My Argument, Part XIX
One factor that we do know that is present in all oil and gas is the decline curve. If no action is taken to work the reserves on a consistent basis the decline in productivity of the wells and the field will become material. Efforts to mitigate the effect of the decline curve include recompletions, drilling laterally, infill drilling and the like. There is a distinct characteristic to these actions in that they’re taken to offset the natural decline in production. My question would therefore be, would these be considered capital expenditures in most businesses or maintenance?
In a world where everything is capitalized, such as oil and gas. Including the receptionists staples and sticky notes. The interest on debt and head office rent. The allocation of overhead is as much as 80% of all of these overhead costs of the producer to property, plant and equipment. This is extreme, what are the exceptions? There are none. I think one of the exceptions that must be considered in terms of whether a cost should be capitalized or not. Is if it was incurred to expand the production profile of the producer, or, if it was incurred to maintain the production profile of the producer. Those two actions are distinctly different in terms of evaluating the performance of the producers management.
The cash crisis at Pengrowth was so severe last year that they did not spend anything on capital expenditures. As a result their production profile decreased by 30%. Maintenance of the asset would have maintained the production profile. Note that those costs would have also been incurred in the current period, just as an operating cost would be. They would have had no residual value as an asset would have had. In essence those costs will have to be incurred again and again in each of the subsequent years in order to avoid a 30% / year erosion in the production profile. A recurring cost just as operating costs are.
We are to believe that capital expenditures involve every aspect of an oil and gas producer. When an investor is promoted into buying an oil and gas producers stock it is on the basis of the next great drilling opportunity. What ends up with their money, however, is that it is expended on overhead and maintaining the production profile that was in existence. Where is the upside? Year after year the producer goes to the market to raise more and more money only to fund their overhead and maintenance? I guess the real attraction is with each subsequent share offering the previous shareholders are diluted once more. That in oil and gas must be what’s called the kicker!
Therefore, I believe that a certain percentage of capital expenditures should be reallocated to operating expenses as a result of being maintenance of the production profile. As a result cash flow from operations would be down significantly in this low commodity price environment. And capital expenditures would be down as well. This would be a more accurate accounting of the performance of the management and consistent with a going concern. One that would be more interested in sustaining itself then annually scamming its shareholders and investors.
We all know the purpose of Generally Accepted Accounting Principles. Things have digressed to this deceptive accounting practice over the past four decades. Allocating overhead was the first “trick” to boost earning and boost the asset value of a company. It also has the effect of increasing the cash flow numbers by recording G&A as capital expenditures as opposed to part of operations. Then interest was added to the list when the 1980’s interest rates hit such high values.The scam has gotten ever more sophisticated over that time frame. From there creative accounting became the only game in town and the basis of how the producers were able to consistently generate investor interest year after year with little to show for the money that was invested. These “attributes” became what are known as Generally Accepted Accounting Principles. Corrupt as they are. When everyone’s robbing the bank then bank robbers won’t be criminals will they.
The Preliminary Specification will establish new accounting discipline and methodologies to report more effectively what it is that the producers are doing. It's time for a clear accounting of what is going on in oil and gas. An accounting that shows the difference between producers. Enabling investors to see who are the real oil men and who are the pretenders. If I was handed the financial statements from an anonymous oil and gas company today I could not tell you if it was commercially successful or not. This has gone on too long as it is. It’s time to fix it.
The Preliminary Specification, our user community and service providers provide the dynamic, innovative, accountable and profitable oil and gas producer with the most profitable means of oil and gas operations. Setting the foundation for North America’s energy independence. People, Ideas & Objects Revenue Model specifies the means in which investors can participate in these user defined software developments. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Twitter @piobiz anyone can contact me at 403-200-2302 or email here.