The formation of private energy companies generally follows commodity prices, with the number of new companies increasing with the prospect of higher energy prices and the number shrinking under prolonged lower prices. Because the barriers to entry are quite low, almost anyone with a smattering of petroleum background can start an oil and gas company. However, whether or not the start-up company succeeds or fails can be explained, at least partially, is determined by how they think and act like a public company in their day-to-day operations.
- develop and implement basic business metrics
- develop capital allocation criteria to govern project portfolio investment
- develop an annual budget and measure related performance
- invest in people and technology
- over-communicate both up to shareholders and down to employees
- fixate on the short term at the expense of the long term
- overregulate or forget the 80/20 rule
- let creeping bureaucracy undermine your ability to act quickly
Private companies generally are in the business of growing shareholder wealth while preserving existing capital assets. For private energy companies, two of the most important metrics are reserve replacement percentages and the corresponding FD&A (Finding, Developing and Acquisition) costs of adding new barrels of reserves. In order for companies to grow, their long term reserve replacement ratios must be much greater than 1.0 and FD&A costs must be much lower than the underlying commodity price. Setting reserve replacement goals and measuring FD&A performance, as well as living within established operating cash flow goals, are keys to long-term success.
To achieve long-term growth through the basic business metrics mentioned above it requires an astute investment. Growth can be achieved through exploration, development, drilling, and/or acquisition. Private companies must review their investment portfolio and employee skill set to determine how to best allocate investment dollars between these suggested growth vehicles. In general, expected rates of return should be higher for exploration versus development drilling. In addition, capital allocated to exploration should have reasonable expectations of additional development if the initial exploration is successful. Furthermore, investment in several wells with a lower working interest is generally better than fewer wells with higher working interests. It is important to diversify the risk of finding and/or developing hydrocarbons over as many outcomes as possible.
Like their public counterparts, private companies need an annual budget. More importantly, private companies must measure their monthly performance against their budget in order to make sure that committed investment can be funded. Private companies cannot issue stock or access the capital markets as easily as a public entity, which makes managing cash flow a paramount goal.
Success for private companies can come only from the efforts of its employees. Where possible, those employees must have the training necessary to succeed in their discipline. Scrimping on training dollars, or not hiring professionals with necessary skills in the short term, will almost certainly lead to underperformance in the long term.
In a private company, the efforts of employees are critical. To channel those efforts, companies must provide clear communication regarding budgets, goals and strategies. Alignment of purpose is required by all, and that dynamic can occur only if everyone understands how their individual efforts affect the company’s cash flow, performance, and long-term goals. Likewise, with more limited funding sources available, shareholders must feel that they understand the company’s current performance and they must buy-in to how the company’s future goals are going to be met.
One of the biggest advantages for private corporations is that they do not have to worry about public expectations. Instead, they have the luxury of planning strategically for the long term without having to face any fallout over quarterly projections and financials. Although cash flow management is important for any company operating in the energy sector, it is crucial that you do not waste your advantage of independence from the public marketplace once cash-flow concerns are satisfied. Keep challenging yourself by focusing on how you are going to grow over time.
With independence from many of the reporting requirements faced by public companies, private companies have more freedom in terms of what controls are required of its employees. In general, with fewer employees and the ability to communicate more directly with the workforce, the old adage of “getting 80% of the benefit from 20% of the rules” is appropriate in today’s energy industry. Obviously, general policies and procedures need to cover financial operations, contracting, field operations, etc. Also, field safety must be covered by policies and procedures in order to satisfy local, state, and federal guidelines. However, not every circumstance should be covered in these controls; the smaller workforce and shorter lines of authority afford the capability to place more direct accountability with the employees.
Similar to overregulation, avoid the temptation to add layers of supervision to afford advancement opportunities for your employees. Private oil and gas companies have the advantage of creative compensation, easy movement within the organization, and possibly direct participation in drilling projects that public companies cannot easily emulate. Use these advantages first before relying on additional supervisory layers as the sole mechanism for increases in salary and responsibility. Often, private companies succeed because they can make decisions faster and with better data by not having had information filtered and delayed by excessive layers of lower supervision.
Private oil and gas companies can emulate the best practices of their publicly traded counterparts by remembering that 80% of the benefit can be achieved through enactment of 20% of the controls that normally govern a public entity. Development of basic performance yardsticks that all employees can buy into allows the efforts of those employees to be laser-focused on long-term strategies and goals, but still be held accountable for current cash-flow management.
The key to success is having strategic long-term goals that are achievable, measurable and communicated to both shareholders and employees for buy-in. At the same time, private companies in the energy industry need to remain nimble and lean, while also investing in the training and development of their employees in order to maximize the contribution of each, and keep everyone engaged in the overall pursuit of continued success.