The Games Energy Producers Play (on Investors)


In a bull market when energy stocks are flying and everybody is making money—like the first eight months of 2014—investors don’t care about what I’m going to tell you now.

It would have been a waste of my time to write this story in January 2014.

But now it’s different; everybody is more cautious and is looking at energy companies and stocks with a sharper pencil in hand.

I see three “games” that energy producers play on investors to make their companies and stocks look better than they really are.  And we do play along willingly with them, so I’m not knocking them.

You can hardly blame the management teams really; the better these companies make themselves look, the more access they have to less expensive capital (i.e. higher stock prices).  In the long run that is good for shareholders.

Game #1 – Half-Cycle Economics

Every oil and gas company has a PowerPoint presentation on its website.  I now pay more attention to what I don’t see in powerpoints.  It’s a Big Red Flag for me if I don’t see IRRs or payback periods for wells in each play.

But even if they do, they are based on “half-cycle” economics—which only includes drilling and operating costs. In the last six years, I can only think of two producers who showed me “full-cycle” economics in a powerpoint–which would include the initial cost of the land or major facility infrastructure—and those are significant up-front costs.

How many industries get to crow about their profitability with a huge portion of their costs not included—and be accepted for it?

Not only that, energy investors allow these producers to write off tens of billions of dollars of assets—their land costs—and the stocks don’t get punished for it.

These powerpoints are made to do one thing, and that thing is help the company get access to as much capital as cheaply as possible.

Game #2 – Look At Our Low Cost Per BOE

Everyone loves to talk about companies on a per BOE (barrel of oil equivalent) basis—it’s how the industry makes natural gas appear in oil-equivalent terms.  Right now the standard is to give oil a 6:1 ratio to natural gas, meaning 6 thousand cubic feet of gas would equal 1 boe of oil.

The main thing to remember with this Game is…there are almost no pure oil producers—especially in the USA.  In December 2014, research firm Unit Economics studied the Q3 2014 financial statements of 33 senior and intermediate domestic energy producers—and found on average they were only 34% oil!  The rest of the production was natural gas liquids (NGLs) and dry gas.

That’s really important to Game #2.  That study showed the average cost per boe for those 33 companies was just under $55/boe in Q3 2014. This was during a time when the US benchmark price—WTI—averaged $97/barrel.  That sounds profitable doesn’t it?

Until you learn the average revenue per boe in Q3 2014 of these 33 companies was $46.30.

Many of these companies don’t say what their revenue per boe is—they just say their cost per boe was $55 and oil was $97.

Game #3 – Look At Us Grow!

This is a more recent game being played as producers cut back on 2015 drilling budgets but say they are still growing well over 10%….which is kind of true.

The typical producer has been telling the market that despite a 30% reduction in capex that they plan to grow production by 10% in 2015.  The producer chalks it up to a high level of efficiency or high-grading of drilling locations or their best-in-industry acreage.

What the producers aren’t telling you….

Is that they are quoting average 2014 production to average 2015 production.  But their Year-End (YE) 2014 production is already either very close to, at, or just over their average 2015 production guesstimate. What investors need to compare is YE 2015 production vs. YE 2014.  In essence, their growth has already ended.

EDITOR’S NOTE–the Saudis know all these games.  They know that to restore balance to the global oil market, they have to go after the American’s Secret Weapon. Learn what they’re really after, and how it could transform your portfolio in 2015.

+Keith Schaefer