## New Systemic Realities

June 18, 2015 1:58 PM by Dr. Scott M. Shemwell

Volume 4 Number 12

In the last edition, we raised the possibility that the risk distribution curve models many use may be fatality flawed.  If this argument has merit, then Systemic Risk management as practiced by many have exposures that can lead to unwelcome surprises.

Moreover, in this series as well as other publications we have argued that the R B C model has value managing the fluid situations we find ourselves in today.[i]  Mathematically, the Relationships variable is latent and therefore not directly observable.[ii]

This suggests that the risk frequency distribution is a function of Behavior and/or Conditions variables.  At the risk of oversimplifying complexity, we can focus on Conditions when seeking to reveal the shape of our risk curve.  We can make this assumption because Behavior often follows Conditions.[iii]

For example, the level of training is a function of Conditions.  A placard at the former Naval Fighter Weapons School read, “Under pressure, you do not rise to the occasion; rather you sink to your level of training.”[iv]

We will need to assess the sum total of the Conditions variables as the foundation of our Individual Risk Probability Distribution (IRPD).  In one sense this makes our task easier since we can eliminate the Behavior set of variables.

However, Conditions may include: Circumstances, Capability, Culture and the Environment.[v]  For a large project with multiple economic actors and an even higher population of individuals, the resulting Conditions Matrix may be large and complex with many elements.

Therefore, a simple Conditions Matrix graphic or table may not be a sufficient method to understand the IRPD.  In these cases risk mitigation models may require a set of difference equations to better understand the exposures.[vi]

As we have noted that within the industry Culture of Safety, there exists thousands of organization Cultures of Safety; this is true with IRPDs as well.[vii]  Moreover, each project may have its own IRPD.

An IRPD may have a “Fat Tail” as described previously.[viii]  If this is the case, the risk associated with that particular activity must be addressed differently than if the IRPD has a more statistically Normal Distribution.

Big Data proponents suggest that the data should define the problem.  We can argue the same model here.

Let the Conditions you find determine the IRPD.  You may be surprised that the curve fit with a Normal Distribution is poor.  Moreover, guard against statistical techniques that enhance fitness or reduce data fidelity.

For example, if straight line fit is poor in some case an exponential curve will show better data fit.[ix]  While the resulting graph may be visually pleasing, it may mask hidden dangers.

In the rush to meet deadlines and financial metrics, we re-purpose materials frequently.  Often this business model is satisfactory and the most cost effective.  However, each IRPD should be developed on the specific merits (Conditions) of that project or activity.

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i]  Shemwell, Scott M. (2012, November 19). What a Difference a Year Makes. Governing Energy. PennEnergy.
[ii]  _______ (2015). Structural Dynamics: Foundation of Next Generation Management Science. pp. 56, 57. Houston: RRI Publications. http://www.amazon.com/Structural-Dynamics-Foundation-Generation-Management-ebook/dp/B00U0JKMT0
[iii]  _______ (1996). Cross Cultural Negotiations between Japanese and American Businessmen: A Systems Analysis, (Exploratory Study). p. 46 Unpublished doctoral dissertation, Nova Southeastern University, Ft. Lauderdale.
[v]  Shemwell, Scott M. (1996). p. 47.
[vi]  https://ccrma.stanford.edu/~jos/fp/Difference_Equation_I.html
[vii]  Shemwell, Scott M. (2015, April 7). How Can Humans Effectively Manage Increasingly Complex Systems? Deep Space Deep Ocean: Aramco Technology and Operational Excellence Forum.  The Woodlands.
[viii]  _______ (2012, June 8). Fat Tail. Governing Energy. PennEnergy.
[ix]  http://www.qsm.com/faq/poor-curve-fit-actual-defect-data

## Fat Tail

June 8, 2015 12:37 PM by Dr. Scott M. Shemwell

Volume 4 Number 11—June 8, 2015

Alan Greenspan, the former chairman of the Federal Reserve Board famously once quipped about “irrational exuberance” in the equity markets of the dot.com era.[i]  Turns out, he was right!

In his recent book, he develops an interesting perspective regarding the risk management techniques that the finance industry used in the lead up to the 2008 financial collapse; arguably even more destructive than the Great Depression of 1929.[ii]  One risk mitigation model challenged is the high consequence—low probability model often used to describe Macondo like incidents.

If one looks at a statistical normal distribution, there is a symmetrical shape to the so called “Bell curve” with the tails, or likelihood of an event occurring under that area of the curve relatively small or virtually nil.  The following graphic depicts this probability distribution.

[iii]

However, what if the probability of an incident is not statistically normal?  If the likelihood of an incident fits another distribution curve, the probability of a high consequence—low probability incident may not be as infrequent as believed.

The so-called “Fat Tail” suggests that the probability of an incident or event can move beyond 3 Standard Deviations.[iv]  This is graphically depicted below.

[v]

Chairman Greenspan challenged the conventional wisdom of the financial markets, expressing concern that Black Swan events may not be as rare as believed.  Perhaps, the energy sector should challenge its conventional bell curve based risk models as well.

If risk mitigation strategies are designed to address probability distributions that are unlikely representations of real world situations, they may not be providing adequate assurances that organizational strategies are well founded.  High Reliability Management suggests that vigilance regarding possible failure scenarios is fundamental to Organizational Health.[vi]

Part of that vigilance may include reconsidering the size of probability distribution tails.  Changes in strategy and operations may be required to better address the likelihood and impact on high consequence incidents whose probability may not be as low as many believe.

## How does your organization update its Risk Management process?

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i]  http://en.wikipedia.org/wiki/Irrational_exuberance
[ii]  Greenspan, Alan. (2013). The Map and the Territory: Risk, Human Nature, and the Future of Forecasting. Penguin: New York.
[iv]  http://www.investopedia.com/terms/t/tailrisk.asp
[v]  http://www.cdc.gov/ophss/csels/dsepd/ss1978/lesson2/images/figure2.10.jpg
[vi]  Holland, Winford “Dutch” E. and Shemwell, Scott M. (2014). Implementing a Culture of Safety: A Roadmap to Performance-Based Compliance. (p. 47). New York: Xlibris.

## Bounding the Boundless

May 18, 2015 9:05 AM by Dr. Scott M. Shemwell

Volume 4 Number 10

One of the difficulties of systemic risk management is to put a boundary or constraints around the problem.  This is a major aspect of framing the initial challenge one is trying to solve.

One assertion about weather systems is the so-called “butterfly effect” whereby a butterfly flapping its wings in Brazil is one of the causal events for storms in Texas later.”[i]  Additionally, economists define an externality as positive or negative economic consequence experienced by unrelated third parties.[ii]

While the butterfly in Brazil most likely has no impact on the weather a continent away, externalities are common.  For example, pollution released form industrial complexes can impact local residents even if they are not employed by that firm or even work in the sector.[iii]

Systemic risk management is a function of Behavioral Economics, the decision making model that incorporates societal, cultural, emotions and other human biases into the process as opposed to the classic rational economic actor theory.[iv]  The holistic nature of systems analysis presents the problem of the title.

Culture of Safety driven systems may include humans, machines, multiple processes and the environment.[v]  None of these may act with economic rationality.  In fact, risk management systems such as the Bowtie recognize possible multiple points of failure and the necessity of redundant and systemically removed barriers and incident management processes.

By systemically removed we mean an exogenous variable or one outside and not dependent on the system.  For example, redundancy may not remove the system dependencies, i.e., multiple sets of rams on the Blowout Preventer.  While one may not fail, if all do for a variety of reasons, the system is compromised.  The open hole bridging model is an exogenous self-killing of the wellbore independent of the BOP.[vi]  However, both are dependent on the quality of the well and reservoir models and in this sense are within model boundaries.

The Two Key Solution is an example of systemically removed economic actors.  Two physically separate and independent decision makers must agree before a decision it taken.[vii]  This works unless there is a level of collusion between the two, in which case they are within system boundaries as well.

While the butterfly may not be responsible for server weather, system planners must thoroughly assess the components of the system and their interactions.  When externalities impact a system, they become endogenous within a newly defined system.

The R B C model is a useful tool helping the systemic modeler to define where logical and realistic boundaries exist.[viii]  A boundary is a Relationship in an environment or set of Conditions, exhibiting Behaviors.

When these behaviors are meaningful, they must be considered in the systems analysis.  A Sensitivity Analysis may help shed light on these boundary relationships and updated according to changes.

## How does your organization bound your physical, organizational and virtual systems?

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i]  http://www.livescience.com/17455-butterfly-effect-weather-prediction.html
[ii]  http://www.investopedia.com/terms/e/externality.asp
[iii]  Ibid.
[iv] Shemwell, Scott M. (2015). Structural Dynamics: Foundation of Next Generation Management Science. Houston: RRI Publications.
[v]  _______ (2014, August). The Emergence of a Culture of Safety Online Class. PennEnergy. http://ogjresearch.stores.yahoo.net/the-emergence-of-a-culture-of-safety-class.html
[vi]  http://www.bsee.gov/Technology-and-Research/Technology-Assessment-Programs/Reports/400-499/408AA/
[vii]  Shemwell, Scott M. (2015, April 1). The Two Key Solution. Governing Energy. PennEnergy.
[viii] _______ (1996). Cross Cultural Negotiations between Japanese and American Businessmen: A Systems Analysis, (Exploratory Study). Unpublished doctoral dissertation, Nova Southeastern University, Ft. Lauderdale.

## On Technology

May 4, 2015 1:11 PM by Dr. Scott M. Shemwell

Volume 4 Number 9

The 2015 Offshore Technology Conference (OTC) is being held amidst another sharp collapse in the crude oil price.  As discussed in this blog and by others, reduction in force (RIF) or layoffs are underway and may continue.  Moreover, industry restructuring continues as the sector seeks the new economic equilibrium.

Mandates to reduce costs abound; however, along with these directives is the superior commandment, “do not compromise safety, compliance or operational performance.”  Process transformation, i.e., a more efficient supply chain, cannot be accomplished by force of will alone.

Implementing a Culture of Safety, assuring Compliance and Risk Mitigation as well as maintaining and even enhancing Operational Performance require appropriate enabling technologies.  While information technology (IT) has long been a process change enabler, other technologies such as those used by the risk mitigation Bowtie model are required.  The model has three basic components:

Prevention Controls
Recovery including Escalation Processes[i]

For example, certain technologies enable products and solutions to prevent a safety related incident such as a fire and others used to mitigate the impact and control the result of a possible incident.  In our complex industrial world, technologies of all types are central to Risk Mitigation strategies.

Moreover, technological advancement is accelerating and dramatically changing the way we do business.[ii]  The challenge of the Convergence of Exponentials is not just the understanding of the technological rate of advancement, but the effective management of this innovation to add business value.[iii]

The OTC will showcase new technologies and vendors will hawk their wares.  The challenge is to harness these capabilities in the current market conditions while meeting the covenants of not compromising safety, compliance or operational performance.

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i]  http://www.skybrary.aero/index.php/Bow_Tie_Risk_Management_Methodology
[iii]  Shemwell, Scott M. (2015, April 23). Titans of the 1940s Today. Governing Energy. PennEnergy.

## Titans of the 1940s Today

April 23, 2015 12:52 PM by Dr. Scott M. Shemwell

Volume 4 Number 8

Re-watching the 2013 movie, ”The Challenger (Disaster)” I was struck by Richard Feynman’s response to a comment, that with 2.5 million parts in the Space Shuttle the Presidential Commission on the Space Shuttle Challenger Accident may never find an answer.[i]

“2.5 million, small potatoes.  Really, look I don't know much about space rockets but I know a little about probability; something I developed called path integral formulation—its quantum mechanics.  Basically, what it means is you can figure out the probability of something occurring not just when you got 2.5 million events but an infinity of possibilities.  Over large, the number of cause will pass for whatever happened to Challenger an explanation can be found.  What we doing here if we don't think it’s possible?”[ii]

Path Integral Formulation or the sum of all possibilities simply put:

1. Consider all possible paths for quantum particles traveling from one point another including nonlinear paths,
2. Place an “absolute value” type of number for each path and finally,
3. The sum of all possible paths describes the probability of a particle at point B at a given time—“a path integral or sum over histories.”[iii]

Clearly, there is more to this quantum mechanics probability theorem than can be stated herein, nor is the expertise of the author and his decades old Bachelor in Physics degree able to address anything but the highest level review of Dr. Feynman’s solution.

However, it appears that this construct has merit in our classical physics world of safe operations.  As with another 65 year old hypothesis, Requisite Variety, the argument made is that our sophisticated, automated decision making systems must be able to address all possible failure paths that a 2.5 million parts or more machine (system) may generate.[iv]

These hypotheses dating back to the time of this author’s birth may hold the key to 21st century complex systems management.[v]  Moreover, the von Neumann (electronic computing) Architecture, circa 1946 is the basis of the current crop of Smart Devices.[vi]

While constrained by classical or Newtonian physics, massively high performance, economic decision support systems should be able to asymptotically approach Requisite Variety or Path Integral Formulation solutions.  Today’s managerial and technical systems enable these models.

Unknowable 2.5 million part systems are from a bygone era.  Moore’s Law is now 50 years old.[vii]  Originally applied to semiconductor performance, it has been extended to other technologies and processes.[viii]  Other systemic laws apply as well.

Without Moore’s Law the number of components and their functions even if advanced (low slope) linearly during the 30 year life of the Space Shuttle of then to the current sophisticated systems would have many more parts and associated functions.  With the possible exception of the International Space Station this has not happened.

Almost 1,300 Boeing 777 (introduced 1995) are in service and each has about 3 million parts provided by about 500 different contractors and suppliers.[ix][x]  Over 250 Boeing 787 Dreamliner (introduced 2011) aircraft are in service and each has about 2.3 million parts.[xi]  Collectively, for these two aircraft alone, almost 4.5 billion components are in service every day.

Granted, this may not be a direct comparison—apples to apples, so to speak.  However, the analogy is that the level of complexity since 1988 has dramatically increased and society must understand this in order to manage complex systems.

In 2004, the author first posited that the Convergence of Exponentials would lead to significant change.[xii]  In 2009, this construct was further refined and further advanced over the intervening years.[xiii]  These converging axioms include:

• Moore’s Law—the number of transistors (power) on a microprocessor doubles every 18 months
• Metcalfe’s Law—usefulness of a network equals the square of the number of users
• Gilder’s Law—bandwidth rises three times faster than the power of the computer

The effect of this convergence in 2015 and beyond is that the Velocity of Information (similar to the economic theory, Velocity of Money, it is the frequency at which information is exchanged) is dramatically increasing.  This effectively enables modern management decision making to approach the criteria set forth by Requisite Variety and Path Integral Formulation.  Effectively, the management tools are available today as technology enables the thinking of 1940s leadership.

The Internet of Things (connectivity among a massive number of smart devices) will continue to present challenges to management to assure safe, environmentally proactive and productive operations.  One can argue that the tools to manage this next iteration of the Convergence of Exponentials are readily available.

## Does your management say it can’t be done and if so what is your response?

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i] http://www.imdb.com/title/tt2421662/
[ii] http://maximusandme.blogspot.com/2013/11/the-challenger-disaster.html
[iii] http://www.einstein-online.info/spotlights/path_integrals
[iv] Shemwell, Scott M. (2014, December 11). Requisite Variety. Governing Energy. PennEnergy.
[v] http://en.wikipedia.org/wiki/Path_integral_formulation
[vi] Shemwell, Scott M. (2005). Disruptive Technologies—Out of the Box Essays on Business and Information Technology Alignment Issues of the Early 21st Century. New York: Xlibris. p. 127.
[vii] http://www.forbes.com/sites/roberthof/2015/04/17/at-50-moores-law-has-only-started-to-disrupt-everything-we-do/
[viii] Shemwell, Scott M. (2015, March 20). Drilling Moore. Governing Energy. PennEnergy.
[ix] http://globalfastenernews.com/main.asp?SectionID=26&SubSectionID=39&ArticleID=10822
[x] http://en.wikipedia.org/wiki/Boeing_777
[xii] Shemwell. Scott M. (2004, January 31). Desperately Seeking Technology: 21st Century Needs of the Downstream, Petrochemicals, and Retail Petroleum Industry Segments. Presentation to the Intel global sales force. Anaheim.
[xiii] _______________ (forthcoming). Rapid Response Management: Thriving in the New World Order. Houston: RRI Publications.

## The Two Key Solution

April 1, 2015 2:38 PM by Dr. Scott M. Shemwell

Volume 4 Number 7

In our book published last year, the late Dutch Holland penned a section, Joint Authorization, e.g., Two-Key Requirements.[i]  The fundamental premise of the two key requirement solution demands that two separate but equal decision makers be spatially or otherwise disconnected so that only when both individuals agree can a high consequence operation be undertaken.  In practice, nuclear launch officers are physically distant so that one individual cannot activate the launch system by turning both keys simultaneously.

This requirement makes a lot of sense for an activity that begins a physical process such as a missile launch.  Dr. Holland includes other process examples such as planning, decision escalation process and management of certain types of changes.[ii]

It is less clear how this requirement would work with other high criticality activities such as when one pilot leaves the flight deck of a commercial airliner.  However, in the aftermath of the crash of Germanwings Flight 9525 where it is alleged that a suicidal co-pilot refused to allow the Captain back to the flight deck by locking the door, the concept may have some merit.[iii]

Secure cockpits, one flight attendant in the cockpit when one pilot is out, using the drink cart to physically block the door when it is open and passengers restraining a malcontent passenger all make sense in our terror consumed world.  While making sure that two individuals are always in the cockpit assures that if the remaining pilot becomes incapacitated the other person can at least open the door.  However, what happens if a deranged pilot attacks and subdues that flight attendant?

This author first addressed the issue of rogue behavior of one or a small number and its potential huge impact on society in 1999.[iv]  This subject was developed in greater detail as it relates to the current issue facing complex organizations in the referenced book section titled, The power of a single player: One man, one disaster.[v]

While no system is foolproof and certainly all are at risk to a determined foe, the 21st century response to a two key requirement might be based on technology.  Biometrics, such as retinal scan, facial recognition, etc. may be a simple and economic solution.

Air crew members can easily “log in” to an aircraft when they board it.  If all members are identified by such a system, any two could open the door if necessary.  This system could not be overridden by anyone in the cockpit.

The obvious question, “Could a potential terrorist force crewmembers to use their biologics to open the door?  Perhaps, but it is less likely.  Passengers have a vested interest in the safe operation of an aircraft.

Passengers are a routine barrier to potential aircraft incidents.  If your age is over 12-15 (depending on carrier) and physical capable of performing the process of removing the emergency exit door you are authorized to sit in seats next to the emergency exits. [vi]   That passenger is effectively deputized to be part of the flight crew.  And who would forget the heroics of the passenger of United Flight 93.[vii]

History has shown that when commotion arises in the cabin, passenger will step forward and intervene.[viii]  This mitigates the risk that a terrorist can “force” the cabin crew to override a bio-two key.

The upstream oil and gas industry uses the Bowtie method to assess risks, establish barriers to the risks and ascribes reactions to the top event (suicidal pilot).[ix]  A new barrier for all industries operating critical heavy equipment may be a bio-two key.

## Do your organizational processes require two keys and what are they?

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i] Holland, Winford “Dutch” E. and Shemwell, Scott M. (2014). Implementing a Culture of Safety: A Roadmap to Performance-Based Compliance. (pp. 55-59). New York: Xlibris.
[ii] Ibid.
[iii] http://www.latimes.com/world/la-fg-german-jet-crash-door-20150325-story.html#page=1
[iv] Shemwell, Scott M. (2011). Essays on Business and Information II: Maximizing Business Performance. (pp. 214-215). New York: Xlibris.
[v] Holland, Winford “Dutch” E. and Shemwell, Scott M. (pp. 35-36.)
[vi] http://en.wikipedia.org/wiki/Exit_row
[vii] http://www.history.com/topics/flight-93
[viii] http://www.cnn.com/2015/03/17/travel/united-airlines-flight-unruly-passenger/
[ix] http://www.sciencedirect.com/science/article/pii/S0304389405003808

## Drilling Moore

March 20, 2015 2:46 PM by Dr. Scott M. Shemwell

Volume 4 Number 6

The Wall Street Journal recently reported that Mark Hill, VP Sales, North America for Allegro Development (software firm) suggested that rapid reduction in the time and cost to drill and complete a well coupled with the increased volume of hydrocarbon recovered was the industry version of Moore’s Law.[i]

Coined by Gordon Moore (former Intel CEO) circa 1970, it suggests that computer processing power will double every two years.[ii]  It was later revamped to read, “Double every 18 months.”[iii]

Not as well known, Moore’s Second Law, aka Rock’s Law indicates that while the cost of a unit of computing power falls, the capital cost to the semiconductor manufacturer increases exponentially.  This stands to reason as these companies must invest in R&D, new facilities, workforce competencies, etc.[iv]

So if the energy industry is now subject to Moore’s Law what does that mean?  If the (economic) marginal cost of drilling one foot or the marginal cost of producing one barrel of oil is falling in accordance with this model, then the capital required to enable these price points will be substantial.

The semiconductor industry survives and thrives as their “chips” are now everywhere.  SEMI (global industry association) predicts that sales of semiconductor manufacturing equipment will increase from \$31.8 billion (actual) in 2013 to \$43.7 billion (forecast) in 2016.[v]

One would expect that those making these levels of capital expenditures in semiconductor production are aggressively managing costs.  One way the sector manages costs is through automation.  For example, production is highly automated including the visual inspection process.[vi]

In 1973 and 1979, OPEC as the global swing producer caused “oil shocks” as petroleum supplies were withheld from the market.[vii]  Beginning in late 2014, that same consortium, led by Saudi Arabia does not appear to be having the same success.[viii]

The Mobility revolution is dramatically changing our world.  Legacy semiconductor and software sector economic actors are changing and new entrants abound.  These technologies are enabling the energy sector in new ways as well.

In our 2004 Roadmap to Enterprise Optimization study, we paraphrased one senior executive’s comments, “The digital oil field is getting more digital and less oil.”[ix]  A decade later, this statement is confirmed.

The semiconductor and its customer sector, hardware and software firms demand and pay high salaries for the managerial, technical and financial (among others) talent and it competes for these individuals at the global level.  The energy industry is similar.

Both of these global sectors depend on talent and a high level of workforce competency.  As such, traditional approaches to cyclical downturns such as massive reductions in the workforce may not be the best approach.

This is not to suggest that eliminating redundancies, reorganizing and restructuring are not appropriate tools, they are.  However, investment in Human Capital and the tools that enable the maximum return on investment from this capital are also appropriate.

The demand for petroleum and derivative products is expected to grow dramatically (by volume) between today and 2040, largely driven by growth in population to approximately 9 billion people and their demands for increased standards of living.  Annual growth in oil is slightly less than one percent (.8%) and natural gas 1.6%.[x]  Supply growth is expected to be led by newer extraction technologies as well as deepwater, tight oil and natural gas liquids.[xi]

For the energy extraction sector, Rock’s Law suggests that the capital investment necessary will be in new technologies and Human Capital.  Moreover, it is likely that Mobility and automation will play major roles in future industry funding models.

The industry can also capitalize on knowledge other sectors have and will continue develop in Mobility and automation.  This should reduce the associated costs and risks and is similar to the approach being taken in the Culture of Safety, Human Factors and High Reliability.

Inherent to all components of the Capital Expenditure Matrix is Human Capital.  It is this investment that will have the highest return.[xii]  Fundamentally, Human Capital is the 21st century equivalent of 20th century requirements for large industrial economies of scale.

The industry may be undergoing a structural change.  Is Shale and its extraction methods the industry equivalent of the integrated circuit?  One suspects it might be.  If this hypothesis is correct, surviving firms will be making dramatic changes as predicted by Structural Dynamics.[xiii]

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i] Ridley, Matt. (2015, March 14-15). Fossil Fuels Will Save the World (Really). Wall Street Journal. p. C1.
[ii] http://www.mooreslaw.org/
[iii] http://en.wikipedia.org/wiki/Moore's_law
[iv] Ibid.
[v] http://www.semi.org/node/52451
[vi] http://www.sciencedirect.com/science/article/pii/S0166361514001845
[vii] http://chenry.webhost.utexas.edu/public_html/elephants/OilShock201979-Final.pdf
[viii] https://consortiumnews.com/2015/01/13/behind-the-saudi-oil-price-gambit/
[ix] Shemwell, Scott M. & Murphy, D. Paul. (2004, September). Roadmap to Enterprise Optimization: A Guide to the Impact of Information Driven Field Operations on the Petroleum Corporation. Authors.
[x] http://cdn.exxonmobil.com/~/media/Reports/Outlook%20For%20Energy/2015/2015-Energy-Outlook-Presentation.pdf
[xi] Ibid.
[xii] Shemwell, Scott M. (2012, March 16). Millennials Arrive. Governing Energy. PennEnergy.
[xiii] _______ (2015). Structural Dynamics: Foundation of Next Generation Management Science. Houston: RRI Publications. http://www.amazon.com/Structural-Dynamics-Foundation-Generation-Management-ebook/dp/B00U0JKMT0

## Cultural Collision

March 3, 2015 2:58 PM by Dr. Scott M. Shemwell

Volume 4 Number 5

Energy industry pundits, including this one have extolled the aerospace safety culture as one to emulate.  It is true that the lessons learned from that sector as well as others can add value and perhaps prevent similar incidents by others.

Many readers may be aware that on January 9, 2015, United Airlines sent a safety warning message to its more than 12,000 pilots.  The basic thrust of the message, “the common thread with all of these [incidents] is that they were preventable.” [i]

According to the Wall Street Journal, United’s safety concerns are rooted in a number of internal matters.  Briefly, performance variables comprise both human interaction and technical flying skills.

Behavioral

Increased retirements as well as significant new hiring
Lack of respect for the Captain’s authority
Shorten Training
Integration of cultures following the merger with Continental
Asset class (air craft types) integration after merger

The memo apparently states that these behavioral issues pose a, “significant risk to the operation.”  These safety issues are largely cultural in nature and reflect changing societal norms as well as the integration of two organizations with different cultures.

Skills

Inflight emergency evasion
Landing with fuel reserves below minimum
Improper landing and takeoff procedures[ii]

It appears that United should be able to address these safety related issues in-house.  In other words, they do not depend on actions from government agencies, suppliers or customers to remedy the poor practices uncovered.

Currently, the oil and gas industry is undergoing a structural transformation.  As discussed in a previous blog, the commodity price trading range is at a step level change downward and may stay there for a long time.[iii]

This puts increasing pressure on already strained field operations.  Moreover, the workforce demographics are changing.  The long awaited Big Crew Change is well underway as well as the changing dynamics with the arrival of the millennials.[iv]

We have previously addressed cultural differences between operators and their supply chain partners.[v]  The United memo points directly to cross-cultural cockpit management as a contributor to the corporation’s safety concerns.  This is an important lesson for an industry that is restructuring and greatly depends on its supply chain.

Moreover, both the airline and energy sectors are highly regulated with a major focus on safety and there does not appear to be a track record whereby regulators have reduced scrutiny during economic downturns.  The more likely scenario is that the regulatory environment will remain strong and operations must adjust accordingly.

The proactive approach that this airline’s leadership is taking is a ‘good practice’ that all industry economic actors should emulate and is in accordance with the first axiom of a Culture Safety—Leadership![vi]  Understanding and addressing cultural collisions can lessen the chance of an actual collision.

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of five books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i] http://www.wsj.com/articles/united-sent-safety-warning-to-pilots-1424900742
[ii] http://www.upi.com/Top_News/US/2015/02/28/United-Airlines-warns-pilots-after-major-safety-events-and-near-misses/5881425121949/
[iii] Shemwell, Scott M. (2015, January 22). Is it Different This Time? Governing Energy. PennEnergy.
[iv] _______ (2013, Fall). Millennials Take On Our Increasingly Complex World. PennEnergy EnergyWorkforce. pp. 7-9.
[v] _______ (2014, November 7). Agile, Resilient, Sustainable Ecosystem. Governing Energy. PennEnergy.

## Positively Negative

February 20, 2015 1:23 PM by Dr. Scott M. Shemwell

Volume 4 Number 4

All of us are probably aware the people can become complacent in routine situations, no matter how fraught with risk it might be.  For instance, driving at higher than posted speeds on the Houston freeway system is routine—during the non-peak hours.  Indeed, driving significantly below “traffic” speed can have its own consequences.

So we become complacent and commute in a relatively dangerous situation on a daily basis.  Usually, nothing happens and we arrive at our destination.

Perhaps there is another perspective on this routine behavior.  In his book, Drift into Failure: From Hunting Broken Components to Understanding Complex Systems, the author Sidney Dekker refers to a construct, The Normalization of Deviance.”[i]

Put forth by Diane Vaughan who argued that risk is continuously constructed and renegotiated.  In other words, potential dangers are acknowledged, rationalized and then accepted as the new normal.  Under apparently similar circumstances the behavior continues.[ii]  Each time the conduct is successful, the gap between the actual risk and the individual decision maker’s (or team) perspective of the risk growths.

As this reinforcing behavior continues it is easy to see why the traffic speed ‘seems to’ continuously increase.  Accidents only happen to the other guy!

One can posit that we are not simply complacent but are active participants in the often dramatic changes in the “apparent” risk profile of a given activity.  As the Type A individual is rewarded with each iteration; Atta Boy, bonus, promotion, etc. others may mimic this behavior.

Moreover, the details that may cast doubt of the process viability often go unreported and perhaps unmeasured or even unknown.  Thus the organization’s culture becomes inherently, even latently less risk averse.

Readers may note that this blog has refers to latent variables previously.  A Latent Variable is one that is not directly measureable but is inferred.  Its behavior can only be measure through the observation of linked variable(s).  The Structural Dynamics construct directly addresses how management can confront this quandary.[iii]

Oil and gas operations are under tremendous cost and production pressure as of this writing.  The specter of lower, sustained crude pricing is real.  Natural gas commodity prices have been soft for years.

The temptation of The Normalization of Deviance’s immediate rewards may induce organizations and even the industry to accommodate a level of risk that it does not believe it is accepting.  In this game of musical chairs, the music may stop on your watch.

This New Normal may undo a lot of hard fought stakeholder value gains.  Guard against too much of a ‘can do’ attitude doing more with less.

## How does your organization assure individual and team behaviors are not changing your acceptable risk profile?

Dr. Scott M. Shemwell has over 30 years technical and executive management experience primarily in the energy sector.  He is the author of four books and has written extensively about the field of operations management.  Shemwell is the Managing Director of The Rapid Response Institute, a firm that focuses on providing its customers with solutions enabling operations excellence and regulatory compliance management.  He has studied cultural interactions for more than 30 years--his dissertation; Cross Cultural Negotiations Between Japanese and American Businessmen: A Systems Analysis (Exploratory Study) is an early peer reviewed manuscript addressing the systemic structure of social relationships.

### End Notes

[i] Dekker, Sidney. (2011). Drift into Failure: From Hunting Broken Components to Understanding Complex Systems. Ashgate.
[ii] Ibid.
[iii] Shemwell, Scott M. (2012, June). Structural Dynamics: The Foundation of Next Generation Management Science—βeta Version of the Construct. Version 1.0. Author.

## Towards Zero

February 4, 2015 1:33 PM by Dr. Scott M. Shemwell

Volume 4 Number 3

Mathematicians tell us that, “The distance between the curve and the asymptote tends to zero as they head to infinity.”[i]  From the ancient Greek, Zeno we learn the ‘dichotomy’ paradox—the repeated division into two leads to an infinite number of steps to cover a finite distance to which one can never arrive.[ii]

In 1997, this author introduced the construct of the Expected Value of Marginal Information (EVMI), which was defined as the (Expected value of the best decision with new information obtained at no cost), minus the (Expected value of the best decision without new information).  Economist will know that this model has its roots in economic utility theory.[iii]

Moreover, the late Nobel laureate R. H. Coase posited the hypothesis that the existence of the firm is justified when its internal set of transactions costs are less than the cost of using external resources.[iv]  In this model, costs are not just monetary but the total cost of doing business—those economic costs including opportunity cost.

What do these axioms have in common?  In a word—zero!

In our Fahrenheit world, we define zero degrees as the freezing point of water or 32 degrees.  Even on the Kelvin scale, absolute zero is defined as the degree where there is minimal particle movement—approximately minus 459.69 degrees Fahrenheit.[v]  True zero remains elusive.

Therefore, we can expect that zero is an unobtainable value.  However, the above examples suggest:

• In the physical and mathematical worlds systems tend towards a very small value
• The expected value of new information has real value even when it is very small
• Business models may drive transaction costs very low

We raise these points, particularly the last two bullets to posit that in our physical and behavioral world the construct of zero is foundational.  Another example, in the era of the Internet and mobility devices we have grown used to free data and information.

Organizations that continually focus on lowering costs are well positioned to assure sustained operations and profit in an era where transaction costs are trending toward zero.  By extension, this suggests that in our new economy, pricing power is limited and when strong it will not be sustainable.

For most firms, a strategy to become and remain the economic low cost producer may be the best strategy.  We use the term economic to reflect the sum total of all costs, monetary and other including human costs.

Low cost producers historically have focused on the small details of the business.  Much like High Reliability Organizations must focus on operational details.[vi]

Today’s firms in the energy value chain are required to do both.  Successful ones will return shareholder value.  Others may face a more uncertain future.