Investments? Industry Needs 'Reformation'

By LOUISE S. DURHAM
EXPLORER Correspondent

When was the last time you heard from one of our own that the oil and gas industry needed a great "reformation?"

No one can accuse J.P. Bryan of refusing to tell it like it is.

Bryan, with Torch Energy Advisors, was the opening act for the dual-bill power lunch at the recent AAPG Prospect and Property Expo (APPEX) event in Houston, sharing the dais with Texas State Geologist Scott Tinker, of Austin.

Now that the E&P stocks once again are being trashed by Wall Street -- along with many others, currently -- Bryan offered some hard-hitting comments/advice that the audience might do well to heed.

"No function in any industry promises as much as the exploration business and delivers so little," he said. "It's just a simple fact.

"There needs to be a great reformation in the oil and gas industry if it's going to continue to attract the investment equity and debt to finance expansion."

The industry as a whole receives little affection from the investment community, and some of the small caps are being totally ignored, Bryan said.

"Is this a knee-jerk reaction because of disappointment with the performance of the oil and gas sector compared to more high-tech companies," he queried, "or has the marketplace put a rational valuation on the upstream E&P sector?"

He offered a number of explanations for the dilemma:

• There are few compelling growth stories. Investors seldom hear anything truly unique at investment conferences, and there is a sameness to all the stories, e.g. "We're using 3-D, we have the lowest finding costs in the industry", etc.
• There is scant historical evidence the sector can generate competitive returns. In the last three-to-five years there have been many negative returns for shareholders.
• The investment model followed by analysts is convenient but flawed, because it has focused on production growth and cash flow and ignored earnings, return on equity, return on total capital, or "God forbid," Bryan said, "something like E.V.A. (Economic Value Added) analysis."

Value on E&P stock prices for the most part can be traced to investors' enchantment with prospects of high-value gains via large exploration successes -- yet such occurrences are rare, Bryan noted.

"There are hundreds of thousands of research reports full of exploration prospects of companies but few successes," he noted. "Billions of dollars have been invested in dry holes, but this exploration effort has propped up stock prices for generations.

"There was a sea-change in the industry back when 3-D took off," Bryan said. "Stocks began to attract high multiples because people recognized a lot of risk was being wrung out of exploration. But there's been no follow-on technology to identify reserves in place."

Bryan outlined a number of things the E&P sector must do to continue as a viable investment vehicle:

• There must be a lot of consolidation. Too many public companies generate enough income only for the staff.
• Companies must demonstrate they can grow production 10 -- 20 percent per year, while restraining debt and not diluting equity values.
• Increase cash flow per share, make earnings and demonstrate at least a 10 percent return on after-tax shareholder equity and a total five-year return on total shareholder value competitive with the manufacturing sector.
• The argument can no longer be to invest to participate in higher commodity prices, then excuse poor performance by the failure of the commodity to respond. Companies must separate themselves from the suspicion that this is a commodity-driven, highly-cyclical business that has only an occasional, rare moment in the sun.

Bryan emphasized particularly the need to create a compelling vision for value creation to excite the investment community.

"Think how you can do something better than your peers," he suggested. "Find a niche or dominate an activity or region, and create a way to distinguish yourself.

"If you're not happy with your critics and want to throw stones at them, I suggest those who can stand up and genuinely say 'I'm better than my peers at doing this', then you can throw the first stone," Bryan said.

"But unless you can lift a boulder, you're not going to impact many critics," he added, "because there aren't enough stone throwers in this industry."

By outsourcing non-core functions, Bryan said, companies can reduce the cost of these functions and also improve performance. Indirect costs such as cell phones, stock options, expense reports and such also can be reduced

"With outsourcing, you'll demand more of your outsourcers than of your staff," he said, "and you'll also remove the focus of the company's outside activities.

"All will be focused on value creation."