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  • The Hedge Bomb - Why Hedging Will Not Save Shale Oil [View article]

    Why would I try to buy a company whose debt is greater than the FMV of their assets? I am a novice to this, but that is what I am thinking. IF oil and gas prices don't rise, then come impairment determinations this year I would anticipate LINE to be writing down the value of their assets substantially. That may mean their debt is more than the FMV of the assets. Not a good situation to be in. Too much was paid out in distributions and no debt was paid "down" when they had the means to do so. I don't like the MLP model. Something is wrong with the DCF formula when this happens. When the DCF formula said they had a 1.0 or better ratio, my guess is they really didn't. Something is haywire to get into the situation LINE finds itself in. Any company needs to put some back for a rainy day.

    I remember commenting several times, two years or so ago, that LINE's debt level was getting too high. That was disregarded as not credible. Wonder what they think, about what I said, now?

    I tried to point out using the cash flow statement, that LINE had paid out 500 million more in distributions that its operating cash flow. That was said to be not credible. MLP Trader or something like that called me a shill for an author on SA. Where are those folks now, and what do they think about it now. I remember arguing with Philip Trender that the DCF formula doesn't take into account the pay off of assets. His reply was that the example I provided showed a very good return. How's that return working out now? What does Philip think now? It's just common sense. But, it seems in this day and age that common sense has left the building.
    May 20, 2015. 06:45 AM | 3 Likes Like |Link to Comment
  • The Hedge Bomb - Why Hedging Will Not Save Shale Oil [View article]
    @Pedro de Almeida,

    "GAAP is MUCH better than any other measure. In particular much better than cash flows. Also, it is the main yardstick that most investors and analysts use. "

    Generally, GAAP is superior to using cash flow because it includes credit transactions, where cash accounting does not. I fully agree with that. And GAAP, with its weaknesses, is the only recognized standard for SEC reports and FASB. It has served us well and made our financial markets the strongest in the world.

    I agree that I don't see LINE as a good investment, it has too much debt and its dependency on the market value of oil and gas has exposed them to a potentially huge loss in value of their assets, which makes the huge debt load even worse. I have commented in the past that I thought that LINE paid out distributions in excess of earnings, using adjusted GAAP, not cash flows, as the measure of earnings.

    But, GAAP does have weaknesses and it is not the only measure that investors and general financial statement users use to value a company or its stock.

    "but notice that your present simplified redaction makes the totally false claim that both derivatives and hedges produce no gains or loses... "

    What I am saying is that when a company hedges its production inventory with derivatives, that any increase in fair market value of the derivative is closely balanced with an offsetting decrease in fair market value of the production inventory that is hedged, and vice versa. GAAP fails to capture this economic reality only because LINE has chosen not to declare the derivatives as hedges for accounting purposes. In other words, it's a paper snafu that has nothing to do with economic reality.

    For LINE, entering into a derivative contract, the derivative hedges against loss of value if the production inventory falls in value. So, if the price of oil goes from $100 to $50, and LINE's derivative guarantees a $100 per barrel payout if the price of oil falls below $100, then as the market price of oil falls the derivative gains in value. Conversely, if the price of oil goes from $50 to $75 per barrel, the derivative that guarantees a $100 payout will fall in value. That is one side of the derivative transaction, and GAAP records those changes in market value and it is reflected on the Income Statement and Balance Sheet each accounting period.

    But the other side of the transaction is that as the derivative gains or loses value, the value of the hedged production inventory goes in the opposite direction and closely balances or offsets the gains or losses from the derivative. GAAP does not record the gain or loss in value of the hedged production inventory. In failing to do so, GAAP distorts the economic reality.

    "What I claim (and also what Kevin discovered by himself) is that these instruments presented big gains that were fully booked but are already in the past; that they will now present loses (unless crude and gas drop in price for the end of this quarter); and that almost everybody is unaware of this"

    They will present losses only under GAAP. As I have gone into detail on this thread to explain, the economic reality is that any losses from the derivatives will be closely balanced with gains in value from the hedged production inventory, which GAAP fails to reflect.

    The hedges are not "bombs", they are tools to protect and insure stable cash flows. To the degree the hedges are effective, there will be no material gain or loss on the sale of the hedged production inventory.
    May 20, 2015. 04:27 AM | 2 Likes Like |Link to Comment
  • Tesla Vs. Porsche - Tales Of Growth [View article]

    GAAP numbers need to be adjusted sometimes to get more reliable information.

    LEt's keep in mind that R&D is entered into to generate future revenue and that under international standards companies like Porshe, VW, and BMW (for Porsche 48 or 52 % Capitalized, can't remember which, BMW and VW are around 33% capitalization) capitalize a material portion of the development costs. So, that factors into how much profit or loss you report and how much operating cash flow you report. If Tesla capitalized a third of its R&D in 2013, that would have put them at break even. That is more reasonable that expensing all R&D as GAAP does.

    Then, if a portion of the guaranteed resale value sales turn out to be actual sales (customers keep their cars), that would put them in the black for 2013.

    So, I disagree that they haven't made a profit so far.
    May 20, 2015. 03:15 AM | 4 Likes Like |Link to Comment
  • An E&P Impairment Corollary: Does The Relative Absence Of Impairments For Successful Efforts Companies Matter? [View article]
    Excellent article, Raw Energy. I see the need to make the impairment testing equal with both types of accounting. I understand what you were trying to say on the other thread now. However, I still favor the SE approach as it relates to what is defined as an asset and what is expensed as a result. (Not talking about impairments) Thanks for your valuable expertise and experience on the forum.
    May 19, 2015. 11:17 PM | Likes Like |Link to Comment
  • The Hedge Bomb - Why Hedging Will Not Save Shale Oil [View article]
    @Kevin Hess,

    "So the company has already declared a big gain by the uncashed value of hedges - so when the price of oil goes back up, they'll have to declare a big loss on the change of value of the remaining hedges"

    Per GAAP a big loss, but to the degree the hedges are effective there is no material gain or loss using derivatives as hedges. When the price of oil goes back up the FMV of the hedged reserves also increases in value in basically like amount as the loss in value of the derivatives. But, that FMV isn't reflected on the Income Statement. GAAP distorts economic reality by not reflecting the increase in FMV of the hedged reserves.
    May 19, 2015. 10:16 PM | 2 Likes Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    "Let's say an E&P company drills a well and hits a water fault which renders the well non-commercial and non-functional, or a dry hole. For not the unfortunate direction of the horizontal, the well might have been a good producer. Does this knowledge not have future economic value to the E&P company? "

    Economic benefit, as in producing revenue for the company. A dry hole doesn't do that. Besides, the economic benefit I think you are speaking of is the knowledge. That is research. Research expenditures are expensed under US GAAP and international standards.

    As I said, I view it as a manufacturing type process where you account for each hole as a cost center. I don't buy the whole company as a cost center or a whole country as a cost center. Hell, if you do that, let's allow pharmaceutical companies to capitalize all of their R&D. After all, everything works to make the company money. You learn lessons from the R&D to make better drugs. And let's do that for every company that has R&D. After all, you gain knowledge from the research which enables you to make better products.

    No, I honestly don't see it. My view of economic benefit is as a future economic resource to generate revenue. Not as a research tool but as a revenue generator. Research is expensed under GAAP.
    May 19, 2015. 10:14 AM | Likes Like |Link to Comment
  • Is There A Dividend Bubble: Kinder Morgan Edition [View article]
    Madoff wasn't a public entity. It does make a difference.
    May 19, 2015. 10:04 AM | Likes Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    Raw Energy,

    I don't see the validity of calling "assets" costs which have no future benefit.

    And if companies and their accountants choose to be unethical, as you are suggesting, in applying well intended accounting guidelines, that is another issue separate and apart from the appropriate accounting method to choose over all.

    If you believe that both FASB and the IASB are unethical, so be it. I don't.
    May 19, 2015. 12:46 AM | 1 Like Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    @Raw Energy,

    "That's partly because you are focusing on dry holes, which are largely irrelevant in relation to the importance of impairments. FC companies don't "hide" anything, since their CAPEX is disclosed in the 10-K and their DD&A rates are higher to normalize results to avoid confusing investors."

    No, I'm not focusing on dry holes. I am stating what accounting theory says is an asset, and a dry hole doesn't fit the definition. Does it? Successful Efforts accounting more appropriately accounts for everything, than does Full Cost Accounting.

    If Successful Efforts companies are skirting the rules, then perhaps we need to revisit the guidelines to make them more stringent, like using a discount number of 8 or 10% with the cash flows when considering if there is an impairment or not. But I don't support Full Cost Accounting. IT doesn't make sense to capitalize what is actually a period cost.
    May 18, 2015. 11:48 PM | Likes Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    @Raw Energy,

    "You completely ignored the main point about the fallacy of SE impairment treatment, which is the main item readers should be focused on in times of price weakness."

    As I said, Full Cost treats as an asset costs that should not be assets. You never addressed that. It makes perfect sense to me that as a result, such a system would have a more stringent impairment guideline. Full Cost companies can always switch accounting if they don't like the impairment guidelines under Full Cost. No one is holding a gun to their head.

    I have stated why I think Successful Efforts guidelines is more reasonable, from an accounting and common sense view. That view is not skewed by money or power. I agree with FASB and the IASB on this one.
    May 18, 2015. 11:31 PM | Likes Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    Yes, the analogy of manufacturing makes perfect sense to me, an accountant who has had years of experience with both public and private companies, one of those being an oil and gas drilling company.

    A company using full cost accounting can hide its unsuccessful drilling efforts by capitalizing everything. The fact such an accounting method has a more stringent impairment guideline doesn't surprise me given that it has supposed assets that aren't really assets in the first place. You do know what the FASB defined definition of an asset is? Here it is from FASB: "Assets are probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." (Paragraph 25 in link)

    A dry hole has no future economic benefit, period. Agree? This has nothing to do with impairments. A dry hole should not ever be recorded as an asset in order to be considered for impairments.

    The expense issue is paramount as to why a dry hole should be expensed. LoL Sir, you are talking nonsense to me. Here you sound more like an insurance salesman than someone who is talking objectively.
    May 18, 2015. 10:55 PM | Likes Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    One other item you overlooked. Price Waterhouse states that:

    ""The successful efforts method is seen as more compatible with the Framework." (IAS standards)

    I suppose the large oil companies lobbied the IASB too?
    May 18, 2015. 10:28 PM | Likes Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    @Raw Energy,

    ""Actually, that is 180 degrees from the truth. The differences in the methods used to determine impairments for SE companies are far more lenient/liberal than for FC, and the reason that FC show apparently higher writedowns is not because they carry PP&E at too high a level, but rather that the guidelines essentially require no writedowns for SE. Many in the industry laugh that the sun is more likely to burn out before a SE company has an impairment."

    Honestly, you are not making sense to me. Here is the guidance from FASB 144:
    "This Statement retains the requirements of Statement 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and fair value of the asset. "

    From LINE's 10-Q, page 8:
    "The Company evaluates the impairment of its proved oil and natural gas properties on a field-by-field basis whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The carrying values of proved properties are reduced to fair value when the expected undiscounted future cash flows of proved and risk-adjusted probable and possible reserves are less than net book value."

    I guess the sun has burnt out several times in the last few years, since LINE has been recording impairments over that time frame.

    "Again, it is just the opposite. In fact, history shows that if a company was at one point a FC company and it determined that a material impairment would have to be booked, it would decide to switch to SE and thereby avoid the impairment."

    It is exactly as I stated. The fact they laughed at just switching to successful efforts does not nullify its validity. The higher asset values using full cost causes more severe write downs, rightfully so since the expenditures shouldn't have been recorded as "assets" in the first place.
    In regards to "weak management" showing "poor results" that is exactly what full cost accounting hides by capitalizing everything and not expensing dry holes. After all, capitalizing items that should have been expensed is why Bernie Elbers of MCI Worldcom is in prison. It overstates Net Income or understates Net Loss.

    "I would suggest you read very carefully how SE companies determine impairments. I doubt that many people REALLY understand the process. The large companies have successful lobbied FASB and others over the years to keep SE, not for some accounting "purity" but largely to avoid having to report larger losses due to impairments."

    I have provided the FASB guidance on how impairments are to be determined and shown that LINE has recorded impairments over the last few years. Where is your evidence that companies don't record impairments using successful efforts? I also don't buy the "lobbying" effort by FASB to keep the SE accounting. FASB received a lot of flack for coming out with the guidance in the first place, and as I have explained from a "purist" point of view with no lobbying pressure, it makes the most sense to me from an accounting stand point.

    As page 624 of "Intermediate Accounting", 14 edition, by Keiso and Weygandt states:
    "Small oil and gas producers, voicing strong opposition, lobbied extensively in Congress. Governmental agencies assessed the implications of this standard from a public interest perspective and reacted contrary to the FASB’s position."

    The lobbying pressure appears to have come from the full cost group.

    I am not trying to be difficult, but from an accounting standpoint, expensing dry holes immediately makes a lot more sense to me and I have explained why. You seem to have an agenda, just my gut feeling. You have tried to present my statements as something other than what they are presented as, as it appears to me you did the same with why FASB came out with the successful efforts guidelines. I don't get it.
    May 18, 2015. 10:15 PM | 1 Like Like |Link to Comment
  • Linn Energy - Get Paid To Wait [View article]
    @Raw Energy,

    "Successful efforts companies do in fact expense unsuccessful exploratory expenses, the original theory being that they were used by large companies who had fairly regular exploration programs from quarter to quarter. Because they thereafter report lower DD&A rates, the method tends to overstate income in future years compared to full cost companies."

    The original theory was that expenditures which result in an unsuccessful drilling effort should be expensed as a period cost. (Refer to AICPA Accounting Research Study 11, produced in 1969.) This is the same theory behind manufacturing accounting. You account for expenses on a per unit basis, not a country wide or per basin basis, as in successful efforts accounting. If a batch of inventory manufacturing results in a botched batch of inventory do you capitalize it? Absolutely no.

    DD&A rates are lower in comparison to full cost accounting, because the company was unsuccessful in finding revenue generating production. I wouldn't consider that "overstating" income in future years.

    "Full cost companies, originally smaller companies whose exploratory expenses could vary largely by quarter, capitalized all costs to the full cost pool so that quarter to quarter results were more indicative of overall results."

    I don't consider improperly accounting for unsuccessful efforts as being indicative of more accurate reporting of assets or income or "overall results".

    "A HUGE difference between the two methods lies in the way they calculate impairments to their PP&E. Full cost companies are subject to a rigid test applied every quarter/year, and impairments are mandatory if the PP&E value of reserves exceeds their SEC value. Successful efforts companies are not subject to the same requirement and the methods they use to determine impairments is subject to great discretion on the part of management. Successful efforts companies, therefore, keep reserves on the books longer and at higher values than full cost companies, especially in low price environments like we are now experiencing."

    Both methods require a write down recognizing an impairment if the future net cash flows is less the carrying amount of the asset. The fact that full cost companies capitalize all costs means that it has a substantially higher asset value, versus successful efforts companies, and that any impairments mean greater write downs, versus successful efforts companies. No surprises here.

    "Ironically, many/most successful efforts companies were at one point full cost companies. However, when it became apparent that they would be faced with imminent writedowns in the 1980s and 90s in the face of lower prices, they switched to successful efforts to avoid them."

    Companies do not want to show losses, period. Because these companies had been using an accounting method that showed their assets at an unjustifiably higher amount, versus successful efforts accounting, the lower valuation environment was going to cause them to show much more significant losses versus successful efforts accounting.

    The FTC's 1983 report is by one person, Marin Rosenberg, and it says in the disclaimer that the report represents only his opinion, not that of the FTC.

    Finally, the FASB's opinion hasn't changed in regards to which method it believes to be more representative of the more accurate method, and the IASB's opinion supports successful efforts as well. (See page 17 in link.)

    "The successful efforts method is seen as more compatible with the Framework."

    My mind remains open to which method is more appropriate, but from all I have researched, looking at oil and gas extraction, what makes the most sense to me is to look at it the way you would a manufacturing business. You don't capitalize expenditures which result in botched inventory or a manufacturing effort that results in no finished goods inventory, in this case the finished goods being profitably recoverable oil and/or gas.
    May 18, 2015. 08:07 PM | 1 Like Like |Link to Comment
  • Is There A Dividend Bubble: Kinder Morgan Edition [View article]

    I do have to wonder about the validity of the depreciation amounts being charged as expense on the income statement. It is FERC, I believe, who sets the allowable rates, not KMI, and not FASB. So, that to me is a red flag, a federal agency setting the depreciation rates.

    Secondly, our city replaces water pipe as it wears out, usually when it bursts, on a piecemeal basis. So, that would probably be an annual budgeted expenditure, like maintenance cap ex for KMI. So, the pipelines probably are being replaced, piecemeal, as time passes, as part of KMI's maintenance cap ex. You seem to have dismissed PenDragon's comment:
    "Maintenance capex is spent out of cash flow to keep the pipelines in good share. So in fact, the pipelines are being replaced piecemeal every year. " Depreciation is a real expense, but the FERC mandated depreciation rates may not be the best way to measure it. Maintenance cap ex, replacing the pipeline piecemeal as sections wear out, may be a more accurate measure of economic or real depreciation.

    To another poster who said FASB sets the depreciation rates and periods. I don't think so. See the links:

    Another problem with GAAP are the impairments which occur. GAAP has a built in conservative bent. You can write down assets to fair value, but you can't write them up to fair value. That distorts earnings, per "Financial Statement Analysis", 9th edition, copyright 2007, by Wild, Subramanyam, and Halsey.

    GAAP depreciation is a method of allocating an assets cost over its estimated useful life, its useful life in this case appears to be mandated by FERC. What hasn't been addressed is how valid such a method is, and whether or not the pipelines, land they are on and right of way rights, increase in their value over time. The increase in land value and right of way rights wouldn't be reflected in GAAP or earnings, since historical cost is used to measure the value of the asset. So, the book value of assets may or may not be a valid measure of their FMV. That needs to be addressed when talking about debt and earnings.
    May 17, 2015. 10:55 PM | 1 Like Like |Link to Comment