How The Money is Made: Introduction

The Essential Guide for Building a Successful Oil & Gas Commercial Strategy

“Watch the pennies and the dollars will take care of themselves.”

-Benjamin Franklin

“How the Money is Made” E-Book

This article is the first chapter in our new e-book series focused on helping oil and gas producers build a successful commercial strategy to maximize the value of their product sales.

We decided to write these lessons down in an e-book format because there is a lack of educational materials around the commercial side of oil and gas. “Making money” is the end goal for oil and gas producers, and our goal is to provide more publicly available resources to help.

In this series we will layout the framework that has taken us years to build. Now you can have it all in a single book, for free.

Each month we will be releasing a new part to the series to help producers master the art of “How the Money is Made.”

When we founded Ancova Energy eight years ago we set out to build a business around one idea, helping producers make more money. Now you can have the years of lessons we have learned in a single resource.

What is the Commercial Function in Oil and Gas?

The oil and gas industry is a complex mosaic of variables that work together to create the life blood of the modern world. The industry has dozens of professional disciplines that are required to make the process work seamlessly to deliver the products we use every day in our lives.  Wells are drilled and completed, production facilities are set, and infrastructure is built to bring these products to market.

At the intersection between the energy being produced, and how the money is made, is one of the least understood disciplines of the industry. This niche is where we have devoted our life’s work.

So much of the industry is focused on science and engineering, and rightfully so, without the technical professions there wouldn’t be any product to sell. But what is often lost in the process is what happens after a successful well is drilled. 

Some people call it commercial, others call it marketing, but at the core of what we do is basic, we make the money. Put another way, commercial is the process of maximizing the value for the sale of the products.

You can have the best acreage, and drill a prolific well, but ultimately it comes down to “how much money are you going to make.”

If a producer can’t move volume because the capacity isn’t available, or a well is getting charged high fees and commodity prices collapse, it is going to materially impact the profitability of the upstream business. It is the role of the commercial function to help the oil and gas producer avoid these issues, as well as the many other potential pitfalls we will discuss in this series.

This guide will outline the lessons we have learned over the years in a concise format that is easy for anyone in the industry to understand. This is not a technical guide on how all the processes work in the commercial world, other people have already written those books.

The goal of this series is to provide the framework for how to create a successful commercial strategy for oil and gas producers.

The lessons that follow are important for everyone in the industry to understand.  From accountants to drilling engineers, all disciplines should have a basic understanding of how the money is made.

Maximizing the value of your product sales is a multidisciplinary function. Reservoir dynamics are just as important as commercial contract structures. Because this is such a broad topic, we will avoid getting too deep into the fine details of each subject.

Instead, this series will focus on the lessons and strategies we have learned over the years that have shaped our framework for building a successful commercial strategy for oil and gas sales.

Whether you are working at an oil and gas company, or simply a passive investor in oil and gas equities, the lessons in this guide can help you better understand how the commercial function impacts the value of oil and gas companies.

How is the Money Made?

This seems like a simple question, but when you ask people in the industry, many will give overly generic answers, like “we use XYZ midstream company” or “ABC oil purchaser.” On the surface these responses give part of the answer, but to really understand how these functions work you must dig deeper.

It’s one thing to understand who the service providers are that facilitate the process of monetizing oil and gas production, but to fully grasp how the money is made, requires a wholistic understanding of:

·     Who the players are, and what roles they play

·     The value chain from the wellhead to sales

·     Commercial strategy creation

·     Physical infrastructure needed to move the products

·     Contract structures that govern product sales

·     Pricing mechanisms used to value the products

·     Incentives and motivations of the stakeholders involved

·     Market dynamics that impact price received

·     Tools to analyze the value being received

·     Back office functions required to administer sales

Only by viewing the commercial function through a strategic framework that takes these variables into account, can you achieve the full answer to “how the money is made.”

Using an incomplete framework to manage the commercial function can lead to material value loss. Small mistakes add up quickly when you multiply the value loss per unit against an upstream asset’s total reserves.

The Human Element

The challenge of maximizing the commercial value of an asset is not only a technical problem, but also a people one. The human element to these challenges cannot be overstated.

The oil and gas producer must get other people (third-parties) to provide the services to facilitate product sales. Soft skills can many times be just as critical as technical skills like engineering and design.

Burning a bridge with a service provider because a negotiation went sideways, can hurt an asset’s value worse than getting a service fee that’s too high. Relationships with third-parties in the value chain can make or break a commercial strategy.

Ultimately the producer must rely on other companies to make sure the product is sold effectively, and that the infrastructure is operated efficiently to maximize value.

Fostering these relationships takes years but the seeds can be planted today. Some of the best commercial people we know are not all that technical, but they always seem to get amazing deals done. Their secret, they are incredible relationship builders.

Every negotiation comes down to one thing, what can you get the other party to agree to. In the end it doesn’t matter how well you ran the numbers, or how good your position of leverage is, you must convince someone to give you something that you want.

Those who can master the soft skills of influence and persuasion will have a higher likelihood of getting the best deals done. 

Yet even after the deals for product sales are executed, there is an ongoing relationship that must be maintained with your service provider. It’s not a matter of if, but when, problems will arise. Who do you want to call when your boss is furious about an issue? A friend that you’ve build a great relationship with, or someone that you’ve been adversarial with.

A contract is only as good as the paper it was written on. When disputes arise (and they will) you either have to work them out or litigate to find resolution. There have been more times than we can count where a bad relationship between the parties has led to a litigious situation that resulted in both parties losing. Had stronger relationships prevailed in these situations, a lot of money and time could have been saved on both sides.

The human element is the hardest piece to get across when teaching the framework for how to create a successful commercial strategy. But those who can master it, will go on to create a lot of value.

Focus on What You Can Control

There are a lot of variables in “How the Money is Made” that the oil and gas producer simply can’t control. Market pricing, supply / demand fundamentals, the weather, force majeure events, etc. Yet many in the industry agonize over these uncontrollable variables.

They check product pricing every day, listen to “macro experts” pontificate on the markets, and even worse, get seduced by marketing firms that claim to have access to “premium pricing” or “dynamic hedging” that will help their clients “beat the market.”

The hard truth is that ~90% of “how the money is made” is already done before the products even make it to a market. At most sales points there typically isn’t much difference between the best market and the worst. It’s the deducts and fees to get to that sales point that will drive the largest portion of the total market price differential.

The market price differential is the aggregate number of deductions that are applied to the product outside of the market price. Producers can manage these deductions with a successful commercial strategy. This is the part you can control.

Fees for gathering, compression, processing, treating and transportation can have significant variance depending on the strategy used to bring products to market. Deductions like fuel, loss, and NGL recoveries also play a major role in the market price differential.

The type of contract structure used to move the products can also be controlled. Dedicating acreage vs wellheads can impact the future of a producer’s development schedule. Having performance language in your agreements that bind the service provider can help to avoid future issues down the road.

Picking an oil sales delivery method, negotiating the term of your sales contracts, and choosing the service providers for trucking or gathering, are all examples of variables that are controlled by the producer.

Understanding the tradeoffs between these structures, and the ramifications of how these decisions will affect the producer moving forward, is crucial when choosing the right commercial strategy to deploy.

A successful commercial strategy is when an oil and gas producer masters the variables that it has control over. In the following chapters we will outline the best practices we have found to manage these variables.

Stay tuned for more!