How One Oil And Gas Company Is Innovating Its Way Through The Bust
“There is no such thing as a fixed cost.” That’s what Chris Heinson, the CEO of Houston-based Maverick Natural Resources told me when we talked during the first week of July.
It’s a concept that accountants – or reformed former accountants like me – are not familiar with. Some costs are fixed, some costs are variable: It’s a concept that is pounded into every accounting major’s brain in cost accounting classes across the University system.
Yet, that concept – and the transformation of his entire organization around it – serves as the key to how Heinson has guided his company to achieve much better results than most of its peers during the course of the current oil bust. By treating traditionally fixed-cost assets like processing plants and compressor stations as variable costs and tying them directly to specific wells, Maverick was actually able to improve its profitability even as it took more than 750 of its wells offline in response to the collapse in oil prices during March and April.
I haven’t personally worked as an accountant in 25 years, but what little of my education and training in the field remains in my mind required a detailed explanation from Heinson about how this all works in the real world. The conversation that ensued was fascinating, to say the least.
“We went through a transformation process (in 2019) in which we fundamentally shifted our cost structure,” Heinson said. “We were able to reduce our LOE to BOE (Lease Operating Expense to Barrels of Oil Equivalent) run rate from about $25 down to $16. We did that in 90 days. It was kind of a shock to the system.
“The question here was, how do we get away from the mindset of optimizing production and start focusing on maximizing the margins? That was built into our foundation in 2019, when we applied this approach to 8 different basins. We had fantastic results in every single one. We felt that this gave us a competitive advantage in terms of what we can do with an asset as opposed to what other competitors are looking at.
“So, when 2020 started, we had found our optimums and were running in a steady state, when all of a sudden we had this dramatic shift in product price. As a result of that shift, we had to quickly review where we were in terms of how each of our assets were running, across the board in all 8 basins where we operate. We went through the same cycle we’d done in 2019, but just a little bit faster. This one took us about 45 days. The end result was that we unlocked so much value, and were able to cut $66 million from our ongoing run rate.”
Got all that?
When you really break it down, the concept is pretty simple: Every cost is variable, but some traditionally-fixed costs are more difficult to tie to specific production than others. As Heinson put it, “we frame the problem not by looking at what’s fixed and what’s variable, but by what is easy to change and what is very difficult to change.”
In a traditional accounting world, the “fixed costs” continue to accrue even when a well is shut-in, whether that is due to low prices or some other factor. The cost savings only come with the variable costs. But if you are able to tie specific parts of those “fixed assets” to the wells being shut-in – say, specific trains in a processing plant or specific compressors in a large compressor station – then you are able to winnow your fixed cost structure related to those wells down to little more than ongoing depreciation costs.
Another area where Maverick has been able to cut costs dramatically has been in field labor. During its initial transformation in 2019, Heinson and his team made the decision to contract out for well-specific field labor like pumpers, who have traditionally been permanent employees at most companies. While the supervisory field jobs remain manned by Maverick employees, Maverick was able to basically eliminate field labor costs below that level when it shut-in those hundreds of wells.
“If you are performing the field services, we view that as a variable cost. In our world, it’s a commodity,” Heinson told me. “So we shifted the model at that lowest level of field operations to being contractor service-driven. Thus, one of the biggest drivers of fixed costs, because of that structural change, becomes 100% variable. So we no longer have breakage costs, we don’t have severance costs, any of those typical issues to deal with because of that structural change.”
Heinson believes this is a model that will allow his company to continue to not just survive but prosper through the frequent booms and busts that he believes the oil and gas business will continue to suffer through in the decades to come. It’s a view I’ve discussed in previous columns: Because the current business model of shale companies depends on other countries like Saudi Arabia and Russia to continue cutting their own production to prop up oil prices, the U.S. industry is doomed to repeat these busts every 2-3 years. While Maverick is not itself mainly a shale player, every U.S. producer’s fortunes are tied to these swings in commodity prices.
“If you believe, like I do, that we are now in a period of time where there will be extreme volatility in commodity prices we’re going to see much more rapid cycles of highs and lows than we have seen historically,” Heinson said. “There’s just not as much buffer in the system. The swing capacity, excess production, whatever you want to call that buffer, our market, because of the shale, is just going to constantly go up and down.
“That sort of volatility on an organization that wants to be a producing asset manager like we are, where we are pushing returns by managing our margins and contributing that back to equity holders – that sort of business is the most vulnerable, the most at risk without making these structural changes that we’ve gone through. That’s been my broader thesis for why we’ve needed to make all of these structural changes in our system.”
This is the kind of directional change and innovation of internal processes the U.S. oil and gas industry has traditionally been famous for adopting, especially during hard times. While the accounting mind initially rebels at the concept, once you work through the details, you see that it provides an elegant model for other operators to emulate.
The contracting of field services could become a real growth industry in the years to come.