These Are Not the Earnings We're Looking For, Part LXI

 The mechanism we use in the Preliminary Specifications decentralized production models price maker strategy, that enables producers to produce oil and gas profitably everywhere and always is being summarized here in answer to the questions raised in Monday’s blog post. This is the methodology and the reasons in which we began our research in August 2003 into using the Joint Operating Committee, which subsequently enabled the development and publication of the Preliminary Specification in December 2013. That shale has changed the oil and gas industry from scarcity to abundance is the reason that things are as desperate as they are today. However, with the state of affairs in terms of organization and application of Information Technology, oil and gas would nonetheless have needed to approach the development of systems to better manage their organizations. That People, Ideas & Objects, our user community and their service provider organizations are timely and address a material need in the market is a benefit that we can build upon and turn the industry into a value generating enterprise for all concerned. All the while providing the energy necessary to ensure the North American economy remains the largest consumer of energy, hence energy independent and the most powerful economy.

The organizational structure that we’ve chosen is one that fits within a decentralized oil and gas industry. Centralization has had its day and fulfilled its purpose in society, however the Internet is enabling new methods of organizations to be formed based on the underlying Information Technologies. Other methods no longer remain a choice due to their inefficiencies, particularly in the area of speed and their capacity to deal with issues. Therefore we have taken the Joint Operating Committee as the key organizational construct of the dynamic, innovative, accountable and profitable oil and gas producer and industry, redesigned and reconfigured them to determine the “what and how” they would need to look like in order to operate based on that change. The Joint Operating Committee being the legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks of the industry. When we move the compliance and governance frameworks of the bureaucracy into alignment with the seven frameworks of the Joint Operating Committee we gain a speed, accountability and profitability that otherwise could not be achieved. We are assuming that if producer bureaucrats were able to deal with these issues, far too much time has passed, proving they’ve been unable to accommodate them. Therefore change is necessary and urgent.

It is People, Ideas & Objects fundamental belief that the overhead costs of oil and gas are material and vastly understated due to their industry wide capitalization of 85% of all its overhead. Dealing with these costs is a necessity in any new producer and industry configuration. What we’ve chosen to do is change these overhead costs from a fixed cost within each of the producer firms to a variable cost within the Joint Operating Committee, variable based on production. Moving the producers fixed cost administrative and accounting capability to become the industry variable cost administrative and accounting capability. We believe that each of the producers maintaining their own administrative and accounting capabilities is being replicated within each and every producer. These costs are not shared or shareable in their current configuration, are not part of the producers fundamental competitive advantage or offering and are costing the industry much of its profitability outside of the low commodity prices. Maintaining the theme of the decentralized organization we are then removing the administrative, accounting and related systems infrastructure and resources away from the producer firms into individual service provider organizations. These service providers are affiliated with People, Ideas & Objects as they deliver our software and their services to their client producers. This configuration enables the producer firm to focus on their key competitive advantages of their earth science & engineering capabilities, and their land & asset base. These service providers will be focused on one individual administrative or accounting process and will manage that process for the entire North American oil and gas industry. Exceptions such as production accounting, which we believe will move closer to the field, will of course need to be made. 

Highlighting the competitive advantages of the service providers would include the following. Specialization and the division of labor will enable the producers and industry to increase their production throughput from the same resource base. Automation of the business process is enabled through our user community member that is the principle behind the service provider. This automation is enabled through their hands on knowledge of the day to day management of their individual process and their ability to access the software development capabilities available to them from People, Ideas & Objects. Establishing a change based leadership in the industry to ensure that oil and gas remains innovative and profitable. And will not, once again, be subject to its accounting and business related issues defining decades of destruction through a complacent bureaucracy and the use of stale, unchanging ERP systems.

With the accounting and reporting focused on the Joint Operating Committee the producers will be receiving detailed comprehensive financial statements complete with actual depletion calculations and detailed, actual overhead costs that arise from the service providers billing for their services directly to each of the Joint Operating Committees. Overhead allowances will no longer be necessary. Therefore, the producers will be able to determine with high levels of precision and confidence which properties are profitable and which are not, based on actual costs. Those properties that are not profitable can be shut-in and as a result none of the service providers will be receiving any data through the People, Ideas & Objects Preliminary Specifications, task and transfer network. Therefore no data being generated leads to no work being done for that property and therefore no billings will be rendered for the shut-in property and therefore a null operation will be reported. No profit, but also no loss. This property is then moved to the producers shut-in inventory to begin work to innovatively return it to profitable operations. 

The benefits of doing this are substantial and increase the value of producers. The dilution of the producers profits will cease as only profitable properties will produce. Profitability will no longer be diluted by any unprofitable properties production. There is also the ability to extend this analysis to the field level where each well will be subject to the same critical review. Any well that is not profitable within that field or unit can also be shut-in in order to enhance the overall profitability of the specific Joint Operating Committee. It is here that the bureaucrats have accused us of collusion for well over a decade. Our response to that accusation has been. If making a fundamental, independent business decision not to lose money, based on detailed, actual, factual accounting is collusion, then… Additional benefits of using our decentralized production models price maker strategy include the reserves being shut-in can be saved for a time in which they’ll be produced profitably. Materially increasing the reserves value. The reserves will no longer have to carry the losses as additional costs that would need to have been earned if the property were to continue to produce unprofitably. These reserves can also be seen as relatively low cost storage as opposed to the high storage costs being incurred today. (Production, transportation and storage costs would not have been incurred.) Commodity markets will find their marginal cost when unprofitable production is removed from the market. Raising the value of the reserves but also the producers overall revenues which we clearly identified as necessities in Monday’s blog post. Markets provide one thing and only one thing. That is their price, which theoretically holds all of the information of the market within it. Using that information is what People, Ideas & Objects Preliminary Specifications decentralized production markets price makers strategy does. By focusing on profitability, producers will ensure investments in oil and gas are competitive in the greater market economy, which also happens to be based on price. And the overall greater oil and gas economic structure will cease to be subject to the boom and bust cycle which everyone has now unfortunately learned is so destructive and counterproductive. That being the industry that “builds balance sheets” and “puts cash in the ground.” 

People, Ideas & Objects White Paper “Profitable North American Energy Independence -- Through the Commercialization of Shale” discussed the pricing dynamics in oil and gas further. The following is an edited version of that discussion based on this graph that captures the assumptions the bureaucracies are operating under.

Looking at this graph from the perception of the producer bureaucrats. Their total costs of each barrel of oil produced in the various shale formations is in the range of $48 to $54. The operating, overhead and royalty cost of each barrel varies between $28 and $37. I would point out the difference, being $16 to $23, in capital costs are based on an allocation of all of the capital costs across the entire reserves of the property. In our white paper we’ve argued that this allocation is unreasonable in a capital market where the demands for the performance in today’s capital markets are far greater than what can be achieved when a producer is cycling their cash through their investments in a manner that retrieves that cash over several decades or more. This unheard of luxury was enabled through the specious accounting producers were performing. As the alternative, People, Ideas & Objects recommend in our Preliminary Specification that the producer retire all of their capital costs within the first 30 months of the properties life to provide for the reuse of this previously invested cash. This was our original recommended period in which to reduce the property, plant and equipment account. However based on our blog posts discussion on Monday we see there is a breakdown in the revenues of the producers, both in price and production volume, and no capacity to meet that criteria. Even five years is outside the possibility of the producers current revenue stream. Proof the state of affairs in the industry are deteriorating at a rapid rate at this point in time.

Providing producers with the means to meet the demands of their future capital costs, shareholder dividends and bank debt repayments, to address the rebuilding, refurbishment and reclamation costs we identified in our New Cost Structures series. Matching these costs better to the rapid decline rates experienced in shale can only be done if the producer is selling their commodities at a price that is well above their break even point which must consider an appropriate accounting of the costs of operations, overhead and reasonable retirement of its capital. Please note this graph reflects that Well Break Even and Shut-in values denote that at any point, and as long as the commodity price covered the operating costs, the property would continue to produce regardless of the impact on capital costs. If a dollar of capital costs were being returned, or one dollar above the shut-in price, that would enable the production of the property to continue. Only at the point in time where the commodity price dropped below the operating costs would the producer allegedly shut-in their production. We saw with March and April 2020 prices below $20 this principle being violated. This is a fundamental misinterpretation of the term break even, it is the reason the industry is in the difficulty that it’s in and why the producers have continued to lose money for the past four decades. Break even is not what is being interpreted here. What in fact the producer is assuming is that as long as there is cash flow above the operating costs, some of the time, then they’re making money and will continue to produce. What they’re stating is acceptable to them is they may not be breaking even, but they’re generating cash flow. As long as new investors were willing to make up for producers' lack of returned cash when bureaucrats did not recognize any of the capital costs to pass these on to the consumer, things were fine. Today with reasonable prices bureaucrats will divert cash flow to new drilling to restart the destruction once again.

What People, Ideas & Objects provide in our Preliminary Specification, if we could assume the accuracy of this graphs numbers, is the point at which the property would be shut-in would be at the breakeven point and below, always and everywhere. The reason for this being the production discipline gained through knowing that producing any property unprofitably only dilutes the producers corporate profits. Producing below the breakeven point is the point where unprofitability begins. Producing below the breakeven point for one producer, in an industry who’s commodities are price makers, will have the effect where the price of the commodities are dropped below the breakeven price for all producers' production. When all producers continue to produce below the breakeven price for four decades, as has occurred in North American oil and gas, you have a comprehensive exhaustion of the value from the industry on an annual and wholesale basis. Times were only “good” when new investors were willing

The Preliminary Specifications assumption is that the industries interpretation that oil and gas commodities are subject to ​price taker​ characteristics is incorrect. This is evidenced in the past years through the actions of OPEC+ with their removal of less than 2% of the oil from the market on two separate occasions which has brought about at least a 32% increase in the global price of oil. And in their most recent action of withholding their scheduled production increase. There’s the example of the Alberta government's mandated production cuts that removed regional differentials on heavy oil that were in excess of 80% of the commodity price. This small production cut, less than 10% of the overall productive deliverability of the province, had a dramatic effect where the differentials were eliminated within one month of the announcement. These are markets that reflect the characteristics of ​price makers​, not price takers. To state that “markets will rebalance” and continue to produce and increase production in a market of declining prices and profitability is not a business. It is foolish, irresponsible and reflects an uncaring attitude that is prevalent in today’s oil and gas producers. But then the bureaucrats did get paid. The Preliminary Specification is structured to implement the decentralized production model’s price maker strategy to rectify this behavior, establish profitability as the only fair and reasonable method of production allocation, and produce only profitable production everywhere and always.

With the inherent value contained within each barrel of oil. With the supply possibly limited to the next half dozen generations. Why would we ever produce any oil or gas that was unprofitable? What would be the purpose of doing so? Would we not just be robbing future generations of the resources they’ll need to expand their quality of life? Ensuring there’ll be no viable industry capable of providing for their oil and gas needs? On the one hand the costs of oil and gas exploration and production continue to escalate with each barrel of oil produced. This is due to the increased difficulty and science necessary to extract the resource. Therefore a more accurate accounting is necessary than what has been provided to the industry in the past decades. People, Ideas & Objects provides a more accurate accounting of the costs of exploration and production as part of the Preliminary Specification, our user community and their service provider operations. When only profitable production is produced it is implied that we're accurately capturing the timing and accuracy of all costs and passing them on to the consumer. Profits and innovation will be used to ensure an abundant, affordable supply is provided to consumers for the long term. Conversely, consumers paying the full cost of their energy will ensure that they’ll choose the most efficient and effective use of the variety of resources they have available.

Let's look at another “business” dynamic of profitability everywhere and always. If producers are interested in instilling some “capital discipline,” as they’ve claimed so many thousands of times before, we have what they’re looking for in the Preliminary Specification. When only profitable production qualifies to be produced: when do new wells get drilled? When is land purchased, and at what price? These are not going to be determined based on the same criteria their grandfathers used. A criteria which has been recycled in the industry for the past many decades. New ideas and understandings of the “markets” will need to be developed and employed to determine when and where activity can and will be conducted. What we have seen is the price of oil and gas recover to a reasonable level and the North American producers resume their parade of lunacy until such time as the price collapses once more. “Oh well, it’s boom or bust they say.” Which reflects the amount of thinking that goes into what is being done to determine the economics of oil and gas exploration, development and production! I believe I’ve called this just a science experiment in prior posts. Turning these into business decisions will be a necessity if any “capital discipline” is ever attained. Mouthing the words, once more for the cameras please, doesn’t really get it done. Wouldn’t it be something if the producer bureaucrats adopted an understate and over-deliver policy, instead of their [specious] claim of [whatever] now and undeliver always posture.

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. Anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

These Are Not the Earnings We're Looking For, Part LX

 As the bureaucrats best friend ever, the reality is at times I have to be cruel to be kind, it’s what good friends do. The Exxon and Apache litigations we noted in our March 2, 2021 blog post should precipitate action by each and every bureaucrat at each and every producer. They don’t need to hear the otherwise anonymous knock at their door. By funding the Preliminary Specification they’ll have the ability to tell the Judge they’ve mitigated these issues. Implying that they now understand their error, are aware of the problems that it caused and have implemented the solution to those issues. And therefore can claim “issue mitigated, nothing litigated.” The stark reality of my 2020 review of the producers financial statements is that the momentum and velocity of these issues we’ve been discussing here at People, Ideas & Objects are terminal to the oil and gas industry. There is no other way to describe it other than to say that the industry is not a viable going concern under the current business model. Certainly the recent increases in oil prices have everyone excited, however the performance of the producers will not and can not change, the bureaucrats business model for oil and gas is not based on generating incremental value. It is based partially on the increase in commodity prices to carry the stock price higher. That is how the bureaucrats rely on the oil and gas business to increase in value. There is no other way in which the bureaucrats that are now responsible for the producer can build any value. It is a pure commodity play and you would do as well, or even better by just investing in the commodities markets themselves. 

Like so many aspects of the producers performance, things are not as they’re claimed to be. Free cash flow for our sample of producers for 2020 was $2.85 billion. To put that in perspective, these producers maintained property, plant and equipment of $406 billion and annual revenues of $151.6 billion. The argument will be that 2020 was the year of covid and the producers should be cut some slack. And I would respond to that by saying I agree, however, the larger point that I’m making here is that oil and gas in North America is not a viable business in good times or bad, as it should be. Whether there is a reason for the poor performance or not. The reason that it was a bad year is because the producers continued to overproduce oil until such time as the prices turned to negative $40. They then continued to suffer through March and April with prices that were below $20. Why? They had the means within themselves to shut-in production and were indeed being forced to do so. Recall how they claimed up to that point that they could not shut-in oil and gas as it would cause irreparable damage to the formation? I wonder why we don’t hear what the consequences of those damaged formations are today? The fact that there is no damage is not newsworthy. Why did they not take enough oil off the market to continue to rehabilitate the price over the $20 threshold in March and April? There has been an inventory overhang depressing prices for about four decades by my estimate. By the second quarter our sample of producers were reducing 1.467 mm boe / day from their production profile. And why has it been that at the beginning of 2021 did our sample of producers report production volumes that were lower by 944 thousand boe / day over December 31, 2020 when OPEC+ were carrying well over 7 mm boe off the market throughout 2020 and to date in 2021? Saudi Arabia also cut an incremental 1 mm boe / day in late 2020? The fact of the matter is that others were doing more than their fair share to get the price of oil to $48.42 at the 2020s year end. And those of our sample producers were recording losses on North American production of $60.07 billion dollars due to those low oil prices did? It has been a struggle to survive but sometimes less is more. 

Based on our sample of producers their fourth quarter performance eked out a small loss of $3.2 billion dollars and achieved a total loss of $60.07 billion for the full year 2020. Granted the majority of the costs of oil and gas exploration and production for our sample was due to the massive write downs they faced. I guess the reserves value isn’t holding up to the prolific and out of control spending machines that we all know and call "producers." Of the $151 billion in annual revenues $101.5 billion was for depletion and impairments. On a straight mathematical basis, at this rate it would take the producers exactly 4 more years to retire the existing balance of $406 billion in property, plant and equipment. However during the past four years the capital expenditures of our sample of producers were $216.5 billion at the end of four years time. And therefore only bringing the property, plant and equipment accounts value down to 53% of today’s value. People, Ideas & Objects have been suggesting that the amount of property, plant and equipment at $406 billion for these 16 producers is obscene. Working capital is at $11.3 billion and we feel that 65% of property, plant and equipment is better redefined as it qualifies in our opinion as the unrecognized capital costs of past production. If that amount of property, plant and equipment was retired the account would need to be $142 billion demanding that a further $74.4 billion of depletion and impairment be recognized in the next 4 fiscal years. 

The reason I brought up the woeful working capital balance was to contrast the amount to capital assets. Retiring the amount of property, plant and equipment as a business will see these costs passed onto the consumer and therefore these assets are replaced with cash. This assumes that producers are charging appropriately profitable prices to cover the full cost of oil and gas exploration and production. That assumes these producers get their act together and instill some form of production discipline based on the market. The only method to do so is People, Ideas & Objects Preliminary Specifications decentralized production models price maker strategy. What these bureaucrats have proven time and again is the inability to understand or manage their inventories. With this cash being generated they can begin to manage the business appropriately. Fund the future capital expenditures and the new, incremental costs that we detailed in our New Cost Structures blog series recently. Pay dividends or pay down debts. 

Throughout our discussion, has been our belief that the symptom of low oil and gas prices are reflected in these accounting issues and are derived from cultural distortions in the industry. These issues manifest failings over the past four decades therefore destroyed the financial structure of the industry. Over reported asset values have a commensurate amount of over reported profitability, which leads to excessive inflows of investors seeking to gain access to those profits. That creates overinvestment which in turn creates overproduction that has been chronic over these past four decades, or at least 30 of the last 35 that I can personally recall, creating collapsed commodity prices. 2020 is a year in which I think that I can verify this claim in better context. If we look at the People, Ideas & Objects amount of recommended depletion and impairment for the next four years being $101.5 billion plus $18.6 billion (one quarter of the $74.4 billion noted above) for a total of $120.1 billion. Assuming the revenues from oil and gas sales in the current business model will not be substantially higher than what they were, as there is a historical cycle of chronic overproduction that destroys the prices when they begin to recover. Therefore if we take the average over the last 5 years then we get $206 billion in average annual revenues. That would reflect that these producers would be generating only $86.2 in net revenues after the cost of capital. Woefully inadequate and in my opinion reflects the chronic lack of any fundamental business understanding. Of course these producer bureaucrats expect that as soon as the investors return to see that absolutely nothing has changed in their business model, they’ll jump at the opportunity to invest. 

These projections reflect that 58.3% of the costs of the average revenues will be the cost of capital. And these costs will continue to be belittled by the bureaucrats as “just accounting” and “those costs are from the past.” I would remind them that the source of that capital was from the investors pocketbook and to expect they’ll return without respecting this point is quite inappropriate. The time frame of five years, 2020 was the first year, to bring these capital costs into a competitive framework is woefully inadequate as far as I’m concerned. These capital investments need to compete in the greater market for capital. How is technology doing these days. That is where many of the bureaucrats might find their former investors. Who are now satisfied and promises based on nothing won’t satisfy that sting of betrayal. “You’re gonna need a bigger oil and gas price.” Chief Brody, said in the movie Jaws. If anything, 2020 proved the inability of the bureaucracy to act in their own best interests when negative $40 and low oil prices throughout 2020 were acceptable, bureaucrats were paid! Yet these producers were well within their means to correct the situation, yet did nothing! With the motivation now to drill to access cash, and do they ever need cash, what will happen in 2022 to 202X? Rinse, repeat.

Producers will claim those assets in property, plant and equipment reflect the reserves value. If that is the case then write them all off as the only thing they’ve proven is that none of their reserves are capable of being produced profitably in their hands for the past four decades and are therefore useless to society. Yes when looking at the perspective of four decades you must consider the capital costs too. At today’s valuation vs what we believe they should be there needs an additional ($406 - $142) $264 billion in depletion has to be realized. My summaries of the quarterlies only goes back to 2016 which show that our sample of producers have lost $38 billion over the course of 2016 - 2020. How many years do we need to go back and find the “reported” profits of ($264 + $38 in losses) $302 billion to make up this difference, or can we? Our sample of producers represent 9.212 mm boe / day in deliverability, what would the amount of unrecognized capital costs of past production for the North American industry be? $1.275 trillion. What I find amusing about that $302 billion in losses is that it’s almost as big as the number of alleged retained earnings, contributed capital and bank debt of $359.8 billion, imagine that! Without investors and bankers this would have never worked! Yet after this record of destruction, an investors strike since in 2015, with no action taken to rectify or even recognize these issues, these bureaucrats expect investors just to cruise on back to be fleeced once more? Bureaucrats day of reckoning has come, here’s a hint it was 2015. 

For many years the disproportionate volume of the property, plant and equipment has been the pride and joy of each and every CEO. Parroting “building the balance sheet” and “putting cash in the ground” as their calling. I have been the lone voice in discussing this point and have paid dearly for the consequences of the ideas that I express in the Preliminary Specification. Ideas that are designed to deal with these and other issues of value erosion by the uncaring bureaucracy. It appears to me that here in 2021 I may have acquired many friends. The SEC has picked this issue up and are investigating the asset valuation issue at ExxonMobil. It is believed that they’re also expanding that to include an investigation of all of the shale producers. Subpoenas have been issued. We noted earlier in this post the fact that Exxon and Apache have pending class action lawsuits that are directly on point about the officers and directors actions regarding asset valuation. Not that I went through to count these actions but there seems to be almost 100 of them. And lastly, every producer that has issued their audited annual report at this time has identified the asset valuation and depletion as a Critical Audit Matter (Key Audit Matter in Canada). Will the auditors be able to issue a Critical Audit Matter for the same reasons in 2021? Asking for a friend? Action by the bureaucrats is demanded and necessary for the sole purpose of saving their souls. I’m only glad to be their very good friend and possibly their best friend ever, and able to help by building the Preliminary Specification. The first thing we need from the current and existing officers and directors is for them to fund our budget. 

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. Anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

These Are Not the Earnings We're Looking For, Part LIX

 Last Friday we discussed the necessary investments that were required in order to refurbish, replace and expand the infrastructure necessary for the future in oil and gas. The discussion focused on the service industry and those within the secondary industries that service oil and gas. I made additional comments about the midstream and pipeline operations and how they needed to be expanded, refurbished and replaced. Most importantly we raised the issue of who was going to pay these costs since the investors in these industries are of the same opinion as what the investors in oil and gas are. People, Ideas & Objects ask, how will producers obtain an adequate return on these investments that will be able to compete with returns in other industries? They’re not, these costs are a trillion dollar tax or legacy cost that will be the burden that oil and gas companies will have to carry as a result of their decades of mismanagement and chronic non-performance. These legacy costs will cause them to be unable to compete in the market for capital and debt. Just as they find the investment environment is today, however on a long term, chronic and terminal basis. The only ones who will be happy with this environment will be the current bureaucrats who are nothing more than wannabe oligarchs. But maybe I don’t understand and these will be nothing more than accounting charges and “sinkable” costs.

At many points in the past decade we’ve discussed the constraints that we believe exist to the forces of creative destruction and spontaneous order. Two economic principles that are a foundation to the dynamic nature of particularly the United States economy. How these principles are affected by the development of software which now holds a commanding position in “how” and “what” is done within organizations. The dynamic nature of organizations were developed on the basis of spontaneous order which enabled the changes and developments to occur naturally, or seamlessly. Now with software having an outsized role in our lives, IT both defines and supports organizations in a comprehensive fashion. At the same time they constrain our organizations when changes that are needed or desired are unable to be made until such time as the software is changed first. And without the required software development capabilities, or access to these capabilities to make the changes these organizations remain stagnant with the status quo. We’ve pointed this out repeatedly throughout our efforts since August 2003. We’ve also noted the behaviour of our good friends the bureaucrats throughout this time when they’ve used this knowledge to ensure that they do not make any changes to the software and therefore not cause any threat to their franchise to develop. And as a result creative destruction is being exercised on the industry as a whole itself, with no replacement.

And there are many other constraints to the development of creative destruction and spontaneous order. In oil and gas we are seeing a revolving door of bankruptcies, reorganizations and consolidations that are designed to secure some scale in terms of capital structure or operations. Once released by the bankruptcy courts these producers limp along for another year or maybe two and then proceed right back to court again. The key is that once a producer declares bankruptcy they are eligible for new loans to carry on their operations. These new loans hold a priority over all the other debts they carry into the process. This revolving door has been carried on for so long in oil and gas and in some cases so many times that now there are creditors that participated in loaning money to bankrupt producers that have no hope of getting these preferred creditor loans repaid. This overall process doesn’t allow for the old to be washed away and replaced by the new. We see the same old bureaucrats that we’ve all known and loved from twenty years ago piloting this process. These constraints to change are having a material effect in all industries through the liberal application of legislation such as bankruptcy that treat the walking dead with bandaids. I assume the key objective of the bureaucrats who’ve destroyed the value of the organization is to ensure that the bankruptcy process relieves their investors of the actual share certificates.

Bureaucratic efforts to deal with their cash demands have been to drill more, complete more and produce more. Contributing to the overproduction and oversupply that plagues the industry. Just ask any drug addict what it is they want and the answer always comes back as “more.” The depth of thought and analysis by the drug addict is consistent with what these industry bureaucrats have been doing. When they drill and expand their reserves, “that’s where the money is.” Except it is no longer, and hasn’t been the case for some time. Now that it’s evident that it’s all been a scam for the past four decades we’ve been through a number of phases of grief which are commonly understood to be “denial, anger, bargaining, depression and acceptance.” Stages that everyone outside of the C suite and boards of directors have been experiencing. To make a decision to remedy this situation appears not possible to me. Due to the realization that there isn’t any grief being reflected in the industry when the bureaucrats are fine, and they thank you for asking. 

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Parler @piobiz, anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

These Are Not the Earnings We're Looking For, Part LVIII

 I’m continuing with Wednesday’s discussion of how the revenues of the producers need to be substantially higher in order to cover the full costs of capital, operations and overhead of exploration and production. This is in order to earn not only a “real profit” but also generate the cash that’ll be necessary to fuel their future capital expenditures, dividends and pay down debts. Wednesday’s analysis showed that on a cash basis the investments that had been provided to the producers from investors were diligently invested. It is the return of that cash from the retirement of those assets that is frittered and wasted in the process of operating these organizations. Where depletion, which was more than inadequate to recognize the real cost of capital, provided the excuse for the producers bureaucrats to have ignored their impact as “just accounting adjustments” and to deal with them as “sunk costs.” Their ability to ignore these capital costs as a significant part of the cost of oil and gas exploration and production has allowed producers to deceive themselves into “building balance sheets” and never recapturing the real cost of oil and gas from the consumers of those products. The costs that were passed on to the consumers were heavily subsidized when the investors were picking up the tab for the capital budget each and every year. Now that this is no longer happening the value that was built within the organization is being cannibalized, sacrificed and destroyed through low commodity price production in order to continue the consumers subsidy and the bureaucrats personal bounty. 

I have suggested consistently that the real cost of oil and gas exploration and production in North America is in the range of $135 to $150 / boe. That would have commanded a far higher price than what was realized in the third quarter of 2020 and even higher than what would have been required in my revised revenue number of $195.72 billion of revenue in Wednesday’s post. Based on our sample of producers production profile the average price received for 2020 as of the third quarter is $45.38 / boe. This considers all forms of revenue from tariffs, royalty, production and hedges. Therefore the price needed for the revenue of $195.72 billion would have been $79.89. Still well below the minimum threshold of what we believe would be necessary to cover all the costs of oil and gas exploration and production. At $135 and $150 / boe revenues for the nine months would have been between $330.7 and $366. billion. Note these are just the costs, an element of profit would be incremental to these prices. These will be the numbers that we work from for the remainder of this post. 

The first aspect of the need for these heightened revenues is the fact that they would be subject to much higher taxes. These would be incremental to the taxes that have been paid and have what I would consider to be a material impact on those revenues. What that amount would be is unknown and to be determined. Our first point regarding increased capital costs is represented in the discussion of the ERP market space in oil and gas. On page 18 in our white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale” we discuss the difficulties that have been created in this market over the past number of decades. There has been and will be no funding of investment made by anyone into these ERP systems at any time in the foreseeable future. The producers activities with respect to the expectations and their behaviors of how the ERP providers were treated has left a bad taste in the mouths of those investors. Large systems providers such as Oracle and IBM also left town as there was no ability to deal with producers that expected everything to be built on spec and once ERP providers investors were able to put their system on the market, and the market being so small, succumbed to producers not paying anything for these systems. Producers will now have to pay for their systems in advance such as the offering People, Ideas & Objects are providing. There will be no other way in which new systems will be brought to the market. 

I raise this as I feel it is now the precursor to understanding the service industry. Who invested diligently and faithfully to service the oil and gas producers and were used and abused in similar ways to the ERP systems providers. Where will the service industry find the resources necessary to rebuild their organizations? Who will be the provider? We saw Oracle and IBM leave in 2000 and 2005. Schlumberger is just leaving now. Haliburton and others appear to be of like mind. Who is going to fund these operations and rebuild the capacities and capabilities of the service industry to support the operations of the oil and gas industry at the capacities that are needed in the near future? The funding of People, Ideas & Objects will become the defacto method in which things are completed in the future. Producers have destroyed their business but most importantly their credibility. If they’re unwilling to fund the next iteration of development, based on the providers Intellectual Property, then the producers will have no choice or opportunity otherwise. Just as People, Ideas & Objects suggest to the producers now, if they can’t invest in their organizations profitability, why would they expect anyone to invest in them? There will need to be direct involvement in the areas that the producers need to conduct their exploration and production. Not involvement from sticking their fingers in things, direct involvement from the point of view of providing the financial resources upfront. The only source of cash that I see for the next 25 years in which the producers will be able to do this will need to come from the consumers in terms of they’ll be paying for the full cost of exploration and production. Producer bureaucrats have now destroyed all other methods of funding for at least a generation. When their credibility has been summarily destroyed as the producers have so effectively done, that’s it they’ll never get it back. 

You want a new pipeline to where? Well then that’s going to cost you. Shifting the burden of developing the infrastructure for oil and gas onto pipeline companies and others is not going to fly any longer. Especially when in the past as soon as the producers commissioned a new line they paid the annual bounty necessary to stop Greenpeace and all the others from picketing their head office. Now that producer bureaucrats have taken a more “progressive” attitude toward clean energy, carbon capture and climate change, why would the pipeline companies want to be the companies that violate this goodwill on behalf of the oil and gas producers in the eyes of their new clean energy and climate change communities. Producers should add Paymaster to the name of their companies. It would better define what it is that they’ll be doing in the very near future. Oil and gas is a primary industry indicating they receive their revenues from the resources they extract. These resource revenues continue irrespective of the actions of the producers and account for the actions of all the sub-industries activities as well. The service industries involved in oil and gas are secondary industries who do not have primary revenues and do not service other industries. Drilling rigs, oil and gas ERP systems and the like are unsuitable for any other industry. Therefore if the primary industry that wants these services will have to start paying for them. Expecting that others will do it for them is over. Investors have been burned comprehensively in every aspect of oil and gas and won’t be back. I only continue to mention investors as they are the ones that initiate action. Action that leads to the activities that generate value, employment throughout the greater oil and gas economy. “Building balance sheets” and “putting cash in the ground” just doesn’t have that old time appeal anymore. The industry has been broken and can only be fixed through a decade of prudent and effective management that mitigates the memories of what has gone on. A decade at a minimum, and People, Ideas & Objects will have years of work to do before that clock even starts ticking. 

There have been some instances where producer bureaucrats thought they could walk away from the assets they’ve benefited from over the past decades. However, a tiring and aging infrastructure is not something that taxpayers are going to accept as a gift from the industry. As more administrations become wise to the actions of those few there will be steps taken to ensure that the burden of one irresponsible producer attempting to abandon their environmental disaster will be shared across the industry in some form. These costs are minor in the great scheme of things today. However, in five to ten years they will become trillion dollar costs of remediation and will exceed bureaucrats comprehension. They most certainly will not be granted the license of muddling through. Expectations will be that these are either refurbished or reclaimed and the demands for energy met. What return on investment will bureaucrats be offering investors on these reclamation, rebuilding and infrastructure projects? Investors just might not be enamoured with "building balance sheets" or "putting money in the ground" anymore.

How do the producers come up with the money to pay for all of this? And to do so in this new era of abundance brought about by shale? Simple, as a primary industry producing commodities that fall within the definition of price makers they start with the development of People, Ideas & Objects Preliminary Specification with its decentralized production models price maker strategy. Which provides the only fair and equitable method of production allocation. If it’s profitable, considering a standard accounting across the industry that includes all of the costs of exploration and production, it should produce. Until such time as there is this method of fair and equitable production allocation in North America, we will continue on this downward trajectory. Once the price maker strategy is implemented then and only then can these producers begin to produce oil and gas profitably from the real sense of the word and consider the full cost of oil and gas exploration and production. What’s going on today is far from this. With a group of self interested and distracted bureaucrats who are only concerned with their needs and looking good to John Q. Public. They have no idea, no ideas, no plan and no strategy but most of all no concept of the looming difficulties and why they’ll be so complex. The energy safety and security of this continent is not something that can be fooled around with. It is reasonably evident that these bureaucrats are satisfied with themselves. They haven’t done anything for over a decade now and should be happy. Please note, within the Preliminary Specification there is the Resource Marketplace module that provides the means in which to establish the methods necessary to rebuild these markets in the secondary industries that the oil and gas producers will need and to move the industry forward. 

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Parler @piobiz, anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

These Are Not the Earnings We're Looking For, Part LVII

 The one thing that I’m at a loss to find in these third quarter 2020 reports is an excuse, any blaming of others or viable scapegoats being raised as to who is responsible for the difficulties these producers are facing. They must have taken my advice, looked at themselves in the mirror and realized it was they themselves that were responsible for all of their own problems. We can understand that they’re not going to be the ones who’ll be standing up to say they're the ones that are responsible. Therefore best to be quiet about it all. And then just like that the industry shifts again. This time in a sea of red ink we have them pursue the lofty goals of renewable energy and carbon neutrality. That is in a post consolidated industry. Bigger, more bureaucratic is always better! It’s now not the oil and gas industry but what we can now call one of two possibilities. Either the Lost Cause Business, or the Politically Correct Sycophants. I of course am partial to both and will use either from time to time. Responsibility was never a requirement to be recognized or upheld by the C Suite or board of directors. Think of these people more as the politicians of the industry, formerly known as oil and gas. 

These cover stories for the destruction that happened on their watch will not fly. What’s the plan, where’s the strategy? Have any of these bureaucrats uttered the word “real” in combination with the word “profits” ever? These are the visions of how they’ll move forward, get out of oil and gas, focus on clean energy and carbon neutrality? How and with what? These are crippled organizations with little to no life remaining.

Does anyone remember how bad it was in 2016. Our sample of producers had losses for the entire year of $30.2 billion. We were assured by these same bureaucrats that they then had things in hand and would be on the upswing. So far in 2020 these producers have now created $56.8 billion in losses. I say created because that is what they do, lose money that was entrusted to them and they promised to be responsible for. Our sample represents one third of the productive capacity of North America therefore it's reasonable to assume that the industry's losses would be approximately three times that value. Let’s be fair to these bureaucrats and note that the pandemic has caused a significant distortion in the market. Creating a demand loss that further destroyed commodity prices. Therefore their write downs of property, plant and equipment due to the ceiling test were substantial. If we reversed the recorded depletion for 2020 of $84.8 billion we see that without having to account for the capital aspect of the business bureaucrats would have reported a specious profit as high as $28 billion! Which of course as People, Ideas & Objects have always claimed that would also represent a return of $84.5 billion of the previously invested cash that investors “had to put in the ground.” However, as our good friends these bureaucrats have been able to do their thing with this money, the amount of cash actually generated by the third quarter of 2020 is negative $3.6 billion. The key here at this point was that in the past there were always more ready and willing investors lined up out the door of every producer to make up the cash difference. As we’ve always said the consumers, who have as a result of these bureaucrats methods, had their consumption of oil and gas subsidized by having the investors paying for the capital costs of that consumption. The value of that subsidy is handsomely represented and accounted for as property, plant and equipment on the producers balance sheets. Yet consumers have no understanding of the fact they’ve been subsidized and no appreciation for the value of the commodity that they use to fuel their highly productive lives. To be as clear as I can. Producers would need to increase their revenues of $110.925 billion in the third quarter of 2020 by at least the $84.8 billion of recorded depletion in order to generate the cash from these assets. Revenues of $195.72 are what are necessary to pass on the “current” costs of oil and gas exploration and production. Making oil and gas a business for the first time that I’ve been involved in it.

When I raised these points in the past I was laughed at. This is certainly not in the realm of any analysis of what companies or analysts conduct. This is just crude checkbook balancing in a way. You have this much coming in and that much going out. In 2020 these producers were able to source $7.519 billion in additional debt. And they paid out a dividend of $7.515 billion. Just crude checkbook balancing, what’s in, what’s out. Cutting dividend payments will continue due to the fact that banks are making these transactions more difficult. When the laughing in the past subsided I would be lectured that “those costs of depletion were not real and are just accounting adjustments.” I would argue they represent the retirement of the assets and the producers prior investors resources. And they would state “those are all sunk costs and we don’t concern ourselves with them.” They would then turn around and state these same things to new investors who were prepared to pay next year's capital budget. Eventually their investors understood the meaning of what the bureaucrats were talking about.

The pandemic can cause a company to look at their depletion and say these are exceptional times and we have to survive them and those losses due to depletion are the consequences of these bad times. Then how is it that these producer bureaucrats have been using this same excuse for decades when they were able to line up investors annually due to the fevered excitement and “good” times they created with their specious reports and filings. Without the annual investor infusion they would not have been able to survive. For evidence of this, review the past five years when the investors have slowly withheld all of their funds from the producers. Working capital as of the third quarter of 2020 is $12.6 billion for all of our sample companies that also list total assets of $520.5 billion. Liquid assets are 2.43% of all assets and they think they’re building balance sheets? Total shareholders equity as of the third quarter of 2019 was $295.4 billion and is now $193.2 billion. Clearly I have no idea what building a balance sheet involves, what it is or how to do it. I don’t know it when I see it and who would have it. Losing $102.2 billion in equity in one year is the end result of building these balance sheets? If anyone is with the bureaucrats in this exercise then I’ll remain on the outside. I’ve always stated that I don’t have to be crazy to do my job, but I find it to be a distinct competitive advantage. I’m beginning to question who’s crazy here. 

People, Ideas & Objects believe that over 65% of property, plant and equipment should be restated on a pro-forma basis in order to understand the full scope of the damage that has been done here. This would represent the capital costs of past production that has not been recognized by the specious accounting conducted in industry on a culturally systemic basis. This is due to the fact that overhead and interest are recorded as capital at very high percentages, and lastly we believe that a redefinition of what is capital and what is not needs to be ascertained in the new shale era. These in combination with the desire to “build balance sheets” has caused producers to systemically demand investors to fuel their capital needs as opposed to having the business generate the financial resources internally. With the state of affairs in the industry the only source of funding in this capital intensive industry is to recognize these capital costs stored in property, plant and equipment, ensure that the prices that producers receive for their production covers all of the cost of exploration and production which will provide them with the financial resources needed to proceed in what is agreed to be a very difficult future. Investors and banks are bowing out due to the well earned reputation of the bureaucrats. The only remedy is through the Preliminary Specifications decentralized production models price maker strategy. Once again to clarify my point. I would include a large portion of the 65% of these assets from the pro-forma adjustment to also be included in the current periods costs of exploration and production. Therefore the revenues needed would be $195.72 billion plus a good portion of those property, plant and equipment assets that would otherwise fall within the 65% pro-forma adjustment.

What I see is that producers in 2020 are not making up for any of the value that they’re consuming in the process of exploration and production. It is just a more severe example of what I’ve seen in each year of the past four decades. They’ve eroded all sense of value from the producer firms themselves in order for the chosen few within the company, those that had the responsibility and authority to do otherwise, to prosper personally and extensively. It is evident at this point that none of these bureaucrats are feeling any shame for what they’ve done as they all remain at their post and continue to reap what others have sown. 

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Parler @piobiz, anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

These Are Not the Earnings We're Looking For, Part LVI

 A quick note to point out I've placed a Patreon button at the top of the left column to help keep the faith.

I can now stand by my claim that the oil and gas producer bureaucrats' universal claim of “building balance sheets” or “putting cash in the ground” are about as false, unreasonable and meaningless as any claim has ever been spoken by anyone in authority. And there is a broader implication involved in this by way of the fact that building balance sheets was code used by bureaucrats to sell their specious accounting to those outside the industry to believe that everything was being conducted equitably. Throughout the time I’ve been writing this blog I’ve noted that the accounting has been purposely deceptive. Producers seeking to uphold the SEC’s requirement of recording their property, plant and equipment account to ensure that it never crossed the threshold of their reserves value was a misinterpretation and fabrication designed to line the pockets of said bureaucrats with the value that they were fleecing from investors each and every year. The SEC does have that requirement, no question about it. However the cultural interpretation by these bureaucrats that they must reach that value each and every year is a distortion. The SEC’s requirement is a safeguard against the lack of performance by the producer spending more than the value they are generating. The fact that most if not all producers over the past number of decades have been subject to reductions of their property, plant and equipment accounts, via the dreaded ceiling test write down, is evidence of the fact that they consistently, and on an industry wide basis spent more than the value they generated. When confronted with this there was a consistent claim that “these were accounting changes and those were sunk costs.” Never once holding any moral obligation to account for their out of control spending or chronic lack of performance. Building balance sheets has no basis in reality or fact. It is not a business objective and does not exist outside of oil and gas. It is code that the producer was actively participating in the fraud as all corporate citizens in the industry do.

To repeat uncontrolled spending in this manner leads to overstated assets on the balance sheet which lead to over reported profits. Which attracts more investment and this overinvestment leads to overproduction. Which is the systemic and chronic problem that we’ve proven has been present in the global oil and gas industry since at least July 1986. These are not “assets” and are nothing more than what we describe as unrecognized capital costs of past production. 

The evidence that arises from the third quarter 2020 reports verify these claims and are precisely the facts that should be the most embarrassing in the history of the industry. For example, the third quarter report of Apache Corporation, on page 1 of this report you’ll find the following.

While significant macro headwinds continue to persist, our strategic approach to creating shareholder value remains unchanged: we are prioritizing long-term returns over growth; generating free cash flow; strengthening our balance sheet through debt reduction; and...

There it is, at the end of that quote and in clear text they’ll be strengthening their balance sheet along with a list of things they’ve never done or believed. So why is this so relevant to the claims that I’ve just made. It is for the fact that Apache’s balance sheet reflects the dead zone. If this is what they have to show after decades of building, someone desperately needs to take it away from them as they’re either wholly corrupt or so naive as to be inappropriate for the role in which they’re employed. Apache is sitting at the end of the third quarter of 2020 with negative equity of $37 million and to note, Paid in Capital was $15.418 billion in the third quarter of 2017. That is a total loss to date of $15.455 billion. In their defence I would suggest at this time they could only build as they’ve destroyed all of the money their investors ever gave them. They’re “safely” just destroying debt now. On February 1, 2011 Apache had a share price of $133.37. Almost three years later, in December 2013 People, Ideas & Objects published the Preliminary Specification. Detailing a solution that specifically addresses the issues that are plaguing the industry today. In November 2020 Apache is trading at $9.75 as of Monday. 7.31% of what it was worth almost a decade ago. I checked with the bureaucrats and they said they lost money in the process too, but are otherwise fine and thank you for asking. The efforts of these bureaucrats, and lets be specific here, the C suite and board of directors have been working at cross purposes to all those that work at Apache, the service industry and its investors. To quantify what has been lost in terms of market capitalization is the easiest method of calculating losses. Similar and equal losses would have been incurred within both the entire staff of Apache and the service industry just from these Apache bureaucrats. 

The point that I am making is something that I want to make perfectly clear. There was time for the bureaucrats at Apache to have acted to participate in the development of the Preliminary Specification. Let's assume for a moment that they participated as if their life depended on a successful development and implementation. People, Ideas & Objects are one organization and this will take the will of the producers to make it successful, most of all. If they should continue to sit around with their finger in their ear then they’ll have wasted everyone’s money. But what if they hadn’t. The cost based on Apache’s current production profile to participate in our development would be $140.3 million dollars. However it would have provided the avoidance of the losses that they’ve experienced. Taking only those losses that we are aware of in terms of market capitalization. Those losses total $50.33 billion, only a very small fraction of the costs and what I would think Apache would agree is a good return. The destruction in the industry is something that People, Ideas & Objects have discussed throughout the past number of years. Starting in August 2003 in fact. We’ve always pointed to the bureaucrats as the reason for the issues and their inability to act to rectify these issues was maybe a close secondary issue. I want to say at this time that I appreciate the fact that they went out of their way to prove without any doubt the validity of the following three facts. Our belief the industry was headed for disaster if they didn’t act in a timely manner. That the bureaucrats were responsible in every and in all ways. And lastly that the losses were the most material losses that any issue has caused the oil and gas industry at any time in its history. I guess congratulations are in order, which bureaucrat should we nominate for Bureaucrat of the 21st Century?

Why are profits, the real kind of profits and value generation that People, Ideas & Objects have been discussing in the Preliminary Specification, profits that account for the full costs of exploration and production in each barrel of oil produced, considered so evil and vile by these bureaucrats? Why the violent response to People, Ideas & Objects and our Preliminary Specification? The determination and persistence shown in fighting us since August 2003 has been impressive. The reason that we believe this has happened is because the effective disintermediation that our system does to these producer bureaucrats. Just as iTunes terminated the dreams of record store managers. They are redundant in a post deployed Preliminary Specification world. And, we believe that it’s fundamentally easier to manage a firm that is focused on spending. Whereas profits, and particularly profits that are real and earned take significantly more work, effort and difficulty to attain in terms of skill than what has been displayed or understood by these bureaucrats. Why would they want to try now to reach for attributes that were previously satisfied through accounting wizardry? The differences between these methods of profitability are as large as what is required to earn the vote vs what’s required to stuff a ballot. 

Back in 2017 we noted that BP’s Chief Economist stated that the world had twice the amount of oil it needed for the next 32 years, or until 2050. Therefore, it would be in the best interest of the OPEC producers to produce what they have and provide the market at whatever price is offered for the next 32 years. With the abundance of supply on hand OPEC’s low cost producers would find that they would be profitable at any price, but their margins would be slim. For high cost producers like those in North America, they’re out of business. That in essence was the message that the BP economist was admitting to. Twice the supply of oil that is needed up to 2050 will be long after the virus has subsided and is therefore the long term issue producers need to be focused on. The business model of North American oil and gas producers has to change in order to accommodate this supply change from scarcity to abundance and shale’s high cost. This environment, unlike the virus, is not a temporary situation in either oil or gas and will need to be addressed by acting to develop the business model of the Preliminary Specifications decentralized production models price maker strategy.

Commodities are too valuable to be produced unprofitably. Continuing to do so aimlessly, or is it purposely, is damaging the industry and its capacity to profitably fuel North America for the remainder of this century. It’s going to take at least that long for a working prototype of the pocket fusion reactor. These major producers are just shifting to clean energy because it makes them look like they’re active in the eyes of John Q. Public. They’ll have to admit at some point they have a responsibility to fuel the economy. Producers are continuing to manage as if they’re in the pre-shale era. References to how they expect the business to behave are based on those assumptions and they’re flawed as the dynamic of shale is destructive to that business model. The point for them is what’s a few more years of poor performance when you have such a record? As I noted they said they were fine.

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Parler @piobiz, anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

These Are Not the Earnings We're Looking For, Part LV

 Earnings, or whatever you want to call what it is that producers do, are very disheartening in the third quarter of 2020. The deterioration of the financial base of the industry is something that I’ve documented here since before the general exit of the investors in 2015. An interesting commentary of how this happens is the series I ran in early 2017 entitled “My Argument.” There is also the White Paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” These detail the decline of the industry on its current trajectory and define its ultimate ending in the reduction of its capabilities and capacities in terms of what the service industry will be able to provide, and ultimately North America’s downward trajectory in terms of its production profile. Now in November 2020 the answer to the kids, is yes most definitely we are here. I’ll concede there’s been an acceleration in the industry's downward trajectory as a result of the virus. I’ve always stated that the ability of the industry to weather another storm would be difficult based on the financial destruction that has and was occurring. The virus is maybe the best example of what can happen when an industry is unprepared for further difficulties however, these oil and gas producers were wholly unprepared for even a mosquito bite. We are in serious jeopardy at this point. 

The state of affairs is untenable. We can coast the downslope for quite some time and enjoy the efforts of those that came before us. We’ve done that now and the previously established value has been extinguished. There is nothing left anywhere in the North American oil and gas industry as it stands today. It needs to be rebuilt brick by brick, and stick by stick once again for the demanding future oil and gas faces. The third quarter reports show that it is not these organizations that are going to be the ones that drive the bus. They have no concept of what it is that’s destroying them, so they feign to the media and themselves. They have no desire to address what it is they’ll do to remedy the difficulties. They’ve done nothing for well over a decade now and these facts are highlighted in the commentary from here and here.

This is going to be a quarter-by-quarter, year-by-year slog and I’m sure we will prevail,” (BP) Chief Financial Officer Murray Auchincloss said in an interview with Bloomberg.

Exxon’s Swiger (CFO) is convinced that prices will recover. Things are so bad that prices across oil, refining and chemicals are “at or significantly below bottom of the cycle conditions,” he said. Whether Big Oil investors are willing to wait for that forecast to come true remains to be seen.

We also have evidence in this World Oil article that the producers have not discovered the solution to what ails them at this time. People, Ideas & Objects have been writing about our solution to their difficulties for many years now. It never dawned on me that the Internet hadn’t been installed in oil and gas yet. Here's another quote from that World Oil article.

“Making energy relevant and investable again is the million dollar question,” said Jennifer Rowland, a St. Louis-based analyst at Edward Jones. “They’re still trying to figure that out.”

The primary issue that I have with the last quote is that making energy relevant and investable again should be the “Trillion” dollar issue. For producer bureaucrats it is as always, they’ll muddle through and do nothing. With the caveat that maybe their “investors are willing to wait for that forecast to come true.” Just as People, Ideas & Objects are concerned about the capacity of the industry to deal with difficulties in its current situation. With the virus raging there is no guarantee that there won’t be any further surprises down the road. The unpreparedness of these producers combined with their lack of financial capabilities and head in the sand routine will cripple its opportunity in terms of North American energy independence. We documented before how the energy sector as represented in the S&P 500 has dropped from 11 to 2%. Noting in today’s market that represents a $2.07 trillion dollar decline. Those are the real losses that have occurred in the financial industry to the producers investors directly. Separately the value proposition of People, Ideas & Objects is in the range of $25.7 and $45.7 trillion over the next 25 years. These values represent the difference between the current bureaucratic business model vs what the Preliminary Specifications decentralized production models price maker strategy provides. A differential generated through the ability to ensure each property is profitable everywhere and always. This value would be distributed in terms of the producers funding for future capital expenditures, dividends and retirement of bank debt. But even more than that it would provide the financial resources for a robust and well managed industry that supports a healthy and robust secondary and tertiary industries the producers rely upon to function. It would also provide career security to those people who have, and most importantly who will need to commit to the industry in the future. Therefore that $2 trillion in losses from the S&P is incremental to People, Ideas & Objects value proposition. 

All of these losses are most likely replicated in the people who no longer desire to work in oil and gas or the service industry and the general economy overall. Creating additional serious long term issues that remain unaddressed by the producers. But more than the losses that we can easily document today, the Preliminary Specification was published in December 2013 and since that time it has been a steady and tragic decline in the value everywhere for anyone associated with oil and gas. We’ve also lost the capability to prepare for the future. We don’t have the resources or infrastructure to build upon what needs to be available for that very difficult future. This is part of the tragic loss that has been incurred by the deviant and irresponsible nature of the producer bureaucrats that have been the cause of all of this. It is they who did nothing in the face of such difficulties. And yet, as we see in those two quotes above, both BP and Exxon suggest that essentially “muddling along” and “doing nothing” are the only routes they’ll pursue. These are pre-retirement statements in my opinion. These forced retirements have to be instituted immediately by those that are capable of doing so and we need, in my opinion, to move forward with the development and implementation of the Preliminary Specification. These third quarter reports show that the downward trajectory has accelerated much faster and further. We are now on the verge of a panic in terms of the “actions” that will be taken to remedy the problems that are seen as the culprits. And as in any panic nothing good is ever decided and no constructive organization or sense can be made until things are worn down to the base.  

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Parler @piobiz, anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here. 

How Producer Bureaucrats Overstate Cash Flow, Part V

 The bigger they are, the harder they fall is the saying. It’s difficult times like these in oil and gas that having the agility of a hummingbird will ensure you have the capacity to meet the threats and realize the opportunities that a producer may face. Much as the resilience and persistence of a startup organization would have. Turning bureaucracies into a larger form of the beast that has brought it to its knees will? I think we’ll find out in very short order. When the world is employing technology to accelerate their organizations to deal with the speed and pace of business. It’s good to know there are still rebels who can shirk that dynamic and show that there are different roads that can be taken. There are many examples in history that show these producer bureaucrats that their grasp of the past will be successful. The former Soviet Union was a basket case and now under Putin? Or how about the doubling down that we’ve seen in Iran? These are the kinds of rebels providing inspiration to our good friends the bureaucrats. Even closer to home we have the pertinent example of Maduro in Venezuela. When so many oil and gas bureaucrats think the same things regarding consolidation, how could they be wrong? And think of the benefits, a single point of contact for everyone for all things oil and gas. What was I thinking of bringing ERP systems based on the Joint Operating Committee to make North American producers dynamic, innovative, accountable and profitable?

We’ve now discussed the allegedly immaterial and irrelevant costs of overhead and interest in the oil and gas industry. Cenovus, post Husky consumption, plans on 25% of their staff being cut, the financial relief from just the staff salaries that are cut will total 100% of what Cenovus reported as G&A for 2019. Yes, overhead is irrelevant in oil and gas and we must always believe that! So the bureaucrats say. Here’s a question I have about these cuts and overhead in general. What is it that these people who are deemed “overhead” do? Do they just sit on their hands all day? Or are they active and productive, in the course of which incurring significant, additional overhead costs in their wake. When you cut the staff, are the activities stopped, or do others just pick up the generation of these other overhead costs? If so, what have you cut?

We move on now to discuss the third category of over capitalization that is used to “build balance sheets,” overstate earnings, attract overinvestment and hence create chronic overproduction. This third item is the line between what is deemed to be capital and what is operations. There is no disagreement that oil and gas is a capital intensive industry. This should apply, in our opinion, to the commodity sales price as well. That commodity prices should reflect the significant capital costs that are involved and included in exploration and production. Producers are facing an acceleration of their costs of exploration and production over the next 25 years. Facilities and infrastructure will need to be either built or extensively refurbished in order to remain in service through this period. The costs of oil and gas contained within each barrel of oil is on an ever increasing trajectory. The effort involved for the exploration and production of each incremental barrel of oil equivalent is higher than the prior barrel was, as it always has been. The logistical, political, environmental and business related complexities and difficulties are accelerating and will continue to do so. Recent history has shown that the industry is uncompetitive in the market for investment capital. Cash can no longer be “put in the ground” for the bureaucratic sport of it. The retrieval of that previously invested cash has to be the primary concern of the producer. This would enable producers to internally generate the funds for their own capital expenditures, pay off their debts and issue dividends which will be a requirement for at least the next decade in order to reestablish themselves with the reputation of profitable, value generating organizations. Until then the only source of cash will be claiming that “cash you have to put in the ground” as producers have been telling their investors these past decades. 

“Shale is a rapidly depleting asset” is the opinion of Wall Street investors. And investors are efficient communicators of the difficulties being faced. There are very high costs associated with shale drilling and completion. All subject to those accelerated decline rates. Extensive reworks and recompletions are necessary in as little as one to one and a half years. Additional laterals may be drilled and completed to expose new reserves to the well bore and enhance the deliverability of the remaining, existing production. These extensive and costly incremental costs are currently tossed on top of the initial drilling and completion costs and depleted over the remaining life of the proven reserves initially revealed and any enhancements exposed through the rework. Which may extend the life of the reserves into the next century. This is contrary to People, Ideas & Objects proposed practice of sourcing and returning previously invested cash for reuse by the producer. It is also contrary to the competitive nature of global capital markets. It is a luxury that no one is afforded and certainly no one is entitled to. An endless supply of financial resources provided by the investors, as a result of questionable accounting, was never acceptable. At the same time the consumer has become accustomed to an energy cost structure which is inadequate, leading them to believe it is cheap and plentiful, leading them to lose all sense of the value the commodities bring to their lives. These attitudes will lead to further political difficulties in the very near future when producers will ultimately have to address the more appropriate costing of their sales. To address these issues producer bureaucrats have stuck their consolidated heads in the sand. It is our opinion that the initial drilling and completion costs of shale should be impaired when additional, extensive work is done downhole. The initial well’s drilling and completion value has somewhat expired. Or, the recompletions and other extensive work needs to be expensed. Having this both ways seems contradictory and is inconsistent with the principle of generating cash, earnings and measuring performance. Which is the last hope for the North American oil and gas producer. The destruction that has been allowed to occur will reveal itself in almost every aspect of the business throughout the next decade. It’s called a reputation, consolidation doesn’t address the bureaucrats diminished reputation.

These solutions of course assume the Preliminary Specification is available to provide the decentralized production models price maker strategy. Where the ability to shut-in unprofitable production is available and hence the commodity markets will have found the marginal costs of oil and gas on a global basis. 

This is all accounting, as I’ve been accused of many times. “Accounting will never make a basin profitable or unprofitable.” Yes it is accounting and business doesn’t enter the logic of the producer bureaucrat. How the industry has approached the recording and recognition of their capital costs over the last four decades has been the chief cause of its decline in financial performance. The landscape today is in shambles and the bureaucrats don’t seem to care other than to pick up on the latest industry trend so that they too look good. Now that they have consolidation as their new calling they’ll be able to resume sitting on the couch while things develop, either good or bad, and leave any issues otherwise unaddressed. Until the next crisis arrives, just like the last crisis, which is the same crisis, at which time they’ll think of something new to make it sound good and buy more time. Except no one is listening, and the investors certainly aren’t biting on the creative nature of their “consolidation” plans. This is just more of the cyclical downturn that we’ve been on for decades. 

I do wish I could write about something positive, I do lose a number of readers because they say I’m too negative. It’s not that I’m negative it’s the industry is in shambles. A situation that I am providing a solution to. I don’t know if anyone else is buying what the bureaucrats are selling anymore, in the past, here in Canada, these themes or is it memes were picked up by John Q. Public and parroted with little to no thought behind them. With more layoffs now baked in the cake due to consolidations, will John Q. Public understand that the trend is not their friend?

The misguided nature of personal executive compensation has no basis in terms of the business performance. This has been noted in the Wall Street Journal recently and elsewhere. Yet nothing happens, this entitled group continues on with whatever flavor of the day with no consideration other than “what’s in it for me” and we all know that the moment that things become untenable it will be they who will leave en masse in order to ensure that no one will remember anyone of these individuals names. Third quarter financial reports for our sample of producers began yesterday and will continue for the next few weeks. I’ll be returning with our quarterly review on November 12, 2020 to report on the rolling tragedy. 

In Part II of this series we noted that the adjustments our sample of producers made for overhead, interest and capital vs. operations totaled around $130 billion. Reflecting an overstatement for their market capitalization of $780 billion for about one third of North America's production profile. The motivation to do this, and to do so systemically and consistently throughout the industry by all producers for all this time, with the obvious and highly detrimental consequences being played out today, shows that the motivation I’m alleging is accurate. We noted the Bloomberg quote on Tuesday that had the “Energy” sub-industry value in the S&P 500 fall from 11% to 2%. The value of that loss can be quantified based on the market capitalization of the S&P, which is currently $23 trillion. Therefore the difference between 11% and 2% in terms of quantifiable loss these bureaucrats are responsible for would total $2.070 trillion. Chump change to these bureaucrats, we know, but losses realized by all others concerned with the industry.

There’s a theory in accounting known as the Efficient Market Hypothesis. In a nutshell it suggests that all information is known in the financial markets and therefore is reflected in the price of the participants in that market. When I see that the energy index represents a $2.07 trillion loss. And at the same time, by my calculations, the amount of overstated cash flow of one third of North America's production profile is approximately $130 billion, representing a market capitalization of $780 billion. It is reasonable then to conclude that what I’m discussing in this post is already understood and acted upon by the investment community. Yet, as we see, nothing is being done, nothing is being admitted to and conversely these producer bureaucrats believe they have everyone convinced otherwise. 

In Part III of this series we noted that the hypercritical issue that producers of all sizes are currently facing is the shortage of cash. The inability to replenish the cash float each month was never understood as an issue when the investors were deceived into loading the annual budget of the producer. Now with no investors for the better part of 5 years the drainage of monthly cash these organizations has cumulatively incurred as a result of their capitalization policies, the subsequent “leakage” or “slippage” that occurs, leaves producers with no cash to pay the bills next month. Consolidation is supposed to help this? It may in my opinion help, in that it will finally call an end to this tragic era of oil and gas history. Remove the cause of the problem, the bureaucrats, and commence the developments of the Preliminary Specification. 

The Preliminary Specification, our user community and service providers provide for a dynamic, innovative, accountable and profitable oil and gas industry with the most profitable means of oil and gas operations, everywhere and always. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Twitter @piobiz, anyone can contact me at 713-965-6720 in Houston or 587-735-2302 in Calgary, or email me here.