etc. are United States
Government bodies and agencies that played a role in responding to this serious incident and regulating
the response actions of BP.

In countries where sectors of the industry are state-owned (nationalized) there are national oil companies
(NOCs) that own and operate all or part of the resources and infrastructure in their country. NOCs can be
very large organizations with huge asset portfolios and workforces (e.g. Saudi Aramco of Saudi Arabia;
PetroChina of China; and Gazprom Russias state-owned gas monopoly). Note that although Gazprom is
a gas company it plays a role very similar to an NOC and is frequently referred to as such.

PEMEX of Mexico was the first NOC to be formed in 1938. The nationalization of petroleum industries
accelerated in the post-colonial area of the 1960s. NOCs such as Pertamina of Indonesia and Sonatrach
of Algeria were amongst the earliest formed after their respective countries gained national
independence.

Most of the large oil and gas producing countries now have their own well-established NOCs. Many of
these were formed around the time of the first oil crisis of the 1970s when OPEC established its position
of power in the upstream sector. However, countries that are large net consumers of oil and gas also
have powerful NOCs (e.g. China, India and South Korea).

Some NOCs have better technical and operating expertise and a better international asset portfolio than
others (e.g. Petronas of Malaysia, Petrobras of Brazil). NOCs in some countries have traditionally acted
primarily as resource holders on the governments behalf and as non-operating partners to the
International Oil Companies (IOCs, e.g. BP, ExxonMobil, Shell) that provide the capital investment, key
skills and technical resources that enable oil and gas activities to be conducted. Increasingly though most
NOCs are keen to gain operating expertise and strive to secure technology transfer from their IOC
partners and increase the skill levels of their national staffs.

26
The abbreviations NOC and IOC are widely used in the industry and sometimes imply that the industry is
highly polarized into these two types of organizations. This can be misleading as there are many different
types of NOC with quite different ideological objectives. It is however true that some (e.g. NIOC of Iran
and PdV of Venezuela) are driven by quite extreme political ideologies and have little autonomy to make
commercially-based decisions.

In recent decades some NOCs have been fully or partially privatized in order to raise capital for their
governments and provide them with a limited level of autonomy. Such a situation enables the resulting
quasi-NOC to raise equity and debt finance more easily and to operate on a more commercial basis in the
international arena. Some partially privatized NOCs, such as Statoil of Norway, ENI of Italy and Petrobras
of Brazil, have the advantage of acting like publicly-traded companies on one level, but with national
interest dominating their strategies and the diplomatic backing of their government to help them they are
able to secure wide-ranging oil and gas deals in bilateral government negotiations.

Directed Learning:

Does your country have a national oil company? Does it have monopoly control of
certain sectors of the industry within your country? Try to find out some information
about your NOC (e.g. number of employees, sectors of the business in which it
operates, overseas interests if any) and publish your brief findings on the module
forum on the Learning Management System so we can share our findings and read
what other people have discovered.

1.9 Introduction to the Supply and Value Chains: Upstream to Downstream

It is useful to consider the different segments of the oil and gas industries identified and described in
section 1.5 of this module arranged in sequences from upstream to downstream along supply and value
chains (see Figure 1.12).

Such supply chains are frequently long, sometimes spanning continents and crossing oceans. This is
because the location of most reserves and production (upstream sectors) is a long way from the main
consuming markets. This fact highlights why the midstream sector of the industry is so important.
Transportation and storage is essential to make the supply chains work.

The upstream end of the supply chains are commodity industries. They interface with pipeline and
shipping or transportation industries as well as the commodity trading sector. On the other hand refining
and the NGL/gas processing sectors are manufacturing industries. These interface with product storage,
transportation trading and distribution (logistics) industries to supply wholesale and retail markets.

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 Figure 1.12

Segments of the Oil Supply Chain Progressing from Upstream to Downstream.

Source: David Wood.

Integrated oil and gas companies therefore need a wide range of business sector skills encompassing
commodity, transport, manufacturing, wholesale trading and retailing expertise (see Figure 1.13).

Figure 1.13

Segments of the Natural Gas Supply Chain Progressing from Upstream to Downstream.
Source: David Wood.

Retail and wholesale markets for transportation fuels (road, aviation and marine) are the sectors where
oil and gas companies have the opportunity to brand their products. Indeed this is why people in most
parts of the world are familiar with the logos of the major oil companies.

Although the branding is possible, differentiation of petroleum products on a quality basis is relatively
difficult among the major companies in specific national markets. This is because the quality of the
products is tightly specified and highly regulated. Oil companies do in some cases include minor
proprietary additives to fuels to improve performance or reduce engine wear and use these to help in the
differentiation process.

In some countries competition between oil companies and other retail sectors (e.g. hyper-markets) is
intense in the retail fuel sector (e.g. US, UK and France). Oil companies now often make more profits on
non-fuel sales in retail fuel service stations.

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Margins that are extracted from these supply and value chains vary from region to region and over time.
Generally margins are higher upstream than downstream. Infrastructure margins are often limited to a
specific rate of return on investment. Refiners margins and retail fuel margins are generally small, but in
some countries these can be high where a monopoly control exists. In some countries government
subsidies obscure the true commercial margins. Considerable value is extracted in the downstream
natural gas supply chains by those companies, often utilities with monopoly control, that own the pipeline
distribution networks connected to millions of customers in city and urban areas.

Directed Learning:

Research the retail road fuel industry in your country. How many companies retail and
brand their fuel? Are there national and international companies? Do the retail fuel
stations have convenience stores and offer other services? Do different companies
appear to be following different strategies with respect to price? Do state-owned
companies benefit from monopoly control of some fuel markets? Or does the
government control or influence the prices charged for road fuels by consumers?
Publish your brief findings on the module forum on the Learning Management System
so we can share our findings and read what other people have discovered.

Some oil and gas companies follow integrated strategies along their supply chains, others, while
operating in all sectors of the supply chains, elect for commercial reasons to follow de-integrated
strategies.

Integrated strategies mean that the different divisions of a company work together to optimize delivery
of product and overall profit extracted from the entire supply chain and strive to own or control key
infrastructure along the full length of the supply chains. Inter-actions with other organizations to facilitate
product movements tend to be limited (except in joint venture relationships). Such companies strive to
produce their own oil and gas supply, handle and deliver that supply to their own refineries (through their
own pipeline or shipping infrastructure) and distribute highly differentiated product brands to loyal
customers. Some national oil companies are structured in this way to supply consumers in their home
countries and often enjoy monopoly control of certain sectors of the supply chains. Historically the major
international oil and gas companies all used to follow such strategies and aspirations (Figure 1.14).

Figure 1.14

Fully Integrated and Self-Sufficient Oil Company Structure that Many IOCs Adopted Many
Decades Ago. Many NOCs Operate Within their Own Countries along Similar
Lines Today. Source: David Wood.

In the past two decades many of the major international oil and gas companies, although remaining
integrated and operating along the full length of the supply chains have elected, for commercial reasons
to follow de-integrated or semi-autonomous strategies.

In the extreme manifestation of this approach each division of the company operates as an autonomous
unit making day-to-day operational decisions that reflect commercial realities of the markets. This means

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that the upstream division optimizes oil production (and reserves holdings) but may sell that production
at a higher margin to the refineries of competitors rather than its own refining division.

On a similar basis it may charter ships for crude oil and product movements rather than use its own
shipping fleet where it makes commercial sense to do so. Also it may secure retail fuel supplies for its
gasoline stations from the refinery of a competitor located closer to certain stations than its own
refineries (see Figure 1.15).

Semi-autonomous and de-integrated strategies for their divisions have enabled many international oil
and gas companies (IOCs) to improve efficiency and extract more value from both oil and gas supply
chains in competitive markets. In regulated markets such strategies are often less effective. In reality
most large, integrated organizations employ portfolio management techniques to implement corporate
strategies that coordinate strategic decisions taken within the divisions. Hence, autonomous operating
strategies may be employed up to a certain investment level, but certain major investment decisions
tend to be coordinated across the entire organization and may involve all sectors of the supply chain.

Figure 1.15

De-integrated Oil Company Structure Adopted Today by many IOCs. Source: David Wood.

An example of how major IOCs organize themselves along supply and value chains that extend beyond
petroleum is provided by Shell in Figure 1.16.

Directed Learning:

Select an integrated IOC company (other than Shell) and go to its website to locate
and review its latest annual report, which should be available to download in pdf
format). Scan the document to see if you can establish information about how they are
structured in terms of their divisions and supply chains and publish your brief findings
on the module forum on the Learning Management System so we can share our
findings and read what other people have discovered.

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 Figure 1.16

Integrated IOCs Operate along Energy and Chemical Supply Chains that Overlap
and Feed into Each Other. Source: Shell Annual Report 2008. See more recent annual reports
available for download at Shell's website for how Shell continues to illustrate its activities
along oil, gas and petrochemical supply chains.

1.10 Organizations Involved Along the Supply Chain

There are a wide range of organizations that operate along the oil and gas supply chains. The NOCs,
government agencies and the IOCs have already been identified. In addition to these entities there are a
wide range of other organizations whose activities are essential for the supply chains to function
effectively. These include:

technical service companies (e.g. drillers, seismic, pipe-laying, etc.) for example:
Schlumberger, Halliburton, Baker Hughes, Transocean;

specialist equipment suppliers (pumps, compressors, turbines, heat exchangers, separators,

crackers, etc.) for example: Air Products, Rolls-Royce, Samsung;

engineering, procurement and construction (EPC) contractors for example: CB&I, Saipem,
JGC, KBR, Technip, Foster Wheeler;

operations and maintenance (O&M) contractors;

shipping companies and port authorities;

tank storage and underground storage (mainly gas) providers;

gas and power utility companies;

independent refiners and petrochemical companies;

sample analysts;

financial services, including commercial banks, multi-lateral banks, export credit agencies
(ECA), capital markets, insurers, auditors and accountants;

Equity providers such as venture capitalists, hedge funds and sovereign wealth funds;

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 lawyers and arbitrators;

physical and paper traders;

commodity markets, brokers and exchanges;

standards and quality assurance providers;

regulators (representing a government or independently established by legislation)

addressing permitting, planning, safety, environment and other issues;

industry associations and lobbyists;

public and community relations;

training providers and human resource specialists;

health, safety, security and environment specialists;

information providers and price discoverers;

market analysts and macro-economists; and

mergers, acquisition and divestment specialists and online auctioneers.

These organizations range from large to small and many employ or subcontract to individual specialist
consultants to provide specific skills and experience. This provides the supply chain with a multi-discipline
skill set and perspective. Superficially it sometimes appears that it is the very large IOCs that dominate
the oil and gas industry, and indeed such companies are often keen to promote that myth. However,
increasingly it is the NOCs and large technical service and EPC companies that dominate activities and
large infrastructure projects.

The industry has a good track record of joint-venture relationships and cooperation. In order to optimize
the recovery of the worlds remaining oil and gas resources will require a continued collaborative effort
between the national oil companies (NOCs), international oil companies (IOCs), engineering, procurement
and construction contractors (EPCs) and service companies.

Traders put buyers and sellers of oil and gas in contact with each other, broker deals and buy and sell
commodities in their own right. It is markets where there is substantial trading activity (volume, liquidity
and large numbers of participants) at transparent prices and with a diverse number of buyers and sellers
following different strategies that confidence in benchmark crude oil, oil product and natural gas prices
are established. These functions of traders, markets and trading exchanges commonly outweigh the
financial role of trading activity.

1.11 Key contributions made by specialist service providers, suppliers and

construction contractors

Most oil and gas facilities along the supply chains are directly built not by the IOCs or NOCs, but by the
EPC contractors being supplied by equipment, engineering and planning by specialist service providers. It
is true that the IOCs and NOCs are ultimately paying for these projects and financing them typically
through combinations of debt and equity funding. However, it is the EPC contractors and specialist
service providers that directly employ most staff and have the most experience of planning, engineering,
fabricating, installing and commissioning oil and gas facilities. IOCs and NOCs certainly hold substantially
technical financial and risk management expertise in the facilities construction sector. This enables them
to be able to evaluate, budget and manage major construction projects. But without the services, skills
and workforce provided by the EPC contractors, their sub-contractors and specialist suppliers and service
providers, very little development would occur in the sector.

NOC and IOCs do employ large work forces to operate their field facilities and plants. However, in the
operations sector too there is a common trend of NOCs and IOCs contracting out the responsibility to
operate and maintain (O&M) existing field sites to experienced service contractors.

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It is important in any operation and supply chain to understand which companies are conducting the
work, which company(s) is(are) responsible for management and decision making, and which
company(s) is(are) sanctioning budgets and ultimately paying for capital costs and operating expenses.

1.12 Distinct Economic Issues for Oil and Gas Supply Chains

The oil and gas industries have different economic structures, despite occurring together in the same
reservoirs in many instances and being extracted as part of the same production processes.

Oil economics are underpinned by its :

physical properties (i.e. liquid) that are amenable to low-cost bulk handling, storage and
transportation;

global market, fungible (i.e. easily traded around the world) with internationally quoted prices
and reliable benchmark prices used around the world;

worldwide supply chains with low-cost handling infrastructure;

ability to be transformed into a wide range of petrochemical products as well as fuels;

flexible access to markets;

dwindling proved reserves of conventional resources outside OPEC countries.

Natural gas economics, on the other hand, must take into account its :

physical properties (i.e. gas) that make it more costly and risky to handle, store and
transport to market;

local and regional markets subject to political and geopolitical manipulation;

long-term contracts needed to justify large capital investments required for infrastructure
development;

more restricted markets (power and heat sectors dominate) than for oil, but with plenty of
market growth opportunities;

less flexible distribution networks;

clean burning and lower emissions than oil and coal enabling it to contribute to emissions
reduction strategies;

longer-life proved reserves than oil, but also with large quantities of stranded reserves,
discovered for many years but too remote from markets to justify the investments required
to develop them.

These factors mean that long-distance gas supply chains are more expensive and take more time to
establish than oil supply chains. It also explains why exploration companies still prefer to find oil
than gas.

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2. SUMMARY & CONCLUSIONS

Having completed this module you should now have a clear understanding of how oil and gas are formed
and the factors that determine where it is located in the subsurface and distributed around the globe. You
should also understand the challenges involved in the recovery of oil and gas to the surface from its
underground reservoirs and what is meant by petroleum being a finite resource and the sustainability
challenges it raises for the industry. The increasing importance of unconventional oil and gas resources
and what those resources are should also now be clear to you.

You should be able to distinguish between the segments of the upstream, midstream and downstream
industry and how they work together as integrated supply chains. You should have gained knowledge
about the government agencies and other entities working in the oil and gas industry and their roles.

This module has synthesized for you the main uses and markets of oil and gas. It should be clear that
while oil and gas are used primarily as energy fuels there are many non-fuel products and uses for oil
derived from the refining and petrochemical industries.

Whereas it is common practice to talk about the oil and gas industries collectively you should now
comprehend that oil and gas have different economic drivers, supply chains and markets and that oil
supply chains are somewhat easier and cheaper to establish and operate.

2.1 The Next Module

Future modules (2 to 6) address the techniques used to detect and assess the commercial viability of
deposits. They look at the extraction process, and the technologies used to process, store, transport and
refine oil and gas. The later modules explore the processes of selling, trading and marketing gas and
petroleum products, and survey environmental and geopolitical risks and opportunities, providing an
assessment of the industrys future.

The next module (Module 2) contains an exciting mix of technical and commercial topics. It provides
insight to the main exploration techniques including the key issues addressed by petroleum geologists
and reservoir engineers. The important exploration technologies are accompanied by an account of the
frameworks available to companies to rights to explore and the associated fiscal terms. That module
concludes with the issues of risk and opportunity analysis and petroleum economic evaluation for the
upstream industry.

What Now?

We hope you have enjoyed this module and can see the quality of materials provided and how much you
could gain from the rest course.

To guarantee your place on the course please apply online:

www.ibc-academy.com/fog

Or if you have further questions about the course or need more information, please do not hesitate to
contact us on:

Tel: +44 (0)20 7017 7636

Email: ibc-academy.admin@informa.com

N.B. This trial is of the module contents only and you will not receive access to the interactive online
classroom, the tutorial discussions, appendices or end of module test.

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3. FURTHER RESEARCH AND USEFUL WEBSITES

Further Research and Useful Websites:

There are many websites and journals that provide much useful statistical, technical and commercial
information at a high level and in detail about the industry. Those considered to be most useful, most
frequently updated and providing contrasting perspectives are:

https://www.iea.org/oilmarketreport/omrpublic/ (IEA International Energy Agency, based in

Paris and representing the energy sector of OECD Organization of Economic Cooperation and
Development. The IEAs monthly Oil Market Report is widely referred to and provides useful perspectives
particularly for the midstream and downstream sectors).

www.eia.doe.gov (EIA US Government Energy Information Agency provides useful information

about all aspects of energy in North America and useful country reports about the energy sectors of
countries around the world, which are updated from time to time. They also offer an impressively
responsive e-mail help service).

http://www.eia.gov/cfapps/ipdbproject/IEDIndex3.cfm (EIAs international statistical database)

www.opec.org (OPEC Organization of Petroleum Exporting Countries their Monthly Market Report
provides an alternative view of current energy issues to the IEA with more upstream information and
strategy information for the main oil-producing countries).

www.bp.com (BPs annual Statistical Review of World Energy is updated each June and compiles
statistics of proved reserves, production, consumption and trade movements of oil, gas and other
primary energies. The raw data is available in a range of media formats including Excel spreadsheets
which enables analysts to interrogate it more easily and generate their own graphics and tables of subset
relevant to their specific requirements. BP also now publishes in January each year its Energy Outlook
2030, which includes some useful analysis of historical statistics and forecasts).

http://www.exxonmobil.com/Corporate/energy_outlook_view.aspx (ExxonMobil provide

forecasts for energy trends to 2040 released annually in December in their View to 2040).

http://www.eni.com/en_IT/company/culture-energy/world-oil-gas-review/world-oil-gas-
review-2013.shtml (ENI provide their annual statistical review of oil and gas trends in their World Oil
& Gas Review, usually updated in October each year. It provides useful complementary data to the BP
Statistical review, particularly on refining and crude oil compositions).

http://www.indexmundi.com/g/r.aspx?v=97 Index Mundi provides some useful country

comparison statistics for oil, gas and energy.

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