To allow thoughts and ideas from other disciplines such as finance and accounting to permeate the scientific community that sits atop the producer firms in oil and gas is never going to happen. That is as far as they’re concerned. It is their domain and the principles of these sciences are too far beyond the scope of what normal humans can comprehend. “The industry is fine and we’ll be moving forward soon,” our bureaucratic friends would say. “What has accounting got to do with profitability?” They would ask. An extension of what I see as the continued degradation of common sense by those who are the elites in society. I personally have had enough of experts as we see the systemic damage that has been caused through their advice which has brought about such comprehensive destruction equalling what we’ve experienced in oil and gas. The first instance I would suggest is the environmental movement and their 50 year fire alarm of chronic, imminent, environmental armageddon. And now from 14 year olds. According to them we should have been liquidated by the toxic nature of our atmosphere by now. The second instance is the financial crisis that began in 2008. What was common knowledge to most people who were reliant on common sense passed beyond the rarified air of the economists except for the one standout, Nouriel Roubini.
Most recently we have seen NY Times columnist Paul Krugman. An individual that has belittled any and all individuals that suggested any possible counter argument to his international trade theories. His characterization of Trump’s nationalistic trade policies were the highlight of his belittling and his career. That is other than winning the Nobel Prize in Economics in 2008 for his work in international trade. It’s ironic that he received the award during the time the economy was melting down in the financial crisis. Krugman’s apology in October 2019 for this 30 year litany of abuse is highlighted when all that he says was that he was wrong. Or today we see in the “science” based approach to the corona virus and the changing landscape that our “scientists” are painting for this mild flu. As with all of these situations, in oil and gas the engineering and earth scientists state that the science is unimpeachable and it is they who have the confidence in the “science” and the rest of us need to sit down and STFU. It’s time to put these elite experts back in their cages and remove them from the halls of power. They do not know what it is they’re doing.
The Attorney General of the United States Bill Barr commented about the situation with Corporate America and their dealings with the Chinese government and military. Calling out specific company names that he called “collaborators” and implementing the policy to have all agents of foreign governments register under the Foreign Agents Registration Act. Any lobbying by these agents who are or are not registered from these corporations will have a new and different approach to how they’re treated by U.S. officials. I raise this point as it’s implied in other comments by the AG that the ethical approach of U.S. corporations in the past decades has been counter to the best interests of the U.S. I would and have argued this same point regarding the activities over these past four decades in oil and gas. No one other than the bureaucrats have gained any financial benefit from the oil and gas industry during that time. Bureaucrats have been defined by People, Ideas & Objects as the Directors and Officers of the producers. The future does not include these unaccountable bureaucrats. That’s the message that I’m getting from all that is happening in the world these days.
This blog post’s opening is provided as background to what I see happening in corporate America as a result of the continuation of the Trump administration. Granted the Democrats have their policies of how they’ll rewrite history however I don’t think anyone is really buying them, other than the misguided youth our education system proudly produces. Nonetheless change is in the air for corporate North America and it is comprehensive and significant. The new trade agreement between the U.S., Mexico and Canada will provide a system where North America can maintain its economic dominance, I believe for the remainder of this century. People, Ideas & Objects vision and strategy is that North America will always be the largest consumer of oil and gas due to it being the most powerful economy. Oil and gas will always be a major component of the energy mix for at least the remainder of this century. It is therefore incumbent on North American producers to fulfill this possibility going forward by adopting the objective of profitably fueling our economies needs for the remainder of this century. The beginning of this would be to read and adopt the plans and strategies that are contained within our July 4, 2019 White Paper “
Profitable, Energy Independence in North America -- Through the Commercialization of Shale.”
Profitability is the critical ingredient needed to fulfill this oil and gas industry objective. People, Ideas & Objects do not believe that we have the right to produce any oil or gas unprofitably. Producing unprofitably only steals from the future the energy they’re entitled to. We therefore owe it to them to prove that we’ve produced all of it profitably and can provide them with a viable, financially healthy industry that is capable of supporting itself. The only way in which we can do that is to ensure that all costs associated with exploration and production are passed onto the consumers in an appropriate and timely manner. I have detailed what and how our methods of profitability are in the
Preliminary Specification and throughout the past 15 years of existence of this blog. We offer the oil and gas producers with the most profitable means of oil and gas operations, everywhere and always. How our determination of profitability is fundamentally different from the reporting of the current producers, and how theirs has exaggerated assets, earnings and cash flow materially for the past four decades. These differences are also detailed in the White Paper I’ve mentioned above and in this graph.
What we’ve learned recently is there is an initiative in play in the industry. We know this is not the Preliminary Specification due to the fact that my phone has not been ringing. Reporting the disastrous second quarter reports of these producers will be a shock to everyone. As bad as people assume them to be, they will be much worse. To continue without any discussion on how to deal with what People, Ideas & Objects believe, is an existential threat to the industry without a plan and strategy is suicide for the bureaucracy. We think the bureaucrats agree with this scenario and have devised a strategy and plan that is coded as a “reorganization” around the “assets” of the producer. Their focus is on assets as they are the purpose, collectable and proof that theirs is bigger than all others in the pursuit of “building balance sheets.” We would ask what is the objective of their “asset reorganization” being undertaken by producers? No producer has filed their second quarter report as of this date and time, giving them all at least a few days to come up with an objective, similar to what People, Ideas & Objects have described above and throughout our publications. But it’s not just a viable future they’ll need to identify, the viable methods and means in which to get there will be mandatory as the bureaucrats reputation for issuing press releases with no follow up is well known. We wish these producers godspeed and good luck in this endeavour. Just as with the producers' Artificial Intelligence initiatives of a few years ago no one will know or understand what they're doing or have done. Will it enhance their profitability in the material way that the Preliminary Specification can, or is it just to buy more time in which the bureaucrats can profit personally and devise other viable scapegoats in their never ending list of already used, viable scapegoats that have fueled their chronic inaction? What we do know is that they’ll demand more time to prove their case, after all it’s only been a steep trajectory of destruction for this past decade.
The motivation for the bureaucrats to come up with this initiative is none other than a series of blog posts we presented in early June 2020. These referenced the officers and directors insurance coverage they carry should they be sued for what are subsequently judged to be acts they are culpable and guilty of. Our initial post pointed out that these insurance companies may force resignations as the cost to cover the individuals was becoming too great on a go forward basis. When insurance companies pull their coverage they force the individual to resign to ensure they’re able to maintain the insurance coverage over the time they were at the organization. On learning of our allegation in early June that they did not uphold their fiduciary duty when the Preliminary Specification was available since December 2013 to deal with these specific issues. They would therefore be found guilty in any litigation.
What happened was producer bureaucrats promptly, and on a wholesale basis, increased their coverage as a result of our commentary. Earlier this month we made the commentary that the focus of the bureaucrats was to cover their buts, not undertake any step towards fulfilling their fiduciary duty and remain blinded to the consequences of their (in)actions towards others across the industry. That stung and as a result they need to be seen as doing something, that something is now what they are generally calling “asset reorganization.” This post today is designed to challenge the depth and breadth of that initiative and to question the motivation, the methods and means in which this is being undertaken. Asking specifically if this is just another “viable scapegoat” along with the “waiting for a cold winter,” “Artificial Intelligence and the cloud,” “waiting for markets to rebalance,” “capital discipline,” “reducing costs through innovations” and “it’s OPEC’s fault.” To name just a few. I’ll be adding “asset reorganization” to this long list for the future.
Compare and contrast the producers use of “asset” and its value vs. the
Preliminary Specifications use of the Joint Operating Committees legal, financial, operational decision making, cultural, communication, innovation and strategic frameworks as its organizational construct. Dare I ask what the value of the “asset” is in terms of an organizational construct? I think what the producers are trying to say is the “asset” is their name for, or ultimately the direction they’re heading is to the Joint Operating Committee. Knowing full well that is territory that is proprietary to People, Ideas & Objects. They also know if they stick to their failed strategies and plans of doing nothing eventually everything will be ok, they hope. Which proves they will always be incapable of realizing the differences in the industry as a result of shale based formations. Which include:
- A change from scarcity to abundance
- Substantially higher drilling and completion costs
- High initial production rates
- Steep production decline curves
- High recompletion and workover costs
- Leading to massive amounts of orphaned capital (unrecognized capital costs of past production) to accumulate on the balance sheet, (hence build balance sheets)
Shale is a fundamental change to the underlying oil and gas industry. Moving forward with cosmetic changes designed to satisfy the need to be seen as “doing something” in this disastrous second quarter is consistent with the large volume of excuses, blaming and scapegoats that have been used by bureaucrats throughout the past decades. “Asset reorganization” will form a new strategy that is nothing more than their current, viable scapegoat. “Asset reorganizations” do nothing to solve the situation at hand and the most critical issue that needs to be addressed and dealt with is the cash and working capital crisis that continues. Fortunate producers were able to access their lines of credit in the second quarter which will begin to bring into context how leveraged the industry really is. These increases in debt will contrast the asset write downs and show the industry is in desperate financial shape. And in particular, understanding that those assets that remain listed as property, plant and equipment are not so much assets as they are the unrecognized capital costs of past production, being what People, Ideas & Objects have identified them to be and categorized them as. More or less when the industry as a whole consumes the kind of cash oil and gas has this past decade, the producers and industry are worthless as they demand cash to operate.
This cash and working capital crisis is into its fourth decade. The structure and culture of the industry has, as a result, been developed into a cash incinerating machine that these producer bureaucrats feign not to be able to comprehend. If it's not investors or governments that need to bail them out on an annual basis its banks. Luckily some producers received the sympathy vote from their banks this quarter. This however does not help them with the problem they’ve created and can only be solved by adopting the Preliminary Specification. When producers capitalize most if not all of their interest and overhead, all of their capital expenditures including the intangible assets. Then leave these assets on the balance sheet for decades at a time you create the cultural and specious industry calling of “you have to put cash in the ground.” That’s because all of the cash that has ever been given the producers, less what the bureaucrats were able to divert for themselves, is currently sitting in the ground. The real issue is that the commodity prices charged to consumers for oil and gas do not recognize anywhere near the appropriate amounts of capital incurred. The full costs of exploration and production are not passed on to the consumer as the investors have paid for the capital costs of these commodities, in order that producer bureaucrats could “put that cash in the ground.” One look, but not too detailed of a look, at the check book would show that without the annual cash infusion from investors these producers never generated any cash from operations above and beyond the operating and overhead costs they were incurring. They reported they did, however if you consider the high overheads necessary to fill those buildings with people in those downtown cores, the overhead in oil and gas is high. Possibly as high as 50% based on today’s commodity prices. No one knows! These costs are capitalized and the cash incurred is not recovered for decades. Leaving a gaping hole in the cash balances each month when products sold are underpriced due to the fact that there is inadequate capital costs recognized in the price of oil and gas. The purpose was to “build balance sheets” not pass costs on to the consumers. These cash balance deficiencies have traditionally needed to be filled by investors, bankers or governments. Because “you have to put cash in the ground.”
Operations never provided enough cash to pay these overhead costs, which are also high due to the creative and innovative ways in which bureaucrats have expanded the concept of executive compensation. Besides the reporting is so skewed through these capitalization policies bureaucrats can always “build balance sheets,” report profits and cash flow. The fact of the matter is that the industry has been consuming cash at voracious rates for the past four decades. Investors became wise to this in 2015 and left. Banks are taking longer to figure this out. Governments seemed to understand it intuitively. Anyway, enough about the good times. This is about 2020 and the new normal as they’re now calling it. I expect the producers that were able to access their lines of credit will have consumed all of that cash by the end of June. It is reported that the average prices that had been received during the quarter were slightly over $22 for oil and just over $1 for natural gas. OPEC+ are having no difficulties making profits and generating cash at the current prices and I expect that $40 oil will be what can best be hoped for for the next few years. As of August 2020 OPEC will have 7.7 mm boe / day of surplus production. $40 is much better than $22, the only difference is the time in which North American producers hit that brick wall. Neither price is adequate to even begin to deal with the cash drainage that we’re talking about. Even if it could, the current cash and working capital balances would take years to recover. Recall prices were anywhere between $45 and $70 these past three years and were incapable of providing the producers with the cash to cover operations and capital.
So when these oil and gas bureaucrats talk about the future of the oil and gas industry they’ll be able to discuss their new fangled “asset reorganization” or, the finer points of their strategy regarding Chapter 11 vs. bankruptcy. And how they’ll be able to implement strategies to ensure the executive compensation for their efforts and bonuses will be granted just moments before that momentous occasion. Then they might realize their accountability to the shareholders would finally end! These are the limited choices bureaucrats can use in their second quarter reports.
The third issue that we need to discuss is the tragedy of shut-in production that will be caused in the second quarter under the current industry methodology. I need to clarify this as I and the Preliminary Specifications decentralized production models price maker strategy doesn’t come across as being hypocritical. One of the reasons that producer profitability is so poor is that the administrative and accounting capabilities are replicated within each oil and gas producer. These capabilities are not part of the producers competitive advantages and are not shared or shareable in the current industry configuration. Utilization rates of these resources may be as low as 40% due to the high levels of specialization necessary. The first objective of the Preliminary Specification is to organize the industry in order to move the producers' fixed costs of administrative and accounting capabilities to the industries variable costs of administrative and accounting capabilities. Once all the producers' costs are variable in nature, shut-in production will incur what we call a null operation, no profit but also no loss. In the current system the fixed costs of overhead are in essence a producer capacity and capability. A better way to describe it would be to call it a fixed industrial capacity. I describe it this way to explain that one of the highest costs an organization or an industry can incur is surplus / idled capacity. It is an insidious cost that is unpredictable in its nature. It is also one of the most costly and can lead to either producers or an industry's demise. If we are correct that fixed overhead is at 50% of revenues in the second quarter the costs of surplus capacity will be horrendous. Earnings and cash flow will evaporate unpredictably under all methods of accounting, and yes even the specious ones. And this same characteristic of surplus capacity costs will be no different than the costs that will be incurred by implementing the Preliminary Specification. Therefore the industry's surplus capacity will need to be worked out of the organization and industry, which our system does through a more dynamic capital allocation based on a new capital discipline that considers only profitable production is ever produced anywhere. The difference between these two methods of dealing with surplus capacity is that People, Ideas & Objects turns these administrative and accounting costs variable, based on production. And the remainder of the production is only produced on a
profitable basis. In today’s systems the overhead remains fixed and there is little that can be done about that in the short term. While the commodity prices remain depressed due to the chronic overproduction, or as we’re calling it here surplus capacity.
The issue producer bureaucrats have with our decentralized production models price maker strategy is that they claim it’s collusion. Contrary to the accusations that the
Preliminary Specification is collusion, what we in essence saw in the second quarter of 2020 was collusion, by the producers definition, from those who chose to shut-in production. I have argued this point for well over a decade now and what the Preliminary Specifications price maker strategy and what the industry participated in during the second quarter was anything but collusion. It was listening to markets telling producers not to produce unprofitably. Which is in the economic definition of price makers. These two issues, the declines in commodity prices and shut-in production volumes, thrown onto the financial skeletons these producers began the second quarter as will become apparent to all. They will need to have an answer. Muddling through and doing nothing will not be acceptable and therefore they have come up with their “asset reorganization” as their current viable scapegoat. I spent over a decade researching the Preliminary Specification as a holistic business model to deal specifically with these issues. Producers may have spent a month on coming up with theirs. If they’ve not done this work, producers have a few days in which to do this much work to prove that they’re not fielding further, viable scapegoats and instead have chosen to pursue real tangible solutions in their “asset reorganization.” I’m certainly here to answer questions about our model. Let’s hope they’ll have answers for theirs.
One last point is the service industry that supports and provides the wherewithal for the producers in the field. We are seeing many bankruptcies in those companies such as BJ Services announcement on Monday. As a pioneer in coiled tubing and fracing techniques, they’re going to be missed. And I can say that with the assurance that their bankruptcy plan sees them exiting Canada. This will no doubt garner at most two shrugs from the Canadian producer bureaucrats. Additional changes include reducing their remaining operational footprint and selling off businesses. How will BJ Services capabilities be recovered in the future. It is really quite simple, producers will have to pay in advance for all of these service industry related services in the future. And will have to pay to have the capabilities purposely rebuilt and expanded with all service industry representatives. There will be no investors or bankers stepping in after they’ve seen the antics of the producers over the past decades. What would be in it for them? These capabilities will have to be (re)built and paid for in advance by the producers in order to have them available. These payments will be nothing more than advances. There will be no equity or rights attached to these payments. The payments will be a means in which to source the capability and live with the past that producer bureaucrats created. No one in the service industry is going to get up off the couch in order to lift a finger without free money from the producers first. Welcome to the new normal!
The question that keeps coming back to my mind is, how do we evolve economically from our current situation? We know that today is not working, and in the past we were able to move towards enhanced solutions that arose from the concepts of creative destruction and spontaneous order. I see the destruction and a static situation that has developed for the following reason. Today bureaucrats understand that locking their organizations in structures that are defined and supported by ERP software disable any changes until the software is changed first. There have been no changes in the ERP systems in oil and gas for the past 30 years, at a minimum. These systems had evolved in order to fuel the bureaucrats personal needs and therefore won’t be changed while they’re in control. We therefore remain locked in to what I call a 21st century software bug. The producer bureaucrats understand what the problem is, they devised it. What they don’t understand is how complex the solution will be and what will be involved. Where does the motivation to move forward come from? And how is it implemented? With vested interests aligned against progress and unmotivated by their own personal greed, destruction on this scale is the only result. And just as I knew that this industry fallout would happen at least a decade ago, and the Preliminary Specification is configured to address these specific issues. I can say today that we haven’t seen anything yet.
