The Missing Block in the Oil & Gas Industry

The oil and gas (O&G) industry has traditionally been one where innovations and developments are more focused on drilling and exploration, whereas office functions remain stagnant. The industry still relies on third-party supervision and paper-based contracting for joint operating agreements, lease agreements, and production sharing contracts exchanging trillions of dollars in revenue and expenses—with single deals and contracts pegged as high as US$ 130 Million.

In general, contracts in the O&G industry have several clauses triggered by different events, and the responsibility of keeping tabs on these events and adjusting interest levels of the affected stakeholders falls to intermediaries, requiring third-party supervision. For example, in joint operating agreements, companies share the cost of reducing risk. There are various obligations related to the drilling of wells, like tracking costs and billing partners based on their share. The terms are subject to change, as clauses are triggered when events occur in certain wells. Any failure in this process can result in misunderstandings between companies, authorities and government organizations, leading to errors in transactions, substantial losses for the companies and even lawsuits for breach of contract.

Shipments is another area where documents must go through several agents and departments. The assets move amongst exporters, brokers, customs agents, freight forwarders, inspectors and port workers, thus affecting trackability. Some suppliers even resort to manipulating invoice values to avoid taxes for global transactions.

Blockchain is an innovative technology, expected to deal with these issues and boost the transaction side of the industry by eradicating complicated paperwork and the slow and inefficient chain of intermediaries.

The key attributes of blockchain-enabled supply chain are efficiency, reliability, security, indelibility, transparency, flexibility and control. Blockchain is further expected to enhance the speed of capital flow and revenue recognition throughout the supply chain.

Blockchain-based smart contracts are the way forward

Smart contracts are self-executing contracts. Mutually-agreed terms and clauses are directly written into lines of code. The code and agreements contained therein are distributed across the entire supply chain, where each entity forms a node of the decentralized network. Smart contract permit clauses in the agreement are initiated only after consensus is reached across the network, without the need for a central authority, legal system or external enforcement mechanism.

For instance, if Company A wants to ship a barrel of oil to Company B, the request for asset transfer is broadcast over the entire network of nodes to be validated. Once the transaction is validated by participants in the network, it combines with other transactions to form a block for the ledger, which is added to the existing chain in an unalterable way, rendering the transaction complete. Since the distributed ledger requires consensus and the information is accessible to all participants in the network, it is not subject to misinterpretation and eliminates the reliance on third-party supervision.

Trackability to augment shipping

In the case of shipments, digital tokens are attached to represent assets being transacted (like a barrel of oil), providing companies with a transparent record of the entire supply chain, generating massive savings opportunities, as nearly 9% of all oil transactions every year are disputed.

Recently, global trading group Mercuria pilot tested the blockchain platform for one of its oil shipments from West Africa to Asia and achieved substantial time savings, where the bill of ladings and other documents were handed over to the buyer within seven days as opposed to traditional average of 40 days, leading to cost reductions of at least 30 percent.

Implementation is also expected to have an impact on record management and risk mitigation of invoice value, as they can only be accessed by using private and public keys, relieving the administrative burden on companies to report transactions and enable faster audits by tax authorities.

The key challenges going forward are to create awareness and transform the change-averting culture of O&G companies. The future might be uncertain, but with organizations like IBM, Natixis, and Trafigura collaborating to develop solutions for the O&G sector, only time will tell if blockchains change the rules of the game.