NEWS U.S. FIRMS STILL RESTRUCTURING, CUTTING COSTS UNDER OIL PRICE UNCERTAINTY

A.D. Koen
Senior Editor-News

Despite more than a decade of downsizing, continuing uncertainty in oil markets is forcing U.S. petroleum companies into another round of cutting and restructuring operations.

Wellhead gas prices in the U.S, although still volatile, in the past 2 years have risen to levels adequate to allow profits for most producers in that sector. Hi her s reserves valuations have strengthened producers' overall balance sheets.

But the slide in oil prices from the middle of fourth quarter 1993 until the recent upswing the past month has withered producers' financial performances and reserves values. With little prospect of significantly higher oil prices anytime soon, U.S. companies feel they have little choice but to continue pressing cost cutting moves in order to sustain profits in the near term while at the same time earning a higher return on investment in the long term.

Petroleum company executives are overlooking almost no operating or investment strategy thought capable of bolstering the bottom line. Because no two U.S. oil and gas companies are alike, each profit protection plan is a unique mix of similar solutions.

Oil and gas production companies most often try to lower operating costs by vigorously selling noncore properties or business units and reducing staff. U.S. major integrated companies in particular have divested many domestic properties in favor of refocusing exploration and development overseas. Most such situations have resulted in layoffs, as the majors cut staffs to fit smaller U.S. operations.

NO AUTOMATIC FIXES

Downsizing, even in combination with other measures, isn't an automatic fix. For that matter, there are no panaceas among tactics U.S. companies are trying to maintain profits.

Economic circumstances in the petroleum industry since the early 1980s have forced companies to adapt or die. The survivors long ago implemented extensive cuts just to stay around. In the current round of cost-cutting, the cost-benefit equations of remaining options are more balanced than ever.

Whatever the long term potential, short term operating gains accruing from smaller payrolls, lower equipment and supply costs, and increased focus on a company's core properties are offset to varying degrees by employee severance settlements and lower wellhead revenues. Similarly, capital gains from asset sales boost revenue at the expense of asset book value and operating income.

Consequently, in addition to concentrating operations on the most profitable activities at the most productive properties, oil and gas companies are trying to maintain profits by streamlining internal operating procedures, applying new technologies wherever possible, offering services that add quality or value to their products, and trying new financial strategies.

Observed consulting company John S. Herold Inc., Greenwich, Conn., and Houston: "The only way an oil executive can fight low oil prices is to hammer down costs and focus on high grading investment projects and enhancing asset productivity."

CLEARCUT RESULTS ELUSIVE

Regardless of the tactics employed, each company's profits can be affected as much by factors beyond its control-wellhead prices and overall economic activity-as by internal restructuring, so clearcut results often are elusive.

For example, Texaco Inc. in first quarter 1994 reported earnings of $75 million from U.S. exploration and production, down from $133 million in first quarter 1993, despite a concerted effort to generate more value for its shareholders. Quarterly results were boosted by higher gas prices, but undermined by sharply lower oil prices and lower production volumes. Texaco achieved higher refining margins on the U.S. East and Gulf coasts, mostly because of lower refinery feedstock acquisition costs. But those gains partly were offset by scheduled maintenance at its Puget Sound, Wash., refinery.

Texaco Chairman Alfred C. DeCrane Jr. said low oil prices company wide during the quarter more than offset continuing benefits from business process improvements, cost containment programs, and higher oil production outside the U.S. In addition to flattening its corporate structure and applying new technology, Texaco is adding value and controlling costs and expenses by:

Restructuring U.S. upstream and downstream operations the past 2 years, creating a pretax savings of about $54 million/year.
Lowering cash operating expenses since 1991 by 8% for a savings of $506 million, partly by reducing finding and development costs to $3.90/bbl.
Replacing on average the last 5 years 106% of its global production.
Developing projects expected to increase its global production by about 125,000 b/d in the
next 5 years.

Whatever the tactics applied, signs are emerging that the efforts to improve productivity are generating some results. Combined earnings of the Oil & Gas journal's group of 22 large U.S. oil and gas companies in 1993 increased 70.9% from 1992 levels (OGJ, Apr. 4, p. 27). The group's U.S. oil and gas E&P earnings were mixed, while earnings from refining and marketing generally improved from 1992 results.

Similarly, the U.S. Energy Information Administration found net income among a group of 82 U.S. oil companies-including 18 majors-was unchanged in fourth quarter 1993, despite an 18% decline in wellhead oil prices. EIA found income from major company oil and gas E&P operations in fourth quarter 1993 fell 58% compared from the year ago period, and independent income was 64% lower. Meanwhile, majors' downstream income in fourth quarter 1993 increased 55% and U.S. independent refiners reported a fivefold increase in earnings.

The effects of widespread cost cutting among U.S. oil and gas companies are reflected in other statistical data. Herold's 1994 reserve replacement costs analysis shows reserve replacement and finding and development costs of some companies are diminishing in the U.S. as well as outside the U.S. EIA data on 25 major companies show the spread between rates of return on upstream investments in the U.S. compared with those outside the U.S. has narrowed sharply since 1991.

ACQUISITIONS AND DIVESTMENTS

Some of the improving domestic performance by U.S. companies results from their shifting emphasis upstream from oil to natural gas activity. Gas E&P in the U.S. is garnering an increasingly bigger share of domestic upstream spending. In 1993 for the first time, the wellhead value of gas produced in the U.S. exceeded that of U.S. produced oil.

Part of better U.S. E&P productivity also likely is due to U.S. oil and gas property acquisition and divestment (A&D) trends. Simply put, U.S. majors have finished divesting most of their noncore, relatively less productive domestic properties and are developing the best prospects in remaining core areas. Productivity is further improved because most of the former major company properties have been acquired by independent companies to be integrated into their own core holdings.

The end result: majors and independents alike are working harder to high grade E&P prospects in the U.S. and pursuing only the best. And U.S. A&D trends indicate further productivity improvements are possible, if not likely.

While the value of oil and gas reserves changing hands in the U.S has remained at an average $6 billion/year since at least 1991, Geoff Roberts, domestic divestment manager at Randall & Dewey Inc. (R&D), Houston, says that, by R&D's count, the number of U.S. X&D transactions has been increasing, to more than 600 in 1993 from 450 in 1992 and 350 in 1991.

Part of the increase indicated by R&D's A&D count stems from the way in which the company tracks transactions. But Roberts says it also indicates that more smaller properties and smaller packages of properties are changing hands.

"That conclusion is supported by the A&D macro-trend," Roberts said, "which is, major oil companies that in the past were selling most of the larger properties no longer are as actively divesting."

Yet the rationalization of U.S. oil and gas properties is continuing, as larger independents divide up large packages of former major company properties, ping properties that fit into their core operating areas and reselling the rest to still smaller companies for integration into their core areas. In that way, many properties are ending up in the hands of producers that can operate them most efficiently.

"By concentrating on its most profitable, relevant properties and selling off less profitable, noncore assets, a company can increase profitability substantially," Roberts said. "It might cut into cash flow and reduce net income, but profitability defined as a ratio of return on spending improves. Over time, that should serve to bolster many oil and gas company bottom lines."

NEW CAPITAL INFUSION

Brian Lidsky, a senior associate at J.S. Herold, says current oil prices are prompting more private companies and noncore E&P companies to get out of the petroleum business.

"More noncore E&P companies have recognized that the upstream oil and gas business is very competitive and takes a lot of attention to create real value," Lidsky said. "They've come to realize more value can be generated from many of these properties if they're in the hands of independent production companies."

By aggregating properties from several different larger companies into integrated, core area packages, U.S. independents are contributing to lower U.S. reserves replacement costs. Companies included in Herold's oil and gas universe in 1993 achieved an average U.S. reserves replacement cost of $4.79[bbl of oil equivalent (BOE), down from $4.84/BOE in 1992. Herold's ma or oil companies as a group in 1993 performed even better, replacing reserves at an average cost of $4.15/BOE vs. $4.89/BOE in 1992. The much lower average replacement cost for majors could reflect how many of their marginal properties have been divested.

Lidsky says widespread alignment of gas ownership during the past 3-5 years, abetted by higher gas reserve valuations in the past 1 years, has allowed many independent companies to aggregate enough value to take a package of assets public. As a result, in the past 12-18 months, initial public stock offerings (IPOs) by independent production companies have been driving energy industry activity on U.S. equity markets.

According to Herold's data, U.S. E&P companies in 1993 raised $5.2 billion by offering equity to investors outside the industry, oilfield equipment and service companies $1.8 billion, and other energy related companies $2.4 billion. IPOs accounted for $4.2 billion of the total, a 258% increase from 1992. Energy company IPOs in 1991 totaled $160 million.

R&D's Roberts says the large infusion of IPO capital into independent E&P companies has created a seller's A&D market.

"Suddenly, we have many billions of dollars ready to be spent on acquisitions of producing properties and an insufficient number of properties available," he said. "I don't recall it ever being this far out of balance before."

With too many dollars chasing too few properties, he says, many independents with excess capital likely will divert some of the cash to drill more exploration and development wells.

MAJORS CUTTING COSTS

While restructuring activity among U.S. independents continues to focus on the reserves A&D foodchain, internal cost cutting measures are at center stage among U.S. majors.

The modest outlook for oil prices through 2000 and rising U.S. regulatory costs mean oil and gas companies that do not continuously improve productivity will not survive, says Constantine S. Nicandros, president and chief executive officer of Conoco Inc.

Nicandros said Conoco in 1993 lowered overhead and operating costs by $1.20/bbl from 1992 levels, improving earnings by more than $200 million. Conoco achieved the gain by developing more realistic asset management strategies, in many cases drastically changing its focus. Among the changes, Conoco has:

Shifted from a broadly diversified exploration strategy to concentrate in core areas and to pinpoint new core areas of operation in such places as Russia and Venezuela.
Continued to apply new technology wherever possible to replace production at the lowest possible cost per barrel.
Organized employees into interdisciplinary teams and empowered them to save time and solve problems.
Concentrated U.S. distribution and marketing assets around refineries and expanded globally where market share can be increased.
More rigorously determined environmental costs and made them better known in an effort to better balance costs with benefits.
Provided training, career development, and reward systems to employees to offset the lack of opportunities to advance in today's flatter oil and gas company organizations.

Conoco reported first quarter 1994 earnings of $215 million, 8% more than prior year earnings-which had included a $32 million gain from an exchange of international properties. Nicandros said effects of lower oil prices were offset by improved refining and marketing margins in the U.S., higher oil and gas production, higher gas prices, and continuing cost reductions.

VIGOROUS COST CUTTING

Chevron Corp. Chairman Ken Derr credits cost cutting for playing a big role in the company's profitability the past 5 years. He noted that during 1989-93, Chevron posted an average yearly return on investment of 18.9%. Derr made the comments in San Francisco earlier this month at Chevron's annual stockholders meeting.

In 1993, Chevron reported operating earnings of more than $2 billion and net earnings of $1.265 billion after special charges amounting to $883 million. About $543 million of the special charges was due to a second quarter 1993 restructuring charge for the company's downstream operations.

Chevron's cost cutting by yearend 1993 had lowered operating and overhead costs by about 94/bbl, a savings of about $1 billion/year compared with 1991 costs. The company this year aims to lower operating and administrative costs another 25%.

Despite a 10% decline in wellhead oil prices in 1993, the company's global E&P earnings increased 11% and worldwide refining and marketing earnings rose 74% from 1992.

Also at the meeting, Chevron Vice Chairman J. Dennis Bonney said the company's U.S. upstream operating expenses dropped 22% from its peak in 1991, a savings of about $600 million/year. U.S. E&P net earnings in 1993 amounted to $566 million.

Chevron's U.S. refining and marketing operations in 1993 netted a loss of $170 million after restructuring charges and other special items totaling $725 million, including a $543 million charge for the planned sale of two refineries.

EMPLOYEE CUTBACKS

Amoco Corp. by midyear intends to announce big changes in its corporate structure intended to build a sustainable competitive advantage, Amoco Chairman H. Laurance Fuller said in late April.

Amoco had first quarter 1994 earnings of $398 million, up from first quarter 1993 earnings of $229 million, excluding nonrecurring items.

Amoco in an early March letter to employees said low oil prices had prompted it to seriously consider reducing its corporate staff to a size required to perform only corporate functions. At the same tune, each of the company's three operating units would be replaced with a sector executive, each also with a minimal staff .

Amoco said doing business in the 1990s and into the 21st century would require it to develop greater speed and agility. Restructuring to achieve that goal would include eliminating "a substantial portion of our cost structure, which will result in a significant transfer of people and a net loss of jobs throughout the corporation."

Among the changes in store is the sale of Amoco Oil Co.'s Amocams/Modular Inc. (A/Ml) business unit, which provides computer hardware and software and gas and water systems to oil and gas production, gas utilities, and pipeline industries. The sale will affect 74 A/MI employees.

Meantime, Marathon Oil Co. in a late April letter to its U.S. downstream employees offered severance packages to workers who agree to resign by the end of May. The company earlier this year had disclosed it was studying ways to further curb costs and improve operating efficiency.

While Marathon's productivity could be boosted long term by a staff reduction and improved management efficiency, short term employee terminations could be costly. The company reportedly is offering workers who accept its assisted resignation plan 2 weeks pay for each year of service, a severance bonus amounting to 1-10 weeks of pay, and health benefits for 12 months after termination of employment.

COST CUTTING CONTINUING

Coastal Corp. posted first quarter 1994 earnings of $81.1 million, more than triple first quarter 1993 earnings of $25 million.

Coastal Chairman Oscar S. Wyatt Jr. says the company is well on its way to doubling earnings again in 1994 and increasing profits by another 15% in 1995.

Wyatt attributed Coastal's robust first quarter performance to a combination of high yield, low cost modifications at core refineries, colder weather in the U.S. Midwest and Northeast, and "Coastal's ongoing emphasis on debt reduction," which lowered company debt and interest charges by $19.1 million from the same period a year earlier.

Last year Coastal eliminated more than $470 million of debt and trimmed its interest expense by more than $40 million. The company intends to reduce debt to 60% of Capitalization by yearend 1995.

Occidental Petroleum Corp. this year intends to trim costs by another $150 million by further flattening its organizational structure, streamlining operating procedures, and consolidating departments. Achieving the goal would bring to $750 million/year the total cost reductions instituted since the company began restructuring in early 1991.

Oxy Chairman Ray R. Irani says reorganizing around the company's core operations strengthens its long term prospects.

Oxy in 1993 replaced 238% of its global oil production even with an 18% increase in its net oil output. The company's net global oil production in 1994 is expected to increase another 25%.

Irani described the company's 1993 earnings as very disappointing but said Oxy's gas transmission and marketing operation remains a steady source of cash flow and earnings and is moving aggressively to capture newly deregulated markets, as well as expanding into electric generation and international gas markets.

Despite low oil prices, Unocal Corp. is poised for growth, said Pres. Roger C. Beach, because it ranks as one of the lowest cost producers among U.S. majors.

According to an independent consulting company, Unocal's production costs in 1993 averaged $3.25/BOE and in the past 5 years $3.54/BOE, lowest and second lowest, respectively, among U.S. majors. Comparable peer company costs in 1993 were $3.37-5.74/BOE and in 1989-93 were $3.408.31/BOE.

In terms of value added from investment, Unocal in 1993 returned $1.38 of pretax value for each $1 invested in exploration and development. During 1989-93, the company's average value added per $1 of investment ratio was $1.67, highest among its peers. Value added by peers in 1993 was 78-$1.83/$1 invested, and for 1989-93 it was 82/$1 invested.

Beach said that no other company in the consultant's study scored as highly as Unocal when both production costs and value added ratios were considered. "While we have been very successful in keeping production costs low, we intend to maintain this number one position," he said.