Thursday, 08/11/2022 Published by: Jason Lindquist
The energy industry — everything from oil and gas production and transportation to oil refining, gas processing and NGL fractionation — has a myriad of variables influenced by dozens of factors. It’s a value chain so vast you’d think it would be impossible to explain in simple terms. But behind it all is a well-oiled machine for developing the resources that literally fuel our modern economy. And, by understanding what happens at each link in the value chain, you can ultimately gain a clearer picture of what’s happening in energy markets. In today’s RBN blog, we kick off a series aimed at examining and explaining the oil and gas value chain, starting with the upstream world of exploration and production — what happens in production areas, the types of companies that operate in that segment, and the critical role of oil and gas reserves.
RBN’s blogs are at their best when they convey an understanding of energy markets that is detailed and easy to follow — but not dumbed down. Explanatory blogs have been a staple since our early days, dating back to 2012’s Complex Refining 101. These blogs have been particularly important when we’ve written about a new technology or a project, or when we’ve expounded on new topics or developing trends in the market, such as clean hydrogen, as we did with Help! in 2020; carbon capture and sequestration, as we did with The Air That I Breathe in 2021; and the emerging conflicts between the energy transition and today’s energy realities, as we did in Monkey Wrench this spring. Today, we begin a new series of blogs set to explore the entire value chain. This first series will focus on the upstream sector, and future blogs will discuss the midstream and downstream segments.
In the upstream segment (black lines in Figure 1 below) of the energy industry, E&Ps focus on finding and extracting hydrocarbons. This includes well-site exploration and development, drilling and completion, as well as gathering and field separation of the recovered crude oil and natural gas. Many of the largest upstream players are independent companies that focus specifically on that segment — names like Occidental Petroleum and Pioneer Natural Resources. (We should also note that the upstream, midstream and downstream segments can have some overlap, so the line colors in Figure 1 are basic descriptions.)
Figure 1. The Oil and Gas Supply Chain. Source: RBN
But there are also major integrated oil and gas firms — meaning that their operations span the value chain from upstream to retail, such as ExxonMobil, Chevron and Shell. Sometimes referred to as Big Oil or supermajors, these are some of the world’s largest companies, with a market capitalization in the hundreds of billions of dollars. (ExxonMobil had a market cap of nearly $380 billion this week, with Chevron at more than $300 billion and Shell at more than $190 billion.)
The midstream segment (blue lines in Figure 1) links the upstream and downstream ends of the value chain and is focused on wellhead gathering, transportation pipelines and storage, and processing and fractionation of NGLs. Companies in this category include Enbridge, Enterprise Products Partners and Kinder Morgan.
The downstream segment (green lines in Figure 1) delivers those commodities or turns them into finished products — such as gasoline, diesel, jet fuel or petrochemicals like ethylene and propylene — for sale to retailers and end users. Examples of companies in this segment include Marathon Petroleum, Phillips 66 and Dow. (Also note that many household items and end products — such as clothing, appliances, toothbrushes, cleaners and flooring — are derived from petrochemicals.)
As the song picked to accompany this blog implies, this series is going to start right at the beginning of the value chain: the upstream segment. In the follow-ups to this blog, we’re going to look at everything in that segment, from well-site development and drilling to gathering lines and field separation. But before we get into all that, let’s take a look at the different aspects of the upstream segment, where they fit in the oil and gas supply chain, and what they do.
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When discussing the upstream segment, it all begins with the hydrocarbons (crude oil, natural gas and NGLs) that can be found below the earth’s surface. They are created by the compression of the remains of plants and animals –– and not just dinosaurs! –– in sedimentary rocks such as sandstone, limestone and shale. The rock itself is a product of deposits in ancient oceans and other bodies of water. As layers of sediment were deposited on the ocean floor, plant and animal remains were integrated into the forming rock. The organic material was transformed into hydrocarbons after being exposed to specific temperatures and pressure ranges deep below the surface over millions of years.
Oil and gas are less dense than water, so over time they move through the pores in sedimentary rock toward the surface. When the hydrocarbons are trapped beneath less-porous cap rock, as shown in Figure 2 below, an oil and gas reservoir is formed. Hydrocarbons are brought to the surface by drilling through the cap rock and into the reservoir (see dashed-red oval) to create a pressure relief for the hydrocarbon molecules trapped in the sedimentary rock. Once the reservoir is reached with a drill bit, oil or gas production facilities are constructed and the hydrocarbons can either free-flow or be pumped to the surface. (If drilling does not result in commercially viable quantities, the well is called a “dry hole” and is usually plugged with cement and abandoned.)
Figure 2. Types of Petroleum Traps. Source: Encyclopedia Britannica
The estimated amounts of crude oil and natural gas trapped underground are referred to as reserves and measure the extent to which a company thinks it can economically produce the recoverable oil and gas in an area given current technology and projected expenses and market pricing. (Not all hydrocarbons can be economically produced.) Reserve estimates are essential to determining what areas will be studied, explored and developed by the upstream segment. Generally speaking, reserve estimates are broken into three categories:
Proved reserves can be split into three additional categories:
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It’s important to note that advances in technology can impact those estimates. For example, the advances in hydraulic fracturing and horizontal drilling caused the U.S. Geological Survey to increase its proved reserves estimate for the Marcellus Shale by 40 times the original estimate. In addition to technology, prices, costs and existing infrastructure can also influence reserve estimates. That’s important because it can affect a producer’s financing options through reserve-based lending (RBL), in which a loan is secured by the oil and gas reserves of the asset to be acquired. The value of the reserves and corresponding RBL are often adjusted throughout the year to reflect any changes in projected commodity prices.
To build on what we said earlier, oil and gas producers typically fall into one of the following categories:
Figure 3. Example of Drilling Rig. Source: Pixabay
E&Ps typically contract with companies that specialize in drilling, completion and oilfield services to extract their oil and gas. Very few E&Ps actually have their own fleet of rigs. Here’s a little bit about how that process works.
In the next blog in this series, we’re going to start with the basics of well-site exploration and development, including how seismic studies are conducted and what they tell you, how drilling and production leases are set up, and how a site is prepared for drilling.
“Square One” was written and performed by Tom Petty and first appeared as the 14th song on Elizabethtown: Songs From the Motion Picture, the soundtrack album for Cameron Crowe’s 2005 film of the same name. The LP featured several artists, including Nancy Wilson, Elton John and Ryan Adams. It was released in September 2005. “Square One” was nominated for a Grammy Award in 2006 for Best Song Written for a Motion Picture. The song would also appear as the second track on Tom Petty’s third and final studio album, Highway Companion. Personnel on the record were: Tom Petty (lead, backing vocals, guitars, bass, drums), Mike Campbell (guitars), and Jeff Lynne (guitars, keyboards, backing vocals).
Highway Companion was recorded in 2005-06 at Bungalow Palace and Shoreline Recorders in Los Angeles, with Jeff Lynne, Tom Petty and Mike Campbell producing. Released in July 2006, it went to #1 on the Billboard Top Rock Albums and #4 on the Billboard 200 Albums charts. It has been certified Gold by the Recording Industry Association of America. Three singles were released from the LP.
Tom Petty was an American rock and roll musician, singer and songwriter. He was the leader of Tom Petty and the Heartbreakers, and a solo artist. Petty released 16 studio albums with the Heartbreakers, three solo albums and 68 singles. He also released albums with the Traveling Wilburys and with Mudcrutch. Tom Petty and the Heartbreakers were inducted into the Rock and Roll Hall of Fame in 2001 and also have a star on the Hollywood Walk of Fame. Petty is also the recipient of a Gershwin Award for Lifetime Musical Achievement, a Billboard Century Award, and an ASCAP Golden Note Award. Tom Petty died in October 2017 at the age of 66.
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