Oil and Gas Work Flow

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THE OIL AND GAS INDUSTRY SUPPLY CHAIN

for the

PITTSBURGH REGIONAL ALLIANCE

from

347 Girod St.

Mandeville, LA 70448

(985) 626-9868

FAX: (985) 626-9869



CONTENTS

INTRODUCTION ................................................................................................................................. 3

SIZE OF DOMESTIC SUPPLY CHAIN .................................................................................................... 3

UPSTREAM ......................................................................................................................................... 6

Exploration .................................................................................................................................... 8

Prior to Leasing .......................................................................................................................... 8

Leasing ....................................................................................................................................... 8

Exploration Wells ....................................................................................................................... 9

Development ............................................................................................................................... 10

Development Drilling ............................................................................................................... 10

Hydraulic Fracturing ................................................................................................................ 10

Completion and Production .................................................................................................... 10

Testing and Workovers ............................................................................................................ 11

MIDSTREAM .................................................................................................................................... 11

DOWNSTREAM ................................................................................................................................ 12

INDUSTRIAL CONCENTRATION in the SUPPLY CHAIN ..................................................................... 12

Integrated Oil and Gas Companies .............................................................................................. 12

Exploration and Production Companies ...................................................................................... 12

Storage and Transmission Companies ......................................................................................... 12

Oil and Gas Drilling Companies ................................................................................................... 13

Oil and Gas Equipment and Service Companies .......................................................................... 13

THE SUPPLY IS HIGHLY CONCENTRATED ......................................................................................... 13

DRIVERS OF INDUSTRY GROWTH AND EXPANSION ........................................................................ 14

CONCLUSIONS FOR INDUSTRY TARGETING ..................................................................................... 15

The Oil and Gas Industry Supply Chain for the Pittsburgh Regional Alliance Rev. July, 2011



INTRODUCTION

Finding and producing oil and gas is a complex set of activities, including identifying a “prospect”

or area of interest, collecting data and evaluating the prospect in comparison with other

prospects, obtaining the rights to drill, drilling wildcat well(s), and evaluating the economics of

potentially developing the reserves.

The “upstream” sector is the portion of the industry involved in extracting the oil and gas from

below the ground until it reaches the surface (see Figure 1 for a flowchart of the supply chain).

This part of the industry incurs the most risk because of the uncertainty in finding gas in

commercially producible quantities and the capital intensive methods needed to extract it

(drilling). Recent technological advances, including 2-D and 3-D computer modeling, have

reduced the uncertainties a great deal. Although the Marcellus Shale is fairly well understood

geologically, some degree of exploration is still necessary on the part of operators to refine their

understanding and identify precise well locations. For this reason “wildcat” or exploration wells

are still being drilled in Pennsylvania.

If a “prospect” turns out to be economical, additional drilling is done and pipelines are installedto transport the hydrocarbons to refineries and from there to market. The “midstream” portion

of the industry begins at the "Christmas tree", a large set of valves at the top of every well and

continues through the gathering and distribution network to the refinery or chemical plant. The

“downstream” part of the industry is comprised of refineries, chemical plants and other types of

processing into products and fuels which are then distributed to markets and end users.

SIZE OF DOMESTIC SUPPLY CHAIN

The global energy industry accounts for about 10 percent of world economic output1. The oil and

gas sector accounts for a major share of it. Oil and gas production, while declining domestically

over the last 40 years, continues to be a major force in world markets. Domestic production of

6.7 billion barrels of oil equivalent generated $227 billion of revenue in 2007. Natural gas

generated about half of the production and a smaller 43 percent of revenues (see Figures 2 and3). Natural gas liquids were a significant share of the production and revenues in the industry.




Figure 1.




Figure 2: Production Revenue

Source: Compiled from 2007 Census of Busi Figure 3: US Domestic Oil and

Natur

Liq

12

Natural Gas

43%

Natural Gas

Natural Gas

Liquids

17%

in 2007 ($227 billion)

iness

Gas Production in 2007 (6.7 billion BOE

Crude

+condensate45%

al Gas

ids

%

Crude

+condensate

32%

)




Of the five sectors in the supply chain, production, referred to by the Census Bureau as

extraction, dominates (see Table 1). The entire supply chain is estimated at $800 billion of

revenues (valued at the downstream end to avoid double counting of revenues), about 22,000establishments with 900,000 employees. The upstream portion of the supply chain accounts for

about 60 percent of the employment and 75 percent of the establishments in the supply chain.

Table 1. Estimated Size of O&G Supply Chain in 2007

NAICS Name O&G

Share

Sales in

$billions

Est. Emp.

UPSTREAM2111 O&G extraction 100% $255 6260 150,443

213111 Drilling O&G 100% $22 2109 106,859

213112 Support activities for O&G 100% $46 7089 239,774

333132 O&G equipment 100% $17 664 48,085

SUBTOTAL $340 16,122 545,161

MIDSTREAM

237120 O&G pipeline construction 100% $30 1986 159,6374862 Pipeline transportation of

natural gas

100% $17 1514 24,202

SUBTOTAL $47 3,500 183,839

DOWNSTREAM

32411 Petroleum refineries 100% $580 195 64,839

32511 Petrochemicals 100% $78 56 9,229

3252 Polymers 100% $101 1338 96,485SUBTOTAL 100% $759 1,589 170,553

COMPLETION EQUIPMENT*

33111 Steel 10% $10 37 10,846

333911 Pumps 31% $4 167 10,666

331210 Pipe & tube 32% $3 60 6,941

332911 Ind. Valves 40% $4 192 15,390

333912 Compressors 31% $3 107 7,693SUBTOTAL $25 563 51,535

TOTAL $1171 21,774 899,553

*Sales, Est. & Emp. Adjusted to reflect O&G share of industry

Source: Compiled from 2007 Census of Business




Examples of companies in the exploration and production services sector include Halliburton,

Schlumberger, and Baker Hughes. Drilling and exploration services account for about half of

upstream services (see Figure 5 at the end of the document). Eleven other services account forthe balance of upstream revenues.

In terms of employment, exploration and production services represent about half of the

upstream employment.

Figure 4.




EXPLORATIONThe exploration process begins when an oil company decides to evaluate a particular area or

region for oil and gas, and continues until a decision is made to develop a particular field.

PRIOR TO LEASING

The exploration process begins long before a well is ever drilled. Geologists and geophysicistsstudy the subsurface characteristics of areas and regions using publically available data combined

with some proprietary data in the possession of or ordered by the oil company. These data

sources include well logs (measurements made within wells2), and production data from old

wells which have become public record, and two or even three-dimensional seismic testing.

Large trucks move along the surface and produce shock waves that bounce off rock formations

below the surface of the earth. The waves are captured by “geophones” or measurement

devices that are strategically placed above ground. The vibrations are translated into electricalsignals and processed for review by geophysicists who confer with geologists.

The geologists and geophysicists confer to develop “prospects” or targeted areas of interest for

potential hydrocarbons.

During exploration, the oil company acquires seismic data, computing equipment, and may

contract for additional data collection or specialized processing. In addition, many non-core

office functions at the oil company are now contracted out, including accounting, IT, and logistics

services (helicopters, trucks, workboats, etc.). The geosciences staff, human resources, and the

legal/land staff are examples of core functions that continue to be employed by the oil company.

Most of the employment associated with the pre-leasing activities occur at the company’s

headquarters location.

LEASING

Once particular prospects are identified, the oil companies will negotiate a contract or lease for

the rights to drill to compensate the mineral owners. Lease terms vary, but generally include a

“bonus” or one time payment, calculated per acre, for the right to drill over a specific period of




EXPLORATION WELLS

Once the needed property is leased, the oil company – now called the “operator” as described in

the lease - must obtain a permit from the state regulatory body to authorize drilling a new well.

Items such as surveys, drilling plans, and other technical information frequently accompany a

permit application, and the permit may require site specific environmental protection measures,

or other permits that pertain to environmental issues. The oil company will contract with

outside organizations to obtain the surveys or environmental evaluations, but would prepare

drilling schematics or plans in-house.

After the Permits are obtained, the drilling site must be prepared and the drilling contractor is

hired. Site prep includes the construction of roads, grading of the site, installation of the well

pad from which the drilling is done and other associated equipment is located as well. Erosion

and drainage control measures are also implemented as needed.

The two primary parties in drilling a well are the Operator and the Drilling Contractor that they

hire to drill the well. Each party has significant responsibilities for supplying the operation. The

Drilling Contractor is responsible for the rig and its crew, and contracts for all rig-associated

services, including maintenance mechanics and electricians, food, and first aid for crew. If a

piece of equipment associated with the rig (motors that power the drilling process, crane, etc.)

breaks down during drilling, the Drilling Contractor is responsible and will purchase or rent the

tools, parts and personnel needed for repairs and maintenance. Drilling Contractors that are

active in the Marcellus Shale region include Pioneer Drilling, and Helmerich and Payne.

The Operator, ultimately responsible for the well and the environmental condition of the site,

contracts for all services and materials not associated with the rig. These services include drilling

mud, rental pipe, cement and cementing services, evaluation tools and services, and logistics

services. Because intangible drilling costs can be used as a tax credit on the Operator’s Federal

tax return, there is a strong motivation to rent as much equipment and services as possible.

Intangibles comprise about 80% of total drilling costs. The Operator will purchase the tangible

equipment (casing, valves, etc.) that will become part of the well. The set of companies that

supply rental equipment and services are known collectively in the industry as “service

companies.” Operators that are active in the Marcellus Shale are Chesapeake Energy, Range

Resources, Chief Oil and Gas, EQT, and Devon.

Af d illi l i ll h i f i i d d i d illi i f d i




DEVELOPMENTThe decision to further develop oil and gas proven by exploration wells marks the end of the

exploration phase and the beginning of the development project.

DEVELOPMENT DRILLING

Usually, bringing all of the oil and gas to the surface requires more wells than are drilled duringexploration. Well-drilling during exploration is kept to a minimum due to the capital intensive

nature. The additional wells drilled at this point in the process are referred to as development

wells. Some portions of the well pad can be removed and other types of more permanent

equipment and infrastructure are installed to accommodate a more permanent operation. As

during exploration drilling, the Drilling Contractor is responsible for supplying the rig and its

personnel, and the Operator is responsible for everything else.

HYDRAULIC FRACTURING

Hydraulic fracturing, necessary to develop the Marcellus and other shales, is a process done

during the drilling of wells in which water, sand or other particles (called “proppants”), and

additives are pumped into a well at pressures high enough to crack the rock formation. The

proppants hold the cracks open, permitting the gas to flow to the surface. The company doingthe hydraulic fracturing contracts for sand or proppants, chemicals, water, water recycling or

disposal, etc. The Operator, however, is ultimately responsible for the environmental condition

of the well site under the terms of the lease with the landowner, and may wish to execute

multiple contracts with water recycling and disposal companies. Halliburton and Schlumberger

are the industry leaders in hydraulic fracturing.

COMPLETION AND PRODUCTION

At this point the wells are “completed” meaning that the final equipment needed for the wells to

produce is installed, including the "Christmas tree” – a large set of valves on top of the well,

combined with other equipment inside the well Equipment needed on site includes separation




Gathering and transmission pipe, compressors and related equipment, storage, processing, and

transportation infrastructure is installed at this point to connect the field’s production to existing

transportation infrastructure. Other needed equipment may include heating equipment,metering and control station equipment, or storage tanks. This is frequently referred to as the

“midstream” part of the industry, and the Operator will contract for all of these operations.

Completion equipment, such as steel tube, compressors, valves and pumps, accounts for about

$25 billion of revenue (see Table 1). Most of the completion equipment is used in the upstream

end of the supply chain.

Oil and gas companies are a significant share of the overall market in these industries. A third of

all tubing, compressors and pumps and about 40 percent of industrial valves are bought by oil

and gas customers. The oil and gas portion of these industries involve over 500 plants and

employ approximately 50,000 workers.

TESTING AND WORKOVERS

Gas production declines over time. After the well has been producing for a while, certain

procedures are needed to maintain the equipment inside the well, evaluate the reservoir

performance over time, and stimulate production. Hydraulic fracturing, when done after the

well has been producing for a while, is one type of workover, done repeatedly on a shale gas well

over its life. The Operator will contract with a service company for these types of operations.

MIDSTREAM

Midstream services consist of transportation, storage and marketing of products. Pipelines are

the principal transportation mode for domestic production. Pipeline construction is a $30 billion

per year industry. Pipeline operations represent an additional 24,000 employees.

Services provided to oil and gas producers by the midstream firms include transportation,

storage, and trading of oil, natural gas, and refined products. Major independent participants

include El Paso Corp., Enterprise Products Partners LP, Kinder Morgan Energy Partners LP,

TransCanada Corp., and Williams Cos. Refining and Marketing.

Gas transmission companies convey the natural gas from the region where it is produced to the




DOWNSTREAMDownstream activities consist principally of manufacturing of fuels, petrochemicals and

polymers. The Downstream end of the supply chain is the largest in terms of revenues (due to

the accumulated value added throughout the supply chain) but is the smallest in terms of

establishments and employment.

INDUSTRIAL CONCENTRATION IN THE SUPPLY CHAIN

While the supply chain includes over 21,000 companies, less than 1,000 companies account for

the majority of revenues and jobs. The principal divisions in the supply chain are Integrated Oil

and Gas Companies, Exploration and Production Companies, Storage and Transportation

Companies, Oil and Gas Drilling companies, and Oil and Gas Equipment & Service Companies.

INTEGRATED OIL AND GAS COMPANIES

The largest companies in the supply chain are termed “integrated oil and gas companies.” These

companies are global in scope and are involved in every aspect of the industry from upstream

through downstream. Examples of the integrated companies include Chevron, Conoco-Phillips,

and Exxon Mobil. Integrated companies headquartered outside the USA include BP, Shell, ENI

spa, Petrobras, Petrochina and Repsol SA. Each of these companies has annual revenues

exceeding $100 billion. The integrated companies have not been pioneers in shale gas. They

have entered the shale gas arena by buying exploration and production companies with

properties in the shale gas plays.

EXPLORATION AND PRODUCTION COMPANIES

Exploration and Production companies are also referred to as Independents because their

upstream activities are not integrated with the downstream operations of refining and

petrochemicals. The Independents have been the major drivers of shale gas development.

Among the largest independents are the pioneers in shale gas: Chesapeake, Devon, Anadarko

and Apache. Each of these independents has annual revenues exceeding $8 billion in 2010.




OIL AND GAS DRILLING COMPANIESThe Integrated and Independent companies typically contract their drilling activities to

contractors which have the specialized rigs and equipment needed to drill the wells. Leading

onshore drilling companies include Noble Drilling, Nabors Industries and Helmerich & Payne.

Each of these companies has revenues exceeding $2 billion in 2010.

OIL AND GAS EQUIPMENT AND SERVICE COMPANIES

Most of the services in exploration are contracted to companies that specialize in providing

equipment and expertise needed to support the drilling and completion of the wells. While this

industry has over 7,000 establishments, just a few major companies dominate the market. The

majors in this division of the supply chain are Schlumberger, National Oilwell, Halliburton, and

Baker Hughes. These four companies all have annual revenues exceeding $10 billion and

collectively have annual revenues exceeding $60 billion in 2010. They represent about 54percent of the market in domestic oil and gas services.

THE SUPPLY IS HIGHLY CONCENTRATED

The oil and gas industry is so capital intensive that the majority of the exploration, production,

services and equipment manufacturing are conducted by large companies with access to Wall

Street and institutional finance. Most production is concentrated among 334 publicly traded

companies while the roster of publicly traded companies in the equipment and services market

includes 82 companies.

In 2009, the seven integrated domestic companies like Exxon Mobil and Chevron had sales

totalling $684 billion while the 12 global integrated companies, like BP, Shell and Total, had sales

of $1,247 billion. The 28 Independents, by contrast, had sales of $58 billion.

In terms of shale gas, the Independents are the pioneers and leaders in the industry. The

integrated companies are gaining entry into the shale plays through acquisitions. Exxon, for

instance, acquired XTO in 2010 while Chevron acquired Atlas in 2011 to acquire its shale gas

resources and technologies.




shipments while the 8 largest generated 47% of shipment. The top 50 companies in the industry,

which has 559 companies, generate 81% of industry revenues.

Completion equipment companies are nearly as concentrated. Out of 451 pump companies in

the USA, the Top-4 generate 31% of shipments and the top 8 generate 41 percent. Twenty

companies in the pump industry generate two-thirds of industry sales. The concentration ratios

are nearly identical in the industrial valve industry and the pipe and tube business.

The lesson for economic developers is that, in the equipment markets, the action lies with the

Top-20 companies. They account for two-thirds of production and employment and are the

most likely to have a need for facilities in the Pittsburgh region.

DRIVERS OF INDUSTRY GROWTH AND EXPANSION

The oil and gas supply chain is highly cyclical. Prices drive upstream activity because they

determine the amount of capital investment that companies can make in new properties. The

equipment industries respond accordingly. The relationship between crude prices and drillingactivity is apparent in Figure 6. The number of establishments in the Upstream division of the

industry grows steadily regardless of price but the job levels upstream track drilling activity (see

Figures 7 and 8). The same pattern is apparent in the equipment sector of the industry (see

Figures 9 and 10).

Gas industry activity in the US has been driven by the shale gas technology since 2005. All of the

service and drilling companies report that activity levels in 2010 exceeded levels in 2008 due tohorizontal drilling for shale gas. Shale gas plays are redefining the market.

For the pipe and tubing division of the industry, industry growth is also being driven by exchange

rates. About 70 percent of the Oil Country Tubular Goods (OCTG) used in the domestic industry

are imported. With a falling US dollar, the economics of production have shifted back to

domestic production.




CONCLUSIONS FOR INDUSTRY TARGETINGThe initial opportunities for the Pittsburgh region in the O&G supply chain were in the upstream

division of the industry. As the Marcellus industry grows, the upstream division will continue to

grow and the share of locally produced completion equipment and E&P services will grow as

well. Pennsylvania has a larger share of drilling employment and a much smaller share of

employment in equipment than Louisiana, Texas and Oklahoma (see Table 2). We believe that

the supply chain in Pennsylvania will become more like the supply chain in Oklahoma, Texas and

Louisiana over time.

Table 2. Oil & Gas Employment in 2009

Extraction Drilling Support Equipment

2111 213111 213112 333132 TOTAL

LA 8871 8968 29331 8700 55870

OK 19410 4375 17800 6862 48447

TX 84833 31597 76118 40351 232899Subtotal 113114 44940 123249 55913 337216

PA 2812 1949 2878 312 7951

USA 160688 67756 193589 60360 482393

LA,OK, TX% 70% 66% 64% 93% 70%

PA% 1.7% 2.9% 1.5% 0.5% 1.6%

US Breakdown 33% 14% 40% 13% 100%

LA,OK,TX BD 34% 13% 37% 17% 100%

PA Breakdown 35% 25% 36% 4% 100%

OK Breakdown 40% 9% 37% 14% 100%

TX Breakdown 36% 14% 33% 17% 100%

LA Breakdown 16% 16% 52% 16% 100%

Source: BLS QCEW employment series




Figure 5. Breakdown of Exploration & Production Services Revenue in 2007

Source: Compiled from 2007 Census of Business

Drilling

36%

Rework

3%

Other drilling nsk

3%

Exploration services

11%

Cementing

2%

Surveying & Well Logging

3%

Hydraulic

facturing

8%Running, cutting, &

pulling casings,

tubes, or rods

3%

Perforating

1%

Installing equipment

3%

Pumping

1%

Other repair and

maintenance

5%

Support activities for oil

& gas operations, nsk

8%

Miscellaneous

13%


Taimerica Management Company | P. O. Box 977 | Mandeville LA 70470 | 985.626.9868 16



Figure 6. Relationship between Crude Price and Drilling Activity

Source: EIA, Baker Hughes

$-

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

$90.00

$100.00

-

50,000

100,000

150,000

200,000

250,000

300,000

350,000

400,000

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

Wells

Feet(000)

Crude price





Figure 7. Establishments in Oil & Gas Exploration & Production


0

5000

10000

15000

20000

25000

30000

2001 2002 2003 2004 2005 2006 2007 2008 2009 March or

Q1-2010

June of

Q2-2010

Pipeline Const.

Drilling

Support Act.

Extraction





Figure 8. Employment in Oil and Gas Exploration & Production


0

100000

200000

300000

400000

500000

600000

700000

2001 2002 2003 2004 2005 2006 2007 2008 2009 March

or Q1-

2010

June of

Q2-2010

Pipeline Const.

Drilling

Support Act.

Extraction



Th Oil d G I d t S l Ch i f th Pitt b h R i l Alli R J l 2011



Figure 9. Establishments in Oil and Gas Equipment Supply Chain


-

500

1,000

1,500

2,000

2,500

2001 2002 2003 2004 2005 2006 2007 2008 2009 March or

Q1-2010

June of

Q2-2010

Compressors

Fab. Pipe

Ind. Valves

Pipe & Tube

Pumps

O&G Equip

Steel Mills



The Oil and Gas Industry Supply Chain for the Pittsburgh Regional Alliance Rev July 2011



Figure 10. Employment in Oil and Gas Equipment Supply Chain


$-

$10.00

$20.00

$30.00

$40.00

$50.00

$60.00

$70.00

$80.00

$90.00

$100.00

-

20,000

40,000

60,000

80,000

100,000

120,000

140,000

C r u d e P r i c e ( $ / b a r r e l )

E m p l o y m e n t Compressors

Fab. Pipe

Ind. Valves

Pipe & Tube

Pumps

O&G Equip

Steel Mills

Crude



Oil and Gas Work Flow

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