by Jesse Mullins
In Part 1 of this three-part series, we examine the fallout from the steep decline in crude oil prices. It’s a story with plenty of misfortune, to be sure, but it’s one with some surprising strokes of fortune. Meanwhile, some operators are getting their DUCs in a row…
There comes a scene, in the heat of the action in the motion picture Black Hawk Down, when the U.S. forces make their way, via their Hum Vees, to the Pakistani soccer stadium, and there, badly shot up by the Somalis, they throw open their doors, unload the wounded for first aid, wash out the blood and shell casings, and repack the vehicles with ammo and supplies for more fighting.
That, according to one source we spoke to, sums up what is going on in the Permian Basin oil and gas community right now, with businesses reeling from the precipitous (and still ongoing) drop in crude oil prices.
“That’s the situation right now,” says Ken Goldsmith, founder and owner/operator of Mudsmith, Inc. “Everybody is in it, in the eye of the hurricane, right now. Industry players—whether they are operators or service companies—are using the ‘breather,’ so to speak, to clean up their equipment, people, accounting, finances, and other unfinished or set-aside business.”
It’s “The Big Cleanup,” and it’s being felt everywhere.
As we open this series on “Bent But Not Beaten,” it’s gratifying that we can begin—just as we’ll want to end—with a bright spot, a flicker of piercing-the-gloom optimism. Two issues ago, in the April edition, we ran a cover story on what we called “The Big Stackup.” The says-it-all icon for that article was our cover photo of the acres of standing, idled drilling rigs that bristled against the blue sky in the Business Park in Odessa. (See photo.) That kind of harsh reality was and is an element in the mix we find ourselves in. But so is “The Big Cleanup,” and it feels somehow apropos to start there.
Because there’s something in what Goldsmith said that speaks to resilience, to can-do-ism, to a go-getter spirit. Yes, conditions are harsh. Yes, some are paying a grim price. But even if the current situation leads to a shakeout, there’s an aftermath to a shakeout that is not entirely bad. A shaken-out industry is a stronger industry. And a smarter one. And a leaner and more ready one.
Some setbacks just serve to bring out the fighter—in the right kind of person.
Questions to Confront
“There’s a lot of pride, and even fear, in this industry, so there aren’t going to be a lot of execs who are willing to admit their books are a real mess,” Goldsmith said. “Actually, right now should be a boom for accountants, lawyers, and financial advisors who have the skills to help people get their finances in good shape to weather the downturn, and to be ready for the next upturn. Both are realities.
“I’ve heard about more than one company that is cleaning up their books after finding out that a lot of their receivables had not been paid,” he added. “Meanwhile, most all operators have put pressure on their vendors to lower prices. This in turn causes vendors to put pressure on their suppliers to lower prices. Eventually, the cost cutting lands on the heads of employees, and layoffs and pay cuts occur.”
Goldsmith suggested some questions every Permian Basin business owner or controller should ponder:
* How many bills have been overpaid or double paid?
* Are there things you forgot to bill for?
* How much of your A/R [accounts receivable] is aged over 30, 60, 90 days? How much is over a year old?
* Have you diligently made collection calls to always keep your A/R current? (Goldsmith: “This is something nobody likes to do and I submit that many did not make those calls because cash flow was so good and that is all that mattered to them during the boom.”)
* What if you learned your bank statements hadn’t been reconciled in years?
* If you reviewed every aspect of your financials, might you discover that you grossly understated expenses and overpaid taxes? Would this justify you filing amended tax returns to get your overpaid taxes refunded?
“This is just the tip of the iceberg,” Goldsmith said. “I could go on and on about this. Some companies will close their doors because of this sort of financial mismanagement during the boom. Lots of jobs have already been lost due to this.”
Goldsmith maintains that there are positives and negatives to the whole affair. The negative, he said, is generally found in the question, “How in the heck did we get in this shape?” And the positive is found in the idea that “We can thank God we’ve got an opportunity and the time to take care of it. It’s not the things we know about that hurt us; it’s the things we never find out about or don’t know about.”
The “Oh Crap” Mode
People will be fired. People are being fired. But, as Goldsmith noted, people have been “too busy driving to stop for gas.” They’ve been “running out ahead of their headlights. They’re managing cash flow, they’re fighting the hottest fires—they’re in a boom. They pay people too much money. They hire too many people. They hire people that don’t have the skill set that they need. And then they find themselves in, you know, an “Oh crap!” mode. It’s all, ‘Well, if we did that, then we’ve got to make drastic overcorrections to get ourselves back into good shape.’
Employers have been hiring employees who are underqualified. “And now, you see people laying off the underqualified people and hiring people who have better qualifications. It’s kind of an upgrade, this business of hiring people who, the next time around, will help them to not get back in this shape again,” he said. “So, these are the scars that help to develop strong companies moving forward.”
Goldsmith offered one of his trademark “Ken-isms”—you get this sort of thing from people who are songwriters and lyricists, which Goldsmith is—to put things in perspective:
You know, good timber doesn’t grow with ease.
The stronger the wind, the stronger the trees.
“It’s the change of the seasons that give us an opportunity to bounce back. It’s that old idea that, “If it doesn’t kill ya, it makes ya stronger.”
Other Side of the Coin
Chris Whigham is senior vice president and manager of energy lending at West Texas National Bank. PBOG asked him if he is seeing a different kind of activity going on these days because of the crude price drop.
“Yes, and it’s a good question, because, unfortunately there is still a broad range of folks [who are affected] in that they are borrowers and they are impacted in one way, and you have another set of players who are affected in a different way,” Whigham said. “As for the first group: you have some guys who are really experiencing a lot of pain right now. They had some marginal production and maybe some debt on that, and for them it is as ugly as it was in the mid ’80s. It’s very painful and they’re trying to survive. The other end of the spectrum is this: you see guys that see this as a lot of opportunity. It was hard to get equipment at $100 oil; it was hard to see properties change hands and deals get done at $100 oil, because some were still thinking it was going to go to $140 again, so they were seeing opportunity.”
And then maybe there’s a third group, Whigham suggested.
“There’s others who are seeing their opportunities in the form of properties actually changing hands or people becoming willing to turn loose of something,” he said. “We’re seeing some drops in costs. At first it was about 10 or 15 percent, but now there have been some price drops in the 20 to 25 percent range, maybe even some 30 percent drops, and people are starting to say that there’s still some wells to be drilled—wells that at $50 oil produce a very adequate rate of return.”
Like Goldsmith, Whigham sees some internal housekeeping matters going on as well. “Companies are using this time to try to fill their staffs,” he said. “There were quite a number of companies who were understaffed. It’s been so hard in Midland, even for the bank, to compete with the oil companies for personnel… when you have businesses like McDonald’s paying signing bonuses. You’re trying to compete using a limited number of personnel, and I think some people are seeing this as an opportunity to fill out their staff and improve their staff.”
The New Reality
Dana Engelstad is managing partner of the Midland office of Johnson Miller and Co., PC, Certified Public Accountants. A CPA himself, Engelstad said that his firm is the largest presence in the Permian Basin in terms of accounts on the ground. And from that perspective, he ought to have a fairly high level view of things in this marketplace. That’s why PBOG looked him up for comment.
His first thoughts: “We see [the effects] across the board in service companies, and producers, and royalty owners. The biggest impact of the fall off in [crude oil] prices is just really starting to be realized, because of the lag in production and payments, mostly because a lot of people had their production hedged. Those hedges are now starting to burn off and they have to replace them with a lot less. The pain was deferred, if you will, a quarter or two. We are seeing, and actively managing and helping our clients to restructure, quite a few things that you were mentioning. We are diligently working with our clients to realign Balance Sheets and cash flows to be ready for the new reality posed by a potentially protracted near-to-intermediate term of depressed energy prices.”
That new reality can mean figuring out how to pay bills incurred “during $90 oil days, using income from $40 run checks,” as Engelstad put it. He explained the industry term “run checks”: “Oil runs. It’s their oil and gas check. Ubiquitously, it’s called a run check. Or an oil and gas run.”
What else does Engelstad see going on today?
“The most forward-thinking people that we’re working with, the ones who are most receptive to reacting rather than trying to wring their hands, have been cutting back on their drilling budgets, cutting back on their acquisitions. They’ve been doing that for six months, while things have been tumbling,” he said.
Engelstad said he doesn’t see a big liquidity crisis, at least not in the sense of people’s receivables growing [which means businesses are not getting paid]. That’s what one might think, given a situation where prices have fallen. But the reality is that “because most people that we’ve been dealing with on the exploration and production side were so busy drilling and spending so much money—either all of their own money, borrowed money, private equity money, partners’ money—that once you cut off that big drilling bill, and therefore are not committed to have to pay those bills, then you kind of stop your biggest negative cash flow item. That helps you catch up on the balance sheet side.”
Not that things are exactly rosy, though.
“The biggest problem, and the biggest pain, is found among folks with drilling commitments that are coming up, but we see land owners, and royalty owners, and lessors not wanting to produce their oil at $50,” Engelstad said. “They’re slowing down. Mostly I think the brakes are being gently applied in the economy. Nobody’s slamming on the brakes, and we’re not having multiple rear-end car crashes. I do think it’s more orderly in this fall off, maybe, than [it was in] the other three or four fall offs I’ve seen. I think maybe the price fall was just such—it’s fallen off $10 a month for seven or eight months—that people didn’t panic. I think they just got very conservative very quick, and got on the brakes but didn’t slam them.”
“I don’t mean to make that sound like everybody’s going to go back to the 1980s, when the banks failed and all the companies failed,” Engelstad said. “That’s not going to happen, but there’s a realignment, a rethinking, that always happens in a fall off. Horizontal drilling in the shale plays out here are so much more expensive than the old vertical wells. And so, just as we invented that new technology, we’re going to have to invent new ways to keep applying it at different price levels. That’s for a lot smarter people than I am to figure out, but it’s going to happen.”
This is a time for astute investors and people in the industry to look for opportunities, Engelstad concluded.
“There are people out there that have trouble keeping their properties going or keeping their leases up and [therefore] prices come down and bargains start popping up. And service companies are up for sale, and some and oil and gas leases and production are up for sale. There’s a yin for a yang.”
Next Month: Hard Truths and Saving Graces. Not many places in the country have been through the highs and lows that the Permian Basin has, and not many places have the energy and even the taste for turning things around, that this region has.