Ethics, Shale Reserves and the Inversion of Proof

Ethics in oil

NASA was under tremendous business pressure when the Challenger shuttle exploded, and the exploratory well was way over budget when BP’s Macondo well blew out.  Scores of oil companies are under even more pressure this reserves season.

The unproduced oil and gas still in the ground is the primary asset of an oil company, and it is the collateral for the financing which has enabled the shale boom. Reserves are effectively inventory, unsold goods warehoused underground, but they are much less straightforward to count, especially reserves for shale wells. 

Rocketing US oil production came from shales, and it was funded primarily by debt with wells costing $5 to $10 million each and thousands of wells being drilled each month.  Now, with the resulting production worth about a third of what it was, the annual reserves determination takes on a whole new significance. 

To put this exercise in perspective, the most common method for determining reserves is over a hundred years old. By comparison, the first year of modern, horizontal, shale drilling was 2005 when over a thousand were drilled in the whole year.  Shale drilling for oil geared up only about five years ago, though there are some older wells, and younger wells are even more uncertain to forecast. The result is that the industry is still learning about the determination of shale reserves, and many people in the industry still use methods and concepts from the bygone world of “conventional” oil production.

Life-or-death financial situation, young wells and engineers still learning to make accurate predictions of recovery.  This sounds like a recipe for trouble, one to approach deliberately.

The easy and natural course is to try to push the reserves as high as possible to protect the company.  Besides short-sighted, that tactic is, unfortunately, unethical.

Codes of ethics for engineers are remarkably similar, from civil to petroleum, from Texas to Canada. The three foremost ethical considerations for an engineer stand:

1.       Protect the safety and welfare of the public

2.       Perform and report work in an objective and truthful manner

A third major tenant is to publish work only within your areas of competence. There are, of course, obligations to an employer, especially about confidentiality and conflict of interest.  There is no obligation, however, to protect a company or its managers from its own mistakes.  And all of the codes I’ve examined specifically include an ethical obligation for “whistleblowing” when one’s company conducts itself improperly. 

The tools of reserves engineering are inherently uncertain.  It is, after all, the prediction of the behavior of systems concealed by miles of solid rock.  And that uncertainty seems to leave generous room for knob-turning, and maybe there is some area of equivalent confidence in the reserves figure.  However, in my experience, most of the uncertainty comes from people operating outside of their area of competence.

Not to say that an engineer is “incompetent”, but only that he has not developed the skill and expertise in a particular area.  I, for instance, gladly claim incompetence when it comes to the mechanics of designing and drilling a well.  As the anachronistic name “unconventional” conveys, shale reserves are something different, and even experienced reserves engineers may not keep up with and use the still-developing state of the art.  Competence comes not from simply having done something but from learning the necessary techniques, just like hacking at a golf ball won’t make a good golfer. Unfortunately, the more sophisticated reserves techniques, which could help to build competence, are neglected or out-of-reach for most engineers.

Even if maybe they should, no one really wants to argue that shale reserves are not in their area of competence.  Does anyone care to argue that deliberately increasing reserves because you know your company needs them is acting “objectively and truthfully”? Does anyone care to argue that a company’s lenders are not part of the “public” whose welfare engineers are obligated to protect?

In the case of both the Macondo and Challenger disasters, engineers working on the projects objected and warned of danger.  In both cases, the decision-makers overruled the engineers because the engineers could not prove there would be a disaster; they could only say that there was a high degree of risk.  Management effectively inverted the burden of proof.  The launch/cementing should only be undertaken when it is proven safe, but management was going forward unless it was proven unsafe. 

In our industry, we have a set of definitions which explicitly require the reserve volumes to be proved,  definitions shared and understood by lenders, definitions which should be honored in an objective and truthful manner.

When the engineer for Macondo continued to object to the cementing plan, his supervisor, who himself was a cementing engineer, rebuked him in an email, “Who cares, it’s done, end of story, will probably be fine and we’ll get a good cement job.” Within just a few days, that manager awoke to news that eleven men were dead, and his company would spend over $30 billion to clean up the mess.  As for the engineer , I doubt he felt better saying “I told you so.”

 

See this post on my LinkedIn page.