Beyond earnings

A recently published study by PricewaterhouseCoopers shows there is a serious discrepancy between how well oil companies believe they communicate financial information to analysts and how analysts view this performance.

A recently published study by PricewaterhouseCoopers shows there is a serious discrepancy between how well oil companies believe they communicate financial information to analysts and how analysts view this performance.

Rick Roberge is head of oil and gas transaction services for PwC. He said the problem boils down to shortsightedness on the part of the operators. Roberge calls this the earnings game, and anyone with even a passing interest in the stock market knows how it's played. Companies, not just oil companies, but virtually all publicly traded companies, estimate what their growth will be for the quarter. Then, they dedicate themselves to meeting or exceeding these numbers. While there seems to be plenty of this type data floating around, the PwC survey found analysts are looking in a different direction for indications on how the companies are performing.

Chief among what analysts are looking for from operators is transparency. This is a term that has gotten very popular since the collapses of Enron and WorldCom. The idea is that people outside the company want to know about its inner workings. Investors are interested in looking behind the curtain to see how the earnings are met, or beaten. Specific to upstream oil and gas, Roberge said, analysts want details on reserve replacement costs. These numbers are considered central to what the oil company does. It sells a barrel of oil, makes a profit, and then has to turn around and replace that barrel, the same as a grocer would replace a can sold off the shelf. What's important here is what it costs to replace these reserves and how they are replaced. Are the reserves replaced through acquisition, or through the typically more expensive drilling route?

Beyond this, Roberge said analysts told PwC they want to know what type of reserves are being replaced, broken down by region and quality of oil. They also would like information on less tangible subjects, such as which geopolitical areas the company is entering and how it will deal with certain governments.

Even more abstract is the desire for more information about a company's management. Roberge said this is also driven by the Enron situation. People want to know everything they can about those who are running the companies in which they invest. This information can be difficult to provide. Will the CEO's resume actually give an analyst the information needed to make an investment decision? A job history of the key executives would be more valuable, as a sort of track record showing which other companies they have run. From this information, an analyst could perhaps predict how the executive will perform on the job.

Oil companies, 80 of which believe they have an almost continuous dialogue with analysts and investors, may find it difficult to provide all of this information. New regulations that went into effect last year insist that any information shared with one investor in a company must be readily available to every shareholder. This explains why the speeches given by major CEOs seem so pat and uninspired. If he discloses any new, valuable information, his staff must scramble to see it is widely distributed.

Bearing that in mind, it will take quite an effort for the operators to provide analysts with the type of touchy-feely information they are asking for. Assuming they have the resources and motivation to follow through with this, then a bigger question looms.

It's all well and good to point fingers at the operators and accuse them of not communicating, of focusing on short-term goals, and less-than-meaningful quarterly earnings. It is another altogether to make use of a greater variety of information.

If they do get what they want, the analysts may very well fall into the "careful what you wish for" trap of having to cull through all this data to extract useful information and make quality recommendations.

Gone will be the paragraph-long reports on whether an operator made its numbers. This will be replaced with an exhaustive analysis of how the operators' goals, replacement costs, and executive line-up will affect its stock price.

When one considers how different such financial reporting would be from what is published currently, it seems to beg the question: Aren't analysts just getting what they want? If they are truly disgusted with the sparsity of information currently available and don't see quarterly numbers as valuable, why do they insist on reporting these? One thing is for sure, if the operators do offer more detailed information on their activities, it will be widely distributed, forcing the financial analysts to address it. Will this needlessly complicate market recommendations, or will it offer more valuable insight? That appears to be the big question.

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