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

 The fourth quarter 2020 earnings of the producers continued the downward trajectory that we’ve seen over the past decade. This downward trajectory is in almost perfect symmetry with the trajectory of care and concern expressed by the bureaucrats involved in this business. How this approach continues with these difficulties with no recognition of the critical issues is beyond me. The belief in the effectiveness of “muddle through” is absolute. There was however an interesting trend that appeared in the fourth quarter. Just before the release of the earnings report there would be an announcement of a merger, divestment or acquisition of material size. These of course were designed to distract from the performance issues presented in the financial statements. Very effective I have to say. And for the first time I can remember in my life I’ve experienced two major producers, Occidental and Pioneer, claim the dog ate their financial reports, would not make their deadline and needed more time. That is they were unable to meet their previously announced deadlines and extended their release an extra week due to the Texas energy crisis. I’ve seen it all now.

All of our sample of producers that have issued audited financial statements have included Critical Audit Matters (CAM). (Definition provided below.) We expect the rest of our sample’s CAM’s will be seen in the annual reports and we expect to see all of them include the same CAM associated with the amount of depletion recognized in 2020. The industry has essentially been put on notice by the SEC that it is investigating Exxon and all the shale producers regarding their valuation of oil and gas reserves / assets. This being the issue that People, Ideas & Objects believes has led to the distortions and disruptions in the financial performance of the industry and a major contributor to what has caused its financial difficulties since 2015. It is an intrinsic part of the bureaucrats culture of “muddle through,” “building balance sheets,” and “putting cash in the ground.” That over reported asset valuations lead to commensurate over reported profits, which attract disproportionate investors which lead to excessive over investment in the industry causing overproduction of oil and gas commodities. These have been taken to obscene valuations and are represented on any and all producer balance sheets by their disproportionate size of property, plant and equipment. It is our belief that audit firms should have been dealing with this issue four decades ago. Their acceptance of the bloating and “building of balance sheets” and the culture of “you have to put cash in the ground” while on their watch makes them culpable and these CAM’s are the beginning of these audit firms house cleaning. A key issue that we’ve resolved within the Preliminary Specification, by our user community and their service provider organizations. Just one of the many issues which this community of software and services were designed to, and indeed, resolve. In addition we establish a solid footing for innovation within the industry. 

Critical Audit Matters

The Board is issuing this concept release to seek public comment on potential changes to the auditor’s reporting model based on concerns of investors and other financial statement users. Auditors, as a result of the performance of required audit procedures, often have significant information regarding a company’s financial statements and the audit of such financial statements, that is not today reported in the standard auditor’s report to the financial statements users. This information might be useful to investors and other financial statement users and could lead to more efficient markets and improved allocations of capital.

One of the more difficult aspects of the outsized nature of property, plant and equipment is the capitalization of overhead and interest that has occurred since the 1980s. Today the detail regarding interest costs is enhanced even further in 2020s fourth quarters reporting. With most of our sample producers now participating in the full disclosure of the treatment of interest costs. Many also reduced the capitalization of interest to zero in the fourth quarter. The detail of what and how interest costs are handled compared to many of the prior periods is very informative. I however still wonder why we never get any level of detail with respect to overhead costs? Overhead costs are capitalized on average by 85% in the industry. It's as I’ve repeatedly stated this is based on my knowledge and experience only. If any producer bureaucrat wants to educate me on what their specific practice is, I’m open to consideration of their facts. My email address is provided below and I see no harm in their being the first to do so! Although interest rates are very low, bordering on negative at times. The interest costs being incurred are becoming material to the producers for two reasons. 1) The revenues being generated are certainly not what they were, particularly in light of the soon to be incurred costs of rebuilding, refurbishing the infrastructure across the continent, and lets not forget the reclamation costs. All of these and more of the expected incremental costs of oil and gas exploration and production process were detailed in our series entitled New Cost Structures. If it is as we suspect that the valuation of these assets are becoming more suspect throughout the regulatory environment. Precipitating more rapid write downs in the future, leverage will quickly become an issue to the banks. 

But the interest paid will become more significant as the rates potentially go higher. The second point on interest rates becoming material is that since the November 3, 2020 election the ten year bond rate has increased by 113.67%. I assume the declared revisions to monetary policy by the Chairman of the Federal Reserve, being the democratic party's attitude of who cares about the debt, is having an effect on the market's perception of interest rates. This trend of increased interest rates, on top of the massive and detrimental effect that write downs will have on leverage may need to be sold as a feature in oil & gas and not a bug. People, Ideas & Objects identified the potential of escalating costs of money and bank leverage as potential crisis # 3 in our series New Cost Structures. We should anticipate this feigned attempt at honesty and transparent reporting to dissipate fairly soon as the demand for profits, real or otherwise, and the ability to produce them will require all the CFO’s tools to be on the table. That will demand the capitalization of interest to begin again, and the process of transparency will need to become more ghost-like. 

I don’t think at times producer bureaucrats fully comprehend the consequences and implications of the issues that I write about. Except I know they know better. Just for those bureaucrats that like to feign the inability to comprehend the tragic aspect of these CAM’s towards their future. They should ask the following questions, have all of the write downs been satisfied? Is the SEC satisfied now? Why have hundreds of lawsuits, some specifically citing the reported SEC investigation launched against Exxon, been started? Will the SEC look for the one scalp that will establish the example for all of the market to respond to. Just as they did with PennWest in September 2014 with their fraud charges for the ineligibility of capitalizing royalties and operating costs. The SEC has done the single violator example once now, it’s only reasonable that the industry did not take PennWest as an example to clean up their act beyond correcting the capitalization of royalties and operations. Therefore the SEC may feel they have to take the process further and extend their sample beyond just Exxon. The knowledge that subpoenas have been sent to other shale producers reflect only SEC fact finding inquiries at this time. Nonetheless, whatever happens with the SEC, the producer bureaucrats may not want to wait until the knock on the door before action is taken. Remember, “issue mitigated, nothing litigated” as expressed in our January 11, 2021 blog post. In addition their bank leverage is going to be increasing due to the reduction in assets as a result of audit and SEC regulatory actions. As it was quickly learned with the demise of PennWest and the prosecution of fraud of its officers by the SEC, capitalizing royalties and operations needed to be reversed quickly throughout the industry by all of the producers. Over the course of the time that we’ve been analyzing our sample of producers, which has been since the third quarter of 2016, the leverage of producer firms is getting more disproportionate by the day. A trend we see accelerating uncontrollably now. How much longer will the banks tolerate this erosion of their risk profile? 

If we take the proceeds from revenues less commodity purchases, transportation and production costs which make up the core of the costs of the producer we come up with the gross profit. These values are never in line, in my opinion, with what a productive, profitable oil and gas industry should be conducting. If we take our sample of producers for the 2020 year. Some may think the 2020 year was exceptional which it was. However these are all variable costs and would be the same percentage of revenues at whatever volume of production. Our sample of producers produced a gross profit of $51.6 billion in the 2020 calendar year. How inadequate the revenues of the producers is reflected in the overall loss of $60.7 billion, as reported based on the specious financial statements that I repeat chronically overreport profitability. This is usually where I’m told oil and gas is all about cash flow.

When considered over the life of the firm. A properly managed enterprise will produce x profit. The amount of that profit is dependent on the management of those assets and should be considered widely variable based on the quality of its management. It is also reasonable to assume that the life of those assets will produce, under an appropriate manager's hands, a similar profitability each and every reporting period. What can happen however is that the assets can be leveraged at any point within their lifetime to generate a reported profitability that boosts the earnings in the short term in order to enhance their position and standing in their community as a good manager. This may have been real valid profitability. Or it could have been specious accounting that did not recognize all of the costs associated with the reality of the situation. This latter situation creates a shortfall in cash that demands the necessity to be augmented in time with outside sources of cash to cover the alleged “profitable” periods that generate no cash. Over time, a firm such as this will have all but extinguished the opportunity to generate these false profits and be subject to the fact, as is the case in oil and gas, the property, plant and equipment account is disproportionate to all else and as a result will need to be drawn down much faster that would otherwise be necessary to correct the historical imbalance. Therefore creating losses that will be equal to the excessive profitable amounts reported on the basis of the falsity of those earnings reported earlier. 

Wise and astute readers may suggest that the fact that profitability was reported without cash will be offset by the periods in which losses will be reported with the generation of cash. And this would be the case in an appropriately managed enterprise. However, as we see the industry was not appropriately managed when the earnings were massaged to the short term, the softness of the management who believed they were superior managers were in reality pikers. Their best day would be to possibly manage the assets as a zero sum game. Which is what they’ve sort of been telling us for a few decades now. We must not have been listening or misunderstood their language. For me to understand or envision how they’ll suddenly become the requisite super-managers that are required demands that I assign a probability of 0%.

As was inevitable at some point, producers will be reporting greater losses than our model for the industry would have reported. Yet remain reporting significant losses under any basis of their management. This becomes inevitable over time as organizations grow older. The young organization may create the opportunity for the greater volume of the deferral of the depletion. As the organization reaches mid age, the amount of depletion begins to increase in excess of what “would have been” required due to the need to catch up with the need for more appropriate reporting. 2020 seems to be the definitive time in which we’ve crossed over that threshold. 

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

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

 In the broader sense of spelling out a compelling vision. I’m finding once again some discussion within the industry that bureaucrats will continue with the work they’ve been doing in reducing the costs of oil and gas exploration and production over the past half decade. 

In Forbes

Let’s all remember that the U.S. shale industry boomed like never before throughout 2018 and 2019, a time during which WTI traded in a range of $53 to no higher than $72 per barrel. While it is true that the financing market for new shale projects remains tight, it is also true that shale producers who have spent the last two years heavily-focused on cutting costs, increasing efficiencies and deploying improved technologies are now able to present a far more attractive profile to potential investors than they could in 2018. That’s what a depression will do to the companies that manage to live through it.

In World Oil

A round-up of data on shale drillers shows they’re sticking to their pledge to cut costs, return money to shareholders and reduce debt. If they stay the course, it would validate the OPEC+ alliance’s high-stakes wager that it can curb output and drive crude prices higher without unleashing an onslaught of supply from U.S. rivals.

We’ll recall that while oil and natural gas prices were in steep decline the producers were able to sharpen their pencils and what could be produced “profitably” yesterday at $60 / boe could suddenly be produced “profitably” at $50 / boe. This went on from $50, to $40 and $30 and so on. I marveled at this capability and suggested that it may be the most miraculous occurrence in the history of business. As oil and gas prices continued to collapse due to overproduction the immediate bureaucratic response was to claim they could still make money at the new threshold of pain the market was applying. Market signals be damned. The difficulty that I have is that these comments and commentary that were asserted over the past half decade and these quotes from Forbes and World Oil, and particularly that which I’ve italicized, are contrary to the reality of the situation and these claims took on mythic proportions throughout the rampantly optimistic oil and gas industry. Bureaucrats obviously have some method of distributing their talking points so that they’ll all be singing from the same hymn sheets. This ensures that no alternative “thinking” as to how they so radically reduced their costs would ever be heard or considered. 

My response to these claims of reduced costs was a further assertion of the nature of their specious accounting that has been undertaken in oil and gas. Where “building balance sheets” and “putting cash in the ground” became a key part of its culture. If we think about the producer firm they’ll have thousands and in the larger producers hundreds of thousands of wells that have been drilled over the prior decades. Of the current year's activities which will total as many as a few hundred wells, I do not doubt that costs have been reduced, and we’ll discuss how later in this post. However, the question that needed to be asked was how is it that the historical cost of all the properties of those thousands and hundreds of thousands of wells that were drilled many years before suddenly had their costs reduced and can now perform profitably at the lower price, and remarkably even half the commodity price? In a capital intensive industry how is this possible? Have there been new innovations in historical accounting that I am unaware of? Or is this just an extension of the specious accounting that People, Ideas & Objects have been writing and concerned about? 

Well it turns out that it has nothing to do with accounting or the financial statements of the producer firm. It’s a story about what could or might possibly happen in the future, if they chose to drill wells in the places where the bureaucrats have identified future drilling locations. These costs and their declining costs per barrel are what are called “Recycle Costs'' in oil and gas. A mythic being that roams the earth at night and invades only the minds of those bureaucrats who need an excuse, someone to blame or a viable scapegoat. They are the answers to questions such as “With today’s depression era service industry prices, what could we contract a drilling rig for, and how much would it cost for the lateral to be fraced?” It’s not that they would ever contract the rig for the work being asked about, they’re only wanting to spec out the cost of a well and then determine what that cost would be and if it would be “profitable,” from their perspective, in the current commodity market. 

How these recycle costs have become so much more “profitable” than what the historical costs of the producers have been. Is easily understood when we consider the devastation that occurred in the oil and gas service industry. If oil and gas we’re in a depression, then the service industry would be devastated. First, when producers did not want to spend their cash they cut their field activities in half, and then significantly further from there. The service industry was faced with layoffs, idling capacity and difficult business decisions as to what to do. At one point producers, unable to find the funding to maintain their contractual obligations in the service industry, were willing to continue the work and extend the payments for these services up to 18 months. That time has now passed and is history, however the service providers were not aware of these changes in payment policies. Having financed the producers activity for a period was not what they wanted or were capable of doing, even though they were at half capacity or less. However, producers being the smart ones they are, knew they were the ones with the money, eventually, and had leverage over the service industry who they knew were desperate. They therefore were cutting the day rates and service costs of any activity to the level where the service industry was experiencing their revenues would not provide for anything more than the variable costs of the activity. After all, the bureaucrats thought, if the producers were conducting their business in that manner for the last four decades, why wouldn’t everyone else? 

Therefore just using these two factors the service industry was faced with a drop of approximately 75% of their revenue streams. Conversely producers were receiving bids for their recycle costs where the costs of the service industry was at best half of what the “normal” business environment would have offered. The two factors that I’ve used here are also incorrect and only used as an example for simple math purposes. We know for example that drilling activity decreased approximately 75 - 80%, therefore the revenues were barely 10 - 12.5% of what they were. And, if we were to look at that from the producer bureaucrats point of view. When producers pay the service industry on an 18 month schedule that’s not a lot of money the service industry had to finance. 

It was about this time, if anyone wants to recall, that scrap metal was all the rage in the oil and gas service industry. Cutting up oil and gas field equipment was sometimes enough to pay for the light bill. Except, some weren’t able to maintain their operations and closed permanently. The devastation in the service industry has always been historically worse than what is experienced in the producers. The producers earned the primary revenues, or as People, Ideas & Objects call it the bureaucrats money, which although were lower from the low commodity prices, were still enough to keep the bureaucrats happy. The service industry has no customers or hopes of any customers in any other industry other than oil and gas. The commensurate drop in the capacities and capabilities of the service industry can only be exacerbated in knowing that oil and gas is up and running, but truthfully who cares? People in the service industry will want and need more than just the first paycheck promised and the vendor will need more than just a purchase order. The expectations will be different and they will be driven out of necessity. Business done the old way will be a bit of a stretch to consider. The ability of the service industry to restaff with experienced personnel may be difficult. How much of the critical knowledge has walked, taken their family and mortgage to work at WalMart where at least they know they’ll be able to work continuously and also be paid? The offer of lucrative pay is not going to offset the poor quality of life they experienced when working in the field and the shoddy treatment producers inflicted on the service industry. 

This also assumes that the service industry vendors will be lining up to receive their beatings once again. Where is Schlumberger, Halliburton and in Canada BJ Services and why are they no longer answering the phone? Enough of the big guys how about so and so, where are they? The fact of the matter is the service industry has been at the beck and call of the oil and gas industry for the past four decades in ways that would redefine customer service as spectacular. These people should be commended and thanked for their service to the oil and gas industry for stellar service that always went twice as far as what was expected of them. They were also the innovators that had their hands and eyes on the issues and opportunities that were happening in the industry. The development of coil tubing and Packers Plus, for example, took almost a decade of hard work and slogging to finally get the attention of producers. Prior to that they were shunned and had to persevere much as what People, Ideas & Objects have had to do. The innovators that producers claim to be is nothing more than hog wash and lies. Regardless, when times were good in the mid naughts in oil and gas, all that the service industry ever heard from oil and gas producers was how greedy and lazy they were. These producer bureaucrats have earned the right to be shown the door with a swift and stern kick from the muddiest work boots that can be found. They are despicable. Such a history should be bronzed for permanent display in the town squares where all the producers reside. 

The costs of rebuilding the service industry was part of the New Cost Structure series we detailed and wrote about in late January 2021. The service industry investors and bankers were left holding the bag, as they say. They’re not standing up for another round and the ability to recapture the North American service based capability and capacities are going to be done on a volunteer basis by the producers philanthropic efforts. This is going to cost more money than what bureaucrats could ever imagine. If they want to contract a new rig, they’ll need to find the operator qualified to build and operate it for him. All on the producers gracious willingness and courtesy, but mostly those primary revenues they’ve been hoarding. And pay the day rates, or whatever basis the driller determines they’ll charge the producer to drill wells in the future. And the producer will be so grateful and thankful for the next few decades they’ll buy all the drillers kids Christmas presents. Bureaucrats should understand that it’s a new day, one in which you get to reap what you sow. And though the producers have always been standing on the top of the heap because they owned the Petroleum & Natural Gas Lease, as I’ve shown them the 21st century is not about physical assets, it's about Intellectual Property. It is the means and methods to have things done in the field that is held in the minds and hands of the service industries operators. This Intellectual Property, much like People, Ideas & Objects Intellectual Property and all Intellectual Property in the 21st century, is going to be expensive.  

It’s good to criticize, which I subscribe to and am endearing at. Far better to have a solution. The Preliminary Specification was published in December 2013 and contains the Resource Marketplace module which captures these facts in the same form. From seven years ago! Nothing ever changes with the producer bureaucrats, something you can bank on. The Resource Marketplace has the means and methods to rebuild the service industry based on the understanding that these resources are a critical part of the North American oil and gas industries, profitable and energy independent production profiles capability and capacity. The service industry is solely responsible for 100% of the industry's innovation. Never let a bureaucrat mouth anything different. I just didn’t know when I published the Preliminary Specification that the bureaucrats would destroy things as badly as they have, however that is where we are today. 

And that is how the industry will have to deal with the service industry or there will be no service industry capable of dealing with the producers needs, ever. In addition to that stack of other costs we identified in our New Cost Structures series of blog posts. Those being the reclamation costs that have even Shell trying to avoid, rebuilding and refurbishing the infrastructure that has aged. There is the expansion of that infrastructure which emulates much of what the service industry has gone through and will need to rebuild its capabilities and capacities. Remember the producer bureaucrats who were standing in front of everyone selling the needs for the Keystone XL Pipeline, or in Canada with the Transmountain Pipeline that Kinder Morgan started? Actually no one remembers these things because they never happened. Kinder Morgan gave up the fight, as I think all the pipeline companies will be doing, and sold to the Canadian government for similar reasons in the failure of Keystone XL. If producers want a pipeline from there to there, then the pipeline companies can talk, but they’ll want to see all of the money upfront just like People, Ideas & Objects and the service industry either demands today, or in the near future. Issuing a purchase order, sitting back on the couch and waiting for someone else to do the job, while you belittle them as greedy and lazy while you never lend a hand is over. Maybe if the bureaucrats had some skin in the game they would saunter down to where the rest of us live and start doing some work too. And when it comes to paying the blackmail from Greenpeace and all those environmentalists threatening to protest you in front of your head office, bureaucrats can continue that, however as the pipeline companies have learned it's very counterproductive to do so. “Muddle through” and “putting cash in the ground” have certainly made it into the bureaucratic hall of fame. Management should be there to manage the business and build value, mostly by way of real profitability, everyday and everywhere no matter what the situation is. 

So where are we going with this one sided dissertation that is well past due. Oh yes, “Recycle Costs.” That utterance right there may be the last time anyone, anywhere says those words again. “Recycle Costs,” no wrong again, will be a minimum of 4 times higher than what they were before. These are the consequences of filling one's pockets at the expense of everyone else in the industry. Filling out the balance sheets as if they’re wish lists. And saying things in the public domain that are just not true, are absolute falsehoods and could never be because they defy reality. 

Producers only wanted to work with the service industry members of size and therefore new and innovative service industry providers were shunned. Then when the depression hollowed out the service industry, much of the critical infrastructure was cut down for scrap metal etc. Schlumberger walked as did many others. Not much can be done with that scrap metal today and the service industry, much like the oil and gas producers themselves don’t have a deep rolodex of investors anymore. Their only source of capital for their rebuilding is the producers themselves. By having them fund much of the rebuilding process of their industry with much, much higher oil and gas prices. Rebuilding the service industry with those primary revenues of theirs. Primary revenues that were generated in the past with the efforts of the service industry and pipeline companies that have been fundamentally betrayed by the oil and gas bureaucrats. These new costs will be reflected very soon in the “Recycle Costs.” As a result of these factors the days of having these “Recycle Costs” quoted may be over. No one will claim they can be profitable at $200 / barrel. Unless that’s a real good price in 2025.

I have to suggest that the bureaucrats be advised not to go on the record today and make these claims to World Oil and Forbes. This would be for two reasons. The first is that those ambulance sirens they’re hearing are really lawyers who have all that they’ve needed to file a variety of class action lawsuits. They’re coming for all of the bureaucrats, what we kindly call the officers and directors of the producer firms and the more they draw attention to what it is they're doing the more difficulty they’ll be causing themselves. Secondly, this is exactly the issue that has motivated these lawyers. They see the SEC investigating Exxon and issuing subpoenas to the shale producers for their asset valuations and now bureaucrats decide to run around town fudging the numbers (again) with mythic tales of super hero status. Can I hear that production can be had profitably in single digits? Oh come on, why not?

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

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

 On Tuesday March 2, 2021 the CERAWeek conference had producers claiming “capital discipline'' as their “new” tool to deal with their issues. This has been their go to claim when oil prices begin to show some strength. And an implicit recognition of their history in crashing prices through overproduction and ensuring that no one really ever makes any money, but they’ve learned “and this time is different.” That reputation is intact today. Cash balances and the generation of surplus levels of cash would reflect that the bureaucrats have been able to “manage” themselves in an appropriate manner. After all a profitable organization would denote that abundant cash was being generated. Which begs answers to two critical questions that these bureaucrats either don’t understand or don’t know the answer to. 1) Why did oil and gas producers need to have annual shareholder issuances for decades at a time in the 1990s, throughout the 2000s and up until 2015? 2) Where’s all the cash that had been raised before and the profits that were reported from those investments?

I am getting tired of people telling me that I’m wrong about what’s going on in the oil and gas marketplace. “There are a lot of people around the city with a lot of cash and are very wealthy.” I’ve been told on many occasions. And I tell them that is what I’ve been saying. No one seems to understand that having an oil and gas industry that is decimated, the service industry all but looks for new ways to deal with the producers, mostly in cash, and the people working within oil and gas actively contemplating what industry they should move to. Instead the excessive wealth held by the small population of oil and gas bureaucrats is somehow acceptable? I am all for wealth, don’t get me wrong but you have to earn it by building value which is what I believe the Preliminary Specification, our user community and their service provider organizations do, mostly by getting rid of the bureaucrats and other means of value generation. Solving problems is the method chosen by People, Ideas & Objects, our user community and their service provider organizations. I deplore the lining of pockets due to “one’s position in life.” Which is nothing more than what the former Soviet Union did, only the powerful get anything, everyone else gets nothing and absolutely nothing happens about it or solves the chronic problems. They’ll “muddle through.” Holding out to me the handful of wealthy oil and gas bureaucrats as an example of why I’m wrong is only evidence that there has been one objective in the industry at the expense of everything else. 

I now know where the cash is! It’s in the ground. Just exactly where the bureaucrats said they put it. And there you have the natural complement to “muddle along” and “do nothing,” by saying “you have to put cash in the ground.” Oil and gas is a capital intensive industry. The SEC allows the industry to record their account of property, plant and equipment to be anything below the reserves value. I’m using the bureaucrats' interpretation here. If any of these producers were dynamic, innovative, accountable and profitable producers they would be seeking to reduce their property, plant and equipment as quickly as possible. That way their cash which had been invested in prior periods is being recaptured when profitably sold to the consumer and either returned to be used for reinvestment, dividends or retiring bank debt. In healthy companies they do all three of these tasks equally each year. Instead all the bureaucrats' costs are capitalized except for royalties and operating expenses as they’ve learned through the infamous SEC investigation of PennWest and that scandal. Never heard of it, don’t worry PennWest doesn’t exist anymore. Overhead is capitalized to the tune of 85% of its cost on average, interest is capitalized at around 35% today. Therefore the only costs hitting the producers income statements are royalties, operations, 15% of the overhead and 65% of interest costs and the woeful amount of capital depletion when allocated over the next 20 years or more. Depleting only the capital costs of the current periods production from the total reserves of the producer will always amount to low percentage depletion of the total amount in property, plant and equipment. Therefore the amounts of the North American producers exploration and production costs that have and are being passed onto the consumer is how much of the real cost of oil and gas exploration and production in North America? No one, and I mean no one knows. Balance sheets have existed to be “built,” they represent the “value” of the firm as far as bureaucrats are concerned, that accounting should be about performance is a novel and unknown concept in oil and gas. 

As a result of no one knowing or understanding the real cost of North American based oil and gas exploration and production. We’re building balance sheets remember. The prices that are realized will always be adequate to show a profit when few of the costs are recognized in the current period. Many costs have been deferred and the investors provide the liquidity necessary to pay for next year's costs. The real damage to the industry comes about when the price discovery mechanisms for oil and gas, on a global scale, are lost due to the high cost producers in the world dumping products at whatever cost onto the market causing the prices to collapse, repeatedly. This is done as a business model, while blaming others for the difficulties in negative $40 prices. Never knowing or understanding the dynamics of costs or prices in the business that you operate is an advantage when you have a willing group of investors and bankers believing the financial statements that have been produced along the way. Oil and gas bureaucrats considered this to be their business model. Most would consider it to be a luxury or benefit. However, as we’ve learned in the financial statements of 2020, the loss of investors and to a large extent bankers, it can now be considered the tragedy People, Ideas & Objects have been saying and warning that it would become. 

One aspect of the simple answer to the question of why bureaucrats needed annual shareholder issuances was to make up for a chronic shortfall in cash. This shortfall was a result of all of the costs of the producer being capitalized and only a portion of the overhead and interest costs, royalties, operating expenses and small portion of the capital assets that were depleted were ever recognized as the costs being passed to the consumer. As bureaucrats were “building balance sheets,” we can see how the ridiculous nature of their claims of “putting cash in the ground” only gets worse, yet contains a granular bit of truth to keep the machine rolling forward. 

What bureaucrats feign not to understand is they were expending cash on all of these costs during the course of the month. Cash was not being returned to them from the consumers as a result of the low commodity prices their producers' chronic overproduction was responsible for. Therefore the monthly “float,” as it is known in all businesses, never existed as the cash balance was extinguished each month and could not be replenished due to the imbalance created to capitalize everything and “build balance sheets.” When investors were plentiful this monthly cash deficit was filled with an annual infusion to get them through an entire year. Now with nothing coming in as a result of low commodity price sales from the consumers, and no investors and scarce bankers, the scramble for cash just to keep the lights on continues anew each and every month. In any business this would have become evident within a month through basic daily cash management, in oil and gas it took four decades to understand so bureaucrats would have us believe. With the abundance of willing investors there was never any issue and certainly no need as far as the bureaucrats were concerned. They also had the CFO pumping out specious financial statements that stated spectacular profitability was continuing and growing. Which kind of indicates the cash was continuing to grow too, yet here we are.

The Preliminary Specification is different from the current status quo. Hence the abuse and difficulties that People, Ideas & Objects have had in getting traction in the industry. We disintermediate the industry. Which of course means we’ll be sending the bureaucrats packing for a long trip away from here. It’s up to them if they live in the retirement style of life they’ve envisioned for themselves. Or if they’ll be waking each morning in a cold sweat about the day's legal actions that have started. I would not want to go into court and try to defend myself on the basis of the quality of the accounting that is conducted in oil and gas. To determine the performance of the producer, in my opinion, does not exist. To determine the performance of any specific property does not exist. Also an opinion of mine and one that I’ve detailed on this blog before. To prove it, just ask what the actual overhead is on a property, make sure you receive the actual overhead and not the overhead allowance. Those latter numbers are moot and inappropriate. To prove that the overhead allowances are moot, ask for the total overhead incurred across the industry vs the total overhead allowances incurred across the industry. That comparison will show that the numbers are not relevant. Hint, industry wide the overhead allowance total begins with the letter Z as in $0.00. It would nonetheless be interesting to see what the actual overhead numbers of any producer or the industry were. They for some reason continue to be the most invisible numbers known to mankind. 

The previous statement has nothing to do with the high quality people who are preparing and conducting the accounting information in the industry. The bureaucrats have, as I’ve stated before, not changed anything in their systems since I published the fact in May 2004 that software defines and supports the organization and to make any organization change you therefore need to change the software first. And the bureaucrats interpretation of that being was they’ll secure their franchise by not changing any of the producers software. Therefore the analogy that best describes the situation is the architects design spec out a spectacular 50 story office building and details the building materials to be balsa wood. What are those involved in the building of that structure going to do to make the building structurally sound? Very little, just as the many individual accountants are unable to effect the necessary changes to deal with the producer or industry issues. 

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Culture, Change, Failure

 It wouldn’t take too much to convince those last few people in oil and gas that the pace of business has far outstripped today’s organizational capacity of the producer firms and industry. It may seem as though our listing of producers current seven crises in our February 2, 2021 post, the overall existential issue the producers face as a result, the wall of costs we recently identified in our “New Cost Structures” series are all symptomatic of the speed of their organization. They’re unable to see, diagnose and deal with the issues and opportunities as they present themselves in today’s marketplace. The acceleration of business in 2021 vs. 2000 is quite remarkable and is wholly attributable to the capabilities and capacities of people’s productivity which has been enhanced by the maturation of Information Technology. The cultural, bureaucratic processes that functioned before are breaking down due to competing alternatives for the producer investors that are seeking “real” returns in other industries, people to find steady, rewarding work capable of supporting a family and a mortgage, etc. What used to work doesn’t pass muster anymore. When the world turns its back on you it’s not the time in which to radically change to new business interests such as clean energy. It’s time to focus.

It was in our May 2004 Preliminary Research report that we noted the work of Professor Anthony Giddens theories of Structuration. And Professor Wanda Orlikowski’s Model of Structuration. Structuration states that society, people and organizations progress together or there is conflict leading to failure. This conflict is evident in the failure of the North American based oil and gas producer organizations. Orlikowski’s Model of Structuration suggests that Information Technology is an element of society, that IT both defines and constrains an organization in terms of its capacity to change. People, Ideas & Objects suggested at that time the ability of the oil and gas industry to seek the changes that are necessary, it needs to develop new ERP systems such as the Preliminary Specification to enable their organizations change and acquire a software development capability for the future. To ensure that changes instituted by management hold they need to be made in the software first or the organization would regress back to the methods defined in the existing software. Bureaucrats rightly interpreted this to mean that if they never implemented the Preliminary Specification, or changed their ERP systems in any way, they would never be challenged in their bureaucratic methods of organization. It was late 2004 when they gleefully pointed out their analysis to me. Seventeen years later they’re finding once again it’s validity with their runaway crises management.

Information Technology (IT) is taking a front seat, and literally the driver seat, in terms of its role in society. As much as many people had suspected, it is both positive and negative with its power being exercised at will and in ways that were not what were contemplated or considered. Just as People, Ideas & Objects assert that it’s not enough to own the oil and gas asset anymore, producers need to have access to the software that makes the oil and gas asset profitable. The role bureaucrats have played in allowing this to happen is absolute. The damage and destruction they’ve caused is comprehensive, they’re responsible, were the authorized individuals that needed to act, and therefore must be held accountable. The outsized role that IT is taking in all industries and all organizations is comprehensive and probably more powerful than what the old guard, the bureaucracy are familiar with and used to. Since the bureaucrats haven’t made any of the necessary changes I don’t think they have much of a chance to make the transition now. Their culture is well established and would be more of a difficulty and obstruction to what we need to do. This is why organizational disintermediation is necessary, rip and replace has become the method of implementation and requirement for ERP systems. And to a greater extent the economic principle of creative destruction has been an effective tool in dealing with societal change. These are all revolutionary powers that don’t respect those that obstruct, or attempt to obstruct their path.

We’ve had a variety of boom / bust cycles in the IT environment. Economic fallout from the belief that this time IT was fulfilling its promise. This was best reflected in the dot.com fiasco that I think was triggered by the belief that Y2K was an issue. When it was proven to be a dud, people stopped listening to IT and the money for any initiative evaporated. Is this time different? Who knows. What I have done is sought to solve oil and gas business related issues as a result of their organizational deficiencies. That means ERP systems need to change. I also now believe that IT has had an overall maturation of the inherent technologies that the commercial enterprise employs. This has to do with the Internet and its implications, FaceBook was not what was considered to be part of the Internet revolution. As a result, it is time to embrace and extend what is commonly being discussed today as the Fourth Industrial revolution.

Aptitude and depth of knowledge necessary to fully comprehend the IT marketplace is more difficult than ever. This is possibly one of the difficulties that the bureaucrats are faced with. They don’t know or understand the technological implications and solutions that are available. At some point very soon the demands for specialization in IT, as well as the earth science and engineering demands in their own industry, will outstrip the capacities and capabilities that a producer can house within their own organization on a commercial basis. The scattering and dilution of the producers IT budgets within their organizations lead to redundant costs being incurred and replicated at each producer across the industry. Demanding producers fill out capabilities and capacities that are beyond the scope of what a commercial enterprise can achieve. Or maybe that is stated more effectively as beyond the reasonable cost that a producer should incur. People, Ideas & Objects have consistently criticized this as another of the reasons that the producers are systemically unprofitable. Their overhead costs in their current organizational configuration are unshared and unshareable. Each producer is building their own empires of accounting, IT and administrative purity without consideration of the costs or the redundant nature of each producer spending to build all of these same non-competitive capabilities. Recall too that all of these overhead costs are capitalized on the average of 85% to property, plant and equipment and do not diminish profit or cash flow until they’re depleted over the course of the next few decades. They are however one of the primary reasons for the producers chronic, massive and otherwise “mysterious” monthly cash drainage. Producers do not have these very high overhead costs included in the price of oil or natural gas and as a result are not recovered when products are sold and hence provide them with what is commonly referred to as a cash float. Money only goes one way, out. What is desperately needed is a new more effective and efficient way of organizing IT resources. A similar reorganization is one of the primary reasons for the success of cloud computing. People, Ideas & Objects have inserted themselves, our user community and their service providers as a sub-industry that sits between oil & gas and the IT suppliers. A sub-industry capable of communicating the needs of ERP systems to producers and the pure technological providers who have both proven their inability to know or understand one another.  

Two years ago bureaucrats were telling people who were interested in People, Ideas & Objects Preliminary Specification that they’d never implement the system as it was too radical of a change for them to consider. Which it was, their bureaucratic culture could never survive our implementation's transition and certainly nothing in that sense has changed in terms of their survivability. Unfortunately, their business has in addition not weathered the storm that the Preliminary Specification is designed to solve and their options have diminished substantially. What bureaucrats propose is to move off into clean energy and zero emissions which is the most radical business change they could have contemplated. Getting out of oil and gas to invest in windmills and solar arrays is not too radical of a direction just two years after suggesting that our oil and gas solution to today’s issues was? They can’t afford to do so. Having an industry subject to the chronic boom / bust is one thing, I am unable to think of another industry that claims this as a feature. Having the continental standard strategy of “muddle along” to deal with the “bad years” is another. If we use July 1986 as the point at which overproduction became a serious issue. It was certainly the point where OPEC had declared war. We are then in what I believe to be our thirtieth bad year out of the last thirty five. And the only thing that’s being considered is for two thirds of the producers to move into clean energy?

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

Bureaucrats Legacy, History and Reputation

 For all the years that I was focused on providing this solution in the form of the Preliminary Specification our user community and their service provider organizations, the bureaucrats could not have cared less due to the fact that they could not have cared less about the business. It wasn’t for them to determine its outcome, they were there for the money. Not until I pointed out the risk and cost to them personally of their past actions did they begin to act. As of last Monday February 22, 2021, the lawsuits began. They first went after Exxon with far too many actions to count. And then on Thursday Apache was the target, once again with far too many actions to count. I would ask these bureaucrats to remember that People, Ideas & Objects et al are the best friends they ever had as we have the solution to their problem. To remember our “issue mitigated, nothing litigated” (our January 11, 2021 blog post) as the strategy they can employ to avoid the risk to their personal fortunes they worked so hard to… I’ll work on that description for later. I see these lawsuits as the imminent possibility that they’re headed your way, whichever company you work for. You don’t have to wait for the knock at the door, they’ve arrived and there are literally an army of them. 

The bureaucrats' vision is and has always been cost control. In a way People, Ideas & Objects agrees with them that the reduction of overhead by eliminating their excessive executive compensation is a worthwhile pursuit. Many of these producers argue with me that they’ll be paying higher taxes as a result of the changes in the Preliminary Specification and it is here we agree again. What they’re saying is in order to avoid the payment of any incremental taxes their motivation was to destroy their organizations and anyone else's in the process of alleged prudence and cost control. We hear cost control echoed in perfect harmony across the continent and that it is the key to the oil and gas industries future. Cost control is not a comprehensive business model. It is a component of a sound organization and all organizations need to have that capability inherent in their internal controls and governance. However cost control is not and never will be a business model. A key element of the bureaucrats cost control business model was, and still is, to recognize every cost as an asset in property, plant and equipment and deplete those costs over the course of the next few decades. In other words defer the recognition of the capital costs of a capital intensive industry. People, Ideas & Objects believe that the capital intensive nature of an oil and gas exploration and production operation would also be reflected in the price of the commodity used by the consumer, not just operating costs. 

The producer's financial statements don’t reflect functioning companies in a functional industry. Producers carry the history, legacy and reputation of their actions over these past four decades and those are eloquently on display for all to see. The progression and steepening of the trajectory of their demise is also clearly displayed since their investors became wise to the bureaucrats' specious accounting methods and began refusing to fund them further. In “good times,” those years when investors didn’t understand they were the mark, investors were only disappointed to see the chronic dilution that they experienced, with each successive funding round reducing their interests. The verbal and written messages that bureaucrats sent to investors over the past number of decades is that “we are massively profitable, we just have a working capital shortage, please send cash!” “We’re building the business!” and my all time favorite which also happens to be the dumbest thing to say “you have to put cash in the ground!” These are the foundations on which the industry has been built, the legacy and reputation that the bureaucrats have rightly earned. The one in which the future of the industry will be all that it can be as soon as the investors realize their brilliance and return to provide the spigate of cash once again. Except, even with the methods of full cost accounting, the claims that were made when taking those financial resources from the investors are not reflected in the financial statements that are presented today. They are worlds apart from a successful, profitable organization that would have existed today if what was claimed then had proceeded to today. Where is the cash, where are the profits?

What are the issues? The bureaucrats believe that everything is fine. They don’t understand why they have no support from the investment and banking communities. “Don’t these investors understand there are reserves out there?” Yes they do. And they know that the industry has been incapable of generating the value necessary to support itself independently. The need for outside capital is not for growth or investment, it's primarily for the excessive executive compensation that is now legendary throughout the business community. They know that profits don’t mean what they understand the word means. To investors oil and gas profits are just a number based on an opinion of what best reflects the CEO’s sincerity that year. What investors do know is that outside influences who are attempting to identify and resolve the industries issues have been shunned and ostracized. That self reflection by the bureaucrats is not a characteristic that is present and it appears they can only reflect the high and mighty, pious opinion of themselves. 

The common complaint I get is these are all accounting issues. And yes indeed they are. They are also the bureaucratic legacy and reputation that reflects the performance of the organizations over their lifetime. So instead of getting into the nuances of the social science of accounting, something that is a regulatory requirement of all organizations in North America I’ll deal in facts instead. The overall business objective of the bureaucrats has been what? I can only assume it has been to build the greatest science experiments known to mankind. Again I could be wrong, but let's stick to the facts. 

We’ve now documented in our recent four part New Cost Structures series the “costs” that bureaucrats will be unable to control in their future. These are the unrecognized capital costs of past production recorded as property plant and equipment, rebuilding of the physical infrastructure across North America, refurbishment costs, the need to fund the rebuild of the service industries capacities and capabilities and the unknown costs of reclamation. All which produce zero return on investment and therefore will need to be “borne by the producer” as they will say. Let's be honest, that means passed on to the consumer. This being one of the key features of the Preliminary Specifications decentralized production models price maker strategy. If the costs of exploration and production are not passed onto the consumers then the consumers are receiving a direct subsidy from the investors who invested in oil and gas. Those investor subsidies accurately reflected on each and every one of the producers balance sheets as property, plant and equipment. Investors paid for them and they’ve never been accurately passed on to the consumers. If the culture, the business model, the remedial effort of the producer bureaucrats since the investors left won't appreciate or understand the need for any change, or to make the industry a commercial enterprise, why would investors return? Muddling through is very effective when you have the continuous cash flow from a capital intensive industry. The ability to “earn” that excessive executive compensation each and every day is as simple as never getting up off the couch or answering the phone. And whatever you do, just don’t pay for anything or anyone else. This more than anything is the culture and meaning of “muddle along” in oil and gas.

Other than the further pursuit of the ultimate science experiment what is it that producers are offering anyone in the industry. From the investors point of view we have to bring up the banks. Leverage was well understood and fully utilized in the industry throughout the past three decades. Build up the debt as high as possible and when the stock is worth much, much more, use the new equity to service the debt. Either through the payment of the debt or to just offset the leverage. For the larger part of the last two decades the interest rates have been menial and the ability to increase the indebtedness has far exceeded the scope of reasonableness. On this basis alone the oil and gas producers are heavily indebted and over leveraged. Shale has also expanded significantly the amount of oil and gas reserves that a producer can book as proven reserves, the basis of the banks evaluation of debt worthiness. Three aggravating factors have been on top of these once in a lifetime anomalies that have seen leverage expand to excessive levels. These are, 1) the losses that have been incurred even under the specious full cost accounting methodology, 2) the lack of access to equity capital has disabled the continued deleveraging that would have occured and 3) banks continued to lend until most recently. As we noted the other day, with the expansion of debt and losses, some producer shareholders equity has been eliminated by these losses. Leaving the situation where bank debt is now higher than what the reserves value as reflected in property, plant and equipment is. People, Ideas & Objects, on top of all these aggravating issues, recommend a pro-forma adjustment be done prior to the evaluation of any of the producers financial statements. Understanding our argument regarding property, plant and equipment is best described as the unrecognized capital costs of prior production. The pro-forma adjustment sees 65% of property, plant and equipment retired to depletion. This will better reflect the producers past performance and what the organization has in terms of a formidable future and the prospects of its performance. 

Banks have recently publicly expressed their disappointment with the producers actions and we are currently unaware what the results of their October 2020 reviews are. The declaration of excessive executive compensation in the form of bonuses minutes before the declaration of bankruptcy is unique and disconcerting to them. The inclusion of the unused portion of the line of credit as part of the working capital available or cash on hand is a stretch of reality and a distortion of the health of the producer. Seemingly a continuation of the methods used to bring us to the imminent financial collapse of the industry.

The preceding shows that from a new investment perspective this would be a no go zone for the remainder of these producers' existence. If they could deal with the issues around their past financial performance, something the bureaucrats have feigned no knowledge or understanding of, the debt would need to be serviced. Any one of the six crises that we mentioned in our last post would further skew the risk of any investment beyond the tolerable level of the capital market. A market that is currently quite satisfied with the continued exceptional performance of other industries that are now defining what the expectations of these producers' performance needs to be. 

This level of performance is not the legacy, history or reputation of the bureaucrats. Theirs is one where they’ve personally feasted at the trough to create their own personal dynasties that will provide them with the healthy alternative when all is gone. Profits were inflated through specious accounting since the late 1970s. The producer as it stands today is an empty vessel at the absolute very best. The industry has been hollowed out of any and all value after four decades of mismanagement. A management that does not understand its issues, the meaning of profits or damage and destruction from its muddle along culture. Facing a stack of trillion dollar costs that have been unaddressed and are escalating uncontrollably. A business model that expects new investors to pay for them, only to be washed away, initially through dilution and then through their well designed bankruptcy wash cycle. It is indebted in a way that leaves nothing for anyone but the banks, and even the banks won’t care for it. Buying the producer firms shares means that you get to “share” in this misery with billions of others who wait, for what is unknown that no one in command cares to utter or define. Metaphorically this is the car at the side of the road in the middle of nowhere, the engine smoking with oil that has been trailing from the engine for the past several miles. The seriousness of the situation I can not express. 

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