These Are Not the Leaders We're Looking For, Part XII
Natural Gas Prices, Again
Producer officers and directors continue to fail comprehensively in managing natural gas overproduction and its consequences. Why? Operationally, it is as simple as determining which property is losing money and shutting it in. Producers can easily execute the process within a short period, thereby increasing profitability by eliminating unprofitable operations that dilute the profitable ones. Yet, for decades, the industry has wasted oil & natural gas as commodities, hollowing out value. We hear from those charged with the responsibility, authority, and accountability, endowed with the resources to remedy these issues, “Natural gas is a byproduct of oil production.” A common refrain from producers in the Permian basin, which I reject.
From the March 21, 2024 EIA Weekly Natural Gas Update, under Select Regional Spot Prices.
In West Texas near Permian Basin production activities, the price at the Waha Hub remained negative at -$0.26/MMBtu yesterday, down 1 cent from last Wednesday. The Waha Hub price was below zero for the entire report week and traded $1.83 below the Henry Hub price yesterday, compared with last Wednesday when it traded $1.49 below the Henry Hub price. The price reached its lowest for the week at -$1.16/MMBtu on Monday, March 18. After several warnings during the report week of strained operating conditions, on March 21, El Paso Natural Gas Company (EPNG) issued a system-wide operational flow order, encouraging shippers to balance natural gas deliveries and receipts. Ongoing maintenance on the EPNG pipeline system, which delivers natural gas westbound out of the Permian Basin, is also contributing to lower prices this week.
“Who Cares About Negative Prices?”
It is problematic that oil and gas are frequently sold below their actual costs, reflecting tragic mismanagement in the industry. Producers must ensure the preservation of reserves for future generations by avoiding waste or unprofitable production, yet this is seldom considered or achieved. This situation demands that producers begin retiring their capital within what People, Ideas & Objects believe to be competitive in the capital markets, or a 30-month period. Bloated asset values in property, plant, and equipment enhance only the bragging rights in the annual competition for the CEO’s biggest balance sheet.
The primary consequence of selling natural gas at negative prices is that it cleans out value from the producer firm faster than any of the many other methods they use. (March 21, 2024 EIA Natural Gas Weekly Report.) If the oil price is $80.82, then natural gas should be priced on a heating value basis at $13.47. Understanding shale gas characteristics—high drilling costs, significant reserves, steep decline curves, and high rework costs—the SEC accounting methodology allocates these capital costs evenly across each molecule of proven reserves. People, Ideas & Objects' Preliminary Specification proposes a more competitive approach: allocating costs to be retired within a 30-month period. Natural gas priced at $13.47 would impute a 10% net profitability, implying a cost of $12.12 per unit and a potential profit of $1.35. Current accounting practices obscure these figures, capitalizing all costs outside of operations and royalties, and spreading capital to be realized across decades. Having an equal impact on the amount of overreported profitability being reported by the producer.
When in fact, the amount of money being lost in the course of selling natural gas at negative prices in this instance is its cost of $12.12 and the negative price of -$0.26 or $12.38. Remember when we noted that these are “just accounting charges, no one cares about those” was the response to our questions. Or if I could be more specific, the money that investors paid in to drill and complete the wells. It will take 9.23 units of natural gas sold at $13.47 generating a profit of $1.35 to offset the value lost in selling one unit at a $12.38 loss today? at the theoretical heating value price to make up for the losses on one unit of production today. This assumes that the culture that produced the natural gas at the $12.38 loss will be able to ever do anything about the chronic, systemic and ridiculous business of natural gas and oil overproduction.
Recording of Capital Assets
People, Ideas & Objects raises critical questions about how the oil and gas industry records capital assets. Why are we so stuck on this concept and apparently the only ones harping on it? I now have compiled the financial statements of our sample of producers for the period 2016 to 2023. When I take the sample’s annual capital expenditures in aggregate for the years 2016 to 2023. We note capital expenditures of $367.090 billion. However, we also note that as of 12/31/2023 assets recorded in property, plant and equipment equals $470.993 billion. Indicating a difference of $103.903 billion.
Ok, so there is a difference, what’s it all mean? People, Ideas & Objects feel producers have the luxury of recording capital assets for almost a decade before $0.01 of 2016 to 2023s capital asset costs will be realized. Since 2016, all our sample producers' capital costs have only entered the property, plant, and equipment account.
All of the depletion of $540.368 billion that was recorded during the 2016 to 2023 period were for capital costs incurred during periods prior to 2016. The remaining balance of capital costs carried forward and unrealized in depletion prior to 2016 includes the $103.903 billion, which remains in our sample of producers property, plant and equipment account today. It would seem that recognizing capital costs of a capital intensive oil & gas industry needs to catch up to reality. The question that we ask is the recording of these sizable costs of oil & gas exploration and production being realized in a timely and accurate manner? Is it competitive with other industries' performances?
The Purpose of the Corporation
The debate over a corporation's purpose has evolved from maximizing shareholder value to encompassing broader stakeholder responsibilities. While Milton Friedman emphasized profit generation, modern perspectives advocate for value creation for all stakeholders, balancing profitability with social and environmental considerations. For the record I’m with Milton Freidman on this. Without profitability where do the financial resources come from? Profits are the excess value generated over what is consumed. The amount that can be used at the discretion of those who generated them. Compensating those who own the resources and generating value for all concerned in the endeavor. Without profitability, where does the money come from? Taxes, printing, theft or in oil & gas’ case investors.
Oil & Gas Culture
This Yahoo News article originated from Bloomberg Businessweek. EQT Corp CEO Toby Rice's comments at the CERAWeek conference reflect the prevailing attitude and culture within the oil & gas industry, emphasizing the need for more pipeline and storage capacity to mitigate dramatic price swings. However, the root issue is overproduction, not infrastructure limitations. People, Ideas & Objects identifies storage as a critical area requiring attention, advocating for production that is profitable and sustainable as the priority.
Quotes from the article will be discussed below. Consider these comments in terms of the purpose of the corporation, how is the value being generated and who is benefiting from this thinking.
After decades of all producers ignoring the issue of pipeline capacity. Letting the pipeline companies fight it out against the regulators and environmentalists themselves. Leaving the ultimate bureaucracy in the form of the government, driven by environmental and other groups, funded by the grift paid by oil & gas producers, to the quasi bureaucratic utilities of pipeline companies. Producers are now stepping in to make it alright again? They’ll be the ones that get the storage and pipelines built? And how do I know the grift was paid by producers? Oil & gas producers are where the money is. There was never a head office of a producer picketed for any environmental purpose. Downtown Houston or Dallas would be far more impactful than in the field. Where does all the money and organization come from to conduct all the environmental activism, the lobbying and protesting.
The chief of the largest US producer of natural gas has warned that a lack of pipelines and storage facilities will trigger dramatic price swings in the years ahead, causing them to surge as much 350%.
Although takeaway capacity may be an issue it is not the issue that plagues the producers. Overproduction is. EQT produces predominantly in the Marcellus and there are pipeline capacity issues there and in the North East where getting the gas out of the Marcellus and getting it into the markets have an impact on pricing. However, storage has only been an issue since it has put a limit on the upside of the natural gas prices throughout the year. Storage facilities have high deliverability during periods of high demand and as such sell into those markets at those prices. Limiting the upside of the producers. And buys the gas throughout the year to replenish their storage at the unseasonable prices that producers incur by producing at 100% year round. People, Ideas & Objects have identified storage as an issue that needs to be realized and resolved by producers using the Preliminary Specification and producing only profitable production, everywhere and always.
Storage also adds to the cost of a producer's reserves through the imputed cost of storage, being the price dynamic introduced, and the operating costs of producing the reserves for storage purposes. Keeping the gas as reserves is the low cost alternative to storage. Control of the overproduction is the process that needs to be more effectively managed by the producers. Not pipelines and storage facilities, these are not their businesses. Supporting pipeline companies in the regulatory battle to have their production taken away and alleviate many of the choke points that do exist today would have been helpful in the past and will be in the future. From the Bloomberg article.
Gas demand in the US has jumped 50% since 2010, while pipeline and storage capacity have increased just 25% and 10% respectively, EQT Corp. Chief Executive Officer Toby Rice said during an interview at the CERAWeek by S&P Global energy conference in Houston. That leaves the market prone to wild price swings, ranging from today’s level of about $1.75 per million British thermal units to as high as $8, Rice said.
And
“That’s no longer an effective lid on prices,” Rice said. “So you can see prices run through that and unfortunately start seeing industrial demand destruction driving price. That’s sort of the dynamic you saw in 2022 and would leave you with prices close to $8.”
Understanding the point about the corporate purpose of profitability and building value. I am at a loss when I read most of the statements from the officers and directors of producer firms. These two paragraphs are examples of the many that are stated by these people. These statements reflect to me that producer officers and directors do not understand their primary focus should be on profitability and value generation. Ensuring their costs are under control and limited by ways such as the Preliminary Specification applies specialization, the division of labor, sharing of administrative and accounting infrastructure and automation through Information Technology can be completed. Knowing and understanding their business. To be concerned about demand destruction and high prices are of no concern. If they can compete and do so profitably is their only concern. The key question and the only question that needs to be asked of them is how will producers recapture the costs being lost in the Permian from negative prices? The $12.38 per unit loss being incurred today. These are two different worlds that are diametrically opposed to one another. One is the reality that is refused to be understood or dealt with. The current world operated by officers and directors is absolute madness.
Read More: Gas Prices Jump as Top US Driller Slashes Output to Fight Glut
EQT announced production cuts, yet the reality, as reported by the EIA, paints a different picture. Press releases used to have a more sustainable nature to them. In an Information Technology environment, facts are preeminent.
Conclusion
The behavior of oil and gas executives often reveals a deliberate effort to obscure accountability, reflected in the underfunding of essential ERP systems. Despite these limitations, software vendors have achieved commendable results. This situation leads us to question the motives and capabilities of these leaders, who seem to be trapped by their own quest for obfuscated responsibilities. Their apparent lack of insight into their own business and operations is alarming. In the oil and gas sector, accounting is relegated to a mere financial function, rather than being integral to strategic decision-making. This CEO’s detachment from solid accounting data is evident in the unrealistic perspectives he presents.
The oil and gas industry, with its operational complacency and financial opacity, urgently needs a radical change. People, Ideas & Objects is at the forefront, pushing for a comprehensive industry overhaul through innovative management and technology. Our goal is to instill a culture of dynamic, innovative, accountable and profitable operations, everywhere and always, by implementing the Preliminary Specification. This initiative is not just about enhancing profitability; it's about reshaping the industry to be more transparent, responsive, and future-ready.