Posted on January 27th, 2015
by Chip Davis
In an effort to understand volatility trends in the price of oil, I looked at “inflation adjusted” prices of WTI for the period 1972 through Jan 27, 2015. I measured the change in price from 1972 to its high in 1980 to its next low in 1986 to its next high in 1990 etc through today noting the magnitude of change in each direction and the period of time required to affect that change.
I noted the internal rate of return for buyers of oil at its 1972 low holding to its 1980 high was better than whomever shorted in 1980 down to its low in 1986. However after this initial period it was increasingly better to have timed shorting perfectly(1) than timed going long perfectly. In fact the IRR trends of the down cycles have steadily improved in each successive down cycle over the preceding up cycle. A chart reflecting how much better the down cycle shorts did than the preceding long is below. It is remarkable.
(1) Defined as buying/selling at absolute low/high so as to maximize return.
Posted on January 21st, 2015
by Chip Davis
Many operators structure their business to be managed on a regional basis. Many service companies structure their selling teams by region rather than by named account. As a result, a service company may have multiple selling teams selling to the same customer but by different location. This regularly results in operators paying materially different prices for the same service in different regions (something akin to demand-based pricing). This is fueled by the fact that much of the operator’s procurement discretion is pushed to the regional/local level.
Cutting costs from the process of finding oil is worth a lot of money. When other industries are able to broadcast to their shareholders that their gross margins are expanding the underlying stock usually benefits from multiple expansion. People like to pay more for companies with greater relative profitability.
If an oil stock traded for 5x cash-flow and, based on typical net margins, increased its gross margin by 3% points, its stock price theoretically would increase by 20%. I would argue that a not insignificant amount of the 3% points can be found in correcting regional price disparity. So why do many operators allow regional price disparity to occur at material levels? How can something seemingly so easy to correct persist and prosper?
See more industry talk at OilPro.com
Posted on January 13th, 2015
by Chip Davis
Mobile technologies are causing some interesting reversals for oil industry operational processes. Processes that inefficiently were managed in the field are now managed at corporate and processes that inefficiently were managed at corporate are now managed in the field. The results reflect examples of better information, faster execution, and better governance. Land-based oil exploration and production are increasingly adopting the complexion of “manufacturing” and with this a maturing mindset toward thinking strategically about how things get done. Mobile technologies are helping this happen.
Example #1 – I Need a Truck Right Now - Finding oil and producing it requires a lot of truck rolls. Truck rolls that take people, gravel, equipment, fluids, food, water, and spares to the planned well site and truck rolls that take all the same including, hopefully, oil away from the same location. A substantial portion of the well cost stems from logistical expense (15% to 20% of site prep, drilling and completion) for an event in the middle of nowhere that occurs one time (think of having to charter a plane to a remote location). Interestingly various logistics requisitions are *managed* in the field by (drilling foremen). The typical drilling foreman operates without the knowledge of the current logistical needs of other foremen around him and most times procures based on a personal relationship. By utilizing tools similar to Uber for oilfield, operators can develop a more holistic view of expected needs of several foremen and thus reduce the number of trips and number of miles in addition to aggregating purchasing.
Example #2 – I Know At least One of These Bills is Wrong – Wells are planned centrally and built remotely. In developing a well, there is regularly a material difference between what was planned and what occurred. When a need differs from the plan, the parties must find a way to accurately agree that a change occurred and this results in different set of charges. Historically this was all done on paper and many times the paper method did not fully appreciate the complexity of the change. This resulted in oil companies getting undercharged and overcharged by service providers. Recognizing that this was the case oil companies and service providers employ legions of auditors to prove one way or another who was wrong and who was right. The numbers were big. Electronic field ticketing put the paper method on tablets and dispensed with the high volume of errors. Corporate can now safely rely on a field process to produce an accurate result.
Posted on January 7th, 2015
by Chip Davis
Since July 1, the price of oil has dropped 50.7%. During this same period the Oil Service Index (OSX) has dropped 34.8% and the Oil Index (XOI) has dropped 23.7% (a 12% point difference (“the Index Spread”)). Oilfield service stocks have dropped 1.5x those of oil companies. Why?
- Contributing Factor #1 – Hedging – Accumulated oil reserves generally are hedged (i.e. sold previously when prices of oil were higher) and oilfield services generally are not. This means that oilfield service companies have more exposure to a negative industry period than do oil companies. To the extent that accumulated reserves are hedged, owners thereof have the option to wait and sell their
currently unhedged reserves in the future when prices may be higher (Note: On January 5, 2015 the futures market believes that by December 2016, oil will be 26% higher than today’s spot price). This discretion is a valuable asset that is reflected in oil company stock
- Contributing Factor #2 – Price Deflation – Because they generally are not hedged, oilfield service companies are exposed on two fronts (i) a likely decline in volume of oilfield service activity, and (ii) price declines that follow reduced activity (i.e. price deflation).
Over the past ten years, the price of oil increased 2.5x and the cost of finding oil that same oil increased 3.5X. Appreciation in oil stocks was driven substantially by price appreciation of previously accumulated unhedged reserves even though marginal profitability was declining on new additions to reserves. Price appreciation could overpower the idea that fundamental, marginal profitability was going down. A portion of the Index Spread reflects (in my judgment) the fact that OSX is going to give back some marginal profitability to the oil companies. So what is interesting here is that oil stocks are going down in price whilst the die is being cast for fundamental, marginal profitability (newly found oil) to go up. Less profits but more profitable (newly found oil). What can oilfield service companies do to stop the relative pain? How do they become less dependent on price-of-oil increases to improve their own marginal profitability? Can an oilfield service company store value similarly to its customers?
See more industry talk at OilPro.com
Posted on November 13th, 2014
by Chip Davis
Where Are We Now?
Since the mid-1970′s discussions of spare capacity have been denominated in OPEC metrics. Spare capacity tempers the oil futures market based on the speed at which capacity can be turned on (and off). Concerns for the future in turn temper the spot market (do I sell now or hold?). It is OPEC’s spare capacity that drives a substantial volume of crystal ball gazing. They can turn it on fast and turn it off fast. It is all a discussion of speed.
A look at a recent Gary Searles’ post reflects that a new Eagle Ford well in 2014 brings on nearly 4x the oil of a new Eagle Ford well in 2010. A review of the Baker Hughes Well Count Report reflects that during the period 2012 through 2014 (YTD) the number of Eagle Ford wells per rig has increased by 41%. More wells and more oil per well.
It was Gary’s article that started some thinking about spare capacity. Dynamics in US Land drilling approaches have improved not only immediate volumes at first oil but also the speed to first oil.
Improvements in Speed to First Oil
The crude graph below reflects data measured for the period 2004 through August 2014.
- - Green Bar Legend – Number of Years in the Preceding 5-year period there was at least a “5% annual price move” of oil.
- - Red Bar Legend – Number of Years in the Preceding 5-year period there was at least a “5% annual production volume move”.
What we are doing here is measuring the number of times during the 5-year period oil prices moved a certain threshold amount and the number of times over the same period production moved a certain threshold amount. Do we see timely action and reaction and at what magnitude? A long history of cycles in the industry has taught us that it takes time for US production to spin back up against price increases (lets call this the US Market Response Time).
2014 US Market Response Rate is 5X that of 2004 – The stair-stepping red bars between 2004 and 2014 reflect that the US Oil industry is more responsive to price moves than it was in the past. For the 5-year period ended 2004 there were 5 annual price moves greater than 5% (green bar) and only *1 production move*. For the 5-year period ended 2013, there were 5 annual price moves greater than 5% and *5 production moves* of an equivalent increase. Production was able to move with the frequency of price (more or less). This jibes at some level with the wells/per rig data (above) and everything we hear about industry efficiencies.
The quickened response rates of US Land must, at some level, weigh into my analysis of oil futures which, in turn, impacts spot today. This is effectively a spare capacity consideration which thus alters (at least notionally) the degree of control held by OPEC around the spare capacity dialogue. There is too much money involved for the US Shale history to not replicate elsewhere and thus the future epicenter of spare capacity becomes increasingly fuzzy. All of this based on speed.
Posted on October 21st, 2014
by Chip Davis
The Oil Industry has for years used ERP systems to manage its operations. These systems typically sit at corporate headquarters and capture data from keyboards located in cubicles. The data they capture is generally of three different types: (a) “the plan”, (b) “the rules”, and (c) “the results”. Here is the plan and if we follow the rules we will likely get these results. The plan and the rules sit in a central computing system and wait for execution from the field to determine the (i) the results, and (ii) if the rules require adjustment. The recording device for most of the results is historically a piece of paper.
Mobile technology takes pieces of the system that historically sat at corporate headquarters and puts them on iPads. Each iPad represents its own mini-ERP system (complete with rules) and all of these systems are bound together and controlled by a centrally-located computer instructing the mini-ERP systems on what to do and how to work together. This is sort of like distributed computing where a job is apportioned among many computers and the results reassembled.
What makes the oilfield version of this so complicated is that many times there is no network to which one can timely connect one’s iPad. As a result, this means that a complete set of business rules needs to sit on the unconnected iPad so that it can instruct the field user what to do (at the time when he/she has no internet access). After completing an “unconnected voyage” in the field, the iPad then has to be able to competently tell the central system what is has been doing. The central system then has to be able to coordinate a bunch of iPad stories accurately and in a time frame that makes sense. This coordination competency makes the oilfield version of mobile technology substantially more complex and (advanced) than other versions of mobile technology. It makes sense to me that the most mobile industry in the world (but for airlines) would develop among the most sophisticated mobile competencies in the world – breaking ERP into a thousand pieces so it can be used in a remote environment.
Posted on October 17th, 2014
by Chip Davis
Posted on September 5th, 2014
by Chip Davis
Houston Ventures wanted to understand what was on the minds of Oil & Gas Industry workers regarding the above question. The OilPro network had a lot to say on the subject and it was a pretty consistent message. It creates a fairly different view from the notion that the whole industry is just “job hopping”.