Keith Schaefer, editor of oilandgas-investments.com.  Subscribe for Keith's free newsletter here.

There’s a race going on in the oilpatch now to the bitter end—the end of the year.

And it’s not being driven by economics.  It’s being driven by the REAL currency in the oilpatch:


The energy market is cyclical and all the veteran producers and bankers of the oilpatch know this.

Each senior management group knows their reputation is built on being able to focus on what you can control and letting the rest of the chips fall where they may.

The single most important that determines your reputation is hitting production rates that you promised to the market—though not at any cost.

That means that right now, many producers are working overtime right now to achieve those exit production rates—even in the face of horrible oil prices.

(After watching the oilpatch for five years, it’s easy to name Management Reputation as the single most mis-understood part of valuing stocks by retail investors.  That’s why you see so many crazy articles on SeekingAlpha.com talk about stocks being under- or over-valued; the author has no clue about the premium or discount some teams get.)

Production is a meaningful and simple tangible way to evaluate teams and companies, so it is used a lot in the business.

Whether it is a VP of Production or Operations for a large foreign owned multi-national business or the President of a small, publicly traded company, that year-end production number will affect somebody’s bonus.

For the small players, it’s more just recognition—Reputation—by  the Market as opposed to outright cash or stock options for their peer in a larger company.  Reputation gives shareholders confidence in allowing you to raise new equity.

There’s more pressure on the small producer to meet those year-end production numbers, as there is a lot more riding on meeting that target—like a potential bank line increase.

Regardless of size, the next two weeks will be very stressful for virtually every company out there as they work frantically to maximize production volumes for year end.

This may seem counter-intuitive in a market that has seen a 40% haircut to its price in the last few months.  The percentage decline is even greater on margins and free cash flow.

Yet management realizes that it’s not all about pricing today or even next month but the long game.  In the long game, your reputation is your currency.  It’s how you are able to raise capital in both good times and bad, attract quality people to your team and trade at a better multiple than your peers.  That higher multiple is what allows teams to issue less stock on financings and M&A work. Less stock = more leverage for investors.

This can lead to a self fulfilling cycle of success as it allows you to take advantage of situations where you can raise money when others can’t or you can use your stock to take out someone who is doing OK but doesn’t have the “all star” premium that you do. Being able to exploit these opportunities is what takes a management team to the next level in the eyes of bankers and investors.

But you still have to be able to bring all that oil up out of the ground cheaply. It’s a fine line to be able to achieve your production targets, especially if they are material increases, without over paying and more importantly, without over extending your balance sheet.

Case in point: today’s market, where it appears we may be in for a period of fairly weak pricing.  If you’ve gone after your production targets at all costs, you will quickly find yourself struggling with lower cash flow to service your debt and potentially not even be able to sustain production with existing cash flow--let alone a dividend if you have one.

It’s a lot easier to show prosperous year over year production gains when WTI is $100. There is so much cash flow--you would really have to screw up badly to get yourself into trouble. The true challenge comes when cash flow and debt are tight.

So reputation is also about achieving those production rates without sacrificing capital.

How often do you hear analysts tell you to follow the successful management teams and you see the market willing to pay a premium when these teams start over?  (In industry lingo that’s what’s called a re-cap; a re-capitalization of an old shell company).

There’s a reason for that – reputation.  This year end will help separate the great management teams from the good management teams.  The great ones will get things done regardless of the challenges thrown at them by the market.

In this business prices come and go—but delivering on your promises—or exceeding them—without hurting your balance sheet is the true currency in the long game.

So this year end be on the lookout for companies that have met production targets and still have a reasonable debt load.  These are the companies that will not only survive this current low price environment but thrive when the pendulum swings and prices start heading back up.

Who says you can’t buy reputation?


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