No One Seem's Immune

Shell is not one of the companies that we include in our sample of 23 producers. They recently published their fourth quarter report and I have a few comments to make regarding their performance. The one thing that is evident, which is the result of their reporting the past five years in comparison to the current year, is the effect that the decline in oil prices have had in the industry. The effect that we’ve documented in our sample of 23 producers has not been limited to the juniors and intermediates, and what appears to be the demise of the start-up, but has had tremendous impact on the integrated companies as well. Nonetheless, the culture that has caused the overproduction in our sample of 23 producers is evident in Shell as well. It is a systemic culture throughout the industry as a result of distortions that the SEC’s accounting requirements have created. Those being the current culture of building balance sheets by expanding property, plant and equipment as the objective, and not recognizing an appropriate amount of these assets as the capital cost of exploration and production, therefore distorting the profits of the producers, these high profits attracting overinvestment, leading to chronic and systemic overproduction.

With that in mind let's take a look at Shells property, plant and equipment account dynamics. They have property, plant and equipment of $223 billion at the end of 2018, depletion of $22.1 billion and capital expenditures of $23.0 billion. In terms of building balance sheets they score an A+ as the amount of cash locked up in property, plant and equipment, due to the increase of $0.9 billion in 2018, will last to eternity. There is no sense anywhere in the industry to free these resources and reuse or redeploy them, dividend the subsequent resources to investors or pay off debt. The question we continually ask is, are these assets or are they the unrecognized capital costs of past production? As with all producers there is a desire to build the balance sheet in the property, plant and equipment account. Which is admirable that they seek to build the asset side of the balance sheet. There are those that seek to build the liabilities. There are however a myriad of different asset accounts other than property, plant and equipment. Some are even classified as current assets like cash and other short term assets used in the calculation of working capital. Why not realize the capital costs of exploration and production, pass those costs on to the end user of the product and in turn boost the balance of those current asset accounts that contribute to increases in working capital? The only thing that big balances of property, plant and equipment provides is the ability for the CEO to strut around town in a vain attempt to prove they have the biggest and best balance sheet, when in reality these balances only reflect the amount that the investors have had to subsidize the consumers for their consumption of oil and gas, and how much Shell has invested in excess of the cash flow that has been generated.

In order to generate value, real tangible value producers will need to stop swapping investors cash around and begin generating value from the activities they perform. No one is buying what these financial statements are selling throughout the industry anymore. Investors stopped participating in the annual petroleum beggars banquet many years ago. Creating the producers cash shortage that exists throughout the industry. Providing further proof that there was never any value being generated from producers activities. Investors had the opportunity to have invested into the oil and gas companies, which they did, or Apple, FaceBook, Google or many others. Companies that have generated value for their investors. As a result they are now demanding the producers begin the process of paying back a more than reasonable return in order to compensate for the oil and gas investments they made, the dilution that occurred and the value that should have been gained. If the investors weren’t able to earn it in the past then they’ll take it out of the producers today and tomorrow. Dividends, buybacks and payments to the banks have been substantially increased throughout oil and gas in 2018. Even Shell has not been immune to these demands. In 2018 they paid out $15.5 billion in debt reductions and $20.2 billion to shareholders for a total of $35.7 billion. These payments were made on operational cash flow of $53.0 billion or 67% of that cash flow. In contrast, during 2013 Shell had cash flow of $40.4 billion, debt increases of $5.4 billion and $12.45 billion in payments to shareholders in one form or another, for a total of $7.0 billion or 17.3% of cash flow. No one is immune from these demands of shareholders and banks in the oil and gas industry. The trend isn’t going to stop either. Investors will continue to demand the value that will far exceed what producers feel they should have earned. With that in mind, Shell’s 2018 shareholder equity was $202.5 billion generating a 17.6% return vs. 2013’s shareholders equity of $181.1 billion providing a 3.87% return. A 454% differential between these two eras and proof as to who’s upset with who’s performance. Shell is one of the best managed companies. If they are being forced into this situation then I can’t imagine what kind of pressure is being put on bureaucrats throughout the industry.

In comparison the investors alternative investment would have created a disastrous tax liability due to the capital gains earned by the shareholders who invested in Apple Inc. Nonetheless, during 2015 - 2018 Shell issued dividends of $46.9 billion on $202.5 billion in shareholders equity or 23%. Whereas apple has paid $50.2 billion in dividends for 2015 - 2018 on shareholders equity of $117.8 billion or 43%. The point of this exercise is to prove that the average investor is not that enamoured with oil and gas performance. Shell’s most recent dividend performance is being boosted as a result of strong investor influences and therefore appear much better than they otherwise would be. It is necessary to consider that there are other, better performing industries in which to put one’s money. It's time for oil and gas to compete beyond the mindset of they’re better than a bank.

Oil and gas producers performances are not better than a bank which is what the bureaucrats believe they are. Invest your money and we’ll return a handsome 4% coupon each and every year, the oil and gas bureaucrat will state. Banks don’t invest their money to make a return. They take deposits. If I deposit $1,000 in Canada the bank will provide me with $20 each year that I do so, and the U.S. is no different, the bank can then take that money as part of their reserves and loan out $10,000 at 6% for a revenue stream of $600. This is on the back of zero investor dollars. If the oil and gas producers want to compete with the performance of a bank then understand that under the banks charter they are authorized to create money. I’d like to see producers earn a net $580 / year on investments of nothing. Time to start dealing with the oil and gas business as a business that competes against all other industries, including banks, and not some fairytale of what other industries are providing their shareholders.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

Differentiating Cash Flow

It used to be that cash flow was everything in oil and gas. Profitability was irrelevant. This was some of the thinking that led to the difficulties the producers face today. Profitability is required and a firm or industry that is not concerned about its earnings is bound to be in financial jeopardy in a short period of time. Oil and gas investors have shifted the attention of the producers to profitability and cash flow has waned as a measure of performance. After all what is cash flow when the oil and gas producers have touted the numbers their firms produced. Oil and gas has never been about building value, it has never been about profitability, it has been about spending investor money on an annual basis. Spend, raise, spend, raise. The only reasonable assumption that can be made is that oil and gas is involved in the activity of drilling wells. That’s where the money is, for the bureaucrats at least. No one else seems to have prospered from the industry.

The measurement of cash flow as a means to determine the value of the firm and its performance is a specious argument in oil and gas. That has been my opinion for many decades now. If you spend a thousand dollars, which then generates a thousand dollars in cash flow what is it that you’re doing? It appears to me to be the act of swapping money from one pocket to the other. Investor money goes in, cash flow comes out. The issue is that there has been sizeably larger volumes of money going in then has come out. This is recorded accurately on the big, beautiful and well built balance sheets of the producers. In property, plant and equipment we can assume the value that is represented there is the amount that the investors have subsidized the consumers, check, but also the amount of excess investment over the cash flow that’s been realized, check. The cash flow numbers are nothing but a return of the capital that had been previously invested in the business in prior years by the firm. There is no incremental value being represented in those numbers above and beyond the capital being returned. If there was incremental value being represented in the cash flow numbers it would be shown in the profitability of the producer. However, until recently it didn’t matter that the firm didn’t produce any profits. Unprofitability was considered the nature of the business.

In terms of spending the investors money there has never been any question regarding the accuracy and integrity of the spending of those dollars. Oil and gas has a premier reputation in terms of how it spends the money from its investors. Bureaucrats know not to divert any of those funds to anything but the drilling of wells and bringing them online. It's the cash flow from that spending which is discretionary as far as bureaucrats are concerned. As long as it is justifiable as business of some form then they’ll spend it. The many forms of bureaucratic compensation flow from these considerations.

I have argued that the profits that had been reported by the producers were of the lowest possible quality imaginable. Taking everything the producer does as a capital expenditure adds up to a significant amount of capital expenditures after a decade or so. It also has the effect of making the income statement look not as bad as it really is. Recognizing a small percentage of capital costs has been enabled through the SEC’s unreasonable method of recognizing a negligible amount of capital costs in a capital intensive business. Allocating all of the costs to the reserves discovered, and then recognizing the small number for each volume of production that year is a poor measure of performance. Properties in oil and gas have been known to produce for 50 years. This does not enable the producer to compete in the current capital markets. Waiting decades for the cash resources to be returned from prior investments is uncompetitive when other industries are turning over capital at much higher rates. We recommend for accounting purposes that producers adopt the 30 month requirement of a straight amortization of the capital costs. This will more accurately match the flush production, which subsequently requires extensive capital to rework the well, it will return the cash in a timely manner in which the producer will be able to redeploy it as incremental capital costs, assuming they are charging the consumers appropriately and producing only profitable production, and will better reflect the risks involved in a highly technical business. Oil and gas is not banking and is not intended to take deposits which are paid out over 10 to 20 year periods.

These changes will separate the leaders from the laggards. Today it is difficult if not impossible to differentiate the producers based on the financial statements that are provided. They’re always profitable! In a very convoluted way. Under the Preliminary Specification the competitive differentiation is based on the earth science and engineering capabilities and their land and asset base. The financial statements of the leaders will be evident in comparison to the laggards. The laggards financial statements would look quite consistent with today’s presentations. Whereas the leaders would be profitable on very high revenues. Have substantial cash and working capital, a smallish capital structure with moderate to high leverage employed in a low interest rate environment. In the stand out producers they would have extinguished their property, plant and equipment consistently and show little to no values in that account. The only requirement that the SEC dictates is that the value of property, plant and equipment doesn’t exceed essentially the market value of the reserves. Otherwise the dreaded ceiling test, which we’ve seen far too often, is invoked. A high performing producer would have consumed their property, plant and equipment due to their competitiveness and performance above the others.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

A Study in Contrasts

The Preliminary Specification offers the only alternative to the status quo. Instead of chronic, systemic overproduction and specious profitability. We prepare software that defines and supports a reorganization of the industry and producer firms. A reorganization that focuses on specialization and the division of labor by converting all of the producers costs to variable costs, based on production. First by establishing service providers to provide the producers with the administrative and accounting functions. These service providers will focus on one process and have the entire producer population as their client base. By reallocating the administrative and accounting resources of the producers to service providers oil and gas production becomes the triggering event for the service provider to invoke their service. They will then invoice the individual Joint Operating Committee the fee for their service. That way the overhead of the Joint Operating Committee is recorded in a timely and accurate fashion. The cash used to pay the service providers, because all production under the Preliminary Specification is produced profitably everywhere and always, is captured in the commodity price charged to the consumer. Those cash resources are then returned to the Joint Operating Committee (working interest owners) to be used to pay the next months overheads, etc. Contrast this to the current overhead process which capitalizes on average 80% of all overhead across the industry and realizes the return of that cash over the course of several decades in some instances. A.K.A. a cash sinkhole. We believe the overhead costs to be material, in the range of 20% of revenues. No one can refute our claim of the amount that overheads consume because the numbers are jumbled on financial statements.

When the service providers are established they provide an industry based administrative and accounting capability that is a variable cost, variable based on production. This replaces the producer based administrative and accounting capability that is fixed. The producers fixed overhead costs are currently replicated in each producer firm, yet unshared and unshareable. This transition will enable producers to be more profitable when the industry wide capability is shared. Also enabling producers to evaluate properties on their actual costs in all areas of capital, revenue, royalties, operations and actual overheads. If the property then produces a profit it will produce, if not it will be shut-in for at least the next production month. Shut-in properties are not profitable, however they also do not incur losses as all the producers costs are variable in the Preliminary Specification. Therefore they incur a null operation. No profit, but also no loss. Providing the oil and gas producers with the most profitable means of oil and gas operations when the properties losses no longer dilute their profitable properties operations. Those shut-in reserves can be saved for a time when they can be produced profitably. They also will not have to carry the incremental burden of subsequent losses on operations as additional costs to be recovered. And the commodity markets will find their marginal cost when the unprofitable production is removed from the market. Production discipline is attained through this process when the producer realizes that the maximum profitability of their organization is obtained through producing only profitable production everywhere and always. Therefore producers are incentivized to adhere to the principles of the Preliminary Specifications decentralized production models price maker strategy. Just as all businesses that follows these principles in the capitalist system are.

This is the key process that provides the majority of the quantified value in our value proposition. Other areas, such as specialization and the division of labor can not be quantified at this time. Yet since the late 1700’s the application of specialization and the division of labor is the only method of generating economic advantage. It enables societies to do more with less. And therefore what the industry could do with the systemic application of specialization and the division of labor throughout the 12 modules of the Preliminary Specification is unknown and unquantifiable. There are many other process changes that provide value in different ways for the industry. And these are all specified there. What is important to note at this point is that this forms a plan for the North American based oil and gas producer to approach the next 25 years. A means in which to deal with the issues that are plaguing the profitability and the cash drainage that is being experienced. A structure to establish the necessary elements to ensure innovation is enabled in a decidedly difficult scientific business. And a way to ensure the secondary and tertiary industries that are dedicated to and support the oil and gas industry are aligned with the needs of the producers, and in turn are able to rely on a healthy and profitable oil and gas industry.

This all starts with an accounting that is shifted from the focus around the “corporate model” as we refer to it. To one that is focused on the Joint Operating Committee, the legal, financial, operational decision making, cultural, communication, innovation and strategic framework of the industry. By moving the compliance and governance framework of the corporate model into alignment with the Joint Operating Committees seven frameworks we achieve a speed, innovativeness, accountability and profitability over today’s status quo. We also attain the capability to deal with the operational difficulties that plague the industry, issues such as chronic overproduction. And instead are able to focus on the opportunities presented to us through what is unquestionably the most difficult and challenging next 25 years. We certainly can not continue to produce oil and gas unprofitably as we have for the past four decades. We need to change in order to be able to plan and realize for our future in these next 25 years. If production continues to consume cash as it does today, no investor will ever resume their participation. The industry must be profitable based on a reasonable accounting in order to ensure that energy self sufficiency on the continent is not only real but sustainable.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

The Producers ATM

John Hess of Hess Corporation was quoted as saying at the World Economic Forum that “the share of energy companies in the S&P index had shrunk to 5.5 percent, from 16 percent 10 years ago.” Reflecting to me that the industry has been left behind. Unable to compete for capital against other industries that have developed in ways where capital is deployed and retrieved in months, not decades. The industry today has one and only one choice. The Preliminary Specification can provide the organization, the structure and culture necessary for it to compete in today’s complex and difficult capital markets. Long gone are the days when producers could belittle their past investments as sunk costs when asked to account for the performance of those spent monies. A unique perspective only ever held by the oil and gas producers.

People, Ideas & Objects estimate there are $1.5 trillion sitting in property, plant and equipment of the North American producers. These are the only resources that will be available to them for the future. Investors are satisfied with the level of investment they currently hold in oil and gas. They also know, unlike from decades before, that they won’t be diluted in terms of their ownership percentage. These “assets” held in property, plant and equipment can be recognized as the unrecognized capital costs of past production that they are. And when past to the income statement as depletion, will return the cash that they need. Assuming of course the producer is charging an adequate price for the commodity produced. A price that will be adequate to cover all of the cost of exploration and production. This is the only source of cash that producers will be provided. The investors have had it, for how long is unknown but it's probably safe to assume it will be the case for the next generation.

After ten years of unprofitable production maybe producers are beginning to see the issue more clearly. Maybe they’re just being told no more sternly by the investors. After almost four years of believing they could wait out the investors, that they’d eventually come around to see the producers point of view, it’s not happening. They’ve had it pretty good for the past four decades. The process of needing some money, then just go to the capital markets to dilute your shareholders, spend that money, go for more, produce. The business involves much more than just that process. Oil and gas is a primary industry. What that means to me is they’re responsible for the overall business. They capture 100% of the proceeds of the oil and gas sales. These sales were made through the efforts of theirs, the secondary and tertiary industries. These industries are not greedy or lazy people who are leeching off of their sales. They have no other business than oil and gas whether that is drilling operations or fracing operations. They don’t operate WalMart’s on the side. A greater consideration of the responsibility that producers hold in that role is a necessity as they are the primary beneficiaries of these sub-industries. In order to achieve this they need to ensure that they are generating profitable operations everywhere and always. The only method in which to do this is with the Preliminary Specifications decentralized production model’s price maker strategy. Only then can they begin to undertake the responsibilities for the greater role that they need to assume.

Institutional memory is a bad thing when your performance has been failing for the past 28 of 33 years. It reflects a culture that is systemic, ingrained and unchanging. If the financial community were to provide further funding to the producers, what would be the outcome of that investment. The only change that they might see is the possibility of bonuses being reinstated. This culture is best captured in the oft repeated mantra within the industry of “muddle along.” The only spunk the industry has shown through these past 33 years has been the argument / disagreement / fight between People, Ideas & Objects. A fight that concerns the bureaucrats because the Preliminary Specification, as has many Information Technology initiatives in other industries, disintermediated the bureaucracy. The best fight that they’ve made doesn’t concern a defense of the business, only the welfare of those that benefit from it the most.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

Profitability Everywhere and Always

What is it that the oil and gas producers are responsible for? What is their primary role in the economy and what is it that the bureaucrats have been doing to meet these responsibilities. Reviewing what it is that the producers are doing and have done is they’ve drilled many wells, and appeared to me to stand on the top rung of the ladder and belittle those below. Outside of these two activities I don’t see any strategy, planning or desire for anything else. It seems to be a good life for the chosen few, both professionally and financially. Critical review is not their forte and I feel they’ve built their own cocoon from the attitude that oil and gas is a very complex and difficult business, which it is, that most people don’t understand it, which is true and therefore they’ve shut off any input from the outside world. It is a self congratulating, groupthink mindset that will continue on in its own world, despite the financial consequences for all concerned and no matter what. How else could the past 28 of 33 years be considered bad years? How else would there be an understanding that there are good years and there are bad years in the industry? Seemingly the only industry in the world, outside of the occasional recession that has continual, chronic bad years. Not once have they asked if this is self inflicted. Their depth of analysis is to blame the most politically expedient individual or group that is standing in front of them at that moment. Whether it’s OPEC+, pipeline companies or governments you only need to look at which month it is to determine the candidate to blame.

The point in fact is that the stated policies of the producers is to destroy the business. First, continued overproduction in the market of lower prices is beneficial because… I’ve noted this point to them since overproduction became a chronic issue in natural gas. Many trillions of dollars have escaped the atmosphere in the process. The second point in their solution to the current situation is to reduce their capital expenditures. To actively sit back and let their assets and production profile atrophy until demand catches up. This also goes by the official slogan / strategy / operating procedure / bureaucratic vacation enabler of “muddle along” and “do nothing.” Here we begin to see the brilliance of their plan.

If we take the recommended exercise of People, Ideas & Objects of moving 65% of property, plant and equipment off the balance sheet and move it to depletion on the income statement. Reclassifying these alleged assets of the producers into the unrealized capital costs of past production. This exercise restating the situation as I feel it stands in the industry. A wasteland like no other before. The only reason that producers are able to continue is that bureaucrats are able to be personally sustained through the cash flows of prior investments in a capital intensive industry. Otherwise this would have ended long ago. The implications of this “downturn” and all of its predecessors on the service industry is tragic. I have not reviewed the financial statements of the service industry as I am not interested in viewing the results of tragedies. When the primary industry you depend upon cuts your volume to one third the activity, then halves your billing rate, it creates some difficulties down the line. No one says anything about this because there have been 28 bad years out of the past 33. The tertiary industries are well oriented to what we should begin to call the “28 year rule.” When the Premier of Alberta, in the one industry province, says the primary industry is in crisis then these words are heard throughout the province in a heartbeat. The effect has been to put your wallet in your pocket and sit on your hands. Who knows it might be another 28 years before things get better. There certainly is no expectation of any actions other than hunker down in the bunker and start living off the stores that you’ve been prepping for.

In contrast a recession in other industries is painful because the growth may drop precipitously, and temporarily sometimes into negative territory. Imagine for a moment if the oil and gas reorganized around the Preliminary Specification and we had profitable production everywhere and always on the North American continent. Is that the role of the oil and gas industry? Should it be the exception to all other industries and always be profitable? Oil and gas is such a critical and valuable resource its profitable production implies so many things. A viable and healthy industry will be able to source abundant, affordable energy everywhere and always through its research, development and innovation. The costs of exploration and production will continue to rise as we proceed through the natural endowment of oil and gas. The Preliminary Specifications ability to better match all of the actual costs of exploration and production will ensure the costs are captured and the profits are “real,” not the ones we’ve experienced these past four decades. The consumer will face higher energy costs, to that there is no doubt. The investors have ceased to subsidize the capital costs of the consumers consumption. Leaving few options for producers other than to charge consumers for the full cost of the products they consume. I think this is how they do it in profitable industries. Any subsequent conservation by the consumers will be the contribution that producers can state they’ve made to the alleged global warming issue.

Budgeting for the industries capital demands of exploration and production is a well developed science. These numbers range between $20 and $40 trillion in the next 25 years. They also form the foundation of our value proposition of $25.7 to $45.7 trillion. Once these numbers are budgeted the producers bureaucrats job is done. The investors are then on notice that they’ll need to come up with that money? Not a hope of that ever happening. The only source for this funding is the consumers. Which implies the producers are going to have to compete for capital by turning theirs over in a competitive manner. Recycling it quickly and repeatedly. Deploying the capital efficiently, charging the right price to cover all of their costs, capturing that price from the consumer and then efficiently redeploying that capital. This is what the Preliminary Specification will do for the dynamic, innovative, accountable and profitable oil and gas producer. They would be dependent on a prosperous and healthy service and tertiary industries in the process of achieving what I see as positive outcomes. This is also known as the capitalist system. Whether that is moral, immoral or amoral is something that Bono can debate with his concert attendees. I’m at a loss to find anyone for the producers to blame.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

Our Plan vs. Their Plan

People, Ideas & Objects provide oil and gas producers with the most profitable means of oil and gas operations. We do this through user community driven software developments that are defined in the Preliminary Specification. This specification has a reorganization of the producer firms and the industry itself in order to achieve profitability everywhere and always in North America. We’ve noted that the capability for North America to be energy independent is a reality as a result of shale. This however demands the oil and gas industry be profitable everywhere and always. How else will we be able to sustain this production profile if we continue to abuse the oil and gas investor by having them subsidize the consumers consumption. Clearly the investors and bankers are telling us that we can’t. In frustration they’ve ceased active participation in the industry. This has created the slow and difficult decline in the health and general well being of the oil and gas industry but also the secondary and tertiary industries.

We believe the industry needs a plan in which to deal with the next 25 years. A future that appears today to be the most difficult in its history. A plan that provides the details of how the industry will approach the demands for capital that range in the $20 to $40 trillion. That will challenge the technical capabilities of oil and gas, the service industry and all the support industries. A future that demands we fuel the continent with the energy that our economy needs. Understanding that the most powerful economy is also the greatest energy consumer. A plan that mitigates the business issues that are creating the chronic and systemic overproduction that plagues the industry. And encourages the return and full participation of the financial community.

We believe the Preliminary Specification is the plan that industry needs to approach the next 25 years. What would be the result if producers adopted the Preliminary Specification? Would the investors who are forward thinking, begin to see the implications of this plan and therefore begin to make their positions in those producers that appealed to them? Would the adoption of the Preliminary Specification enable producers to buy the time necessary to complete their reorganization and begin the pursuit of profitable energy independence on the continent? And do so with their investors support? All of the evidence to the validity of the Preliminary Specification is in. The Alberta government's mandate to reduce Alberta production by 325 thousand barrels completely eliminated the differentials which were in the range of 90%, even before the actual implementation of the policy, and almost immediately upon the announcement. Oil and gas commodities are subject to the economic principles of price makers. Therefore our plan which involves producers using detailed, actual accounting information to determine the profitability of a Joint Operating Committee, to support the independent business decision of whether or not to continue to produce, is a sound and appropriate business principle. It’s not collusion.

The choices for the producers are unfortunately very limited. There are the Preliminary Specification and the status quo. Unfortunately the industry has chosen the status quo as their choice since the publication of the Preliminary Specification in December 2013. It would appear to me that the choice of the status quo has been fully explored at this time and has been found wanting. That’s just my opinion, but the industry may not appreciate me pointing out that they have no choices. The fact of the matter is that they have very little time in which to continue without the support of some kind. The incineration of cash each month to pay the overhead goes on without any relief. The recognition of any of the capital, in a capital intensive industry, never happens. Whatever, the time to make the choice for an alternative to the status quo is necessary and upon us.

I don’t think I would want to be a CFO in oil and gas this coming annual general meeting. What benefit would there be? And what exactly are the boards of these producers doing? I can not reconcile the situation that exists on the ground today and the demands that arise from the future of the industry. They are polar opposites as are there demands for action. The future of the industry can not be left to a strategy where people just collectively shrug and say they’ll muddle through. At what point in our past did that ever work? It didn’t, and I know that to be the case. I had the fortunate situation of reviewing the operations of Imperial Oil in my audit days. After that time I was so impressed with the vision and persistence that was expressed in the assets of that firm. Someone, in fact many decades of people were putting together pieces here and there that finally came together as a whole. And it was brilliant. Then the rationalization craze came into being and the pieces were sold off bit by bit to the highest bidder. This industry wide rationalization phase later became the “just drill wells” phase that everyone seems to have been stuck in now for many decades. A collective rush into this or that, one day it’s SAGD, “royalty trusts” in Canada, the next it’s heavy oil, unconventional gas and then into shale oil. Leaving nothing but disaster in each of these areas as a result of massive overinvestment and little planning on how to deal with the subsequent overproduction. Also known as no pipeline capacity. Maybe there’s a zig and a couple of zag’s left in industry to run before it collapses but there’s no doubt where it's headed. It just doesn’t have to be.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

Third Friday

Profitable, Everywhere and Always, as a Standard

Why would any oil and gas ever be produced unprofitably? I believe we need to adopt a standard policy throughout the North American industry that states: every molecule of oil and gas will be produced profitably to ensure we can responsibly justify our current consumption to future generations. If we continue to produce unprofitably, as it appears all oil and gas production in North America is, would that be considered reasonable by our children and grandchildren? In terms of conservation of unquestionably the most valuable resource, there are 23,000 man hours in each barrel of oil equivalent. And therefore it will be the largest consumer of oil and gas that is the most powerful economy. We can only fuel the most powerful economy if it is profitable to do so. In terms of the environment, the issue of carbon is less justified if we consumed the energy irresponsibly. And financially, with the Preliminary Specification all production can be produced profitably. Whether that is from Exxon or yesterday’s startup. The competitive landscape is equal when all costs are variable. If it was known in 2013 that the Preliminary Specification provided this capability, what justification will industry use to continue in the manner that they have for the prior four decades?

This is all logical and justifiable so someone is going to have to sit down with the bureaucrats and explain it to them. The need for the Preliminary Specification to be operational in the industry is as follows. The accounting that is conducted by the producers is inadequate to determine each individual Joint Operating Committees actual profitability or loss. The use of standardized overhead allowances that approximate the overhead burden involved in operating the property were initially determined in the 1960’s and adjusted annually for inflation. They are not poor representatives of the costs of overhead in the industry. They are ridiculous. The need for these was the administrative cost to allocate the time of the production, revenue, and royalty accounting etc. costs to each property was not possible due to the organizational methodology, the high throughput production model, and the computers capabilities present in that era. These overheads were also from a different regulatory time period when the SEC and governments were in their infancy. The need to address the much higher costs of overhead in the industry, the need to have the cash that is consumed each month by these expenses being recycled each month (see yesterday’s post) and the capability to have the actual costs recorded at each property are now available with the Preliminary Specification.

Once this is available then each property will be known to have produced either a profit or loss based on the actual, detailed accounting. Those that did not produce a profit will provide the evidence to the ownership that they do not qualify in terms of continuing production. They will then be shut-in for at least the next production month or until such time as they can be produced profitably. The profitability could come about as a result of an increase in the commodity price, the increase in production or some innovation that the producers determined would either reduce the costs or achieve any other criteria necessary to return it to production. Ensuring all of the production is produced profitably everywhere and always is the first criteria of the Preliminary Specification. If the producer has an inventory of properties that are not producing then that will be the focus of their innovation initiatives in order to return them to profitable production as soon as possible. What we learned in the development of the Preliminary Specification is that the process of innovation is defined and supported within the organization that produces it. This is why Apple continues to innovate, it is the culture. This culture is understood by the academic community and we have captured that understanding in our research and placed those elements within the Preliminary Specification. On the one hand the producing properties will be profitable, and on the other hand the producers will be reconfigured, defined and supported by the Preliminary Specification to ensure that innovation is the product of their efforts.

The purpose of establishing innovation within the oil and gas industry is clear. Producers claims that they are highly innovative today is specious. It’s the service industry that is innovative. Examples such as the coil tubing providers and Packers Plus who developed the ability to conduct shale operations. It was many years before the producers even tried these technologies after the service industry providers begged for them to do so. Are producers the ones that conduct the innovation on drill bits? Their competitive advantages are their earth science and engineering capabilities, and their land and asset base. It is within these disciplines that they have not prepared or provided any of the necessary foundation technologies, structures or organizations in which to innovative from. They’ll need to focus on the areas of innovation that fall within their competitive domain in order to expand their innovativeness and competitiveness. Drill bits is the wrong direction. The second reason for establishing innovation within the industry is to ensure that the costs of oil and gas are as low as can possibly be for the consumer. As the easy oil and gas continues to be consumed we are left with the more challenging fields such as shale and offshore. Which are far more difficult and expensive. We can expect that the trend of higher costs of oil and gas exploration and production to continue for the remainder of its useful life. We therefore need to first of all account for that much more accurately. We need to ensure that it is produced profitably and we need to ensure that it’s affordable for the consumers. After all it is the most powerful economy that is also the largest consumer of oil and gas and that is the role we aspire to keep.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

Marginal Costs

There is a disparity between the term “marginal costs” when used on this blog and that which is used by the producers. For our purposes here we use the economic definition that states in the long run all costs are marginal. Whereas the producers are dealing only with the costs that are not capital in nature. I continue to state that oil and gas is a capital intensive industry and therefore needs to account for its capital in a more appropriate manner than what it has in the past four decades. What we have today is a distortion of significant proportions that is recorded on the well “built” balance sheets of the producers. If I gross up the third quarter 2018 capital expenditures to the full year, then the past three years average capital expenditures of our sample of 23 producers has been $57.2 billion. When we compare this amount to that which is recorded in property, plant and equipment in the third quarter of 2018 which totals $474.7 billion. That amount in property, plant and equipment represents 8.3 years of capital expenditures. An endorsement of the fact that oil and gas is a capital intensive industry, there certainly has been some “building” going on in the industry, and it’s reasonable to assume that the industry does not share People, Ideas & Objects definition of marginal costs.

There are some that might argue that those costs will be subject to depletion in the coming years. To which I say exactly. The balance of property, plant and equipment has also been subject to depletion for the past 8.3 years and more. The residual balance is a balance that never goes down in oil and gas. It’s a number that only rises. Which is reasonable in any business as it grows, what I’m suggesting is the growth in property, plant and equipment has been an aberration due to the method of recognizing the capital costs of each barrel of oil equivalent is inaccurate and is inadequate to capture the real costs of exploration and production. It is our assertion that the consumers have paid for the operating costs of the oil and gas that they’ve consumed and the investors were the ones who paid for the capital costs of that consumption.

The one thing that I’m certain of from my experience in oil and gas. Is the amounts recorded in property, plant and equipment are accurate and have the full integrity of the management. They would be hard pressed to find an error or anomaly in any of the producers recording of any of the capital costs that they’ve recognized. The point that I’m suggesting is, try to have them justify the amounts being so stratospherically high. No one ever could. It’s an attempt by the producer to represent the market value of the underlying properties. The feeling is, that is what you’re worth and hence the desire to “build” the number ever higher. It is an asset and never a capital cost that would be recognized in the course of the business. The accounting of oil and gas has become culturally distorted to attempt to reflect the value of the producer as opposed to reflect the performance of the producer. If it was about performance, the producer would proudly display $0.00 in property, plant and equipment, massive cash and working capital, and retained earnings far exceeding the amount of capital that was raised. Instead what we have are “assets” of the capital cost nature, negative working capital and to a large extent no retained earnings on average throughout the industry, and many producers with no shareholders equity whatsoever. Who cares about performance when you’ve “built” a balance sheet!

If we take People, Ideas & Objects recommended exercise of removing 65% of these producers assets and recognize them as the unrecognized capital costs of prior production in the current period to better understand their performance. When we do this we end up with a reflection of the catastrophe that has been created. We only recommend this as an ad-hoc presentation of the financial statements to put across to these bureaucrats how badly they’ve mismanaged these organizations. They may have spit polished facilities that are wonders of the engineering world but they are worthless when they take additional cash just to produce them. This ad-hoc exercise also shows that the extent of the damage and worthlessness that these bureaucrats have been consumed in, is truly financially devastating. The calculation for our sample of 23 producers, based on third quarter 2018 values, is we end up taking 65% of $474.7 billion in assets or $308.5 billion off of $281.3 billion in total shareholders equity leaving nothing left of what the investors provided other than negative $27.2 billion in shareholders equity. (Tax implications are held constant here.) This deficits implied meaning is that the bankers, too, have been punching well above their weight in terms of their contribution to the oil and gas industry for a significant period of time for this to have occurred.

People, Ideas & Objects do recommend that producers begin to amortize these “assets” on a permanent 30 month schedule, or faster, to ensure that the capital costs in the industry are recognized in a more timely manner ($15.8 billion in depletion / month, or $190 billion / year for our sample of 23 producers vs. the average of the last three years of $57.2 billion / year.) and the amount of invested cash that these “assets” represent is returned to the industry in the form of cash for further redeployment. Assuming of course the Preliminary Specifications price maker strategy is in place and the producers are receiving adequate compensation for their product. If the industry needs $20 to $40 trillion over the next 25 years they’re going to have to recycle some “assets” quickly and repeatedly. In addition the policies of capitalizing everything that is spent by the producer has to stop. This is ludicrous, and when added to the fact that the “assets” represent 8.3 years of capital expenditures! The Preliminary Specifications stops this in two critical ways. The first is to capitalize only tangibles. The intangibles should be expensed. Secondly apply a different perspective to the production profile. If the production profile grows by 5% then how much of the capital expenditures were to expand the production profile and how much of the capital expenditures were expended to maintain the production profile. Those expenditures that maintain the production profile should be expensed.

Another point to be made that is different in the Preliminary Specification is the manner in which overhead is dealt with. Overhead costs in the industry are unknown due to the producers capitalizing the majority of these expenses. Leaving them on the balance sheet as assets for the ridiculous time they are. The Preliminary Specification reorganizes the administrative and accounting resources of the industry into service providers who manage one process and have the entire industry as their clients. The service providers charge each individual Joint Operating Committee in the current period for the overhead expenses that are incurred by the property, not the corporation as is done today. These expenses are then recaptured by the property in the process of normal operations from the price of the commodity. This is in contrast to the capitalization policies in place today which consumes the cash in the producer for at least 8.3 years on average. What we do know is that the cash that is spent this month to pay the receptionist, the Post-it-Notes and the telephone service costs incurred at Cenovus will not be fully returned to the company for 27 years, which is what their depletion schedule dictated in the second quarter of 2017. Therefore instead of having essentially the same cash recycled each month through a working capital component to pay for the overhead, each producer has to find new cash each month to pay the overhead because they archived last months cash as “assets” on their well “built” balance sheets for a few decades. And then the producers wonder why the investors have been withholding their cash.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.

Overproduction is Not Going Away

People, Ideas & Objects provide the oil and gas industry with the opportunity to build software based on the Preliminary Specification. This will provide a reorganization of the producer firm and industry to deal with the issues and opportunities that are present in the marketplace today. This software will set in place an innovative framework throughout the industry, to ensure the profitability necessary to approach the difficult and challenging future the industry faces is generated. The key issue we face today is overproduction throughout the North American oil and gas marketplace. Commodity prices have collapsed for the past four years in oil, and the past decade in natural gas. To review the landscape the discussion of this issue doesn’t occur. Nowhere in the industry is there recognition of the overproduction or the acceptance of the Preliminary Specification. The financial difficulties being experienced by producers are as a result of OPEC+, or the Canadian and B.C. Governments or pipeline providers. Any straw man will do as long as no one mentions the fact that overproduction is systemic, chronic and has been a feature of the industry since the collapse of the oil price in 1986.

If the takeaway capacity of a region is 3.5 mmboe / day you can be certain the producers will be producing 4 mmboe / day. And if OPEC+ doesn’t curtail their production to accommodate the increase in North American production there will be further oil price pressure. It is the role of the producer to produce everything they have no matter the consequences. Due to the accounting treatment of capital costs, in a capital intensive industry, no matter how low the commodity price drops they’ll always be able to reduce depletion to the point where profitability reemerges. Therefore proving, mostly to themselves, that they are not the ones responsible for the overproduction in the industry, if there should ever be recognition of such an issue. Although this overproduction is experienced everywhere in North America the problem has manifest itself into a full blown crisis North of the Canadian border. There are fundamental differences in the way that business is conducted in Canada and the U.S. Canada is a very large country with close to no people. 9.5 people / square mile vs. 92.2 people / square mile in the U.S. Therefore we are well to do from a resource base that is distributed across those few individuals. The Americans have to work a bit harder for their benefits. This has them paying closer attention and with sharper pencils than Canadians. What I suggest is that what is happening in Canada is the precursor to what will happen throughout North America.

Overproduction became a crisis in December 2018 in Canada. As a result producers asked the government to intervene and implement a mandatory production allocation scheme across the industry. The consequences of the government mandate were effective in eliminating the deep differentials, however, it now shows the producers the difficulties with government mandated production quotas. Due to the structure of the industry the producers losses will increase as the overhead of the producers is fixed as opposed to variable under the Preliminary Specification. Less production will now be available to cover their overhead costs. This may not be evident to them in the financial statements since their profit and loss are such an accounting sludgefest, it will have a detrimental effect on their cash. Investors have expressed their opinion of the industries turn toward government control, and pipeline companies are far less certain of the producers deliverables in the future. As would be expected the government mandates have had a chilling effect on the upside of the industry when the regular market incentives are circumvented.

Running the industry as a business such as what is proposed in the Preliminary Specification has been wholesale rejected. Which inspires those who depend on market signals for their decisions, such as investors, bankers and service industry representatives. The Preliminary Specifications decentralized production models price maker strategy changes all of the producers costs to variable as a result of the reorganization that is conducted. It also enhances the quality of the accounting substantially so that each individual property will know the precise profitability or loss on the operations of that property. Therefore determining that the unprofitable production should be the production that is shut-in to satisfy the need to reduce the unnecessary overproduction. This quality of accounting can not be achieved due to overhead allowances at the property level skewing the actual costs, actual overheads at the properties are unknown and unknowable in the current systems. The Preliminary Specification will enable producers to use the detailed, factual accounting data generated to make independent business decisions to enhance their profits by eliminating their losing propositions and turning them into null operations. Oil and gas bureaucrats of course will have nothing of this “business logic.” They claim making independent business decisions based on detailed, factual accounting data is collusion. And therefore will just sit back and demand the government tell them what to produce. Despite the detrimental consequences.

Fourth quarter financial reports for 2018 will begin being reported tomorrow with Hess starting the season as usual. As always the decline in the quality of the financial condition of the producers will be on clear display for those who just can’t believe that nothing is ever done about any of this. After all “these are just numbers that have no bearing on the outcome of any wells that are drilled! They’re all just sunk costs and should be forgotten about.” In prior era’s these comments would be followed by “how many shares are you buying of our new offering?” The bureaucrat never connecting that on the one hand they were slapping the investor in the face by never accounting for the capital they raised from the investors each of the last ten years, and on the other hand begging for more cash. Investors can be slapped in the face for a period of time but will begin to change their attitude if they see that nothing is done to make the alleged business a business. So once again producers will parrot their operating earnings, or EBITDA and expect that the media will follow their lead once again. The capital costs, in a capital intensive business, building ever so much higher on the big, beautiful balance sheets.

The best measure of a producer these days is the amount of cash and working capital they have. They’ve eroded these resources so extensively in the past three years that I’m sure we’ll be seeing new methods of deferring payment to those that are owed. I anticipate this will also precipitate the layoffs that everyone has been concerned about. The need to lay the people off being necessary as opposed to have the payroll bounce. Taking the lesser of two evils rule. The point of all of this is to never admit that there’s a problem and make sure nothing is done to change that.

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. Setting the foundation for profitable North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in our future Initial Coin Offering (ICO) that will fund these user defined software developments. It is through the process of issuing our ICO that we are leading the way in which creative destruction can be implemented within the oil and gas industry. 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 403-200-2302 or email here.