Economics of Oil & Gas With People, Ideas & Objects
Changes in Overhead
People, Ideas & Objects have refrained from estimating the overhead cost reductions achievable through the Preliminary Specification, until now. Overhead, primarily personnel costs for building and maintaining the capacity and capabilities to support oil and gas operations, faces imminent disruption. Dynamic technological advancements, particularly in automation and AI, are poised to transform work processes significantly.Cloud Administration & Accounting for Oil & Gas: Currently, each producer redundantly builds its own accounting and administrative infrastructure. Our centralized, cloud-based solution eliminates this duplication, leveraging the cloud computing paradigm to drastically cut industry-wide overhead costs.
Variable Cost Structure via Joint Operating Committee: The Preliminary Specification restructures operations around the Joint Operating Committee, making all costs, including overhead, variable based on profitable production. Shutting in unprofitable production results in a null operation—neither profit nor loss—maximizing corporate profitability.
Hyperspecialization and Division of Labor: Artificial Intelligence enables hyperspecialization and enhanced division of labor, orchestrating complex processes that would otherwise be unmanageable and chaotic. Intellectual Property, one of seven Organizational Constructs in the Preliminary Specification, defines, controls access, administers licenses, and enforces authority, ensuring efficient management. Read our paper on Hyper-specialization, Artificial Intelligence and Intellectual Property.
Automation through Permanent Software Development: The Preliminary Specification’s ongoing software development capability delivers high levels of automation, further reducing overhead costs.
Together, these features could achieve up to a two-thirds reduction in overhead costs for North American oil and gas producers. Gross overhead, typically 12–20% of revenue, translates to cost savings of 8–13% of revenue. (Note: All overhead discussed is gross, excluding capitalization and allowances.)
Discussions like these often spark fear and uncertainty about Information Technology-driven change. People, Ideas & Objects claims assumes a static comparison of a producer in the same configuration and timeframe, which may not reflect the future. We must shift from working for computers, as is common in oil and gas today, to leveraging them to amplify our strategic competitive advantages. These include harnessing Artificial Intelligence, automation, collaboration, conflict and contradiction as analytical tools, creativity, decision-making, tacit and explicit knowledge integration, design, financing, ideas, innovation, issue identification and resolution, judgment, leadership, planning, performance, quality, reasoning, research, thinking, and vision.
The future of work remains uncertain and unpredictable but is undeniably unstoppable. Embracing this path is the most productive approach for all stakeholders. Opening a buggy-whip factory today would be as misguided as it was a century ago.
Capitalization
The oil and gas industry’s capitalization practices, as critiqued extensively in this blog, have devolved into a cultural fixation on “building balance sheets” and “putting cash in the ground.” Such misguided corporate goals, occasionally punctuated by claims that “profits don’t matter,” dominated discourse for decades.
Most oil and gas costs, being intangible, are capitalized and depleted over the life of proven reserves. SEC regulations dictate that for X proven reserves, Y expenditures are recognized, resulting in a depletion of Y/X per barrel produced. Shale’s vast reserves inflate reported profitability by stretching depletion schedules. Tax treatments differ, but People, Ideas & Objects focus on what’s required for oil and gas to compete in North American capital markets: determining the marginal price or replacement cost of an incremental barrel.
We propose a pricing model that accelerates capital recognition, treating many intangible costs as operational expenses. This approach, akin to a “third set of books” in Hollywood accounting, reflects the reality that businesses maintain multiple accounting perspectives for distinct purposes. This clarification seems necessary when, as recently as 2023, officers and directors misunderstood basic terms like “free on board” while developing the LNG export market.
Each Joint Operating Committee will receive standardized, objective monthly financial statements to assess property profitability. If a property incurs losses, partners can shut-in production, preserving reserves for future profitable operations.
In a capital-intensive industry like oil and gas, People, Ideas & Objects advocate for a fundamentally different accounting approach. Capital, the dominant cost component, must be passed to consumers in line with North American capital market expectations. We propose depleting capital costs over 30 months to remain competitive, significantly reducing the property, plant, and equipment (PP&E) account.
This accelerated depletion will establish the marginal price needed to replace a barrel of oil or gas equivalent, regardless of whether the property is a decades-old conventional well or a new shale operation. Our model also shifts some capital costs to current-month operations in product pricing calculations.
Compared to today’s market, PP&E balances will drop to 15–20% of current levels, with field activity as the key differentiator. Future profitability and enhanced free cash flows will drive significantly higher field activity.
Investors pursuing our Arbitrage Strategy should exercise caution. Current officers and directors, intoxicated by the cash flows of a capital intensive, primary industry based on partnerships, make poor decisions in this capital-intensive primary industry. With even larger future free cash flows, robust accountability—enabled by Oracle Cloud ERP and our Compliance & Governance model—and disciplined dividend policies are essential to prevent mismanagement.
Where’s the Value
Financial statements evaluate a firm’s performance, they do not capture an organization’s value. Capital markets assess a firm’s value by discounting its future cash flows, driven by the capacity and capability of its reserves to sustain or expand those flows.
These adjustments to capital costs, combined with higher commodity prices needed to achieve replacement value, will boost the free cash flow of a profitable producer. Additionally, overhead costs, now variable and charged directly to the Joint Operating Committee, will be included in commodity price calculations. This ensures that incurred overhead costs are recovered the following month, creating a “cash float”—a standard business practice.
The capital-intensive nature of oil and gas, with the scope and scale required to maintain and grow deliverability over the next 25 years, presents a formidable challenge.
Conclusion to Capital Assets, Cash and Working Capital
Contrary to “building balance sheets" and “putting cash in the ground,” or spending the allowance investors are willing to provide to what we’ve described as the “old” producers. The Preliminary Specification sets in place a method of business operations to meet their future demands. Where officers and directors will be able to independently undertake the profitable operations of an actual business.
The “new” producers as we’ve described them will have an independence in their operations unlike what we have seen before. Where financial performance dictates that they are in control and are able to pick among the best opportunities available. Where they have the financial wherewithal to undertake successful completion of what it is they undertake. Where the drilling rig price quoted is x and the producer respectfully pays x with no expectation of a discount, only the absolute performance that x commands.
Instead of having property, plant and equipment recorded at sky high levels in an attempt to emulate the value of the firm. The capital configuration is different through the Preliminary Specification. Costs are being passed to the consumers in a competitive manner. Competitive in terms of price and competitive in terms of performance in the capital markets. Cash and working capital more specifically are the tools in which producers accomplish their objectives.
The industry in the past two decades has had diminishing working capital due to their lack of performance. This is the reason that nothing is being done in the industry today, no one has the money. They don’t have the money because they haven’t made it, don’t know how to make it, no one’s giving it to them anymore and therefore choose only to listen to music with their friends in the basement.
Compare what an effective executive such as President Biden is able to accomplish in one term and contrast that to one day of President Trump. There’s a reason for the performance differential, however the contrast is appropriate between what a producer is like today and the type we need very soon. Having cash to enact the producers' will is what’s needed. Without it all you can do is beat up vendors for discounts. And in turn, just don’t ask for focus or performance.
