A focus on operational excellence

I started off as an international tax planning specialist, and made partner in that group. I moved out of the core tax function into our transaction advisory services group right around the time that the shale boom hit. EY needed somebody that knew oil and gas, could help build the oil and gas transaction M&A practice in Houston, but could also help companies with structuring. If you go back and look at 2006 to before the financial crisis, there was a huge amount of inbound investment into oil and gas. National oil companies, Chinese companies, they were all coming in. Private equity was also rushing into the sector. They needed somebody with my skillset, so I came in and we built our practice to serve the oil and gas transaction market. We started with nine, and now there are over 100 of us. We made it through the 2009 financial bust, and then, about three years ago, the firm asked me to take over as the office managing partner in Houston. They wanted someone that was familiar with the industry and the companies here. I love the city and I love this office, and it gave me an opportunity to do something a little different. In addition to the very technical, transactional work with companies and flying around the world, the position helped me focus more on the city, the community, and the people. I've also had the opportunity to move into a broader role in oil and gas and energy, I head up our energy practice for North America. Oil and gas is a global sector, and so I'm part of the global oil and gas leadership team, as well. It's a long journey, but the common theme is the connectivity to the oil and gas sector.

OGFJ: The oil and gas industry is still in a state of intense volatility. As it pushes forward, what capabilities does EY offer oil and gas clients working through instability?

BYERS: The industry is in a profound state of transformation. The way we look at it is, we're going from a period of scarcity where people were concerned about Peak Oil to now a period of abundance. We look at it from a very strategic point of view. When you do that, it impacts every aspect of the company's strategic focus because it impacts how investors will evaluate a company. If a resource is abundant, you care about operational efficiency, generating positive cash flow. When it was thought that the resource was scarce, companies were rewarded for finding and replacing reserves, securing supply. Now we know it's there and it's a question of what's economic. You're concerned about who's going to produce that last barrel the most efficiently. EY's capabilities are centered around financial excellence and the advisory function-improving processes whether its finance processes, operational processes, or supply chain. One thing that we've really looked at over the last three years is building up our transactional capability because this becomes a very transactional business as more players come into the market. Once dominated by big players doing big M&A, you now have a lot of smaller players and foreign inbound players. They need advice in a very nimble, fast way. We built up the transaction practice with people that know oil and gas from all sub-sectors. We've also invested heavily in strategy. People talk a lot about strategy, but we're focused on optimizing portfolios-bringing in people with engineering and operational experience. We marry that with our financial expertise. Where's the portfolio going? Where's the market going? And now the talk of the day is digital. But what does that really mean? That's where the industry is going to be looking. How do you take the digital technology being developed in all sectors and use that to compress your processes?

OGFJ: OPEC announced an agreement to cut production. Is there a timetable for equilibrium on supply? If oil prices rise and hold on the news, is there concern that at-the-ready North American shale producers will push supply resulting in another round of low prices?

BYERS: This is the question everyone is asking. People have been waiting for supply equilibrium since 2014 when prices dropped and they realized shale production was going to increase much faster and be more sustainable than anyone expected. There are two elements of the equilibrium. The market was already starting to move toward equilibrium because of the price itself-the fact that you have low prices meant that there was less production, especially coming out of North America because they react to the market force. I always say, North America already gave at the table-they put in their cuts. Production has declined about 900,000 b/d. That cut happened simply as a result of low oil price. That still left quite a bit of supply on the market. There's a lot of discussion about the oversupply, but I think the other aspect is flattening of demand. Demand is not growing as quickly as people anticipated. Some of that is related to GDP growth, but some of it is related, frankly, to things that needed to happen and will continue to happen-efficiencies. Energy-intensive industries are more efficient, transformation with China and industrialization-that has drastically slowed.

The action by OPEC, which, I think was the right thing to do at this point, will take about six months to feel. Following drawdown from storage, it could take six to nine months before you really start to see that excess supply come off the market. OPEC is made up of smart people and they've internalized how much production capability there is in North America and factored that into their calculus of the cut. Certainly there are many variables facets. Drilled Uncompleted Wells can come on fairly quickly. Then, longer-term, new horizons...take the Permian, for example, it's gone from an area headed toward depletion, to the hot play. It's basin by basin, but there certainly are shale plays that will start to come back online in the mid-$50s. We've seen that before. The other thing that you have to consider is that as soon as prices start to go up, a lot of independents will hedge production forward, guaranteeing a stable cash flow and allowing them to continue to support the drilling programs. Mexico just had their bid round and they're estimating 900,000 b/d if those projects get developed. US shallow water could come back. You've got to factor all of that in pretty quickly. The question is economics.

OGFJ: You mentioned some onshore coming back online at mid-$50s. What would it take for offshore?

BYERS: The majors have the balance sheet and can look forward three or four years. At some point you do begin to worry that you're going to go short. These are not projects that take three months to ramp up production. When you start getting into the mid-$60s, there are some projects out there. In Brazil there was a recent transaction where a company bought into the pre-salt. If you simply look at the price of the transaction, you scratch your head and think "That's amazing that they bought into that at a couple billion dollars," but if you talk to the experts, they believe that will make money potentially below $60. A lot of people have this idea that if it's offshore, it's this North Sea, harsh environment, Arctic, $80+ oil endeavor, and that's not the case anymore.

OGFJ: Back to OPEC, does the agreement silence questions about the continued relevance of OPEC and whose role is that of Swing Producer?

BYERS: That's a great question. I've been thinking a lot about this. OPEC was always relevant. If you look at Saudi Arabia alone, it can go 10+ million barrels per day...you can't discount that. When you start adding up Iran, Iraq, Nigeria...they're always relevant. Saudi Arabia has always been seen as the Swing Producer because they could move up and down very quickly; they were the most nimble. This latest agreement shows that not only are they relevant, but they can act somewhat in concert. Although it's still to be seen whether the cuts are realized. The better question might be how relevant is North America and the new producers? Two years ago people might have thought that shale producers were not as relevant, that they could be relegated to the back burner because they couldn't be economic once prices dropped below $80. Then $70...$60...well maybe it's $50...well wait a minute, can they survive at $40? The last round of bankruptcies didn't kill shale. It put a little realism into their balance sheets and took out what can be seen as poor economic decisions in a high oil price environment. But the fundamental question is how relevant are the producers like Russia? How much will they be in lock-step with OPEC countries and how quickly and how strategic or how cautious will shale be? We've had over 100 companies go into bankruptcy in the last 18 months and only a handful have emerged. When they do emerge, they emerge with a clean balance sheet...it was a balance sheet fix. It's not like a widget manufacturer that goes bankrupt and suddenly those widgets are no longer in the market. These assets, by and large, are still producing and are now going to be stewarded by a new group of owners. There will be some consolidation in the next year and that'll distract some new development, but the stronger players-the big independents that really pioneered all of this-they're still going strong, doubling down in the Permian, for example. They wouldn't do that unless it was economic.

Again, I think OPEC has always been relevant. As far as a Swing Producer, I don't think there's a single Swing Producer anymore, but there are some that can play the role of putting a cap on price. If prices start creeping up to say, $60, its going to make a lot of production economic for the shale producer. And they can swing up pretty quickly. That puts a lid on price. In my view, prices will float within a band for the next four or five years. If people go crazy and oversupply the market, the bottom is going to fall out. There's no bottom, but there may be a cap to how high oil prices go, and that's not a bad thing.

OGFJ: OPEC may have underestimated the power of the North American shale industry, but there's no denying that the industry suffered tremendously. That said, the strategy forced US producers to a more efficient and innovative place. Are we starting a new era of E&Ps? Has the business model changed and what does it mean for long-cycle or high-cost projects such as those in deepwater and internationally?

BYERS: People have now recognized that operationally, running a shale business is very different from running a deepwater, two-platform program. Shale is very much a manufacturing process. It's almost like a refining business where they count every single penny. When you're drilling so many wells, it becomes a supply chain management, operational excellence, manufacturing process. How can you squeeze that process down as much as possible? Yes, I think the shale business has transformed, and from that, I think there's some learning that can be transferred to the bigger, longer-cycle projects. EY did a study on large capital projects-above $1B-and, by and large, they don't perform well in terms of meeting budgets and meeting timelines. The basic blocking and tackling of good processes, good project management, managing multiple vendors-those kinds of things came out of shale, which had very tight margins. There's an opportunity to try to transfer that into these longer-cycle projects. If you bring a three-year project in at two years and 10 months, that's two extra months of production that you weren't expecting and that can help the net present value of that project.

The other thing that I like to talk about is the role of oilfield service companies. They've been hurt tremendously by the downturn and I think there's going to be a lot of pressure on them when the market revives in the next year to continue to deliver some of the efficiencies and price reductions that they've given up as concessions. The only way they can survive and do that is to be more efficient. The innovation and the R&D that has taken place in the OFS sector and the way they look at the business model and the relationship between the service sector and the operator-perhaps more risk sharing with E&Ps-is transforming. You're going to see a lot more efficiency as they work closer together to innovate and to drive those cost-savings.

OGFJ: How has the borrower/lender relationship changed with the downturn and will lenders continue to be as stringent as, hopefully, prices begin to move higher?

BYERS: The team that loans you the money is not the same team that manages your loan once it starts to look as though things aren't performing as well. You go from the relationship guy or gal that loves doing business with you to the restructuring group that comes in, pencils sharp. Moving from the lending side to the workout group can be bruising...those guys are tough...they're trying to salvage their investment. Speaking with some very senior bankers at a recent women's event, I was told, yeah, it's been really tough, but we're seeing the light at the end of the tunnel. Coming back in, the thinking is maybe there were some poor decisions made...too much exuberance in the lending, but let's reset and do so more rigorously. I think with better cash forecasting, and a lot more due diligence by the lender, good loans will still be made. Lenders will bring in experts that understand the reservoir. They're going to be looking for people to come in and not only kick the tires not only on the financial projections, but what underlies those financial projections, which is really the reservoir information.

OGFJ: What about private equity in the space? Mid-2016, EY published a report on private equity investment in oil and gas. At that time, over half of the respondents said improving the operational performance of portfolio companies was the top priority for their funds looking out to 2018. Second was acquisitions to existing portfolio companies. Do these still hold true?

BYERS: During the shale boom, private equity rushed in. They will incubate a company. Many of the real seasoned investors that came in with energy funds were backing good management teams. Let's say they made the investment in 2007-2008 when prices were really moving...they're going to hold those investments 5-10 years. Some of them will continue to hold because prices have been so low. They're working on how to best monetize existing investments, but now they're seeing more opportunity as more companies come out of bankruptcies with cleaned up balance sheets. They're looking to put some of these companies together to create more value and that's a great role for private equity to play. You have management teams that know how to manage the assets, and private equity that understands the financials, the economics, and the importance of discipline around cashflow. If you put those two together, you'll see more transactions on the asset side. We're also seeing majors and independents coring down portfolios. These are not bad assets. These companies either need to raise capital to shore up their own balance sheets or drill down to focus on one or two areas. Companies may want to focus on the Permian, but they also happen to have really good assets in the Bakken that they're choosing not to focus on. Or maybe its offshore. Companies may have both onshore and offshore assets, but they're choosing to get rid of offshore assets because it's a very different business. These assets are coming on the market and if you're a private equity buyer and you're sitting on billions of dollars of undeployed capital, putting that into the market now with a solid management team, using it as a platform to consolidate, it could be nice timing, especially if you expect the equity markets to start to open up in 2017, 2018, 2019. You haven't seen a lot of IPOs and I think the investing public is hungry for that. They're anxious to participate.

OGFJ: M&A was slow to get going as buyers and sellers struggled with valuations, but we've seen an increase in deal pace. What is your sense of the level of activity we'll see in 2017?

BYERS: Well I'll tell you, our M&A team activity is up double digits. They're not all closing, but we're looking at a lot of deals. That's the first indicator of an active M&A market. On the mid-sized deal market, I think you're going to see a tremendous amount of activity in 2017 and we're gearing up to serve that market. I also think foreign investment will come back in. You've got to deploy that capital somewhere. If you think about applying the Buy Low, Sell High concept, commodities are low now. And, psychologically, companies are coming to terms with the fact that, as I mentioned earlier, oil price may hover in a band for the next four to five years. If you have that certainty, you start transacting. I think that with the OPEC deal coming on, and so much talk out there about an equilibrium price, you start to feel comfortable and you can transact on that. Of course you can have volatility around equilibrium. Equilibrium could be $60, and any given incident-maybe a geopolitical shock, a weather shock-could spike price to $70, but it comes back to equilibrium, the inherent cost of lifting that marginal barrel. Also, people are starting to close the valuation gap. Those that may have been sitting on reserves waiting for oil to reach $80 realize that may be 10 years from now.

OGFJ: The uncertainty around the presidential election is over, but questions remain. President-elect Donald Trump has said he will work to repeal many of the regulatory initiatives promulgated during President Obama's two terms and promote domestic resource development in coal, crude oil and natural gas. Can you offer thoughts on how successful the incoming administration could be in doing so?

BYERS: To a large extent, the market itself is pretty good. You saw the largest increase in production during an administration that was arguably not the friendliest to this sector. Some of that is just basic economics, if it makes sense, you can't just stop what is good, safe, project development. There are certainly some areas, especially around the infrastructure, and most notably the Keystone pipeline, where there was some blockage where I think the incoming administration can have an immediate impact. There could also be more certainty regarding what will happen with the Bureau of Ocean Energy Management with regard to shallow water and the agency's concerns around decommissioning. If you look at the signals that the administration is giving, it is not, in my view, that it's so pro-fossil fuels and anti-environment, but that it's just more pragmatic. From the industry's perspective, I think you'll see a more balanced, pragmatic approach to regulatory action. To that extent, it's good.

OGFJ: You have a strong background in taxation. Do you see any possibility for federal tax reform in the near term?

BYERS: I think you're going to see tax reform. It's something that has been needed for a long time that just couldn't get done in the last eight years. A lot of what's been happening in terms of making our US domiciled companies competitive is really around our tax code, which is overly complex. It's overdue for a big overhaul and there's likely a great opportunity in 2017 to come to a bi-partisan agreement on the things that need to be done to simplify the tax code so that it's more competitive to be a US-domiciled company.

OGFJ: Are there any trends developing as the industry adjusts coming out of this downturn? Can you paint a picture of the short-term?

BYERS: It's really focusing on operational excellence. That's a great catch-phrase, but what does that mean? It means being disciplined about your finance processes, your management and supply chain, your vendor management. It's all the boring stuff that, the above-ground process, that are so critical. There are quite a few studies that talk about the oil and gas industry being one of the last adopters of digital technology and really taking advantage of that high-end processing technology. I think accelerating adoption of digital technology, whether its digital workforce, sensors, higher analytics, or even something more exotic...tapping into artificial intelligence, is a must do.

OGFJ: Is there anything else you'd like to touch on?

BYERS: We've been thinking a lot about the workforce of the future. Everyone talks about the millennials, but it's especially critical for the oil and gas industry because it's not a sector that attracts millennials. Millennials are attracted to the digital company-the handheld, the cool environment, the purpose-driven company. They're not thinking about working in the oilfield sector and it's a big challenge. It was a challenge even before the downturn. How do you transform yourself as an industry to talk about all the cool things you really do? The oil and gas sector is one of the most high-tech, innovative, and R&D intensive sectors in the world, but many millennials don't know that. They think about the old derrick from pictures of the old Humble field, not the well that's being drilled a mile deep, or the physics, the thermodynamics, and the massive computers. The industry must communicate in a different way to get the talent that it needs.

OGFJ: It was a pleasure. Thank you for your time.