The value of human capital
TOUGH TIMES NEVER LAST - TOUGH PEOPLE DO
CHRISTINA KITCHENS, EASTWEST BANK, DALLAS
RECENTLY WHILE PREPARING for the Winter NAPE conference and exposition in Houston, I contemplated the likely level of activities at the event and the probable attendees' focuses to bank booths this year. I expected many in attendance were focused on sourcing for distressed energy assets or distressed energy credits as a continuation of activities from 2015. I, half-jokingly and half-seriously, considered having a small sign printed for our booth that read, "We do not have distressed energy credits."
While many would have understood the sign and found the humor in it, a few might misinterpret its intent. Therefore, while I grinned at the idea, I passed on posting it. However, after more thought and recalling numerous articles about the upcoming energy credit crisis, characterized in some publications as an "energy finance apocalypse," I decided to change course on this editorial.
Initially, I intended to discuss energy credit workout processes, tips to navigate and what trends are in play from the fall borrowing base redetermination cycle to the current spring cycle. Instead, with market trends in mind, I decided to examine something that has had little coverage- recent trends in our oil and gas human capital and its impact on invested capital opportunities.
What I mean by human capital is the people factor - the people in the oil and gas business and in energy finance - their perseverance and ingenuity, their skills and knowledge. How will they be affected by the current industry downturn and how will their impact then change the industry that employs them? Human capital is what powers our industry and has led to innovation and technology advancements that enabled the United States to develop its immense shale resources, making them economically viable. No oil and gas asset produces income without the significant input of human capital into the equation.
Generally, when a bank underwrites an energy loan or when private equity backs a particular management team, they understand the importance of human capital. Unfortunately, human capital tends to be downplayed during a downturn, as if somehow it is less relevant. It is not.
To explain, a dollars-and-cents analysis takes center stage when capital is abundant, when liquidity and solvency concerns are being monitored, and when a broader trend is believed to create investment opportunity. Largely, investment capital is focused on "known" asset preferences. Investors tend to look at the potential return on capital trends by focusing on regions and assets in which the investment in human capital has already been proven successful. For example, the Permian Basin in Texas and the STACK play in Oklahoma are both highly regarded by today's investors and lenders because of their return potential. This is especially true when companies are economically challenged by low prices. In times like these, investment capital is driven by financial analysis largely cash flow driven and asset focused so to model out sufficient returns on capital in various scenarios.
Of course this makes sense. Drawing conclusions about returns on capital is the method nearly every investor uses in analyzing the merits of an investment. From my perspective as a banker, understanding the importance of human capital during oil and gas downturns is critical to our understanding of the industry we serve.
Energy portfolios are distressed largely for the same reasons. The homogeneity of the other factors amplifies the importance of human capital in any evaluation. When other factors are roughly equal, it is the merits of a firm's human capital and their decisions that have the greatest impact on a company's ability to survive times of decreased cash flow and liquidity.
The human capital component sometimes surprises us. As an example, independent oil companies often are the ones that show us how to create efficiencies and develop technologies that drive better results. The breakthroughs pioneered by these companies have frequently outpaced those of larger corporations, which has enabled them to out-produce and outperform their larger rivals in many cases.
It is human capital that, so far, has mitigated the anticipated capital crisis that many imagined would occur at a much quicker pace. Bankers and their counterparts in the energy business are working together continually to devise ways to improve results and evolve strategies to help weather the downturn. Although this doesn't assure a satisfactory solution to all, the investment community should consider the value of human capital and seek an opportunity to recapitalize versus waiting for transaction opportunities that may not materialize. As we know, there are staggering amounts of investment capital looking to acquire severely distressed energy assets at the right price. However, in my view, the prevalent strategy of hunkering down and waiting for the bottom of the bottom does not attribute the deserved value to this human capital.
As a member of a multi-generational oil and gas family, I am painfully aware of how deeply impacted industry professionals can be in a significant downturn. We should all be mindful of the importance of supporting our peers, developing and encouraging the human capital in oil and gas, and on my part, in energy finance. A significant downturn such as the one we're in can have a profound effect on human capital for generations to come, and thus can hinder our ability to attract the best talent when the industry makes its inevitable comeback.
As we know, past industry downturns have resulted in a so-called "missing generation" of petroleum professionals and managers. Some of us who grew up in the 1980s bust were discouraged from joining the oil and gas industry, and many did stay away.
Let's be respectful of those that may be exiting the industry, in part by choice or need, while doing our best to retain and inspire talent. We should recall the difficulty we had in recruiting qualified talent during the recent growth cycle as we consider the value of human capital today and what our needs may be tomorrow. This forward-thinking will facilitate our recovery and provide the growth capital that the industry will need to fuel our future.
Without any doubt, the downturn will accelerate the pace and depth of the "Great Crew Change," as "Baby Boomers" and the few members of "Greatest Generation" that preceded them leave the workforce, leaving a vacuum of talent and experience. This loss was considered a material threat to our industry just a few short years ago. That threat has not gone away.
Personally, I am seeing many nearing retirement. Highly experienced professionals are exiting the industry faster than they had originally planned. This latest down cycle seems to be weighing more heavily on them than their younger counterparts. Many of them have enjoyed a long career in the oil and gas space and weathered previous downturns. At this time in their lives they have lost enthusiasm and sense this is the final hoorah of their careers.
Obviously the need to cut costs sometimes requires layoffs, but I wonder if the industry, upon recovery, will be positioned to replace this expertise and the influence these generations have had on our ways of doing business. The human capital of each generation is unique. Do we know how our course will be charted as these generations exit?
Future technological advancements will perhaps ease this shift along with a continuation of the industry's innovative drive, but there are likely to be valuable lessons learned from those that preceded us. How will we capture that knowledge?
I hope that through the recovery we see a rebound in the spirits of those that still have so much to offer. Knowing many that are deciding that this is their last downturn and others that might consider themselves a part of the Great Crew Change, I hope we all recognize the value of their contributions and are grateful for those who have paved the way. They have left big shoes to fill, providing great opportunities for younger talent, including individuals new to the industry and those in mid-career. How companies adapt to this change will be especially relevant when new investments are being considered.
Lastly, here is the takeaway for OGFJ readers who may be seeking or participating in investment opportunities in this downturn. While sizing up an asset purchase or even calling a banker for an introduction, we should not lose sight of the imagination, courage, talent, passion, heart, and brawn that is our human capital. We all share in this capital and should properly appreciate those working through this tough time with all of their resources. Our wins should not be at their cost. With creativity and purpose, we can collectively navigate a course that enables us to make excellent returns on our invested dollars. As the title of this article suggests, tough people will persist past troubled times and will enable human capital driven returns to once again be plentiful. Invest wisely.
ABOUT THE AUTHOR
Christina Kitchens is the Group Managing Director of Energy Finance at East West Bancorp (NASDAQ: EWBC), a publicly traded bank with total assets in excess of $33 billion and ranked in the top 25 public banks by market capitalization in the US. Named for the third year in a row to the Who's Who in Energy and recognized in The Dallas 500 featuring the most influential business leaders in the Dallas-Fort Worth Metroplex, Kitchens' oil and gas expertise spans nearly 20 years. She guided the launch of the bank's national energy finance platform in January 2016.