Published by the American Oil and Gas Reporter, October 2004

Marketing Strategies Maximize Value

By Michele A. Markey and Terry Coulter

About Author: MICHELE A. MARKEY Michele A. Markey is responsible for special projects in Apache Corp.’s U.S. operations division. Previously, she served as Apache’s director of natural gas marketing, where she participated in successfully starting up the company’s natural gas marketing organization. Markey has 25 years of trading and marketing experience in the energy industry.

DALLAS–As good as business conditions are for oil and natural gas producers, turmoil and uncertainty seem to continue to be the standard in certain sectors of the business. For the past three years, gas marketing and services companies have struggled to reinvent themselves amid the collapse of Enron and other intermediary companies.

Producers find themselves in uncharted territory as they take back the roles of marketer and transporter. Pipeline (particularly unregulated and gathering groups) attempts to squeeze additional revenues through spin-downs of sections of pipeline have many producers and royalty owners in an uproar, claiming they are held hostage by the pipelines. The remaining marketing companies struggle for credibility both in the marketing arena and in terms of credit exposure. Acquisitions and divestitures have occurred at a blistering pace to maintain levels of production and stockholder value. At the same time, all entities within the industry are scrambling to meet pending deadlines to comply with Sarbanes-Oxley. And, finally, the threat of terrorism looms in the minds of everyone, knowing that everything can change in the blink of an eye.

With historic highs in oil and gas prices occurring almost daily, who can complain about such issues? Increased profitability in the midst of uncertain times, however, is a two-edged sword, and certainly a challenge to manage as the market continues to face ongoing concerns about supply’s ability to keep pace with demand, and producer worries that oil and gas companies may ultimately find themselves dealing with higher costs and shrinking markets. It is only natural that these industrywide issues command so much focus and attention.

Yet, with uncertainty almost always comes opportunity. With the right marketing strategies, independent producers can turn perceived obstacles into profitable opportunities. The first step is understanding the key issues in the new marketing environment, and how can they impact the bottom line for producing companies.

Ronald Reagan once said, “Every new day begins with possibilities. It is up to us to fill it with the things that move us toward progress.” In this period of historic commodity prices, it is not the time to maintain the status quo, but to consider new possibilities and seize new opportunities. What better time to strengthen a company’s marketing organization so it is equipped and prepared to handle the challenges of assuring optimal revenue, not only today, but in the future? Just as the country relies on the president to provide leadership and vision, every company’s employees, stockholders and royalty owners look to their executives to lead the way.

Maximizing Margins

Many executives seem convinced that since oil and gas are commodities and prices are set by the market, they have no significant control over the net price received. They believe the marketing department only needs to assure that all the production is sold to a credit-worthy buyer. Therefore, why place focus and effort in an area where there is little or no payoff?

Consider the range of net prices, before hedging, top U.S. producers received in the second quarter of this year for their domestic oil and gas production. For crude, the price range was $11.75 a barrel between the highest and lowest net prices, and for gas, $1.94 an Mcf. Certainly, there are valid adjustments for volume shrinkage and imbalances, different market locations, quality, transportation and gathering that account for a portion of this range. However, it is these same adjustments that must be proactively managed to avoid sacrificing margins.

Is there complete transparency in the producing company’s marketing activities? Do executives have 100 percent assurance that all aspects of their companies’ marketing efforts are effective and accurate? Only when the right people are empowered with the right tools and able to focus on the right activities can companies be certain they are realizing the maximum return for their production every day.

But does it really matter if the producing company is not squeezing every possible dollar out of its production? Undoubtedly, there are many opportunities for producers to mitigate costs, increase revenue, decrease the pain of lawsuits, increase knowledge management capabilities, and become more efficient. These issues are of great importance to royalty interest owners and stockholders. Whether a company manages its own marketing activities internally or outsources the marketing function, this key area must be managed with efficiency and effectiveness. If not, overall profitability will suffer.

Some innovative producers have already said yes to the question of whether it is worth the effort to examine the possibility of being more profitable by enhancing marketing capabilities, and are successfully finding ways to capture more value along the value chain. Their efforts and investments are providing a significant return by increasing cash flows and enabling the recirculation of more cash back into the company. Although deploying a more strategic marketing organization requires commitment and effort, the benefits can be significant. The real question for producers is not whether they should invest in improved marketing capabilities, but whether they can afford not to invest in the effort to make certain they get their share of the margins.

Challenge Or Opportunity?

One thing is for certain: the various stakeholders in the physical oil and gas value chain will continue to vigorously compete for their shares of the margins. Therefore, it is safe to say that the marketing environment will continue to evolve and become more complex. To turn this challenge into an opportunity to maximize revenues, production company executives must provide valuable leadership by communicating the value of marketing throughout all divisions of the company, requiring that risks be mitigated not only at the exploration level, but also at the sales point.

For those producing companies that have opted to outsource key marketing functions, many excellent marketing companies contribute to their success every day. A good working relationship with the outsource partner with well planned and managed expectations is critical to success. A marketing partner that has adopted proven best practices and invested in the right systems to support those practices is clearly positioned as a great partner.

However, at some point, it might make more sense to manage the marketing of a company’s production by a full-fledged internal marketing department. The economies of scale and the scope of the effort should be completely reviewed to determine at what point a company should expend the effort and resources to develop its own marketing division. For some companies, the decision is made when total daily production volumes reach a certain level. For others, it may be prompted by the number of pipelines with which a company has to schedule, or the producer may simply decide that it would be easier to reconcile production and financial data internally rather than with an external partner. For some companies, the decision to market one’s own production boils down to deciding that “no one can do it better” than their own employees, who ultimately put the company’s vested interests first.

The fact that a production company has outsourced some or all of the marketing function certainly does not diminish its importance or the responsibility of monitoring and managing the process. Producers choosing this path are, in the end, still responsible for managing production sales from the wellhead all the way through to the point of sale and revenue collection. Especially in light of Sarbanes-Oxley requirements, executives still must assure proper internal controls and recording of all transactions from the wellhead to the custody transfer point, not to mention guaranteeing that all oil and gas production was sold and that the maximum value for the production was secured.

With so many changes swirling around, it is important to understand the full implications of how these changes can impact a producing organization, and focus on the key opportunities that will produce a positive impact. Whether a producer markets internally or outsources, what are the keys to success in today’s environment? What are the challenges that producers face in effectively managing their marketing activities?

Most Valued Objective

The first hurdle to overcome is the most valued objective of the marketing group (internal or external): defining clear roles and responsibilities. Careful attention must be taken to assure that expectations are clearly understood of each team member, and what performance level is expected of the overall department to achieve the goals and objectives critical to company success.

As an example, by establishing whether a marketing group will market only its own production or actively seek out third-party supply in addition to its own sets the tone and processes for how a group will function on a daily, monthly and annual basis. Once a definite role has been established for the group, it is important that all other departments understand not only the role of the marketing department, but also how departments will interact with one another. Finally, a proper structure must be put in place to measure performance and provide the company’s executives a transparent view into the department’s activities. Establishing proper lines of communication early in the game allows the inevitable information flow to conduct itself in a smooth and orderly fashion.

The next step is to construct a technical infrastructure. The best place to start and maintain anything is with accurate and complete information. Perhaps it is easier to make decisions based on assumptions, old information and pieces of information, but that only leads to disappointment. Because the entire marketing process has traditionally been managed with paper and spreadsheet-based systems, information is disjointed and impossible to integrate to provide management with a full-blown view of how production is managed and marketed. How can a company chart a course for a destination if it does not know exactly where it is or exactly where it is going?

While there is likely no instantaneous resolution to this dilemma, operators have to start somewhere. The problem is not that the data are missing, but that the data are on paper in boxes and file cabinets, countless spreadsheets, or multiple disconnected systems that do not talk to one another. The place to start is by fixing the underlying problem; putting sound, integrated internal systems in place throughout the organization. Transacting the business within the confines of a structured database system enables valuable and strategic capabilities in information management, and links all the pieces of the puzzle together in a cohesive and coherent manner.

With an integrated system, executives and management have a transparent view into revenue generation activities, enabling them to support the marketing efforts, assure critical internal controls are enforced, and make more accurate and timely decisions. Marketers establish best practices in evaluating and negotiating sales to maximize revenue opportunities. There may not always be obvious opportunities to increase revenue by means of higher sales prices. However, with an integrated system that links daily production volumes and pipeline scheduled volumes, schedulers can intuitively manage volumes more effectively, minimizing costly pipeline penalties and price deductions.

With an integrated system that links marketing/scheduling data to accounting data, staff can easily reconcile wellhead, processing and transportation statements and contracts to assure correctness of deductions and shrinkage to assure the producer has received payment for both the correct volume and unit price for oil and gas. Whether a company markets its own gas or outsources, every producer, stockholder, royalty owner, and state and federal entity deserves and demands the maximum value for production–value that cannot be achieved without timely access to critical information.

Critical Area

Another critical area is managing royalty owner relationships. As royalty owners impose their demands for maximum value for their interests in production, both parties suffer the severe penalties of the lengthy process of royalty owners and producers battling through retrospective audits. While some might argue that it is easier to defend a lawsuit by simply selling at the wellhead, perhaps it is easier yet to simply achieve the maximum revenue while fully documenting the process.

In an effort to defray the spiraling cost of audits, many state, federal and tribal entities are seeking more collaborative approaches to efficiently manage this complex issue. Whether by taking royalties in-kind or pioneering innovative ways to communicate more effectively, it certainly is in the best interest of both producers and royalty owners to invest in new solutions. After all, both parties are in search of the same objective of attaining the maximum value for production.

While producers argue they are creating the maximum value for royalty owners, the results of many lawsuits tend to suggest otherwise. The best defense against this issue is developing and deploying best marketing practices, coupled with complete documentation of all transactions, movements, pricing and adjustments for each MMBtu or barrel sold.

Working hard is a good idea, but working smart is much better. Marketing department staffs traditionally work long, hard hours gathering information, tracking sales, working through issues with accounting, and providing information to engineers and management. But marketing departments, which tend to be viewed largely as part of administrative functions, should more fittingly be treated as a strategic revenue-generating machines.

In all cases, highly competent marketing staffs strive to focus their efforts on high-value activities such as optimizing revenue, mitigating penalties, reconciling transactions, minimizing the time to connect and market new wells, negotiating transportation agreements, and developing long-term relationships directly with end users. However, without proper tools, staffing and executive support, these strategic opportunities are inevitably lost.

As Sarbanes-Oxley implementations begin to permeate into marketing department processes, care must be taken to carefully examine for opportunities, which eliminate dysfunction and facilitate the most efficient use of marketing resources. Addressing these issues lays a solid foundation for establishing the marketing department as a viable and successful asset to any exploration and production company, and assures the company that its production is generating maximum value.

Strategic Steps

For operators that have not yet taken the strategic steps to empower their marketing departments and strengthen their revenue capabilities, there are several suggested best practices to help them work through the process and start maximizing the value of their production.

First, they should calculate the risk-reward/cost-benefit of operating a fully functional marketing group versus outsourcing to an existing marketing entity. The next step is to establish goals, objectives and expectations for the marketing group well in advance of actively marketing the company’s production. Define the functional roles for each member of the team. At this point, the company should determine the technical infrastructure needed to manage all flows of information from and to the marketing group and the interaction between internal departments. Appropriate reports should be created for senior management.

The entire organization should be informed and educated about the role and purpose of the marketing group, with complete buy-in from the senior management team. The company then needs to determine how far downstream the company will market its production, whether the marketing group will market third-party production, and whether it will actively hedge (most companies typically have some type of hedging policy already in place).

Prior to making any sales, the operator should establish a credit policy and finalize base contracts with all potential customers, and of course, ensure that the procedures and systems are in place to document all business processes for Sarbanes-Oxley requirements. Building a performance matrix to measure the performance of the marketing group is also a must. Finally, the producer needs to study the market to identify the major players and end users in the areas in which it intends to market gas.

Successfully accomplishing each of these steps enables the producing company to optimize one of its most valuable assets: the marketing division.