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Just How Real is Blockchain for Oil and Gas

The slow pace that oil and gas is exploring the intriguing potential of Blockchain makes one wonder just how real the promise is. It’s very real, as evidenced by a recent field trial in Europe.

 

Much thanks to my friend and colleague, Randy Wilson, who has been orchestrating the field work.

 

Setting the context

 

Watch some YouTube videos to get your head around the whole idea of Blockchain, and then read this previous post to get a primer on how Blockchain could impact the oil and gas industry.

 

There’s been plenty of breathless announcements of Blockchain trials around the industry. Here’s an example, and another, and another. Most of the trials, however, are pretty narrow in their scope, perhaps involving a couple of traders, a large and expensive cargo (oil or LNG), and a cargo inspector.

 

There’s a lot of traded crude cargos, but there’s also considerable trading activity around refined petroleum products. The number of cargos is greater, the volume of a specific cargo is smaller, and there are many more products involved (diesel, gasoline, jet fuel, bunker, gas oil, and so on), so there is more overall trading activity. If the approach to crude trading with its fewer large cargos was also applied to finished products with its many more smaller cargos, then the productivity improvements from Blockchain would be amplified since the fixed costs of transacting are spread over a smaller per cargo volume.

 

The field trial set out to test this logic and see if it held.

 

The trial decided to take aim at the Amsterdam-Rotterdam-Antwerp or ARA fuel marketplace in Europe. The specific commodity was diesel fuel and the use case was the purchase, sale and delivery of a cargo of diesel between two parties. Why ARA? Because it’s at the center of the European oil sector, and Europeans are more active in exploring blockchain potential.

 

The Use Case

 

Let’s assume that you work for a large oil company and you have a refinery somewhere in the ARA area. Your refinery pumps out diesel, and some of it surplus to your specific customer base. Therefore you wish to sell diesel to someone in the opposite situation (ie, they need diesel fuel to meet their customer demand).

 

In the current world, your traders get on the phone and call around to their contacts at other trading desks. Eventually, they find a buyer, and the two parties go back and forth to land on the deal (basically, the loading port, volume to be exchanged, the date of loading, the date of delivery, the per unit price, the pricing basis either CIF or FOB, the product and its relevant specifications such as sulphur content, and the port of discharge). The buyer enters the deal details in her system, and your guy does the same in his system. The buyer and seller then run a confirmation process to make sure the systems are lined up.

 

Paper contracts are prepared, and in many cases, mailed between parties, or perhaps converted to PDF and emailed.

 

Next the parties need to charter a barge who will pick up the cargo. There’s no transparent market for barges, so the buyer (if the deal is FOB or free on board), or the seller (if the deal is CIF or cost, insurance and freight), has to call around for barge services and terms. There can be quite the run-around to find a suitable barge – call 6 places, decide that the first barge was actually the right price, only to call back and find that it’s no longer available.

 

The barge charter is put in place, captured in the barge guy’s system, shared with the buyer and seller, and backed with more paperwork. The barge charter has much of the same data as the purchase and sale agreement (the loading port, the delivery port, the volume to be loaded, the date of loading, the date of delivery, the per unit shipping price, the product, any penalties to be levied such as demurrage charges). 

 

Next the parties need an inspector who will be on deck to check out the product being loaded, and that it meets the buyer’s specifications. A contract is put in place with the inspector, who enters the details into his system. Other parties to the transaction might include tank farm operators, port authorities who might charge for moorage, lock operators, canal authorities, and so on, all of whom have their own contracts and systems to feed. More paperwork is prepared and exchanged.

 

Eventually, d-day arrives, the barge shows up for the cargo, and the paperwork hopefully all lines up to allow the barge to load the cargo, take title, transport the cargo, be inspected, and offload the cargo at the correct site. Months later, the paperwork catches up, assuming there’s no dispute, and payment for the cargo is settled.

 

Heaven forbid that the cargo be sold while enroute to the buyer. More paperwork.

 

Blockchain to the rescue

 

Blockchain technology turns this process on its head.

 

When the traders agree the terms of the deal, the key data gets written to a blockchain, where it is recorded as a single data block accessible and shared by the two parties, and cannot be later disputed. Any errors in the buyer or seller systems are therefore their own fault – the single truth is on the blockchain. All of the other specific events (the contracting of the inspector, the barge charter, the canal passage) are likewise written to the blockchain as single agreed records of truth and connected to previous blockchain entries involving the same cargo.

 

Much of the paperwork, which encodes the key data (like port of loading, port of discharge, dates, volumes, prices) into legal contracts, can be displaced with standing contract terms and the blockchain data.

 

As the blockchain logs the various transactions, smart contracts trigger the next steps in the process, including launching enquiries for services (like barge and inspector services), issuing key documentation and releasing funds. No more waiting for staff to get around to it.

 

In the end, the oil companies even agreed that the invoice was a fully superfluous document that no longer served any meaningful purpose. Smart contracts on blockchain could handle payment automatically.

 

The Results

 

This trial involved just one commodity and one trading market, but the two oil companies involved estimated that a blockchain solution for finished products trading would eliminate up to 50% of their back office costs (which handle all the paperwork, reconcile the accounts, handle disputes). This is not a trivial sum of money in companies that ofttimes claim 2 back-office team members for each front office trader.

 

Disputes related to contracts would be almost eliminated. Business processes would become more nimble and responsive to change. Processes could be largely automated. Cash flow could be accelerated since the smart contracts could be triggered as soon as key events occurred, and not several days or weeks later when paperwork caught up.

 

Lessons from the field trial

 

The companies involved in this field trial have gained critical insight into how blockchain behaves, where it works, and the hassles of adoption.

 

Blockchain is like having a great Facebook page but no friends

 

This small trial involved 8 companies (buyer, seller, barge outfits, tank hubs, inspectors), but a full solution would include hundreds of players. A lot of energy is going to have to be invested in pulling parties together to get agreement to work together in a new common way. That common way has to offer benefits for everyone or the solution will be hard to get off the ground. In oil and gas anti-combines laws and the scale and size mismatch between the players in a blockchain are barriers. Many consortiums will fail.

Security and privacy are table stakes

 

Your first friends in your blockchain consortium are going to be lawyers. Expect a lot of pre-work in the form of agreements on privacy and security before any tangible results emerge in real value areas.

 

 

Small trials are one thing, but industrial scale is another

 

Blockchain technology in the field trial worked very well, but there were just a few companies involved. Technical performance as more companies get involved could become a problem. As process understanding advances, selecting the right underlying technology that enables the process properly becomes important.

 

Exchanging data between different blockchains is a work in process

 

Industry looks like it will be in a multi-blockchain setting in the future, and assuring that a smart contract on one blockchain triggers action on another is still a study area. Interoperability between blockchains will have to be solved.

 

The technology is actually the easy part

 

Blockchain is a change management problem. For example, the team built the technical blockchain solution in just a few weeks, but in the end, the back office teams could not quite bring themselves to abandon the invoice process (invoices trigger payment). I suspect CFOs and CEOs are going to have to weigh in and direct their businesses to get on board.

 

Conclusion?

 

There’s no ignoring it. Blockchain is real. The big oil and gas players are going to eventually deploy because the benefits are very significant. The adventurous are learning rapidly with small trials how to adapt to this new digital technology.

 

If you would like a presentation and demo of the solution, contact me and we can set something up.

 

 

My friend and colleague, Randy Wilson, has been instrumental in moving this technology into the energy field.

 

 

 

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