Exploding Myths, Part I
We return to 2020 with an interesting point of view being reflected by our good friends the bureaucrats of the oil and gas producers. The two things that I noticed the most were the continuation of the exits, the most prominent of which being Mr. Harold Hamm giving up the CEO post at Continental Energy. The second point seems to be a desperate attempt to seize the narrative. As a result I’ll be running this “Exploding Myth” series countering the arguments in the producers narrative. First up at bat is Chevron’s write down of $10 to $11 billion in the fourth quarter of 2019 for their natural gas properties. Chevron had $169 billion in property, plant and equipment as of 12/31/2018, a 7% write down doesn’t seem material enough to me when natural gas prices are down 26% since that time. Granted Chevron’s property, plant and equipment includes oil, downstream and international assets, it just isn’t a prosperous time in oil and gas. My argument has always been that the majority of these “assets” are better described as the unrecognized capital costs of past production.
One of the differences between the Preliminary Specification and the manner in which the industry is operated today is the management of property, plant and equipment. We believe as a capital intensive industry oil and gas should reflect a large portion of capital as part of the cost of the commodities price in providing the product to the consumer. Current producers believe capital assets are to be used to bloat the balance sheets in order for the CEO to strut about town with the biggest balance sheet. We believe the Preliminary Specifications timely recognition of capital costs in the commodity price would provide producers with the return of the previously invested cash resources necessary to fund future capital expenditures, dividends and pay down debt. Current producers seem to think that investors enjoy the brilliance of the deployment of their cash in the development of state of the art engineering experiments. We believe oil and gas has not been profitable for four decades as a result of these policy differences, which has created a management culture that is systemic, unchangeable and terminal for the status quo. A culture that knows no difference and is unwilling to accept responsibility. We also believe that the value that oil and gas provides the consumer, the 23,200 man hours of labor per barrel, is significant and ask: why would we ever sell any oil and gas that is unprofitable? How would we justify such actions to future generations? At least if it was profitable then we would know it was not used inappropriately or wasted. Asking if renewable energy, a substantial energy user during its development, had to pay the real cost of oil and gas producers exploration and production would they ever become economic?
The Wall Street Journal wrote about the Chevron write down, Chevron’s CEO Michael Wirth comments.
This sounds to me to be a capitulation of any responsibility for the past development of sub-grade assets, and the desire to do anything about them! People, Ideas & Objects have argued that our business model provides oil and gas producers with the most profitable means of oil and gas operations. Is this the response to our business model? It also appears to me that Chevron’s CEO is unwilling to take his own advice to make the necessary changes before changes are forced upon Chevron.
I mentioned in our White Paper the analogy that I draw to the bureaucrats in the oil and gas producers. These bureaucrats as Keystone Cops are always running around to the next best thing in oil and gas. Heavy oil, SAGD, unconventional gas, shale… Once everyone jumps on board and the “new” thing is determined to be uneconomic, they all run to the next great thing. “High grading” Chevron’s portfolio is them running down the back alley to the next great thing. The Preliminary Specification looks at the producers portfolio of properties and evaluates them on the basis of a standardized accounting that determines the properties profitability based on all of their actual costs. Revenue, royalty, capital, operations and actual overhead. Then if the property is profitable it will continue to produce, otherwise it will be shut-in where it will incur no profit but also no loss. Enabling the producers to focus on their shut-in properties and innovatively bring them back onto production. While these properties are shut-in they will be leaving their reserves in place for a time in which they can be produced profitably, not adding the incremental losses to the cost of the reserves to be captured in the future, ensuring the producer reaches their highest profitability when only profitable properties are produced and allowing the commodity markets to find their marginal cost. Instead the narrative to refute our logic is that we’ll ignore the assets that aren’t as pristine from an engineering “high-grade” point of view, as they aren’t as entertaining to us? Maybe Chevron’s write down should include those assets they are no longer interested in.
In our White Paper we documented how producers alleged the business model in our Preliminary Specification is collusion. We argued these past years that it’s not, and anyone making independent business decisions to shut-in production based on actual, factual accounting data to determine profitability was not collusion, otherwise we are the new Soviet Union. It’s actually good business and what most industries do that don’t have investors lined up around the block. Those were the good ol days weren’t they? Our argument seems to have permeated the craniums of the bureaucrats and they’ve now come up with the “high grade” reasoning to refute our claim of providing the most profitable means of oil and gas operations.
It’s our argument about their storage of cash in the ground that the producer bureaucrats refuse to listen to. By capitalizing everything for decades they’ve locked the investors cash into the ground until such time as they recognize it as depletion. However, this game has gone on for four decades now and the revenues being generated by these assets are so pale in comparison to what they should be, they’re not generating adequate cash due to the heavily discounted commodity prices producers created for themselves and have been selling their products for. Storing these capital assets on the balance sheet also reflects the amount of the capital subsidy consumers have enjoyed which the producers investors have unwillingly provided. If oil and gas was a business they would begin to treat all properties somewhat the same. If they’re profitable then they’ll produce but oil and gas hasn’t been a business for many decades. It’s been an exercise in destruction, whose purpose is almost complete and will not be resolved constructively or judiciously.
The other aspect of the cash deficiencies these producers are unwilling to accept or listen to is the fact that most of their costs are capitalized. We point out this has become so extreme that the receptionists time, telephone service and Post-it-Notes are all capitalized and left as property, plant and equipment for decades too. This therefore has turned the producers into chronic spending machines wholly dependent on continuous outside funding, until these past few years that is. Their oil and gas revenues have become poor in comparison to what they should be. And whatever is earned is inadequate to cover all of the current costs of the producers as they continue to sink every dollar they find in the ground each month. When you had willing investors lined up down the block and breaking down the door this was not an issue. Now however, the cash drainage each month is epic. Money goes in, and never comes out. Then the search for next months cash begins, and so on. Hence we have the producers stuck in a never ending cash drain of their own making, refusing to admit they have an issue and only refuting the claims that we’ve made in our Preliminary Specification and White Paper. This cash issue will be the terminal factor that they’ve refused to address over the past five years of diminished investor interest. Now with severely deficient working capital, time has become their biggest enemy. Time remaining in which they can keep the doors open.
We recently learned that Houston’s office vacancy rate has hit 26% which represents 60 million vacant square feet. Calgary has over 30% vacancy rate with 15 million vacant square feet. Meaning Houston has more vacant square footage than Calgary has square footage. Nonetheless I’m always called to prove my claim that overhead is in the range of 20% of revenues. No one knows what the overhead is in oil and gas. The question I have, if the producers claimed costs of overhead at 2 to 4%, why would they shut down so much of their head offices? The best they could be saving here is 0.6% to 1.2%. Seems to me to be too much grief and pain being realized for a 1% cost reduction? Maybe bureaucrats find layoffs to be the best part of their job!
This working capital issue is more than just what the operational producers will concern themselves with. During bankruptcy a “client” will always command respect from the justice and the administrators when they have strong cash flow. Oil and gas is a cash flow industry. Until it is realized that the cash flow that is produced is incapable of providing the day-to-day operations of the producer. The administrator will assess these firms on the basis of their cash generating capabilities. Which we have seen in the past 5 years and even in the past 10 years since natural gas collapsed, doesn’t exist. I would argue that the accounting has been suspect since the late 1970’s but then I’m alone with only the facts on that. I leave you with one question: how does an industry, a primary industry at that, become worthless?
Here’s a clue as to where all the value went. This graph from the WSJ’s Lev Borodovsky was included in the White Paper. It accurately captures the attitude in oil and gas. It states when a producer would shut-in a property and it’s breakeven point for a variety of shale properties. (Note, never have I seen a property shut-in for its lack of economic performance. Ever.) Assuming if we could that the shut-in price in this chart is the variable operating costs of the property that were not capitalized. The well breakeven price is a fundamental misunderstanding of what breakeven means. Nonetheless, we’ll take their numbers and assume the amount is the capital and operating costs of the property. Essentially the graph proves that the producers will always produce as long as they were covering off the variable operating costs. Now this is what I said in the White paper that captures the fallacy in this thinking.
We have also argued the allocation of capital costs to each and every barrel of oil in reserves is inconsistent with the capital investment market. Whether the barrel is produced today, this decade or even this century, we believe this SEC allowed outer limit of what is allowed is unacceptable for each producer to reach each year. Therefore the actual cost of these shale production volumes capital costs would be substantially higher if allocated in a manner consistent with a market economy.
As we look toward the next 25 years in this industry we know we can’t get through this period with the producers that we have today. The legacy of their bloated balance sheets will haunt them from this point forward. Their capital structures are permanently destroyed through decades of not recognizing adequate costs of capital in the products they sold. Now they’ll be forced to compensate for that with revenues and cash flows that are wholly inadequate due to their destruction of commodity prices. They’re incapable of surviving today’s business environment, how bad will it be in just three years? The only way to approach this next phase of oil and gas is through a redefined industry and producer structure. One based on succeeding always and everywhere, where producers are dynamic, innovative, accountable and profitable. Where everyone can depend on the primary industry that oil and gas is to fuel the careers, prosperity and quality of lives that have not been provided in the past 29 out of 34 years. At least I think we’ve had 5 good years. Where the next 25 years capital expenditures demand the $20 to $40 trillion necessary for the next phase of North America’s development, will be sourced from the commodities sales themselves. Investors are saying it won’t be them. This is beginning to almost sound like a plan! And what is the industry’s plan? Much like Chevron’s, ignore the majority of their non-performing properties, they cover the overhead, and look for gleaming, state of the art, engineering projects. After all it’s what they 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. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.
One of the differences between the Preliminary Specification and the manner in which the industry is operated today is the management of property, plant and equipment. We believe as a capital intensive industry oil and gas should reflect a large portion of capital as part of the cost of the commodities price in providing the product to the consumer. Current producers believe capital assets are to be used to bloat the balance sheets in order for the CEO to strut about town with the biggest balance sheet. We believe the Preliminary Specifications timely recognition of capital costs in the commodity price would provide producers with the return of the previously invested cash resources necessary to fund future capital expenditures, dividends and pay down debt. Current producers seem to think that investors enjoy the brilliance of the deployment of their cash in the development of state of the art engineering experiments. We believe oil and gas has not been profitable for four decades as a result of these policy differences, which has created a management culture that is systemic, unchangeable and terminal for the status quo. A culture that knows no difference and is unwilling to accept responsibility. We also believe that the value that oil and gas provides the consumer, the 23,200 man hours of labor per barrel, is significant and ask: why would we ever sell any oil and gas that is unprofitable? How would we justify such actions to future generations? At least if it was profitable then we would know it was not used inappropriately or wasted. Asking if renewable energy, a substantial energy user during its development, had to pay the real cost of oil and gas producers exploration and production would they ever become economic?
The Wall Street Journal wrote about the Chevron write down, Chevron’s CEO Michael Wirth comments.
Chevron Corp. is writing down the value of its assets by more than $10 billion, a concession that in an age of abundant oil and gas some of its holdings won’t be profitable anytime soon.
The company is also undertaking a restructuring, going from four global production units to three. “Companies that wait until change is forced upon them fail,” Mr. Wirth said in a video sent to employees last week. “We’re not going to let that happen at Chevron.”
We have to make the tough choices to high-grade our portfolio and invest in the highest-return projects in the world we see ahead of us, and that’s a different world than the one that lies behind us.”
This sounds to me to be a capitulation of any responsibility for the past development of sub-grade assets, and the desire to do anything about them! People, Ideas & Objects have argued that our business model provides oil and gas producers with the most profitable means of oil and gas operations. Is this the response to our business model? It also appears to me that Chevron’s CEO is unwilling to take his own advice to make the necessary changes before changes are forced upon Chevron.
I mentioned in our White Paper the analogy that I draw to the bureaucrats in the oil and gas producers. These bureaucrats as Keystone Cops are always running around to the next best thing in oil and gas. Heavy oil, SAGD, unconventional gas, shale… Once everyone jumps on board and the “new” thing is determined to be uneconomic, they all run to the next great thing. “High grading” Chevron’s portfolio is them running down the back alley to the next great thing. The Preliminary Specification looks at the producers portfolio of properties and evaluates them on the basis of a standardized accounting that determines the properties profitability based on all of their actual costs. Revenue, royalty, capital, operations and actual overhead. Then if the property is profitable it will continue to produce, otherwise it will be shut-in where it will incur no profit but also no loss. Enabling the producers to focus on their shut-in properties and innovatively bring them back onto production. While these properties are shut-in they will be leaving their reserves in place for a time in which they can be produced profitably, not adding the incremental losses to the cost of the reserves to be captured in the future, ensuring the producer reaches their highest profitability when only profitable properties are produced and allowing the commodity markets to find their marginal cost. Instead the narrative to refute our logic is that we’ll ignore the assets that aren’t as pristine from an engineering “high-grade” point of view, as they aren’t as entertaining to us? Maybe Chevron’s write down should include those assets they are no longer interested in.
In our White Paper we documented how producers alleged the business model in our Preliminary Specification is collusion. We argued these past years that it’s not, and anyone making independent business decisions to shut-in production based on actual, factual accounting data to determine profitability was not collusion, otherwise we are the new Soviet Union. It’s actually good business and what most industries do that don’t have investors lined up around the block. Those were the good ol days weren’t they? Our argument seems to have permeated the craniums of the bureaucrats and they’ve now come up with the “high grade” reasoning to refute our claim of providing the most profitable means of oil and gas operations.
It’s our argument about their storage of cash in the ground that the producer bureaucrats refuse to listen to. By capitalizing everything for decades they’ve locked the investors cash into the ground until such time as they recognize it as depletion. However, this game has gone on for four decades now and the revenues being generated by these assets are so pale in comparison to what they should be, they’re not generating adequate cash due to the heavily discounted commodity prices producers created for themselves and have been selling their products for. Storing these capital assets on the balance sheet also reflects the amount of the capital subsidy consumers have enjoyed which the producers investors have unwillingly provided. If oil and gas was a business they would begin to treat all properties somewhat the same. If they’re profitable then they’ll produce but oil and gas hasn’t been a business for many decades. It’s been an exercise in destruction, whose purpose is almost complete and will not be resolved constructively or judiciously.
The other aspect of the cash deficiencies these producers are unwilling to accept or listen to is the fact that most of their costs are capitalized. We point out this has become so extreme that the receptionists time, telephone service and Post-it-Notes are all capitalized and left as property, plant and equipment for decades too. This therefore has turned the producers into chronic spending machines wholly dependent on continuous outside funding, until these past few years that is. Their oil and gas revenues have become poor in comparison to what they should be. And whatever is earned is inadequate to cover all of the current costs of the producers as they continue to sink every dollar they find in the ground each month. When you had willing investors lined up down the block and breaking down the door this was not an issue. Now however, the cash drainage each month is epic. Money goes in, and never comes out. Then the search for next months cash begins, and so on. Hence we have the producers stuck in a never ending cash drain of their own making, refusing to admit they have an issue and only refuting the claims that we’ve made in our Preliminary Specification and White Paper. This cash issue will be the terminal factor that they’ve refused to address over the past five years of diminished investor interest. Now with severely deficient working capital, time has become their biggest enemy. Time remaining in which they can keep the doors open.
We recently learned that Houston’s office vacancy rate has hit 26% which represents 60 million vacant square feet. Calgary has over 30% vacancy rate with 15 million vacant square feet. Meaning Houston has more vacant square footage than Calgary has square footage. Nonetheless I’m always called to prove my claim that overhead is in the range of 20% of revenues. No one knows what the overhead is in oil and gas. The question I have, if the producers claimed costs of overhead at 2 to 4%, why would they shut down so much of their head offices? The best they could be saving here is 0.6% to 1.2%. Seems to me to be too much grief and pain being realized for a 1% cost reduction? Maybe bureaucrats find layoffs to be the best part of their job!
This working capital issue is more than just what the operational producers will concern themselves with. During bankruptcy a “client” will always command respect from the justice and the administrators when they have strong cash flow. Oil and gas is a cash flow industry. Until it is realized that the cash flow that is produced is incapable of providing the day-to-day operations of the producer. The administrator will assess these firms on the basis of their cash generating capabilities. Which we have seen in the past 5 years and even in the past 10 years since natural gas collapsed, doesn’t exist. I would argue that the accounting has been suspect since the late 1970’s but then I’m alone with only the facts on that. I leave you with one question: how does an industry, a primary industry at that, become worthless?
Here’s a clue as to where all the value went. This graph from the WSJ’s Lev Borodovsky was included in the White Paper. It accurately captures the attitude in oil and gas. It states when a producer would shut-in a property and it’s breakeven point for a variety of shale properties. (Note, never have I seen a property shut-in for its lack of economic performance. Ever.) Assuming if we could that the shut-in price in this chart is the variable operating costs of the property that were not capitalized. The well breakeven price is a fundamental misunderstanding of what breakeven means. Nonetheless, we’ll take their numbers and assume the amount is the capital and operating costs of the property. Essentially the graph proves that the producers will always produce as long as they were covering off the variable operating costs. Now this is what I said in the White paper that captures the fallacy in this thinking.
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. 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 will be dropped below the breakeven price for all producers. When all producers continue to produce below the breakeven price for four decades you have an exhaustion of the value from the industry on an annual and wholesale basis. Times were only “good” when investors were willing.
We have also argued the allocation of capital costs to each and every barrel of oil in reserves is inconsistent with the capital investment market. Whether the barrel is produced today, this decade or even this century, we believe this SEC allowed outer limit of what is allowed is unacceptable for each producer to reach each year. Therefore the actual cost of these shale production volumes capital costs would be substantially higher if allocated in a manner consistent with a market economy.
As we look toward the next 25 years in this industry we know we can’t get through this period with the producers that we have today. The legacy of their bloated balance sheets will haunt them from this point forward. Their capital structures are permanently destroyed through decades of not recognizing adequate costs of capital in the products they sold. Now they’ll be forced to compensate for that with revenues and cash flows that are wholly inadequate due to their destruction of commodity prices. They’re incapable of surviving today’s business environment, how bad will it be in just three years? The only way to approach this next phase of oil and gas is through a redefined industry and producer structure. One based on succeeding always and everywhere, where producers are dynamic, innovative, accountable and profitable. Where everyone can depend on the primary industry that oil and gas is to fuel the careers, prosperity and quality of lives that have not been provided in the past 29 out of 34 years. At least I think we’ve had 5 good years. Where the next 25 years capital expenditures demand the $20 to $40 trillion necessary for the next phase of North America’s development, will be sourced from the commodities sales themselves. Investors are saying it won’t be them. This is beginning to almost sound like a plan! And what is the industry’s plan? Much like Chevron’s, ignore the majority of their non-performing properties, they cover the overhead, and look for gleaming, state of the art, engineering projects. After all it’s what they 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. Setting the foundation for profitable North American energy independence. People, Ideas & Objects have published a white paper “Profitable, North American Energy Independence -- Through the Commercialization of Shale.” that captures the vision of the Preliminary Specification and our actions. Users are welcome to join me here. Together we can begin to meet the future demands for energy. And don’t forget to join our network on Telegram @piobiz or Twitter @piobiz anyone can contact me at 403-200-2302 or email here.
