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New role for venture capital in E&P technology start-ups

Helge Tveit &Bob Schwartz Energy Ventures Houston

The words “exploration and production technology” are not often uttered in venture capital circles. VC firms are better known for looking to computer start-ups and, in more recent years, just about any company touting “green” technology. These endeavors have taken the VC community far from the oil field, which is typically viewed as non-technical, dirty, and polluting. This perception is particularly pervasive in the United States, the home of venture capitalism.

This shortage of VC funding for oil and gas technology is exacerbated by the E&P industry’s conservative business strategies and incredibly long development cycles, where the incubation period for a new technology can last for decades. Additionally, the supply chain management structures at most oil and gas operators succeed in driving prices down by commoditizing their vendor market – often at the cost of encouraging the development of new and unique technology.

However, growing challenges like the shortage of qualified professionals and the rising prominence of national oil companies (NOCs) have begun to spur a change in how the industry expedites new technologies. As a result, the E&P technology landscape is becoming increasingly attractive for VC investors who can fathom the intricacies of the industry. Firms like Energy Ventures, for example, are focused exclusively on maximizing the hydrocarbon value chain and are riding the industry’s changing tide, experiencing success in the VC arena and seeding game-changing innovations in the oil and gas space.

Growing VC acumen

Traditionally, oil and gas innovation has come from the research and development departments of international oil companies or from the service companies’ acquisition of independent technology developers. In the current industry climate, these companies can no longer afford to divert manpower and resources from the remaining big plays to focus on investing in truly new technologies.

No VC investor is capable of replacing the R&D organizations of the industry’s leaders. However, VC firms with the right combination of industry and financial expertise, risk tolerance, and time do have an opportunity to succeed where the industry’s traditional methods have failed.

Narrowly focused VC firms like Energy Ventures enjoy a luxury that large oil and gas operators do not have in their ability to focus on specific industry segments. In the last few years, the VC community has zeroed in on this model, creating firms whose investors have long professional histories in the industry they plan to invest in, whether it’s solar energy or exploration and production technology. For example, Energy Ventures’ management team has more than 100 years of combined experience in oil and gas.

This kind of industry experience provides a VC firm with several key advantages when evaluating portfolio companies. First, it allows investors to easily develop an understanding of the technology presented by a potential portfolio company. This basic level of knowledge is also critical for the next step, accurately evaluating the value proposition of a new technology for its end user.

For example, Ingrain, a Houston-based company funded by Energy Ventures offers the oil and gas industry highly accurate analyses of physical reservoir-rock properties from digital images of core samples or drill cuttings. This technology stands to save oil and gas operators large amounts of time and manpower, both because it negates the need for conventional core sampling techniques to determine rock properties, and because it reduces the number of employees required to collect and analyze samples. Without Energy Ventures professional history in energy and geology, an accurate evaluation of Ingrain’s potential would have been incredibly difficult.

Commercial success in the industry marketplace is also key to ensuring a positive return on an investment in any start-up company. A VC firm with knowledge of the industry is better equipped to know how to position its portfolio companies to be attractive acquisition targets.

In mid-2007, Energy Ventures exited the Scottish company MTEM, an investment from its first VC fund. MTEM, an abbreviation for multi-transient electro-magnetic, developed a breakthrough technology for determining the existence and extent of hydrocarbons in land and marine reservoirs. Using its knowledge of the players in the oil and gas technology field, Energy Ventures was able to secure a transaction that not only brought impressive financial returns, but also ensured the future viability of MTEM’s technology.

Additionally, when compared with oil and gas operators, VC firms have an inherently better tolerance for the intrinsic risk that comes with investing in a start-up company, and are better prepared to dedicate the time required to ensure that a new offering is commercialized in the context of a sound business strategy.

Better technology

While properly prepared VC firms are making headway in oil and gas technology, the quality of the industry’s start-ups is also improving. The mergers and acquisitions occurring at both the oil and gas operators and the service companies are shaking loose talented industry experts. Rather than work their way up through a new corporate hierarchy, these professionals are quickly realizing that it is now possible to find success and profit through a small technology-based business in the oil and gas industry.

At the same time, in light of rising prices and the current concentration of resources, the industry tables have turned and the NOCs are taking control of their resources back from the IOCs. The NOCs are often more open to working with small start-up companies. And, many of them are demanding new technology developed specifically to address the unique needs of their assets.

Just 10 years ago, an entrepreneurial tech start-up in the oil and gas space faced a small number of bleak scenarios, including turning to friends and family for funding or seeking a buyout from a larger company. In either case, the technology’s potential was likely to be stunted by a lack of funding or because after the start up was absorbed the support for its technology disappeared. Most likely, these groundbreaking companies would simply never have gotten off the ground because the right combination of funding and investor knowledge was not available to them.

In the new industry climate these creative, entrepreneurial companies are pairing with VC firms like Energy Ventures to bring truly game-changing innovations to the industry – technologies that enable exploration and production professionals to work smarter and more efficiently. For example, Energy Ventures portfolio company ARKeX, provides the industry with Gravity Gradient Imaging. This technology not only provides exploration professionals with more accurate views of subsurface technology than traditional methods, but does so using a light aircraft flown at low altitudes. ARKeX’s methods save the time and expense required to perform laborious land-based seismic surveys and eliminate the need to send personnel into dangerous terrain to collect data.

Exploration and production technology has proven to be a tough phrase for the VC community and often for the oil and gas industry itself. However, forces and trends have brought the industry to a place where it demands enabling technologies to continue its success, but it is also hard pressed to create such game-changing tools internally. For investors who can manage to learn the language and understand the technology the time is right for oil and gas investment.

About Energy Ventures

Formed in 2002, Energy Ventures currently has $425 million under management. The company has nine investment professionals located in the key energy centers of Houston, Aberdeen, and Stavanger. Energy Ventures targets companies offering new technology with the potential to improve performance, raise productivity, reduce costs or open up new territory for E&P activities. 

About the authors

Helge Tveit [helge.tveit@energyventures.no], partner and president of Energy Ventures’ Houston office is a former executive advisor for BP Norway. He has also worked as a former strategic planning director and senior economist for Amoco in Houston where he was responsible for planning efforts in Azerbaijan, Kazakhstan, and Russia. Prior to that, Tveit was a reservoir and workover engineer for Amoco. In that position, he was responsible for planning and implementing well intervention operations in addition to reserves estimation and prediction.

Bob Schwartz [bob.schwartz@energyventures.no], vice president and senior advisor at Energy Ventures in Houston was formerly the president of HTC Energy, part of the Houston Technology Center. He has held management positions with ExxonMobil, ConocoPhillips, Weatherford, and FMC, and has served as a senior lecturer at the University of Texas.

Investors should want to know more about automation

Mark V. Goloby TC Technologies Houston

Everyone is aware of the benefits of automation for the oil and gas industry. Nearly everyone has heard intricate details about the intrinsic value automation brings to the industry and the companies that adopt it. However, there is an inexplicable slowness by the industry to embrace these solutions, and only rarely do these concepts and capabilities influence the thought processes of the investment decision.

Even after the economic returns of an effective automation strategy have been clearly delineated time and again in conversations with investor groups, both individual and institutional, there is ambivalence toward the automation plan of the company in which they are going to invest. Why is this?

Let’s take a look at a small company that provided its investors with some exceptional returns for many years. Early on, this company put together a strategic inventory automation plan and then spent the capital dollars on equipment, training, and implementation.

The company is Wal-Mart Stores Inc., which has put together some pretty good returns for its investors over the years.

Some of you may say, “Oh sure Wal-Mart.” But when Wal-Mart started down the automated inventory control path it was not the Wal-Mart we know today. The company became the Wal-Mart we know today in part because management chose that path.

Some of you may consider retail and energy apples and oranges, but are they? Fundamentally, we are trying to account for inventory. Wal-Mart’s inventory consists of consumer goods, oil and gas deals in an inventory of hydrocarbons.

Investors may consider automation decisions too mundane, but there are good reasons why curious investors should want to know. After all, would you invest in a retail store if all the check-out clerks used abacuses or 1950s-style cash registers?

Data gathering costs

While there are some uplinks available for automated downloading, wellhead production data is inordinately gathered the same way it has always been gathered – by hand. Tanks are still strapped with a sinking bob at the end of a measuring tape. There are the actual costs of time, fuel, and vehicle mileage, but the real cost could be the cost of not knowing anything until the next day’s visit.

Not knowing could be a cost borne more by the investors than the producer. Companies with remote monitoring have production data in a mode that allows them to take action. Systems can be configured to notify them of production drop-offs of as little as 10% in any one hour. These anomalies would never show up in a monthly report.

One might ask, “So what?” Consider this: a gas well with a production rate as little as 70mcf/day is increased 10% in production; result, 7mcf/day. At $6.50/mcf that incremental production is $45/day or $1,350/mo. One month’s optimized production is more than the yearly fee for subscription based remote monitoring services; the second month pays for the hardware. From then on, the remote monitoring is essentially free.

A sharp engineer utilizing these solutions will find additional anomalies during the life of the well yielding still more positive dividends. Or, in investor parlance, kaching! 

And the news gets better. The fixes are typically easy and cheap. Simple fixes, like better choke sizing, more efficient and timely soap stick launching, and better chemical treatment applications. These are simple fixes that yield these operators sophisticated returns.

Well optimization is a fancy way to say when our engineers see the problem they can fix it. The hard part is getting the data to the engineers to identify the problem. When the primary focus is on simply gathering the data, little time is left to transform the data into information with which to increase production.

Production data originated in a digitized format

Study after study has shown the value of digitizing the data from the field to back-office accounting and financial reporting. The Cambridge Energy Research Associates (CERA) has generated results indicating a 10% increase to the bottom line. IHS (CERA’s parent company) proclaims a 3% to 8% savings can be generated just by having digitized hand-collected data.

If this is true, what is the savings of truly automated monitoring and reporting? Any tool that can reduce or eliminate the unknown elements of a producing well has value. If the uncontrollable time and risk can be sharply cut the returns fall to producers and investors alike. Today’s business environment demands accurate information delivered on a timely basis.

“Clearly, forward-acting producers will recognize the benefits of real-time data access for operating and technical reasons alone. However, the finance and treasury departments may ultimately derive the greatest benefits,” says Ryk Holden, director of energy risk management with Legacy Energy Solutions.

Many investors do not look at the deal per se, but the forward thinking ability of the management team in whom they are investing. Presenting an automation plan to investors can give the technology-savvy producer an edge in its capital search.

So what aspects of an automation plan would interest an investor?

Optimized production

As an example, in a number of cases, dew point analyzers have been integrated into a remote monitoring solution. Alarming off dew points of 5 lbs allows the producer to deploy his crews to address the glycol, pilot light, or whatever ails the dehydrator. Reducing shut-in time keeps well production levels constant. Consistent production levels mean consistent cash flow – always a hit with investors.

But this pales in comparison to the true value. If a well falls out of its dew point tolerance, usually 7 lbs, and is shut-in, it can take a tremendous effort to bring the gas quality back within tolerance. This effort may require flaring off the out-of-tolerance gas until it once again meets specs. Flared gas is not shut-in gas; flared gas is not gas that will be produced at a later date; flared gas is burnt money, money that will never be recouped. No one likes that sound of that.

Information is power

Investors clearly understand the value of information. Replacing the uncontrollable elements of a producing well with constant monitoring, alarming capability and data reporting reduces risk both operationally and financially. And low risk, high return is music to an investor’s ear.

Monetization of the commodity

Investors are not looking for in-kind return. They do not want a tanker truck showing up at their bank to make a deposit. Remote monitoring is the means with which the producer can better monetize its production. Investors want to know the plan for marketing the production and insuring that there is a plan to maximize the value of the commodity.

“The key to ensuring adequate monthly true up risk management is to be armed with quality daily production information,” said Rian Grisemer, president of Shoreline Gas. Either with your own efforts or the utilization of a third-party gas marketer, remote monitoring delivers significant advantages.

No one knows what will happen to the price of oil and gas, but everyone knows the price will be volatile. Investors thrive on volatility. They want to know that their management team has the capability and the tools in place to capture that volatility at its maximum return.

To accomplish this, the producer needs access to production data—more importantly, refined production data that can identify exposures in under as well as over producing properties. The investor can look at the producer as not only able to better track production, but to more aggressively hedge production for selling into spikes and absorbing the lows.

Tank level monitoring is a prime example. Imagine a producer, or better yet his marketer, having the ability to view more than 100 wells at 8 am. At a glance, they know the above ground inventory. How much more effectively can markets be found and delivery be scheduled; or maybe not, if the price isn’t right?

Value at Risk

With remote monitoring, producer, marketer, and now the buyer can more frequently check real-time comparisons between actual production and existing hedge positions. This gives financial management more time to make adjustments and determine alternative strategies all the while reducing its value at risk (VAR). Remote monitoring can allow the producer to reduce the elapsed time following a significant impairment to production and keep exposed hedges from becoming speculative trades; again, on-time data to the rescue.

Timely data averts problems and eliminates the fallout of small problems becoming big ones. Small problems are cheaper to fix, meaning higher returns and lower chance of defaults, thus putting smiles on the faces of investors. Producers with smiling investors enjoy more attractive and competitive lending terms and borrowing rates. Again lowering inherent cost structures, putting still bigger grins on investors’ faces.

Conclusion

Oil and gas investors should be concerned about the automation plan of their respective management teams. Timely data leads to productive information that yields positive results to the bottom line.

Lenders who ensure their management team is attentive to this aspect of their investment should recognize a management team focused on implementing today’s best of business practices to achieve higher returns. Producers adopting best of business practices have greater access to financing at better terms. OGFJ