Posted on July 12th, 2014
A TRUE STORY
There is a substantial operator that owns a large number of portable frac tanks. The total number of frac tanks owned by Operator X substantially exceeds the number required by its drilling operations (even after giving effect to consideration of spares, maintenance, logistics, etc.). Despite this material excess, the operator is in the practice of renting a significant number of additional tanks in order to meet its operational needs. This sounds like a riddle.
Operator X drills in many regions across the US. Each region has its own management, profit & loss statement and performance-based bonus plan. Employees are paid to complete as many drilling projects as possible. This is where the mystery reveals itself.
Operator X’s various regions are competing with each other. In order to avail themselves of today’s market they are vying for internal resources to complete as many projects as possible (making hay while the sun is shining]. As a result…regional/district managers have been hiding assets [FRAC TANKS] from each other causing excesses in some regions and shortages in others. The shortages must then be covered with rentals.
This human dynamic occurs across a number of oil field equipment categories and is hiding the fact that, in one operator’s case, there is an equipment market overhang not a real shortage. Individual aspirations inside the larger entity are negatively impacting the enterprise as a whole.
Posted on July 1st, 2014
by Chip Davis
Apache recently filed suit in Bexar County against two oil field service companies for customer billing fraud. The complaint asserts that, among other things, the service providers (a) overcharged for services provided, (b) charged multiple times for the same service classic (“work ticket shell game”), and (c) charged for services never provided. Based on the elements of the suit revealed by the press, I can speculate how this happened.
First – It’s all going too fast | The speed of activity in the oil industry is so great that customers do not have the resources to match new field tickets up against requisitions/contracts prior to the time of payment. Yes I know this sounds crazy.
Second – It’s all going too slow | The audit function designed to sample test field tickets reviews but a small percentage of the whole and generally several months after payment has occurred. Yes I know this sounds crazy.
Third – I have only one set of eyes | Operators must rely upon on-site, eye witnesses (in remote locations) to confirm receipt of services. Apache had an employee who was willing to sign-off on false field tickets making the witness requirement not a viable internal control.
I know for a fact there exist technologies that prevent the above (Apache probably knows this as well). While I believe Apache wants its $1.5 million back, I separately believe this lawsuit involves hundreds of millions of dollars. I have got to believe Apache understood the benefit of a public filing as an effective theft deterrent (to all others) and this involves a ton of money. This is a strategy put in place until such time Apache is able to develop a more operational approach (using new technologies etc) to deal with the issues. The additional takeaway is that the filer believed the problem of fraud bad enough to take this course (again…me speculating but they have my attention).
Posted on May 24th, 2014
We have seen a number of investment prospects that base their growth case on a theory called “consumerization”. This theory posits that an application (“app”) useful to one person outside of business will reveal itself to be useful in a business context such that it propagates and self organizes into an enterprise level platform. These “consumerization” apps are expected to start on a single iPhone and spread thereafter.
In adopting a platform an enterprise must agree that the platform is a positive incremental or replacement means of communicating/interacting and this is no small decision. History has shown that these types of decisions are never left to the populace but rather are controlled by leadership. It is human convention.
So for the theory of consumerization to work, one must believe that the app is so powerful that it will swell from the bottom and force leadership to respond to the popular will. Sounds like revolution.
Revolutions, while necessary, can occur only so often. It does happen but the odds of triggering a revolution are low. There is, in the market, an over abundance of expected revolution. Based on this I believe the consumerization theory of business software investment as a portfolio strategy is implausible.
Posted on May 16th, 2014
Today we met in Houston, Texas with the CIO of a large oilfield service company to demonstrate technologies our fund was reviewing for investment. We learned the following:
- Personnel capabilities and project requirements are generally matched haphazardly and based on “tribal knowledge”.
- Oil & Gas supply chain is undergoing a significant geographic change making process improvement difficult to manage (see and execute).
- Physical security is becoming increasingly important and is now a priority. Remote solutions are sought.
- Supplier performance measurement is an interesting area for consideration.
Posted on April 27th, 2014
Early in our professional careers, we are generalists. We gain experience, we become specialized and, hopefully, we become highly valued.
Our first job usually results from our rated intelligence (school, sat score etc). We then apply our mental capacity to configure ourselves to the chosen area of expertise. Our configurations cause us to stand out depending on the how well we can solve our chosen problems and how complex and thus valuable the problems happen to be.
Software is Like People
When companies shop for software they consider hiring either (a) a generalist, or (b) a specialist. A generalist might be bought to solve a wide range of problems and the specialist a narrow set. Buying software is no different than hiring a human to fill a role. Software many times assumes human functions and must fit well with the group of people to whom it becomes a team member. That team wants to know the following:
(a) Do I like the way this candidate (software) presents itself?
(b) Do I think this candidate (software) understands my business (problem)?
(c) Do I think this software (team member) can adapt and be reliable in the future?
(d) Does this software (team member) has good references?
It has been suggested that good technology is human behavior. In that same vein all technology must undergo an interview process with prospects answering the four questions.
Most young software companies fail to understand the interview process and find the clues to the questions they all must answer. Most technology works – it does something. Successful software vendors learn very quickly whether or not they are at the right interview.
Posted on April 6th, 2014
The graph below compares annual price increases of a barrel of oil (WTI) to annual cost increases for finding a barrel of oil (as reported by a sample of super majors). The data for 2002 through 2012 indicates that the price of oil increased 2.5x while the costs to find oil increased 3.5x. Of further note, the price increases for oil have categorically lagged cost increases (this is indicated by the gray line always below the blue line). This means that marginal benefit to shareholders of an incremental barrel of oil has decreased consistently since 2002.
Large oil companies typically rely on oilfield service companies to perform work in places where they find oil. Finding and producing oil depends on a wide range of tasks performed by service companies who combine labor (employees), equipment and knowhow to get the oil out of the ground.
There are three ways a company can retain the employees it needs: it can (a) hire them from the outside, (b) hire them from the inside (generally least expensive), or (c) borrow them (i.e. sub-contract – generally most expensive). These choices present different business considerations to a company trying to determine a strategy that best suits its industry and individual conditions.The range of contemplations include (i) what skills do we need today vs. tomorrow? (ii) how much investment do I need to make in my workforce before I realize a return? (iii) how do I source for mission-critical functions vs. short-term requirements? Service companies appeal to their customers for a number of business reasons including that they handle recruiting and retaining the specialized workforces needed to operate in locations all over the globe.
Less Experience Means Less Productivity
In the context of the Energy industry we can observe that by relying on oilfield service companies, oil companies are “borrowing” a workforce to perform mission critical functions. In other words, oil companies are relying on the most expensive form of sourcing labor to complete an essential function. This expense is compounded by the detrimental effect of a oilfield workforce with more inexperience currently than ever before. Stated another way, oil companies are sourcing their workforce through the most expensive means available (i.e. borrowing), doing so at the highest rates ever, and subject to a notionally less productive labor pool.
Labor Vs Oil
To put this in terms of math, available oilfield employment statistics indicate that average hourly rates for field workers rose approximately 35% during the period 2006 through 2011. During the same period finding costs per barrel of oil rose 28%. If we assume that labor comprises 20% of the total finding costs, we can infer that each one dollar increase in the cost of labor during the period 2006 to 2011 corresponded to a three dollar increase in all other finding costs. The point is that the Oil Industry is locked into a labor strategy designed to mitigate downturns but whose course now has a compounding negative consequence. We believe that the implied costs of on-the-job training is revealed in the three dollar increase. All other things held equal the only way to reverse the consequence of this course is to decrease dependence on labor in general and reduced exposure to its inexperienced elements.
A Never Ending Industry Problem
The Oil & Gas Industry has long been characterized by huge “boom or bust” cycles during which many fortunes have been made and lost (see chart below). The industry’s boom or bust personality results in a supply chain that is highly unstable marked by rapid industry expansion and contraction.This instability results in supply chain costs that present huge economic risks to oil & gas companies who prefer to find oil & gas for the least amount of money.
The Oil & Gas Industry operates in remote locations which complicates its manufacturing process The most favored oil field service companies earn their reputations based on an ability to address complications quickly and reliably. The cost of superior responsiveness comes at a high price invariably passed on to the operator. As industry activity increases tension in the supply chain is magnified causing material price inflation. Operators are constantly looking for ways to reduce these costs (we want cheap oil).
How do I Keep My Costs Down?
An operator’s primary strategy to fight increasing prices is to “rationalize” its vendor list – which in plain english means they fire a bunch of vendors in sight of remaining vendors in order to get price concessions. An operator’s secondary strategy is “synchronization” which means better coordination across the supply chain so as to reduce delay. A heavily relied upon tactic to bolster synchronization in oil & gas has been for service companies to place equipment (i.e. inventory) at customer sites. This means “inventory” is available when needed thus reducing delays.
What Does the Rest of the World Do?
An opportunity exists for the oil industry to use remote communications infrastructure, remote communications devices and mobile process improvement software to exploit weaknesses and cost overruns in its management of operations in remote locations.Information flow technologies have made it to the oil field in the last several years, but companies have not yet maximized the potential cost savings available with intelligent management of inventories, supplies and people in remote drilling locations. Full exploitation of information flow could result in the kind of cost savings that, for instance, retailers have seen in the smart management of their inventory during demand spikes and troughs.
And in Conclusion
The oil & gas industry has among the least stable supply chains in the world. This attribute is completely at odds with its goal of decreasing finding costs. The ingredients necessary to positively impact this goal through improved supply chain management now exist.