The Tragic State of Affairs, Part II

 The one thing that People, Ideas & Objects have been able to prove over the past fifteen and one half years throughout our writings on this blog is our general concern for oil and gas. And the fact is the bureaucrats don’t care about the business. So if we talk about the tragedy that is the current state of affairs of the oil and gas industry the audience we are speaking to is everyone else as it's always been. All of our attempts to convince the bureaucrats of their need for action have been in vain and I really don’t expect any of that to have changed. Although bureaucrats have been put in personal financial and legal jeopardy. Enough jeopardy to materially impact their quality of retirement and the value of their personal holdings. Their ability to act remains in doubt and by giving them the benefit of the doubt, that they would act at some reasonable time and in some reasonable way, would be foolhardy on our behalf at any time. To be clear it must be difficult for bureaucrats to understand and appreciate the difficulties they’re in and to finally realize that they’re alone and their situation has become untenable. The speed of business today is blisteringly fast. The speed of the issues of the oil and gas producers officers and directors are facing are far greater than what humans could handle. Their organizations are dinosaurs in terms of what is possible. I am in no way soliciting sympathy for their cause. The traditional strategy they’ve employed would have seen them exit their role in the organization and avoid the fallout. I’m thinking they left this one too late and are unable to do so at this time. They’re trapped for all intents and purposes. If they should happen to leave the producer firms, they’ll lose control of the leverage they have in managing their personal legal and financial risk. . 

Enough of the bureaucrats, let's talk about the details. The past couple of months we’ve been able to document the demise of the industry in a number of series here at People, Ideas & Objects. They’ve painted a picture of the industry as it stands today from my point of view and although some may feel it’s a unique point of view. It defines a steep downward trajectory that accelerates unabated each and every year. My assertion that this has been in place for four decades can provide an understanding of the momentum behind its current trajectory. Much like a log rolling down a hill, catchable in its initial stages, becomes progressively more difficult as time passes. The future of the industry is what concerns me and how do we get to the point where the North American continent can consistently and profitably produce oil and gas to achieve and maintain energy independence. Where consumers are provided with the lowest possible cost of energy that keeps their economy as robust and growing to maintain its dominant position in the world. Imputing that producers would be dynamic and innovative in order to attain their profitability. Where the next six generations, or however long, of oil and gas exploration and production are maintained in a profitable and healthy greater economic environment where everyone can benefit and grow. To hand down an industry that is healthy and prosperous to each new generation for them to continue as the situation demands. 

We have suggested that the current environment that exists is the greatest difficulty that the oil and gas industry has ever faced. Not one area has been left undamaged by the inactions and purposeful ignorance of the bureaucrats. People throughout the greater oil and gas economy are the ones that have lost the most. They trusted the bureaucrats, and to a large extent many still do, the sting of betrayal is sometimes hard to accept. However, once the betrayal occurs there is no going back to the trusting relationships that existed before. Either the people who were betrayed will leave or the bureaucrats must go. It’s a simple choice. 

What is it that the bureaucrats are offering? I don’t know. I can not discern that they understand or appreciate their own organizational difficulties or much beyond their own skin. It is therefore fair and reasonable to project that more of the same will be happening. With the current trajectory there’ll be no volunteers willing to step in front to die for the cause. I suggested the producers were too far gone for the Preliminary Specification to get involved in the producer's business during July 2019 in the publication of our White Paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” Maybe more people will now see my point. A fundamental rebuild of the organizations within the industry are what is necessary through the development of the Preliminary Specification to define and support the organizations necessary for a dynamic, innovative, accountable and profitable oil and gas producers and industry. Where we provide the most profitable means of oil and gas production everywhere and always. An appropriately researched solution based on the fundamental culture of the industry, the Joint Operating Committee. The legal, financial, operational decision making, cultural, communication, innovation and strategic framework of the industry. A ten year research effort that defines what the industry and producer firms would need to look like and how they would operate to adopt that organizational construct. The Preliminary Specification is the result of that research which is a 200,000 word, 12 module definition of a workable business model that functions in the way that a 21st century industry and organization needs to. 

And what is it that we now know about the bureaucrats that I honestly did not know at this time last year and only learned in the summer of 2020. It was in my June 2, 2020 blog post that I discussed a nuance and dynamic of officers and directors liability insurance that was at best brief. The logs to my blog blew up. It was one of many comments in the post and therefore I didn’t know specifically what it was that attracted all the attention. That is until Reuters told me on June 9, 2020 in their article entitled “Shale Companies Look to Bolster Insurance for Officers and Directors.” My naivety and stupidity hit me all at once. For decades I’ve been detailing the consequences to the industry and producers of the bureaucratic inactions. That's where I was being foolish. Bureaucrats don’t care. We can say with perfect clarity they’re only in it for themselves and the fact that they felt personal financial risk and legal jeopardy was the only cause to immediately upgrade their insurance. It also made me realize I had to change my focus. 

What proof did I have that this issue has been evident for four decades? Another good question that I’d never answered directly and one that I relied on my own understanding of the history of the industry. Therefore I set out to prove the overcapitalization leads to the commensurate over reported profits, which leads to investors rushing in to capture those profits, leading to overinvestment which produces overproduction. And as we further defined overproduction as unprofitable production. These are simple basic business principles. Then I stumbled in the most circuitous route imaginable upon a newspaper article in newspapers.com (paywall) that hit all the high notes. A set of July 26, 1986 Calgary Herald page 33 articles that document the desire of OPEC to work within the greater oil and gas market to deal with the consequences of low oil prices. The first article is entitled “OPEC Minister Can See Economic Destruction” and its opening paragraph is. 

Qatar’s oil minister has called on both non-OPEC and industrialized countries to cooperate with OPEC to work out a policy aimed at restoring stability in the world oil market or face grave consequences. 

But in Kuwait, the United Arab Emirates petroleum minister said OPEC has no alternative but an oil price war until rival producers agree to reduce output. 

This coming from 1986, which I assume means the overproduction was well in place for OPEC to have raised it as a concern, as they did in the article, as the justification for the war they had declared on North American producers, and the reason for flooding the market with oil till the price hit $10 U.S. I then noted that this was documentary evidence of these chronic business symptoms, that were discussed above, going back to at least 1986. I then noted the Preliminary Specification as a solution was published in December 2013. A solution that I have been working on in several different iterations of software companies since May 1991. The North American producers response to this, as it has been every day over the past four decades, was to continually increase production in a declining price environment, creating losses that would be offset by new investors being called upon annually to make up the cash shortfall. Shareholders that had been motivated by specious accounting that reported profitability throughout this time. 

If I, who am too thick to understand that bureaucrats only work for their own interests, could see the problem in 1991 and eventually develop a solution by 2013. Why couldn’t the bureaucrats just read the Preliminary Specification? But they did. I have a multitude of evidence of the interactions that People, Ideas & Objects has had with producer bureaucrats since the publication of People, Ideas & Objects Preliminary Research Report proposal in August 2003. This was the founding document that proposed the use of the Joint Operating Committee as the key organizational construct of a dynamic, innovative, accountable and profitable oil and gas industry and producer. The basis of the research undertaken to develop and publish the Preliminary Specification in December 2013.

Putting two and two together. If the issue was evident on a global basis in July 1986 why was no action taken by the bureaucrats for the past 35 years? We’ve seen in the shale era a further deterioration of the business into natural gas and last year's obscene oil prices. Yet, nothing but excuses, blaming, and viable scapegoats from the bureaucrats as they “muddle through.” Creative executive compensation however has placed oil and gas companies bureaucrats in the top three in terms of all industries. 

Shareholder litigation against the producers, and specifically the officers, has therefore begun. Exxon and Apache are currently the subject of several proposed class action lawsuits seeking certification. The SEC has begun an investigation into Exxon and is sending subpoenas to many of the shale producers. These investigations and lawsuits are either directly or indirectly on point to the issue of overcapitalization through to overproduction. The SEC investigated and prosecuted PennWest for the capitalization of operations and royalties which subsequently destroyed the organization. Clearly the SEC’s message was not heard by all the producers during the PennWest case and I’m not of the belief that this time the investigations and prosecutions will stop at a single firm. They’ll need to make an example of a much larger population of producers in order for the concept to stick. The point I’m making is that the bureaucrats' reliance on “our policies are within the guidelines and regulations” is nothing more than a viable scapegoat used for the past few decades to justify their overcapitalization of these costs. The SEC never issued any guidance stating that what has happened is acceptable. Basic business practices state that this would never be acceptable. Bernie Madoff’s prison sentence of 125 years states that this type of practice is never acceptable. That the culture of the oil and gas industry has developed to where this is acceptable by producers, by their CPA firms who are allegedly there to safeguard shareholders from such ludicrous actions, to such a scope and scale, for this long is going to go down in history as a primary failure of bureaucracy. 

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. 

The Tragic State of Affairs, Part I

 Everyone carries a part of society on his shoulders; no one is relieved of his share of responsibility by others. And no one can find a safe way for himself if society is sweeping towards de­struction. Therefore everyone, in his own interests, must thrust himself vigorously into the intellectual battle. No one can stand aside with unconcern: the interests of everyone hang on the result. Whether he chooses or not, every man is drawn into the great historical struggle, the decisive battle into which our epoch has plunged us.

-- Ludwig Von Mises

Professor Mises died in 1974 and should be excused for his sexism. Nonetheless this is what I consider my personal motivation in pursuing this task. Which allows me to ask what the bureaucrats motivation has been over these past decades other than personal financial gain. Their lack of professionalism has extended to all aspects of their positions. They were the ones that were responsible for the greater oil and gas economy. Oil and gas being a primary industry and therefore must take on a greater role in all aspects of the greater oil and gas economy. One where they understand how those revenues were earned and who exactly it is that’s responsible for making them happen. That begins with the drilling rig owner down to the clerk at the corner grocery store. What was it that we could have expected they could have done about the chronic boom and bust cycles that these bureaucrats literally sat through uncaringly mouthing the words “muddle through?” Lets not forget they had control of the revenues so they were fine. No one else had the authority to make the necessary changes, to look at the situation critically and evaluate why this was ever acceptable? It is not, and it certainly should never have been accepted in the 21st century. Yet here we are with the economic bust that defines them all. A full blown depression by anyone’s standards and one in which those in industry who were dependent on oil and gas, and in turn oil and gas can’t function without, really don’t care what it is the bureaucrats do from this point. We’ve all learned that they’re in it for themselves and are entrenched in those positions, spewing orders to everyone with the accusations of greed and laziness in everything they see and everywhere they look except in the one place it truly exists, the mirror. 

Everyone is now laughing at the North American oil and gas bureaucrats. Everyone now understands how the destruction has been carried out and who the winners were and always will be in their system. They’re not laughing so loud that bureaucrats can hear it, but people are now snickering behind their back. Bureaucrats tried to take this recent oil rally as a guide to the next boom phase. “We’ve seen this before, now is the time to capture the future.” they’ve always said. Except there was no commensurate hopping on the wagon this time. I’m not saying no one believed them, but absolutely no one believed them and how dare they try that same stunt again! The script is old and doing the same things again and again, expecting different results… How many times have they tried this routine? Producers shares did rally quite handsomely, however not as well as GameStops have. When playing in the shallow end of the bottom, sometimes the feeders will take a quick gamble. That does not imply they’ll be lining up to fund the next rounds of trillion dollar spending binges or have the wherewithal to do so. What the real investors see is an exit strategy that they never thought previously possible. It’s just like Christmas, they can now leave with some value and wash their hands of the bunch. Those producers who think they can maybe raise some capital off this new found strength should consider they’ve just priced themselves out of that possibility. They’re now too expensive and have clearly defined how far the downside can be. 

In contrast to my dire presentation there are the sycophantic media selling their share of the bureaucrats' story in this renewed “optimistic” environment. You have to be an optimist to be in oil and gas. There is never any doubt about that, but read this article in Forbes and ask yourself is this what’s really going on and is it possible? Are we just able to pick ourselves up, dust ourselves off and resume exactly where we were so many decades ago?

OPEC+ made their opinions known recently. Stating that they could increase the price of oil at will without a commensurate production increase from the North American shale producers. I’ll bet that stung a bit didn’t it. They didn’t laugh, they’re too solemn to engage in that sort of thing. What they know and understand is the extent of the damage that the North American oil and gas industry has sustained over the past number of decades is well past the remedial opportunities to deal with it. They know that to move forward with what exists today is not going to happen. The analogy of the car at the side of the road in the middle of nowhere, that has spewed oil from the crankcase for the past two miles isn’t going anywhere. And just as the bureaucrats continue to try, our car at the side of the road will soon have a dead battery too. The cupboards are bare, the service industry is unable to provide a compelling reason or valid business model to the investment community that will attract anything. Sound familiar? They’ll wait until the producers resurrect themselves, prove they can be consistently profitable and can pay for the work they want done. In cash, up front which will include the cost to build new capacities and capabilities. People only laugh after all the cash is gone, which occurs soon after the betrayal that’s been perpetrated on them. They lose trust, they don’t believe and they don’t need anymore promises or threats. They’ve been destroyed by them, it's time to pick up and move on with their lives and make what they can of what they have. Producers need to think in terms of generations, not immediate like just hitting the lights. And that's what OPEC+ knows that the producers are too thick to realize. The only resource the North American greater oil and gas economy has is a substantial, but diminishing, revenue stream of oil and gas sales to fund and rebuild the industry infrastructure that has been laid to waste. 

With the Biden-Harris regime fully installed now, any substantial investments made in oil and gas will at best be dormant for the next four years. Therefore why bother, says John Q. Investor. With the aptitude for change by the bureaucrats and status quo regime there is probably more downside in the wind for any investment anywhere in the North American oil and gas industry. The Keystone XL decision shows the Biden-Harris regime may be the most unstable and unreliable anywhere in the world at this time. And if something should happen to change from the Biden-Harris regime in the next four years, things will only go down hill further and faster. A very risky proposition. Maybe they could have kept a good relationship with the Trump administration and looked forward to that continuing in 2024. I can assure you that will never happen. Leadership has failed within the bureaucracy, and leadership has failed the American political system. It's time for everyone to re-read the quote in the first paragraph of this blog post. Relying on leadership now will continue to fail as no one person can conduct all of these impossibilities. It's up to the people in society to become active to make the changes in their lives and stop taking things for granted. Stop allowing these bureaucrats and politicians to take what is not theirs and destroying what is ours. Or give up. People, Ideas & Objects is wholly reliant on the individuals who make up the user community and their service provider organizations to make the transition to a dynamic, innovative, accountable and profitable oil and gas industry and producer. There is no one individual that can lead the charge. Individuals making up the difference in their daily lives must be the reason that oil and gas is rebuilt and the American political system doesn’t continue down the road that it is on. 

The overcapitalization issues are not difficult to comprehend. They’re covered in accounting 101 and make up what is considered basic business sense regarding accountings two key principles of timing and the accuracy of an organization's cost. The impact of shale is also inherently understood. The manifest failings of these two issues over the past had significant influence over the cultural development of the industry. A cultural division has grown over time where the accountants ability to assert the business issues doesn’t exist. The release of reserves value through further drilling is the business and the only business as far as the culture of the industry is concerned. The nuance of recording and reporting the accurate timing and recognition of capital costs of exploration and production are not a topic of discussion when “everyone” is following the SEC’s regulated requirements and are “building their balance sheets” faster than “we” are. This is how the goals and objectives became “putting cash in the ground,” “building balance sheets” and any number of other misguided adventures but never profitability, performance or productivity. 

The perfect example of this cultural distortion is none other than the Anadarko acquisition by Occidental. It is here that Occidental paid an enterprise value of $68.3 billion for the assets of Anadarko. It is these assets' history that had performed on Anadarko’s financial statements to the tune of $695 million in lifetime earnings. We have to remember that over the prior four decades the method of accounting in oil and gas was to recognize as much cost as possible as a capital asset in property, plant and equipment. The limiting factor to what can be recorded in that account is the valuation of the petroleum and natural gas reserves. If they, subject to a handful of discounts, were higher than the account of property, plant and equipment then all was well. (In 2020 Occidental was recording significant impairments to their property, plant and equipment account. I guess the reserves didn’t hold up.) Therefore the race was on to reach that reserves value by cranking up the spending machine by each and every producer in each and every year they were in business. Throwing in overhead and interest is still done today. Royalties and operations didn’t fare as successfully and some producers are no longer with us as a result. The point of increasing the capital assets in this manner has the equal and exact amount of increased profitability reported. Therefore the $695 million in lifetime profits is more accurately stated as significant losses. If that were the case then the producers would be incurring significant cash drainage! Which highlights the importance and need of the annual shareholders issuance that became the cultural expectation that solved the accounting deficiencies described here. When the deception of false profits are attracting new investment then the world spins on the axis of those who issue such specious financial statements. It does not, however, say positive things about those who pay the full price for reserves that never performed, and by the looks of it, never will.

What are Anadarko’s “real” lifetime earnings? No one knows but I think Occidental is beginning to find out. How could such a large $70 billion transaction be undertaken on this basis? The full year 2020 Occidental has successfully drawn down their debt from $84.4 billion immediately upon the acquisition in the 3rd quarter of 2019 to $61.4 billion. Revenues were down $5 billion from 2019 and Occidental recorded revenues of $16.261 billion for 2020. Creating a loss of $15.675 billion. Sure it’s all covid, however I’ve noted everything was well within Occidentals hands and they did not need to run the oil price to negative $40 or continue to produce through March and April at under $20. Just out of curiosity, why would you? And who’s fault was it for the loss and selling of that production into that market? The one thing about the virus in 2020 is that it gave the bureaucrats a viable scapegoat that lasted almost the entire year and did solicit some sympathy in some quarters. Therefore an overall successful, viable scapegoat, but it's 2021 now. What it appears to me is that Occidental paid for the future revenues of Anadarko to make the acquisition. What else defines this lunacy? And what are the prospects of this once great company? But then again, pick up any oil and gas producers report over the past decade and you’ll see the same behavior, the same performance with the same results. It’s old school. 

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. 

Critical and Final Decision Time

 It is now time for our good friends, the oil and gas bureaucrats which are the officers and directors, to make the most consequential decision on behalf of the industry. And to do so before May 31, 2021, the time in which producer firms need to proceed with the developments of the Preliminary Specification, our user community and service providers. That would enable People, Ideas & Objects to set a September 1, 2021 start date. A time in which to remake their producer firms and the oil and gas industry in the dynamic, accountable, innovative and profitable vision of what People, Ideas & Objects have defined in our Preliminary Specification. “Muddling through” has been incapable of dealing with the issues and opportunities that are ever present. The speed in which the industry is able to act and react, in addition to the loss of capabilities and capacities have been on accelerating downward trajectories. There is much to be done internally within the industry to shore up the infrastructure and begin operating in what we can all agree will be a far more challenging environment. 

The ERP systems in use today have been established to support and define the bureaucracy, at the bureaucracies direction, and we have detailed the history and motivation behind keeping those systems operational. Seeking to offset the threat that People, Ideas & Objects Preliminary Specification disintermediating the bureaucrats into full and permanent retirement. Just as every other bureaucracy in every other industry has, is or will face. The current ERP marketplace, as detailed on page 18 of our White Paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale,” has not been able to support the oil and gas producers. With the existing, conflicted and self interested bureaucrats “muddling through” with inappropriate systems we are now entering an environment in the next half decade where the methods, speed, opportunities, issues, people, capabilities, capacities and a large variety of other variables will become comprehensively unmanageable within the current oil and gas industry. What we also know is that the wholesale destruction of the industry over the past decade has not stimulated the bureaucrats to even bother getting up off the couch. Any assumption that they’ll do anything about leaving the industry in better shape than now would be foolhardy. Bureaucrats are seen as not concerning themselves with their own producers businesses profitability or any of the issues that led to the 2015 investors strike. It is the same old, same old. That’s not good enough and will not be adequate for such a difficult future ahead for all of us. 

What appears to be happening and is being actively pursued in all industries is that Information Technology is fundamentally remaking all industries. These are predominantly in the planning stages with the goal of optimizing the IT environment to benefit the business materially by the year 2025. Leaving little time for action for the producers to act in their best interests, or alternatively, the bureaucrats can do nothing, mark their calendars for their December 31, 2024 retirement and resume their well worn position on the couch until then. The systems that are in use in oil and gas today are not doing the job as evidenced by the fact that the industry has fallen into such a financial disaster. Systems define and support the organization, bureaucrats wanted their bureaucratic franchise defined and supported, and that is what the systems providers were paid to do. They were more than willing to remain “blind sleepwalking agents of whomever would feed them.” Something that we have incorporated into People, Ideas & Objects business model to avoid. The compelling argument today that I find tosses the cat amongst the pigeons in terms of what 2025 will be like is the prediction by Oracle that there will be a five fold increase in the volume of data. For me that raises many concerns as to how an industry can function outside of a highly sophisticated IT environment. This increase in data is attributable to the implementation of the “Internet of Things” concept which is consistent with the needs of the oil and gas industry and the Preliminary Specification. For bureaucrats, they begin salivating at the size of the prospective growth of their empire and the difficulty that will be created in attempting to remove them at that time. Just a contrast in our two perspectives. 

Time has become the critical resource for all concerned. With billions and indeed trillions of dollars of value being wasted annually as a result of oil and gas’ “management” by the bureaucrats, time takes on an exponential value. I’d say time to the power of 10. There is also the question of the source of our energy resources being independent or foreign. They’ll need to come from somewhere. Someone explain to me what the bureaucrats plan is in the next five years to resuscitate the industry, infrastructure, service industry and its infrastructure and all the things we’ve discussed in the past number of years? I’m sure it will be an excellent document, as all committee based products are. Staffed with all the “right” people to ensure that the bureaucracy is made whole. After all one hundred years of bureaucratic history would never lead anyone astray. 

In our White Paper I stated I couldn’t do anything for the bureaucrats, they were too far gone in my opinion to save. Does anyone doubt that now? We are at a critical time where the Preliminary Specification may fail as it will be too late, as there will be little to no industry left in North America. Laugh all you want, bureaucrats have been enjoying the laughs here since 2005, and yet here we are in 2021! Is a total industry collapse necessary as the precursor to any rebuilding effort? Have we not learned anything from our history? Are we unable to invoke change? After May 31, 2021 I’ll have to assess the situation again. I see OPEC+ is of the same mind as I am. They don’t believe the North American producers will be capable of increasing deliverability in the $60 plus oil price environment. And therefore will continue to essentially ignore those who foolishly destroyed the market before, the North American bureaucrat. This achievement by our good friends the bureaucrats deserves our recognition and we’re therefore announcing another People, Ideas & Objects Participation Ribbon for each and every bureaucrat. They’ve now acquired a mighty handsome collection! Here’s a quotation from 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.

These Information Technology issues being presented are being seen as a further existential threat to the deliverability of North American energy independence. The current U.S. administration and the man on the street will be cheering this on from the sidelines. Such is the world that bureaucrats have created. Nonetheless fewer people will be jumping in to help the industry as it sheds deliverability and is seen as a dying source of “dirty” energy. That is until it's too late and their sad reality bites. IT is also providing the opportunity to remedy all of these problems and get the ship back on course and sailing profitably again. Time being the critical resource of which the industry has none of. Only the Preliminary Specification, our user community and service providers can deliver a solution to the market on a timely basis. The only guarantee of success will be the level of participation that we’re able to receive from the industry as a whole. We can’t have people sitting back on the couch waiting for someone to deliver them from their mistakes, it’s a simple matter of leadership. Lead, follow or get out of the way. Industry therefore has to have some skin in the game. That means they have to use their primary revenues to begin this process and fund People, Ideas & Objects, or wait until June 1, 2021 and see what I come up with. Get on with it or continue to play the “Royal” victim like some Princesses do. 

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 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.