Exploding Myths, Part XI

Not long ago North American producers were recognized as and accepted the role of swing producer in the oil market. Taking this from its former designate Saudi Arabia. A swing producer fills two major roles for the supply of oil in the market. The first is that any variance in demand will require an adjustment, either up or down, in terms of deliverability being undertaken by the swing producer. And secondly the swing producers handle the increase in demand of the market. Other lower cost producers produce everything they have and always. Although Saudi Arabia undertook this role prior to a few years ago, the swing producer is traditionally the high cost producer. Therefore swing producers are the last ones to be profitable in the marketplace, therefore they demand higher prices in order to raise their production volumes to ensure their costs are covered. At least that is the theory.

One of the myths that never seems to be challenged is the North American producers claim that the Saudis need $83.60 to balance their budgets. Which is true when you add in all of the costs that their Kingdom pays on behalf of their society. With oil being such a significant part of their economy this is reasonable. To therefore make this a reasonable comparison to the Saudi calculation one would have to include the costs of the United States Federal debt and deficit as part of the American producers costs.

If we were to compare production costs from a marginal cost basis $83.60 is not what the Saudi production costs are. Recall that marginal costs are defined as all costs are marginal over the long term. The chart listing the marginal costs of production indicates the Saudi marginal costs are only $3. Whereas the marginal cost of United States production is $73 for shale and $57 for deepwater. With oil prices around $50 per barrel, is it any surprise that cash and profits are such an issue in the industry? People, Ideas & Objects argument is that these United States costs misrepresent the situation in North America. By allocating all of the capital, including overhead and interest, to every molecule of reserves whether it produces this century or decade doesn’t do anything for anyone. This process enables producers to effectively store cash in the ground for decades at a time while investors are expected to continually fund their current capital demands. We call this cash storage issue the bloating of balance sheets in property, plant and equipment which may also be understood as the unrecognized capital costs of past production. Therefore the real cost of capital in the above quoted prices do not capture all of the cash that has been stored by these producers on their balance sheets. And are therefore materially understated in the $73 and $57 calculations. Saudi Arabia on the other hand has their major field Ghawar which has been producing since 1948 and implies that most if not all of that capital has been recognized and therefore this invested capital has been returned in the form of cash.

The second myth we want to discuss today is the collusion myth that producers have accused People, Ideas & Objects of throughout the past few years. When we first published the final edited version of the Preliminary Specification in December 2013 the knee jerk reaction from producers was that it was collusion and unacceptable. Recall that our decentralized production model’s price maker strategy ensures that all production is profitable everywhere and always. Achieving this by moving the accounting to the Joint Operating Committee and providing detailed financial statements at each property. Then if a property is unprofitable, the producers can shut-in that property in order to save their reserves for a time when they’ll be produced profitably, ensure that these reserves don’t have to carry the additional burden of any future financial losses being added to the reserves if production were to have continued, which also provides the producers with the most profitable means of oil and gas operations by only producing profitable production and not being diluted by losses on other properties, and removing the unprofitable production from the commodity markets to ensure they find their marginal price. The first mention of the decentralized production model in this blog was in 2008 therefore it may be considered reasonable to ask what’s been going on?

By publishing our Preliminary Specifications decentralized production models price maker strategy it was as if People, Ideas & Objects had committed murder on a mass scale. Producer bureaucrats shrieked and writhed with the news. Remember oil and gas is not a business. Therefore making effective, independent business decisions based on objective accounting data that determines profitability and acting in their own best interests, as all other industries do, was beyond their comprehension and deemed unacceptable by the producer bureaucrats who live handsomely at the expense of their investors. To have your CEO strut about town with the largest balance sheet is the only game in town. This is what accounting is all about in oil and gas. It’s just that accounting has nothing to do with the valuation of a company and everything to do with performance. It has therefore been an astute sleight of hand to focus on valuation from accounting in order to draw one's attention away from the rampant destruction going on throughout the industry. If they focused on what accounting was designed to provide people would have seen the chronic destruction that has been played out for the past four decades. But hey, lets not forget as we stand today the plan is to muddle through and do nothing.

Since Christmas, Santa has fallen out of favor as the culprit responsible for the destruction in oil and gas. But don’t worry, as with all of the excuses bureaucrats have used each has a cycle that is rotated in and out when the time is right. We seem to be getting back to the pipeline culprits again. Which to me is the most comical of all the excuses used by the producers. Pipelines can be deemed common carriers or private facilities. Common carriers are regulated businesses that operate on the basis of cost plus. They are utilities. And therefore are quasi bureaucracies. They are not the ones we should look to for leadership regarding the future of the oil and gas industry. Pipelines operate on the basis of commitments from producers who will use their line if its built. Once adequate commitments are secured then the pipeline will be built and it will be profitable for the pipeline company, on a guaranteed basis. If they don’t get the commitments the pipeline company will be profitable, on a guaranteed basis. So yes these are the people we want to blame for the fact that North American producers have not been able to attain the full value of their oil and gas revenue streams.

We noted too that producers are not recognizing that if they had all the pipeline capacity that they could ever want or dream of. That would enable them to shift their inventories from one pipeline constrained region in North America to somewhere else in the global glut of oil and gas commodities. Producer bureaucrats have also been found to be the most willing hostages of the green and environmental movements. Cutting checks to these groups to ensure that they’re never brought to the attention of anyone by demonstrating at their head office. These funds are then used by these groups to legislate, litigate and harass the pipeline companies development processes and make the time and money necessary to build the pipelines increase. With these additional costs the pipeline companies are therefore able to increase their profits in their cost plus profitable business model that the utility regulates them under. The fact remains producer bureaucrats have always found someone to blame for their lack of revenue upside.

We’re entering the fourth quarter reporting season and it appears producers are really hitting it out of the park. As one can see my disgust at the events in this industry are becoming more colorful. Therefore in order to finish with this series in time to resume our review of earnings I’ll be shifting to phase II of this theme. That being how the Preliminary Specification deals with the specific myths and returns the industry to prosperity and profitability.

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 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 403-200-2302 or email here.

Exploding Myths, Part X

Your credibility only becomes a major issue when you don’t have any. When I started these developments the industry was doing very well and what I was telling people was the Joint Operating Committee was the answer. Most people just kindly walked away. Some asked what was the issue? Being called a fool, a nut or just downright crazy shows that you have a credibility problem. No one is listening and no one is buying. Two things that I’ve learned through this experience is that you don’t argue when people say you’re crazy. And that it’s a very liberating process, and indeed I now find it a distinct competitive advantage. The point in today’s post about credibility is that the oil and gas industry in North America has none. It started with the investors not believing the financial statements, the banks are coming around to the same understanding, the service industry has been financially betrayed and the people that are needed to operate the industry in the future don’t find the engineering and geology faculties to be of any interest. Those that were shown the door may have been able to move to another producer, but many have also decided the boom and mostly bust cycle of oil and gas isn’t where you want to carry a mortgage or raise a family. Producers and the industry believe they’re credible however most people now think their fools, nuts and crazy for having these things carry on for so long in this manner. Especially when there was a solution available in the Preliminary Specification.

The muddle along and do nothing strategy is currently operating on the understanding that once they start paying everyone again they’ll be able to bark out the orders and everyone will jump just as high as they did before. It may cost them a bit more than when they barked last time, but not as much as what they would have had to pay if they maintained a steady state of operations. Progress such as this is sometimes difficult to measure. This therefore being considered a positive attribute that the producers will realize when whatever it is they’re so diligently waiting for comes to be. Since the EIA issued their report noting that it’ll be the same old, same old until 2050, interest in the industry has waned even further. Credibility such as the EIA’s is difficult to come by. This time it seems to be taking the super majors with it. Something that we’ve not seen in the downturn up until this point. Exxon, Chevron and Shell all received strongly negative responses to their fourth quarter earnings. Which is difficult to understand considering the number of alternatives that people could be invested in or interested in moving to other industries.

Who’ll be the first to stand up and say that they find the oil and gas industry is where they’ll make their fortune. Or that they’re committed to providing the most advanced drilling rigs to the industry at no cost. What compels people to enmass say that oil and gas is where they want to risk their careers, irrespective of the intermittent financial disasters it causes them. Where the dynamic nature of the industry, its vision of the future and history of profitability show that change is the culture and nature of all the producers. “It is, trust me” the producers will say, “you just have to be patient.”

The old business model of oil and gas, the one they’re still operating under, was from a scientifically difficult business to be in. Scarcity of the oil and gas commodities made the industry a challenge for all concerned. It was the strength of the minds of the engineers and geologists that could make the key difference between success and failure. There were other business models employed in the industry too. Some producers were headed up by lawyers who better understood the law, and some were headed up by Wall Street veterans. It is all of these business models that have failed. To be successful in oil and gas does not require real profitability as all of your cash can be consumed by capital assets that will be replenished by gullible investors each and every year. It would seem that the world has run out of gullible investors and those that are remaining see no credible reason to invest in oil and gas. The underlying business has changed through the development of shale based reservoirs making oil and gas abundant. However the business model has not changed to accommodate this new era. Technically shale operations are far more complex than conventional operations however the ability to deliver product to market is substantially easier. Shale makes oil and gas easy, and just as the prior business model didn’t, shale with the old business models do not make oil and gas commercial.

“Buddy can you spare some change to drill a longer lateral?” We haven’t reached the point of begging for financial resources. There needs to be two parties in the room. The question becomes who is going to jump when the producers say they’re ready to resume normalcy. Right now they believe they are all powerful as they’ve been for many decades. How much of that is a myth? Does anyone stand up to these people and say they don’t like what it is that they’re doing? Where would any bureaucrat have heard the negative response to their inaction outside of People, Ideas & Objects? I don’t think anyone will make the argument because they know the message won’t be received and most importantly, won’t be received without retribution in some form. What we have is a culture that defined their success by the volume of investors they had lined up out and around the block. Letting only a select few in each year. Where that was the business, and if it wasn’t, which was often, the patient and disciplined were rewarded for inaction. If anyone sees these carcasses leaping up off the floor to address the opportunities and issues that this industry faces, they have a far more optimistic point of view in life than I do. The concept of creative destruction is where People, Ideas & Objects are hanging our hat. The building of the Preliminary Specification to remake the industry to address these is the way that I see the dynamic, innovative, accountable and profitable oil and gas future the rest of us know is there.

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part IX

The news yesterday from the Energy Information Agency (EIA) was a sober look for anyone thinking about oil and gas as a place to bet their future. What they say is very clear to me and that is forget about getting involved in any way with this industry, and if you’re already there get out. My interpretation I know, strong words but here are the facts according to the EIA. Both quotations are using their reference case.

Petroleum and Other Liquids

In the AEO2020 Reference case, net exports of U.S. petroleum and other liquids peak at more than 3.8 million barrels per day (b/d) in the early 2030s before gradually declining as domestic consumption rises. The United States continues to export more petroleum and other liquids than it imports. Net exports of petroleum and other liquids reach 0.2 million b/d in 2050 as domestic consumption slowly increases but remains 1.2 million b/d below the peak levels recorded in 2004. 

Natural Gas

The United States continues to export more natural gas than it imports in the AEO2020 Reference case because near-term growth in liquefied natural gas export capacity delivers domestic production to global markets. In the AEO2020 Reference case, pipeline exports to Mexico and liquefied natural gas (LNG) exports to world markets increase moderately until 2025, after which pipeline export growth to Mexico slows. LNG exports continue to rise through 2030 before remaining relatively flat for the remainder of the projection period.

What the EIA appears to have included in their understanding is the same bias that I developed many decades ago. Although neither they or I have expressly stated this bias, it is the natural and consistent behavior of all of the oil and gas producers. Overproduction at whatever level of demand will always occur. This overproduction is irrespective of the price that the commodity receives. There is no inherent understanding that oil and gas, in its current business model, is a business, it’s rather an engineering exercise where any and all production will be accommodated by the market. The EIA has projected this non-business based methodology out towards 2050 with no inherent change. Or in other words continued chronic overproduction for another three decades. Why would they project otherwise? After 40 years the culture of the industry knows no difference and is incapable of even addressing the subject. This is culturally ingrained in the industry with people believing that this is how business is done. The EIA have made the following quotation one of their key takeaways from the Reference case.

The United States continues to produce historically high levels of crude oil and natural gas. Slow growth in domestic consumption of these fuels leads to increasing exports of crude oil, petroleum products, and liquefied natural gas.

My assumptions are that the global markets for both commodities remain constant to 2050. Possibly an unreasonable assumption. However the history of the industry shows that nothing has changed in the past four decades that I am personally aware of. Nothing has changed as a result of the fundamental collapse of natural gas prices. Initially on a continental basis, however now globally. Nothing has changed as a result of the decline in oil prices in 2014. And nothing has changed as a result of the investors withholding their support. Other than of course the cash crisis which is now in it’s full stride.

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part VIII

Given more time the producer bureaucrats will have this situation resolved. “Muddling along and doing nothing” is a long term strategy and operating procedure after all. It’s not that the decade or more in natural gas, or the half decade in oil weren’t appreciated, it's just that they need more time. Nothing could be further from the truth. Their difficulty is they have no time and their cash consumption continues at a horrendous pace. Industries only hope is that it will be addressed by implementing the Preliminary Specification. In order to do so would require them to bite the bullet and admit that it is their fault and start developing our solution. This would also require that they stop blaming others for the difficulties that they’re facing and take responsibility for the industry as they’re the ones that sit on top of everything. It is producer revenues which they’ve gladly accepted however those revenues come with responsibilities. Arguing that others have not done what was required to safeguard the upside in the producers revenues is the dumbest argument known to mankind. If there were all the pipelines that could have ever been conceived. If these were built and operational, the impact on the current global oil and gas supply glut would be absolutely nothing. Overproduction and oversupply are the issues and have been since 1986. Shale just makes the issue terminal in terms of its scope and scale.

We are beginning to see an increase in the discussion about the policies and behaviors of the North American producers. Such as commentary by Chevron that only some of their production will ever be profitable in the era of abundant, overabundance. We believe this discussion to be reflective of the culture of the industry not knowing better and incapable of grasping basic business concepts of how to run a business. I’m granting them the benefit of the doubt here and not accusing them of running a scam. For today. A discussion regarding an industry that provides a highly valuable commodity that is in limited supply when taken from a long term perspective. Taking investor money and spending it on a sustainable business model with the ability to manage a profitable business is evidently beyond even the super majors' understanding.

The myth we wish to destroy today is the narrative that we’ve seen over the past month that some of the producers' production is shut-in due to a lack of financial performance. This I can assure you is not valid and can clearly be proven otherwise. First the producer is unaware which property is providing them with profitable operations, if any of their properties are. Detailed financial statements at the property level, such as those we’ve proposed in the Preliminary Specification, are necessary as they are not currently prepared by any producer in the industry. If there is a producer that is preparing financial statements at a property level I can assure you that they are garbage and not worth the paper they’re written on. Under no circumstances, anywhere in the industry can any producer provide accurate information regarding the actual overhead costs of operating the property or the allocation of their specific depletion. What are the scale of overhead costs in oil and gas, no one knows, but we suspect it may be as high as 20% of revenues. Producers are certainly welcome to prove me wrong with the actual numbers. But they won’t because they can’t. Most overhead costs are recorded at the corporate level. Then at year end, with one entry involving up to 85% of the total corporate overhead is capitalized to property, plant and equipment. Only overhead allowances are recorded at the property level. Find a producer anywhere that thinks there making out like bandits on the fees they generate from overhead allowances.

Therefore to determine which property is producing profitably will be a guess that doesn’t include much actual knowledge. Properties are like people, and there are a lot of different people. Some properties are oil and some are gas. Gas is substantially more difficult to administer and account for. Some properties are owned outright by a single producer, some are large diverse unitized properties with many different owners with interests in different producing zones, adjoining properties and facilities. I’m stating no one knows which properties are profitable. Producers use the high throughput production model where high production volumes are used to offset their high overheads. That is their business model, it would be ludicrous for them to spend time and energy in determining the detailed profitability of any property when the business model is to throw as much spaghetti at the wall as possible. Bad analogy maybe.

Shale gas is the most costly gas due to the multilateral and multi-fracing that occurs to expose as much of the productive shale to the well bore. Therefore in theory it would be the most costly, least profitable, and more than anything unprofitable, therefore these properties would be placed within the producers alleged inventory of shut-in properties, if they were managing their business. Looking at this EIA graph of the shale deliverability shows that not much of the industry’s shale gas has been suspended. Or alternatively, if they’ve been shutting-in unprofitable shale gas throughout these past 15 years then they certainly won’t be needing any more investor capital for drilling will they?

The same issue is occuring in oil. With almost a doubling of the U.S. production in the past few years, it’s obvious producers have been holding back the majority of their production there too? What we can conclude therefore is that we have absolute proof that none of the producers are suspending any of their productive capacity. They are all producing everything and always at full bore and will continue to do so under the high throughput production model that is used. If on the other hand producers are just focusing on refuting the points contained within People, Ideas & Objects Preliminary Specification it will be for one reason only. They’ve run out of excuses otherwise. Remember the litany of useless commentary from the past that included such classics as “waiting for a cold winter, market rebalancing, reducing costs through innovations, Artificial Intelligence, capital discipline, natural gas is a by-product, it’s the Saudi’s or the pipeline companies fault or having to ensure that alternatives don’t become viable” up to today where the old standby of capital discipline is repeated but just doesn’t have that old time ring to it anymore. Whether it was overused or just pure abuse it just doesn’t seem to sway the investors to return. If we look at the following graph of natural gas drilling rigs, and contrast that to the deliverability of shale we see one more interesting myth of the shale era. In the hands of the producers engineers, deliverability always increases.

People, Ideas & Objects claim that we provide the most profitable means of oil and gas operations resonates with oil and gas investors and bankers. What more could they ask for? People throughout the greater energy economy can now see the value that real profitability provides an industry beyond just the investors. Profitable industries are prosperous for all involved. Refuting our claim of the most profitable means of oil and gas operations is difficult to achieve in the environment the producers find themselves in. Therefore to claim that they have indeed shut-in the unprofitable production is the myth that enables the producers to circumvent the support that People, Ideas & Objects Preliminary Specification achieves. Or in other words if they’re already shutting in production then what would the purpose be of developing 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. 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part VII

With the declining operational field capacity and overall general destruction that producers have caused the general oil and gas economy. Many are now seeing the potential for a decline in the overall deliverability of oil and gas in North America. We have stated in these past few years that the industry has lost control of the financial, operational and political frameworks of the industry. Someone should inform President Trump of this potential decline in North American deliverability. Our assertion throughout the Preliminary Specification is that the term producers had used in times like these of “market rebalancing” or even “capital discipline” are nothing more than the deliberate destruction of oil and gas productive deliverability. Allowing excess productive capacity to diminish and eventually match demand. Although they don’t seem to be taking credit for these “do nothing” actions at this time, the bureaucrats should be congratulated on what can only be described as their most significant achievement this century!

No one can predict the future, but I can state unequivocally that the bureaucrats can’t, won’t and will not ever make the changes to remedy this situation. The Preliminary Specification disintermediates them and they have it too comfortable at this time. They have the revenues of a primary industry flowing directly into their pockets! Why would anyone give that up? This logic also applies to them undertaking any changes themselves. At any point in these past decades they knew what had to be done, then why didn’t they do something? It just hasn’t been in their best interests. Hence my chronic discontent with the situation that is occurring today in the industry. I see serious issues being played out with the damages and their consequences taking many decades to resolve. Challenging our advanced way of living. A way of living that we may not have a full understanding or appreciation of the substantial role that oil and gas provides. Does anyone still believe the bureaucrats will be the ones that show the way to a prosperous energy future?

I would argue the cultural inertia of the bureaucracy can not be overcome. Creative destruction is the only method to establish a culture that will focus on the most profitable means of oil and gas operations everywhere and always. The industry believes that reducing its costs, an engineering based business model, is the only way to fame and fortune. Overproduction, oversupply and oil and gas commodities as price makers are not relevant to the situation at hand. They won’t accept that there is no magic cost reduction on the horizon that will make these commodities profitable in today’s price environment. Squeezing people and suppliers a bit more, as has been done for the past four decades, will continue to be the modus operandi of the bureaucrats. It’s all that they know and all that they do. What we do know is that each incremental barrel of oil is more difficult than the one before. The costs of exploration and production will not be going down as we continue to produce the technically easiest barrels to produce. The Preliminary Specification ensures that all of the costs of exploration and production are recognized in a timely manner to ensure that the industry is profitable and prosperous. What is today’s plan?

The next shoe to drop may be the fourth quarter financial statements. We anticipate on the basis of what has been published that Chevron and others are recognizing large asset write downs of natural gas, particularly in shale based reservoirs. These natural gas write downs will be precipitated by two aspects that are outside of the control of the producer. The natural gas prices are in a state of collapse, rendering a lesser value to the reserves. And the amount of shale based reserves that qualify as commercial will therefore be reassessed using these prices, reducing the actual reserves of the producers. Therefore the amount of remaining reserves that the independent engineers report provides will be incapable of carrying the hefty natural gas costs recorded in property, plant and equipment. We have argued that these capital costs are really the unrecognized capital costs of past production and should have been recognized many decades ago, but that’s just our opinion.

Which brings us to the myth that we wish to explode today. That being the costs of depletion and impairments recorded on the income statement, as far as the producer bureaucrats are concerned, is irrelevant. “That’s history, the money was spent years ago and it’s irrelevant today, no one concerns themselves with these ‘accounting’ numbers.” These write downs will not preclude the producers from saying that they’ve been profitable and will continue to claim that they’re generating free cash flow. I turn to what is now my favorite graph that accurately reflects the attitude of the producers. Their attitude is they’ll consume capital that the investors and bankers have graciously provided. When accounting capitalizes everything and hence everything that is reported is profitable, you have a scam. When that sliver of capital that is recorded as depletion on the income statement, and it is of no concern to the bureaucrats, you have an advanced scam whose culture is the scam. This chart shows their alleged break even point and the price in which they would shut-in production. Note that their understanding of break even is flawed towards their cultural scam. In the Preliminary Specification we would shut-in production at the point where they note that costs breakeven. That breakeven point would include the capital, royalty, operating and overhead. Or the marginal cost. Not the operating cost which is what the bureaucrats represent in this graph, and the point where they would shut-in production. Which as far as I know no oil or gas production has ever been shut-in due to the financial performance of the property.

Let’s not kid ourselves you can goose your earnings by capitalizing everything like the receptionists time, telephone service and Post-it-Notes, and get away with it for a long time. The fact is however those over reported earnings will have to be offset by losses at some point during the firms lifetime. Pursuit of the biggest balance sheet is a contest that can’t survive forever. Eventually those bloated balances of property, plant and equipment become disproportionate to the rest of the organization and demand recognition at a faster pace than what would otherwise be the case. This alone may be the reason for the high number of write downs that we’ve seen over the past decade. There is also this graph that shows this trend may be well entrenched at this point. Making the bureaucrats business model all the more untenable.

Of course bureaucrats will take offense to being called scammers. They have now established a record of performance that is reflected poorly in the chart below. Recall during these periods that producers did not at any time recognize the appropriate amount of capital in the costs of the commodity to the consumer. Accumulating capital in property, plant and equipment as if it is a cherished commodity. Having investors therefore subsidize the consumers consumption of energy by never including the appropriate amount of capital into the price of the commodity in a capital intensive industry. The game is almost up now. The trickle of exits from the C-Suite started in late 2019 and it has become policy, it would seem, not to pay any of your “unsecured creditors.” When everyone isn’t paying it's hard to be identified. The producer organizations have limited lives remaining. Companies such as Chesapeake who’ve declared they’re not a going concern, who’ve had their bonds downgraded to a Probability of Default rating and whose $0.57 stock is trading below the $1.00 threshold necessary to maintain its listing on the NYSE. It’s their belief that these carcasses that will rise up to make the future of the industry what it has 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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part VI

In Part V of our Exploding Myths series we documented the changes that we believe producers will be faced with in the near future. Those challenges include the current lack of investor and banker support, but also a systemic service industry demand for cash upfront for them to conduct any operations. Rendering producers financial capabilities a number of decades behind other industries, making their capacity to provide adequate, competitive returns in the capital markets that much more difficult to achieve. You do reap what you sow however, and the abuse that has been handed out by the producer bureaucrats to the service industry these past few decades has been epic in its disrespect, rudeness and the financial or business risk being placed on those outside of the producer firm. Let us count the ways in which this has occurred.

First it’s important to recognize that oil and gas exploration and production is a primary industry. The revenues that are generated are those derived from the sale of oil and natural gas. Custody of the oil and gas is taken by the producers once the royalties have been paid to earn title of the commodity. Then, and here is the important point, it’s all the producers. At no point does the consideration that the service industry was the critical resource the producer used to obtain those revenues. The service industry representatives are considered to be leeches on the good fortune of the producer. This is the effect that occurs when the revenues that are realized are not recognized for who and what was done to earn them. Therefore the relationship with the service industry can and is in conflict by the bureaucrats hanging on to their cash and the service industry begging to be ordained for a slice of the pie. It is this conflicted relationship with the producers that keeps the service industry from realizing their full potential. If recognized as the dynamic, innovative and productive extension of the producer themselves the relationship would be collaborative and respectful. Instead any new field based developments must be fully described and displayed to the producer before it will be accepted by industry. Essentially expecting the provider to show the producer their Intellectual Property so the producer can understand, but also pass it around to other friendlier service industry representatives. Ones in which the bureaucrat may have an undisclosed personal interest in. China has nothing on the shenanigans of oil and gas bureaucrats. I call this the wash cycle that is systemic throughout the industry. This also allows the producers to claim that they are the ones who are the drivers of innovation. Whereas in reality they’re hesitant to try any new technology for decades, such as coiled tubing and the well known difficulties that Packers Plus enjoyed. Yet bureaucrats are the ones out selling themselves as the innovative ones! Even last year they stated the upside in their profitability from Artificial Intelligence was dramatic! Sure. 

When times are good as they were earlier in this century the chronic boom / bust cycle has caused the service industry to be tepid in their response to the boom’s. This has had an effect on their pricing for high cost items like drilling rigs and the like. When capacities are reached and exceeded as they always are in the boom times it becomes a matter of allocating their few resources on the basis of price, after all they’re running businesses. Therefore exploration and production costs of the producers go up. And this precipitates the producers to open the flood gates in terms of the derogatory terms of what they’ll call their service industry partners, or is that the working class. Greedy, lazy are a few of the Canadian producers favorite. I say “let them eat cake!” has a higher level of empathy than bureaucrats.

Companies such as Chesapeake who commented in their third quarter report that they may not be a going concern, who Moody’s have downgraded their bonds to include a Probability of Default rating will now find that the simple things that took a second or two to complete before may now take a number of hours to complete. I refer to this activity as the herding of cats. When, after several hours of work is done, you turn around and half the cats you thought you had lined up somehow wandered off. Undeterred you begin the process once again.

Yet all of this would be so simple to solve. People, Ideas & Objects have been promoting our solution since 2013 with key components of it as far back as 2007. Well before the issue of overproduction and oversupply became as problematic as it has today. World Oil is now stating that...

On that basis the route to salvation for this very important fuel increasingly has to come from companies cutting production, either voluntary or involuntary.

When they say this it almost sounds like common sense! Yet natural gas has been depressed for ten years, oil for 5. Investors left almost 4 years ago. The net result of this deterioration in the producers business, is nothing. A shrug and an “oh well, we’ll muddle through like we always do.” The extent of this crisis is past anything that can be considered acceptable. Serious degradation in the financial capabilities and now in the capacities and capabilities in the operating theater are collapsing. Humpty Dumpty style. And the only thing we’ll hear as a result of the World Oil suggestion of shutting in production is “Shut-in production? Not me, we’re profitable!”

Only a crisis - actual or perceived - produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes the politically inevitable.

Milton Friedman

The now common claim that capitalism is waning and a broader perspective is needed is unnecessary. Capitalism is in fine shape and all that is required in oil and gas is that they practice it. The difficulties in the service industries and general economy are directly relatable to the inability of the bureaucracy in the producer firms to give a damn about their profitability. Once producers are profitable from a real perspective, not these specious accounting profits of the past four decades, then the prosperity will “trickle down” to everyone who is associated with them. As a primary industry they are the ones that receive the revenues from the oil and gas sales. These sales make the economies operate when they are distributed in a manner that is consistent with the needs of the markets. Having a handful of bureaucrats divvy up the proceeds by putting four in their pockets for every one that anyone else receives would most certainly generate a consensus in the marketplace today. I’m not saying the producers don’t have the right to the revenues as the producers in a primary industry. What I am saying is that with every right comes along the associated responsibilities. These responsibilities have been ignored as a convenience to those who don’t give a damn about the damage they’ve caused and are causing in this industry. I’m sure I could generate a consensus on this point as well.

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part V

The myth producers continue to push that all is well is certainly counter to the arguments put forward by People, Ideas & Objects. Our White Paper “Profitable, North American Energy Independence - Through the Commercialization of Shale” identifies the following scenario if producers do not change their ways. Noting on page 12 that “the state of industry affairs on an objective basis is terminal.” First by pointing out that none of the value that was built in prior generations, and all of the investors resources over the past number of decades doesn’t mount to a hill of beans. The industry retains no value and demands cash in order to operate which it has done for many decades. The difference today is that investors and bankers are wise to the bureaucrats wanton destruction of value. Secondly our White paper noted that cash was to become hyper critical in the fourth quarter of 2019. I then stated as the third issue “as night follows day the financial destruction within the oil and gas producers will lead to diminished operational capacities and capabilities.” On Friday January 17, 2020 an article was published in the Wall Street Journal entitled “Schlumberger Plans U.S. Pullback as Shale Oil Drillers Struggle.” Producers should realize the implications of what is being stated in this article. It documents the changes being undertaken by Schlumberger in the North American market. Schlumberger being the largest oil field services company, these changes have implications that are far reaching and will take decades to mitigate the damage to producers future capacities and capabilities. These are the Schlumberger changes.

• Reducing their headcount by 1,400 people.
• Drawing down their North American operational shale capacity by 50%.
• Reallocating this North American spending to global initiatives.
• Recognized a $12 billion writedown in the fourth quarter, mostly attributable to North American operations. Unknown what the amount of the total of this asset write down was in terms of accounts receivable. 

The CEO Mr. Olivier Le Peuch then stated the following.

As the year progresses, the effect of slowing North America production growth is likely to cause tightness in the market and further stimulate international operators to step up their investments in the second half of the year and beyond,” Mr. Le Peuch said.

I read this as goodbye for good. Any downside in North America productive capacity will be Schlumberger's gain in the international markets. I also see this as part of an overall movement from denial to anger which is the second of five levels of grief. With the destruction of cash which has been a feature, not a bug, of the current downturn. Producer management of their field services has been abysmal. Systemic default of “unsecured creditors” is all the rage in oil and gas. I suspect that this was one of the motivating factors in Schlumberger $10 billion fourth quarter loss and their exiting the continent. We have noted elsewhere that these defaults will precipitate the need for producers to pay cash up front in the future. No matter who they are. Making what we are experiencing now a much longer and more protracted decline. If producers have to generate the necessary capital in advance, with no assistance from investors or bankers, it will be a few additional years before they generate the necessary funds and be able to pay in advance. Service industry participants will ask for cash up front and producers will say “they can pay in 30 days.” At which point the service industry will say “see you in 30 days.” When you have fundamentally betrayed the people that depend upon you, you’ve changed the rules of engagement. I guess the producer could threaten to take their business to Schlumberger instead, at which point the service industry will say, “see you in 30 days, if you have that cash.” The Preliminary Specifications decentralized production models price maker strategy takes the cash that producers have buried in the ground and spit polished on their well built balance sheets in property, plant and equipment. And begins to pass those costs on to the consumer of the oil and gas commodities. Oil and gas is a capital intensive industry indicating that the majority of the cost of the commodity will be capital. In today’s competitive capital markets no industry can compete by storing cash in the ground for decades. Only People, Ideas & Objects Preliminary Specification enables the return of the invested cash in a timely fashion (30 months) to begin rebuilding the oil and gas producers. We’ve been discussing this major difference of our system for over a decade now, and you would think that if the producers were able to make the necessary changes to achieve this on their own, they would have done so. But they can’t do it, won’t do it and will obviously never try. Bureaucrats are terribly conflicted as the Preliminary Specification disintermediates them from the industry.

I see strong parallels in what is happening today with the market that I compete in, that being oil and gas ERP software. There was a dynamic, interested investor marketplace for systems in the early 1990’s. The ability to raise capital was relatively easy. But producers believed that ERP systems stole from their drilling budget and worked to ensure they paid nothing for the ERP product and only its service contract. As a result, today it is all but impossible to raise capital for oil and gas ERP systems, as it has been since late 1996. I don’t say this from any experience. I say it from the point of view that I would not take anyone’s capital as I would have no ability or capacity in which to accurately predict if I could ever return a single dime to any one of those investors. This is not just the ERP providers. The same shenanigans have been conducted by these producers on all of their suppliers. They don’t recognize other people’s Intellectual Property, they won’t work with anyone unless they are of a size and pedigree, an example of two ways producers dictate terms. The point that I’m making is the oil and gas industry will have to conduct itself with much less sophisticated financial capabilities, that being cash. Having abused their absolute power in these markets over the past number of decades will demand a different basis of dealing in the future. Which will include a lack of investors when the cash is sitting in the ground, and a lack of willing investors stepping into the oil and gas service industry.

As our White Paper noted, the method of dealing with overproduction by the producers was to muddle through and do nothing. As evidenced by the past ten years of inaction its clear to see they’re fully committed to this strategy. Although I do not believe that we will see a decline in oil and gas deliverability in North America. We have a new risk that is inherent in the shale era. The rapid decline rates of shale is something that we’ve never experienced before. Will it now get ahead of the producers ability to continually increase their production? Will the loss of the capacities and capabilities we’re experiencing in the service industry today be too much for producers to stop the erosion of their productive capacity?

You do reap what you sow. The only systems development or plan being offered to solve the industry issues is the Preliminary Specification. And we are of the opinion the damage that has been experienced by the industry by its bureaucracy is in excess of what anyone can fix. We are therefore pursuing creative destruction and our Initial Coin Offering. Nonetheless no one would offer anything without payment upfront before any development work would be done. Payment in full I would add. I see this same treatment being applied to the oil and gas industry by all of its suppliers. And it will be applied consistently to each and every producer, no one will be immune. The only business risk that will be entertained by anyone providing any service to the oil and gas industry has now fully shifted to the oil and gas producers themselves.

In related news Cenovus has announced that they’ll be carbon neutral in a few decades. Such leadership! It’s clear these producers are unable to focus on their business agenda or prioritize. And that is the myth we explode today, that all is not well. Cenovus announcements are not expressions of naivety, they are distractions and cover stories for the avoidance of any responsibility. It’s not that they feel any guilt about the state of affairs, it's that they want to appear oblivious. We’ve heard nothing but sunshine and rainbows from these producers, no action and their time has run out.

We’ll break now to continue this discussion again tomorrow in Part VI.

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part IV

The question needs to be asked, how does North America become a higher performing economy with a highly defined and evolving specialization and division of labor, integrating all of the new technologies on a spontaneous basis? We address and resolve these issues in the Preliminary Specification and noted that the current installed technologies have locked organizations in an unchanging steady state. Where the capabilities and capacities to make the necessary changes are unknown and unaware of the need for change. Organizations throughout North America are encased in proverbial cement as a result of the Information Technologies they employ. Making any changes to the organization must be executed first in the software to ensure that the organization does not regress back to its prior state. Software defines and supports, but also constrains organizations in the status quo. We believe our good friends the bureaucrats have taken this knowledge and used it to their benefit. If they never changed their software, they would never be challenged in the manner in which they operate. We can see throughout this oil and gas crisis that no discussion of organizational change is ever initiated. What we do know, since March 9, 1776 from Adam Smith's The Wealth of Nations, is that all economic progress has been the result of specialization and the division of labor.

The myth that we hear in the market today is that planning is ineffective. There are a myriad oil and gas pilot software development projects being funded by handfuls of oil and gas producers and this is not inconsistent with their history. These pilots are either forgotten about, or proven to be ineffective. Occasionally one might succeed with its sliver of scope and scale to be deployed at those sponsoring producers. There they’ll work together with the thousands of other applications that have been developed over the past number of decades to make what these unique oil and gas producers need to function. And this is where much of the administrative and accounting costs are replicated within each oil and gas producer. Each producer undertaking the same tasks as all the others in their own unique way. Unable to share these unshareable capabilities that drain the industry of any hope of profitability. The same applies to most of the budget for the IT department which is spent on maintaining its empire with little if anything conceived to make effective business change. Planning in this environment is clearly redundant.

The mantra of muddling through and doing nothing as they key strategy and operating procedure of the oil and gas producers becomes clearer as to its purpose and function. To propose anything would be ludicrous and too costly. And that is where we are in terms of the producer demand for the Preliminary Specification. “It’s too comprehensive and won’t work.” “The treatment appears to be toxic to the patient.” Yet they seek to provide the same scope and scale within their own organization on a budget that pales in comparison to our proposed budget. We expect under their current organizational structure, none of these producers will be able to survive, even for the short term. Chronic difficulties with cash and profitability will continue and become more acute as each quarter passes. The only way in which to make the industry and producer based changes in the Preliminary Specification is through creative destruction. We’ll be creative while the producers destroy themselves.

And that is the situation we face today. We don’t believe this industry can prepare itself for a challenging future such as what the oil and gas industry faces. With piecemeal applications and little to no change management capabilities built into any of their software, its development and those that are responsible for implementing and operating it. People, Ideas & Objects seek to build a dynamic, innovative, accountable and profitable industry capable of meeting the needs of the industry as it changes and evolves, with the technologies as they are developed. This will not be done on a muddle through strategy. This will not be done without planning. And our plan is designed to continue to support the industry throughout its challenging and difficult period to 2045.

What I am suggesting here is that the economic concept of spontaneous order is dead. How in this highly structured Information Technology environment that we operate in, and will be even further constrained and defined by in our future, are we just going to break out on an industry-wide basis and pursue new business models and opportunities? Maybe creative destruction will have to become a quarterly event! When “things” could be defined and controlled within the producer firm itself, reorganizations were productive and applying specialization and the division of labor could be conducted on a clear basis. Now with supply chains being developed across continents how will they be efficiently defined and developed? This is how the bureaucrats propose the oil and gas industry continue to proceed on a go forward basis. Cashless, investor and bankerless, organizations conceived and operated in the third industrial revolution, and capital expenditures to refurbish, repair, rebuild the aging infrastructure, unable to maintain profitable energy independence or even generate the financial resources necessary to deal with these demanding capital expenditures.

I can understand and appreciate the bureaucrats belief in muddling along. Planning over the past four decades hasn’t been conducted and they’ve survived and personally prospered to this point. Maybe bureaucratic survival isn’t adequate anymore and the needs of others should be considered. Profitability affects more than just investors. It reflects a healthy industry that is able to function and prosper in society for all concerned. Something the bureaucrats have chosen not to care about.

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part III

Since the 2009 financial crisis the market rebalancing of natural gas has been one of the consistent claims of the producers. The same has been the case for oil since 2014. What we see in 2020 is neither market has been “rebalanced.” Why is that? How does one go about rebalancing a market? Have these steps been taken by North American producers? Or are the Russians manipulating these commodity markets between Presidential elections?

The fact of the matter, as we’ve described in the Preliminary Specification and our White Paper, is that “market rebalancing” is one of the key myths that producers bureaucrats continue to push so that they can continue to sit on their hands. There is no such concept outside of oil and gas known as “market rebalancing” that goes on. As we’ve pointed out markets do one, and only one thing, which is to provide information in the form of a market price. If the price is adequate to make a profit then a reasonable, rational person would produce. If the market is not providing an adequate price then that same individual would choose not to produce. Market rebalancing is the myth that keeps on giving the producer bureaucrats cover for their “muddle along” and “do nothing” ways. Don’t believe me, go back and check the dates when prices collapsed in these commodity markets. Why would any rational, reasonable person continue for a decade without any response to the destruction being caused by producing at low prices? The answer is at one time they had willing investors duped by specious financial statements.

Natural gas prices are the worst they’ve been for this time of year since 2016. Which doesn’t say very much and isn’t news. Oil prices in 2019 were substantially lower than in 2018. Projections for earnings in the fourth quarter are expected to be a surprise to the downside. The IEA believes that 2020 will see oil supply exceed demand by 1 million barrels per day. Anyone want to guess what natural gas markets will be like? The thing to remember is these bureaucrats when caught in the camera’s lights can say with all confidence that they have this. Just ignore the look of horror on their face.

Maybe producers should look at the bigger picture of what their investors want. Sure free cash flow is the word of the day. And oil and gas bureaucrats have always been able to pick out the one business criteria to make their claims of what they’ll do within a specific year. What they need to learn is that business is about building value year after year, and what I mean by that is not destroying value, which requires real profitability which would generate real free cash flow. Using the cash that is generated in the business to fund all of the necessary capital expenditures, pay dividends and pay down debt. All three, each and every year. Not claiming one of these business metrics they’ll magically perform in the current year, only to come up short again. Investors don’t want to run the business, that’s the producers job. To make them money, that’s what businesses do.

Last year it was share buybacks that were all the rage. Until it was pointed out to them that buying shares on the market, then running those shares through the shredder and burning them was not building any value. Producers purchased their shares on a wholesale basis by diverting their cash that should have been used to pay their suppliers in the field. Members of what we all used to call the “service industry.” The service industry was useful during the initial phase of the investor strike to finance much of the capital expenditures of the producers by having them extend to producers 90, 180 and 270 days to pay. What these producer bureaucrats have deemed here in 2020 is that the service industry is an old and nondescript sort of name. They’ve come up with a better name that suits the producers needs on a go forward basis, one that much better describes their view of the service industry. What they’re now calling them is “unsecured creditors.” Pengrowth in a plan of arrangement, or heck in any arrangement these people really don’t have to be paid! “Unsecured creditors” kind of has a nice ring to it, doesn't it?

Encana was buying $1.6 billion of their shares, then shredding them when they could have easily drawn down their accounts payable. It was the industry trend and the cool thing to do. If they were interested in building value, reducing the liabilities of a business would have made a substantial increase to their investors, instead producers must meet the narrative, there’ll be no deviations. Stock buybacks were the narrative at the beginning of 2019, free cash flow is today’s and later this year it will be defaulting on their “unsecured creditors.” Just as all of the pain that is being experienced by everyone in the general economy that is affected by oil and gas. The producer bureaucrats are the gang that could shoot straight right into their boots. The steep downward trajectory throughout the general economy in oil and gas is a result of the self-interested, conflicted and lazy bureaucrats. But this mistake of not paying those that are rightly owed, if I could call it a mistake, will come back quickly to cause serious issues to the bureaucrats. Producers will now have to get their cash out. Oil and gas will now be an all cash business. Want something done. Get some cash to pay the whole freight up front. And don’t be surprised when the “unsecured creditor” says he thought the producer was paying down their 270 day outstanding balance of accounts payable instead.

The term unsecured may begin to take on a much larger than life image in 2020 than the producer bureaucrats may have wanted. The other area where unsecured seems to be applied this year is in the employees of the producers. As in unsecured employees are on the street. Occidental is the first that I’m aware of out of the gate this year. Sort of like the first new years baby. Think of these layoffs as a post acquisition / Christmas gift. Occidental had been offering a voluntary retirement program since the acquisition of Anadarko however this is an increased cut in the unsecured employees. No numbers were announced. Apache chimed in the next day to make sure they were being seen as prudent with the hacking of 500 people and an announcement of the closure of their San Antonio office. This closing will bring on another 270 unsecureds when it occurs. Discussing the larger cuts being made in the general economy as a result of the irresponsibility of these producers would be redundant and melt down the Internet. The question that I guess I have is who gives a damn about what the price of oil or gas is in 2020?

One thing we can be assured of is the safety and security of the bureaucrats. Their ability to deliver on free cash flow is unknown and unknowable. It was the Saudi’s fault or the winter wasn’t cold enough as their reason for non-performance. None of this has been their fault in anyway, they’re innocent. With the designated unsecured classification being established, diverting that cash to source the funding of the bureaucrats personal empires in 2020 is secure. They always seem to have the winning hand, not caring has its benefits. It certainly is dark and gloomy outside in oil and gas. This is as I have been saying for many years and offered the Preliminary Specification as the means to mitigate these damages. There is no need to sugar coat any of this now, it’s only going to become much worse.

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.

Exploding Myths, Part II

One of the myths that we’re hearing being chanted is that free cash flow is now the focus of the producer bureaucrats. Feeling the pressure from disgruntled shareholders, bureaucrats are lining up saying that free cash flow is what they’re all about. For the record free cash flow is the remaining amount of operational cash flow after the deduction of capital expenditures. In oil and gas this number has generally been negative for many decades. It’s difficult for me to discern whether there is more authenticity in this claim than the litany of other excuses they’ve used. Excuses like waiting for a cold winter, capital discipline, yada yada yada. We’ve always stated that the methodology of accounting in oil and gas is that balance sheets and income statements are overstated due to the policies used to capitalize costs to property, plant and equipment, these past four decades. Capital costs are seemingly never recognized in the price of the commodity to the consumer. These costs, in a capital intensive industry, are stored for generations on the producers balance sheet. We have argued that cash flow is therefore overstated when the capitalization of every possible cost is undertaken, those costs then being allocated to each and every molecule of oil and gas reserves, and only the current productions portion of those capital costs are recognized as depletion. The nuance of overstated cash flow is not one that is easy to understand. Changing the amount of depletion from one number, by increasing the recognition of capital costs in an accelerated manner, does nothing to the amount of operational cash flow recognized in an accounting period.

You do however have an overstatement of operational cash flow due to the overhead costs being recorded at 2 - 4% instead of the probable real incurred costs of 20% of revenues. The difference here being the overhead that is capitalized. Have a producer prove me wrong if you don’t believe my percentage of overhead in the industry, or read Exploding Myth, Part I. This point alone seriously overstates the amount of cash flow generated by the producer and industry overall. When producers are evaluated at six times cash flow, would it not be prudent to boost cash flow? The fact is that in the Preliminary Specification producers will begin recognizing the cash that is being burned in the form of overhead in the organization each and every month. Our method of recognizing and costing the actual overhead as part of the price of the commodity instead of storing these overhead costs on the balance sheet for decades. Why would we do this in the Preliminary Specification? To ensure that these substantial overhead costs were immediately passed on to the consumer in the form of higher commodity prices and therefore the cash incurred on those overhead items are returned to the producer through the establishment of a 60 day float in order to have the money to pay the overhead costs in the subsequent month. This currently doesn’t exist in oil and gas. These overhead costs would also materially affect the balance sheet as we’ll be recording none of the overhead as capital from the point of when the Preliminary Specification becomes operational. This method will materially affect the earnings of the producer by increasing the costs that are recognized in any period. These costs of the operation will be substantial, overhead being upwards of 20% of revenues, which would offset the minor costs of recognizing the amount of overhead that is being depleted from property, plant and equipment. Therefore operational cash flow would be substantially reduced in comparison to today's method, as would free cash flow. It would however leave the same choice that producers face today in determining if they should pay dividends and never having cash again.

Capitalizing operating costs is an effective tool to overstate balance sheets, income statements and cash flow. In Canada producers became very effective at this method when they also include royalties in the calculation of what would be capitalized. I have little evidence of this activity other than the SEC prosecution of executives of Obsidian’s former persona of PennWest. We haven’t seen any of this activity in the industry since the SEC launched their litigation. Todd Takeyasu was the CFO that the SEC is most enthused about in their litigation. I can understand why. I knew Todd when we conducted audits together in the late 1980’s and early 1990’s. I can assure you Todd will have the nicest audit file put together in terms of the discussions and documentation regarding the capitalization of operations, overhead and royalties. Who authorized it and what was said. What he doesn’t seem to understand is it’s the CFO’s role to stop such nonsense from happening.

The Preliminary Specification also looks at the capitalization of assets from a different perspective in terms of what is or should be a capital asset in property, plant and equipment. Throwing everything that is spent into property, plant and equipment is only an effective business model when there are investors who can be deceived by these actions. A more nuanced accounting will now be necessary and that is what we’re bringing with the Preliminary Specification. Most of the work done at the well site is intangible in nature. Yet intangibles are not treated any differently than tangibles on the financial statements. We think they should be and as a result subject to a much more rapid method of depletion or depreciation. Again what producers will find here in this accounting change is hoards of cash when using the Preliminary Specifications decentralized production models price maker strategy. Which ensures only profitable production is produced everywhere and always. In addition we believe only the initial drilling and completion should be capitalized, particularly when dealing with shale wells. The majority of the capital costs incurred to drill and complete those wells should have been retired by the time the wells have had to be heavily reworked with additional laterals drilled and multiple completions on these new laterals. Shale has a rapid decline rate that demands significant rework where new capital needs to be employed to maintain deliverability. What is the effective accounting policy for such a property? The other characteristic of shale is that the proven reserves that are exposed are orders of magnitude higher than what oil and gas has ever been familiar with. Is allocating all of the capital costs equally across the entire proven reserve base, which will be produced over the next century, with each of the subsequent reworks costs added to those original costs the most effective business model? Or is this just the best way to bank cash in the ground?

If the producers continue with their myth that they’re providing free cash flow then they’ll have to provide an understanding where it is exactly that all of their cash is going. What should be obvious to most people in the industry is that cash only goes in and never comes out. This fact is being realized now that the investors and bankers are protesting. The myriad excuses and myths that have been peddled by these producers are more to deceive one another now. They’re the only ones that still believe in what they’re doing is right, or is it that they have to keep their story straight?

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 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 Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.