Holy Grail – What blockchain holds for the energy industry?
January 9, 2019
IHS Markit EMEA director of consulting for energy wide perspectives and strategy Vinodkumar Raghothamarao tells InnovOil about how energy industry could utilise blockchain
Oil and gas companies operate in dynamic and complex environments, where they face constant challenges especially in terms of supply and demand. Now with the oil prices barely emerging from historic lows, the time has come to evaluate and adapt new technology.
When the price of crude oil is low, the high cost of upstream oil exploration and development coupled with downstream efficiency challenges forces most companies to reduce costs. The oil and gas industry presents a particularly compelling opportunity to leverage blockchain technologies owing to the high transactional values (and therefore risks) and economic pressures to reduce costs.
A secure system that mitigates risk, increases transparency, provides an audit trail and speeds up transactions at a significantly reduced cost may be appealing to oil and gas companies.
Blockchain is a distributed transaction-ledger database shared across traditional boundaries. The seamlessness of sharing a constantly updated, single source of the truth is one of the digital technology’s primary strengths.
The expanding chain of “blocks” of digital data preserve every follow-on action by parties who have played roles in sourcing, producing, transporting, installing, trading and reselling oil and gas products. After business rules have been encoded, blockchain helps eliminate the need for human intervention to validate and reconcile the data.
One of the most obvious and powerful uses for the digital ledger technology is to provide a reliable and efficient platform for executing and recording energy trades. The entire non-hydrocarbon supply chain could be transformed with blockchain.
The interaction with thousands of suppliers, vendors and counterparties drives up complexity and cost, but blockchain can help companies monitor compliance from their suppliers. Additionally, the introduction of smart contracts, which are essentially computer code stored on blockchain that can execute actions under specified circumstances, should give oil and gas executives a greater incentive to improve their supply chain and finance activities.
Smart contracts enable counterparties to automate transaction tasks that are typically performed manually and that require the involvement of third-party intermediaries. Smart contract technology can result in processes that are faster and more accurate and cost-efficient. Also, the parties to a smart contract agree to be bound by the rules and determinations of the underlying code, which in theory should lead to fewer contract disputes.
Joint ventures are common in the oil and gas industry and generally require a suite of complex agreements (for example, relating to the sharing of costs or revenues), which could be implemented as smart contracts.
Most contracts contain audit clauses giving the parties the right to audit each other to make sure that all parties are complying with the contract. Introducing a blockchain ledger to record joint venture transactions and using smart contracts to define, negotiate and execute the contractual conditions will provide all involved parties, including the tax authorities, with transparency and consensus on what has occurred.
This single audit trail, agreed upon by all participants, will significantly reduce the effort needed to ensure timely tax compliance and reporting, as well as the effort needed by the tax authorities to understand tax positions.
Global supply chains in the oil and gas industry comprise a complex web of suppliers, shippers and contractors. The complexity and scale of this network requires substantial administration and creates opportunities for errors.
From the tax authorities’ and customers’ perspectives, there also is a concern that suppliers might manipulate invoice values, potentially avoiding taxes or inflating costs, as goods are sold and shipped around the world.
Utilising blockchain technology to record and manage the movement of goods and related invoices will significantly mitigate the risk of errors and the opportunity to alter invoice values or recipients. Goods will be tracked from source to customer, reducing time and costs, and providing insight into the supply chain process that could be used to create efficiencies.
Invoices will be recorded in the blockchain, creating an immutable record of its contents. The movement of invoices also can be addressed in the blockchain using public and private keys, preventing unapproved parties from accessing the invoices.
This again could help to reduce the administrative burden on companies to report transactions to authorities and reduce the time taken by tax authority audits because of the reliability and transparency of data in the blockchain.
Operations and maintenance and quality control personnel have a real need to track where asset components have come from, and what manufacturing activities and which heat-treating processes have been used.
Blockchain has the capability to help track all related components and assets, and to share records among business partners. It provides a framework for registering contractors, tracking performance and reliability.
A blockchain could be used, for example, to track which suppliers produced the components and subcomponents for a blowout preventer (BOP). If a certain component breaks down, the operator could consult data in the chain to determine when, where and by which company the component was produced.
Manufacturers might examine the data to see if maintenance – frequently outsourced – was performed as recommended. As an increasing number of assets are computerised, blockchain technology also could help to keep track of software updates to protect internet of things devices so as to avert sabotage and potential damage from cyberattacks.
In addition, using blockchain, the operational performance of a critical asset or equipment can be tracked based not only the cost of the equipment but also the cost of all aspects of the performance lifecycle – including maintenance, operating costs, uptime, downtime, etc. Once a service-level agreement has been determined and coded in the system, sensors could communicate to the blockchain, and performance factors would determine payment amounts (including bonuses or penalties).
Going forward, although some of the best technological best practices have trickled through the energy industry, there is always still scope for further improvement.
Using blockchain, the oil and gas industry can see reductions in cost of managing complex financial agreements, such as those governing royalties and payments, improvement in transparency through their supply chain, reduction in trade finance costs, and ultimately greater responsiveness to changing market conditions.
Effective deployment of pertinent blockchain technologies is the way forward for the oil and gas companies to reduce costs in this era of low oil prices and to focus on oil and gas production and exploration in the most optimised way. It will be interesting to see how blockchain adoption evolves in the energy industry, and the ramifications of blockchain for the energy and oil and gas industry in 2018.