Where is the energy business headed in the year ahead? Oil & Gas Financial Journal recently interviewed several senior executives from some of the industry’s major players.
Jim Trippon, CPA
Question: What significant changes do you see occurring in the industry?
Louis Raspino, CEO of Pride International: The industry, particularly the drilling sector, for the first time in a long time is in a period of sustained growth. The business has in the past been highly cyclical, but right now we are entering a world where the industry sees a lot of growth ahead. It is interesting to see how companies will deal with protecting themselves from a downside scenario, while also positioning themselves to participate further in the growth of the industry.
Robert Phillips, CEO of Enterprise Products Partners LP: We see significant growth in the need for new midstream infrastructure as new oil, natural gas, and natural gas liquids supplies in the US begin to shift from some of their traditional producing regions to some of the newer exploratory regions. Three examples that we’re involved in today are the significant growth in new oil and gas supplies from the deepwater trend of the Gulf of Mexico. A second is the accelerated pace of drilling and development for new oil and gas supplies in the Rocky Mountain region, and third is what appears to be a significant new source of natural gas and natural gas liquids in the North Texas area known as the Barnett shale.
John Sherwood, CEO of Anglo-Suisse: A common concern for most companies right now is the availability of equipment and people in the service sector, which has been exacerbated by Rita and Katrina. We have had high oil and gas prices for a good 18 months now and everybody’s got a lot of cash and doing a lot of projects, which puts a strain on the service companies.
Q: What kind of financial challenges do companies have to address?
David Trice, CEO of Newfield Exploration: From a financial standpoint most companies are healthier than they have ever been because of high prices, and most companies probably have the least amount of debt they have ever had. So from an overall standpoint, the industry is extremely healthy. The major financial challenges today are rising service costs and how to control them in this kind of environment. There is a lot of money and a lot of people and because prospects are few and far between, there is a great deal of competition for service providers.
Doug Foshee, CEO of El Paso Corp.: Companies that have used acquisitions strategically are finding them more difficult because of the combination of high commodity prices and service company costs. We are in a constant battle to keep our finding and development costs down, so we can keep our economics good and not lose the advantage of high commodity prices by having our cost structure blow up. It is a big challenge for everybody in the industry, and it means we have to be more creative when it comes to how we go about solving problems.
Claire Farley, CEO of Randall & Dewey: From what I have seen, managers are trying to address financial challenges in several ways. Some are trying to get long-term service contracts so they can control rigs and resources over a longer period of time. Some are employing hedging strategies and others are being very measured with their capital expenditures, in other words, taking a through-the-cycle kind of view on the projects they will pursue.
Q: Looking out longer-term, what do you see on the horizon?
Park Shaper, president of Kinder Morgan: Over the next several years I see a continued need for investment. Stability is what this industry needs, and I hope that is what will happen. It is difficult to predict what will occur, but I think the indications are that we will have that stability. As long as the regulatory environment can stay steady, then I believe that it will be a good environment to meet the incremental needs for infrastructure and a good atmosphere for things to stay the way they are now.
Bill Greehey, CEO of Valero Energy Corp.: We see crude oil prices remaining high. Prices are a function of supply and demand. We are going to continue to be dependent upon imports, and I do not think that there will be much surplus deliverability of crude oil as energy demand continues to increase.
Q: Do you have a sense of whether there’s an adequate supply of college graduates coming into the industry?
Phillips: As an employer who needs to build and staff a record number of new energy infrastructure projects, I know how challenging it is right now to hire good engineers and other technical positions. There’s a shortage of them in the market today and coming out of college with technical degrees, and given all the project work that’s going on out there you’re not only competing against other industry companies but also the engineering firms as well for good talent out of college.
Sherwood: That is a huge problem, on both sides. The service industry has a terrible time finding people and the oil companies have the same issue. A recent statistic I read said that the average age of the exploration and production professional working for oil companies gets greater 11 months for every year.
Greehey: While there are fewer students majoring in chemical engineering than there used to be, I am convinced that if you have a good summer internship program that gives students an opportunity to know the company and its special culture, you will be able to hire almost 100 percent of the students you would like to hire. If we ever do run into a shortage, the answer would be to beef up our summer internship program.
Shaper: Over the past 10 to 15 years there has been a gap where we kind of lost a generation of workers who were not attracted to the industry, and that is definitely a hole that needs to be filled. Right now we are in an environment where I think people will pay more attention because there are more attractive opportunities for younger workers.
Q: Given the high prices of oil and gas and the prevalence stock options play in the industry, do you think it will be an even bigger challenge going forward as some of the more experienced workers exercise those options and put themselves in a financial position to consider early retirement?
Sherwood: Yes. Traditionally the oil company’s stock barely moved, and most employees’ stock options were barely above water - if at all. But now most people’s stock options are well above water, so they are able to cash them out. I think it is going to be very tempting and a real challenge for companies to keep their senior professionals and stop them from cashing out and enjoying retirement.
Raspino: I think the industry has been performing quite well over the last two or three years, and there has been a lot of profit created in senior-level equity positions. Yet even people who have done quite well continue to want to stay involved in fun and challenging work. In my opinion, most people who do what we do aren’t in it just for the money. They do it because they enjoy it. There are a lot of people, even before this up-cycle, who made a lot of money in the industry and continue to work because there’s a lot more to life than just profits and stock options.
Q: Have you seen an increased use of independent contractors or consultants in your sector?
Raspino: Absolutely, and it’s making up for the gap in the workforce we keep talking about. There are not enough people in the middle of the workforce, age-wise, and we don’t have sufficient depth of really experienced talent we can pull on to make major changes happen. Right now, we are looking at re-engineering our supply chain processes, our worldwide tax structure, and our accounting and information technology systems. There are not enough people to do all of that on our own. We have invested in substantial consulting time, as I think the rest of the industry has also. There is a great deal of work to be done across the industry, while many of the qualified people have left the workforce over the past 10 years because, until now, it just hasn’t been much fun.
Using consultants creates financial challenges as they are quite expensive. There are also operational challenges because there is a built-in bias from people inside the company who believe consultants don’t have to live with their recommendations and give them as much credibility as they should. The challenge is to make sure you have consultants who the company people believe in and want to listen to.
Q: Do you sense that there is an adequate supply of domestic exploration prospects?
Trice: No. There is clearly a shortage of quality prospects and everybody is hungry for them. Two or three years ago when somebody got a prospect, they brought it up a little and were able to turn around and sell it in multiples of what they paid for it. That gets harder to do every year. It is harder unless prices continue to go up, but somewhere in the cycle, they are bound to flatten out. If you bought a prospect assuming the prices will increase and they do not, you have probably made a poor economic decision. There are still many issues, but clearly in the US there is a shortage. That is why we have high gas prices, because we are not producing as much oil and gas and we are not producing enough because we cannot find it [in places that are easy to get to] anymore.
Q: How does today’s regulatory environment affect the industry?
Foshee: I think it is very difficult and more challenging in our current environment because of the recent spike in gasoline prices. Our industry has taken another hit to its public image. The current response is sort of the reverse of what logic would dictate. If we are short supply, the answer is not to lower profits, it is to increase land access for drilling and to promote conservation. That is not the situation we’re in today, I am afraid.
Shaper: We need regulatory stability so we can have certainty in our returns. We need to have confidence that returns will be reasonable. We need to have confidence that a stable regulatory environment will prevail and that we will be able to earn what we expect. Regulatory risk is one of our primary risks and we need that to be managed and minimized to the greatest extent possible.
Trice: The inability to drill in the eastern Gulf of Mexico and offshore Florida, which we need to do, is a big issue. Every time somebody wants to do something anywhere in the West, there is a series of environmental litigations that come up against us. There are a lot of frustrations. There is an unwillingness of some environmentalists to believe that you can have a coexistence of good environmental policy and oil and gas at the same time. In our view they are not mutually exclusive and people who I know in the oil business feel a strong sense of obligation to protect the environment and to run our business in a way that can coexist and have a reasonable balance.
Q: Are there any impacts from foreign governmental policies affecting the industry?
Raspino: There are parts of the world where US companies are not preferred due to the outside view of the US, and of course there are a few places in the world where US companies aren’t even allowed to operate. But it really doesn’t impact us in a big way. The US has taken the lead with laws like the Foreign Corrupt Practices Act, which other countries haven’t followed strongly yet. We are major supporters of the act, and it has been instilled in the operating discipline of our company. However, when you look around the world there are a lot of other countries that have their own business laws in place that are not nearly as broad in scope and as deep in regulations as the FCPA.
Q: What do you think the industry can do to best improve its image in the minds of US consumers?
Farley: That is a subject of great frustration to me because it is something we should have started long, long ago. We should have done non-controversial things such as embrace conservation in a very meaningful and consistent way. The whole message of conservation allows you to talk about the fact that it is a finite resource and discuss what a company has to do in order to extract that resource without it sounding self-serving. Now we are seeing individual company campaigns that are addressing that, which is wonderful, but it is hard for the average citizen to not be cynical when the prices are what they are and then all of a sudden there is this great need to educate on the part of the oil companies. We should be consistently doing it, it is really a shame on us.
Foshee: As an industry, we all have to be very concerned about how we conduct ourselves and what kind of public image we create. Our public image right now has been dented. For those of us in the industry who have been asking our employees to work 24/7 in response to Katrina and Rita so that we meet the demand for natural gas and try to make it affordable by getting supplies back on as quickly as we can, it has been hard. Our employees have done things that you would not expect were humanly possible, and it is very difficult for them to read in the paper what the public image of our industry is. As an industry, we need to get to the point where people trust what we say, especially about issues such as conservation and the environment.
Q: Do you sense that the current economic development of China is impacting the US domestic industry?
Raspino: Now, we see nothing but continued growth, but we also see the world’s requirement for oil increasing with tremendous demand coming from China. The long-term challenge is going to be adjusting to the Chinese economy and what that means for our industry. There is increased risk if the Chinese expansion slows, with a commensurate impact on the entire energy industry.
Trice: I think that you will continue to see growth and oil demand in China, and there is not a way we can produce enough oil in the world to satisfy that increasing demand. All the oil prices will probably have to stay pretty high because we have a potentially burgeoning economic society there, unless you have a major world-wide recession that changes the increase in demand.
Shaper: Yes. Clearly it has had an impact on prices - and that’s both energy prices and then also steel and other commodities. You have to factor that in when you look at acquiring or constructing a new asset. I think this is going to be an ongoing factor. If China remains strong, you will see stronger commodity prices and if they weaken, it will likely result in weaker commodity prices. This is just something we will have to stay on top of and be aware of.
Q: What issues are out there that concern you, but aren’t on everyone’s radar?
Greehey: One of the major things is MTBE [Methyl Tertiary Butyl Ether]. We began making MTBE because under the Clean Air Act, Congress required oxygenates, which swell gasoline volumes and help engines burn cleaner. Congress knew MTBE was the only oxygenate that could be readily available, so at Congress’s request we built a big plant and also put in some smaller MTBE units at our other refineries. Now Congress has decided they do not want MTBE. Under the new [Energy Policy Act of 2005], the oxygenate mandate goes away in May of 2006. Very few people realize that Valero and the majority of the refining industry are pulling the plug on MTBE. We are not going to make it without the legal protection the mandate afforded. So, right ahead of the peak summer demand for gasoline, the US is going to lose 150,000 barrels a day of gasoline production. Losing that much per day is a big, big deal, and it is going to have a big impact on supply.
Foshee: Competition for LNG supplies will become a big issue. There are three components to the LNG chain: re-gasification, which is the piece that is on US soil; transportation; and liquefaction. Liquefaction facilities have very long lead times because you not only have to discover enough reserves to justify a facility, you then have to design and build it. From the time you break ground on an LNG liquefaction facility, the construction period is 40 to 45 months. These facilities are not on American soil and many of them are in undeveloped countries, some of which have never produced LNG before. The thing everybody will have to watch is what happens to liquefaction supply and the competition for it. The markets with the largest demand for LNG are in the US and Asia, roughly equidistant from the largest liquefaction facilities. Competition is going to grow for LNG, and we just cannot assume it will end up here in the US.
Phillips: I think the real challenge for the industry is where you invest all the capital that is being created by today’s high commodity prices. Is it going to be reinvested domestically? Unlikely, because the majority of the capital is going to the majors - and the majors have long since left the US. Now on the upstream side, given some of these manufacturing play type deals, such as shale projects in Texas and the Rockies with the possibility of 1,000 or 2,000 well programs over a five-year period of time, you may actually attract the majors back to some of those plays now that the technology is there to drill into the shale and extract hydrocarbons on an economic basis. That may be enough to recruit some of the majors to come back to the US and focus on the domestic opportunities. Absent that, you’re going to see the majority of the industry’s earnings reinvested in international projects, which further highlights the notion that this is very much a global industry that we operate in. $
The author
Jim Trippon [[email protected]] is CEO of a financial advisory firm that helps energy executives optimize their personal finances. A recognized expert on stock option exercise strategy and managing employer stock concentration risk, Trippon authored the 2005 best-seller “How Millionaires Stay Rich Forever.” Trippon has 23 years’ energy industry experience, including a stint with Price Waterhouse, where he ran the audits of Exxon and its pension plans.
