Managing Oil and Gas Companies-I Company Profile: Big Changes Revive Independent's Profits

American Exploration's Mark Andrews

The list contained names of 25 companies that Andrews considered models. And in 1991, most of them no longer existed. While some of the companies had become healthy parts of larger concerns, "Quite a few of them," he says now, "were just gone."

"Gone"-whether through bankruptcy or liquidation-was an option that, in 1991, Andrews had to consider for American Exploration Co. The alternative, as Andrews puts it, was to "completely reshape the company."

Andrews, chairman and chief executive officer, reshaped the company. Completely. In 4 years' time, American Exploration has changed from an aggressive acquirer and manager of producing properties for institutional investors into a geographically focused independent producer dedicated to making money by finding and producing oil and gas (Fig. 1 [30619 bytes]).

Through its adaptations to unexpectedly stagnant oil prices, American Exploration reflects the type of top-to-bottom changes many independent producers have made to survive a brutal decade. It also demonstrates that an independent producer can prosper in the absence of ever-rising prices: The company reported net income of $3.9 million last year following a $54.8 million loss-much of it related to an accounting change-in 1994 and a string of losses before that.

In an interview with Oil & Gas Journal, Andrews discussed his company's transformation and financial turnaround, his new appreciation for the balance between capital and technology, and future directions of his company and industry.

On the brink

Between its founding in 1980 and its crossroads year of 1991, American Exploration made 35 acquisitions in the U.S. and abroad and accumulated assets totaling nearly $1 billion. It had met its goal of controlling 100 million bbl of oil equivalent reserves.

"The only problem," Andrews says, "was that prices went down instead of up."

Having borrowed funds to pay for its shares of the limited partnerships it managed for institutional investors, the company was seriously overleveraged, committed to a business Andrews no longer considered viable.

During a 1991 meeting in New York to decide how to proceed, Andrews received fateful advice from one of his company's directors. John Moore, who headed Denver independent Ladd Petroleum until it was acquired by General Electric in the 1980s, had joined the American Exploration board when GE became a major investor in the company's acquisition partnerships.

"If you had a blank sheet of paper, I'd draw your organization chart a lot different than it is now," Andrews remembers Moore saying. "So I said, 'Okay, John, here's a blank sheet of paper. Have at it.'"

On Moore's recommendation, American Exploration moved all of its operations to Houston, closing its New York, Calgary, and Los Angeles offices.

Moore also advised Andrews to hire-in Andrews's words-"a really strong operating guy" and "a really strong chief financial officer."

The "operating guy" Andrews hired is Harold M. Korell, senior vice-president-operations, who had worked for 16 years with Tenneco Oil Co. and 3 years with private independent producer McCormick Resources. The chief financial officer (and senior vice-president) is John M. Hogan, who had been chief financial officer of Moran Energy.

Korell added vice-presidents responsible for exploration, production, and engineering and organized operations into geographically oriented teams. The company now has 35 geologists, geophysicists, and engineers, 27 of them hired since Korell joined the company.

While Korell was adding technical professionals, Hogan was trimming what Andrews now describes as the "huge back office, accounting, clerical operation" that tracked revenues from the nearly 1,000 properties in which American Exploration partnerships held interests. A staff of almost 300 financial reporting workers shrank to less than 100. The reduction in administrative costs helped pull down overall costs per barrel of oil equivalent produced (Fig. 2 [15214 bytes]).

The company also attacked its long term debt, which fell from $135 million in 1991 to $40 million at the end of last year, while cash flow increased (Figs. 3 [12010 bytes] and 4 [30584 bytes]). By May of last year, it had completed the consolidation of its institutional investment programs and this April reached agreement to liquidate a program of publicly traded limited partnerships it managed with New York Life Insurance Co. Andrews notes that institutional partners representing a majority of the total asset value accepted American Exploration stock instead of cash in the roll-up of the limited partnerships.

With those moves, the transformation was complete. Earlier, Andrews says, "Our main object was to make sure we got every barrel we thought we were buying and were entitled to and that we didn't get bamboozled in the engineering."

Now the company's objective is to add value by drilling wells.

Focused operations

American Exploration concentrates on the Gulf of Mexico, South Texas, and the Smackover Trend in Arkansas. In all of the areas, the company relies heavily on seismic and other technology.

In the gulf, for example, its strategy is to use 2D seismic data to identify exploration and development prospects, establish a strong leasehold position, and use 3D seismic surveys to determine drilling locations. It has interests in the Matagorda, Brazos, Vermilion, South Marsh Island, West Delta, East Cameron, West Cameron, and High Island areas as well as 14,000 net acres in Texas state waters, where last year it participated in a 400 sq mile 3D seismic survey.

American Exploration has held interests in the Smackover Trend since 1989, where it used horizontal drilling to improve recovery in the waterflood unit of Midway oil field. It plans to apply the horizontal drilling expertise it gained at Midway to other fields in the trend.

First target is Buckner field, about 10 miles southeast of Midway, which had produced more than 12 million bbl of oil but had never been unitized or waterflooded when American Exploration bought it for $2.4 million in 1995. The company plans a horizontal drilling and waterflood project in the field, which has geology similar to that of Midway field. The company has booked reserves for the field of 1.4 million bbl but thinks it has potential to produce significantly more.

In South Texas, American Exploration has projects under way in West McAllen natural gas field and the Wilcox Trend.

With Fina Oil & Chemical as a joint venture partner, it has used 3D seismic to identify drilling targets in undrained fault blocks on West McAllen's eastern flank. Drilling success rates have been high.

American Exploration began its Wilcox Trend work in 1994 with the acquisition of a 30% working interest in the Miocene, Frio, and Yegua formations of Provident City gas field.

After participating in several Yegua producers and a deeper Wilcox discovery in that program, it identified a number of exploration leads using 2D seismic data from Lavaca County in the Frio and Yegua formations above 6,500 ft and the lower Wilcox down to 15,000 ft.

Many of the features are associated with a large shale channel called the Yoakum Gorge, which has been difficult to image precisely with 2D seismic. This year, in a joint venture with Louis Dreyfus Natural Gas Corp. and Seisgen Inc., American Exploration commissioned a 152 sq mile proprietary 3D seismic survey of the area.

The joint venture this year will start drilling shallow, low risk wells for gas targets identified as amplitude anomalies in seismic data. Production from those wells will help pay for the survey, data from which American Exploration and contractor Western Geophysical Co. will use to image the Yoakum structure, seeking higher-potential Wilcox pays abutting or below it (Fig. 5 [40042 bytes]).

Capital and technology

American Exploration's emphasis on technology brings into balance advice Andrews received from his father, an independent oil producer, in the 1960s: The two factors crucial to success are capital and technology.

When Andrews started American Exploration in 1980 at age 29, having worked for the regional investment banker Rotan-Mosle, "I did feel that capital was the key." Hence the early focus on property acquisition and management-and the wait for a price rebound that never happened.

"The piece of Dad's advice that is only now coming into sharper focus is the keen reliance on technology," Andrews says now. "It's a shame to see technically competent people without capital. That's a real tragedy, and there are plenty of situations like that."

The experience American Exploration gained and contacts it made raising capital in the 1980s-when Andrews viewed the company's role as that of "a bridge between Houston and New York"-serve it well now. Andrews says the institutional appetite for energy investments rises and falls, and different types of institutional investors seek energy ventures at different times.

But some things don't change, he says, such as the need for honesty and communications: "The typical oil man and the typical financial person really speak somewhat different languages."

Good projects can nearly always find financing, Andrews believes. Increasingly, that means technology. Investors "would consider you to be pretty backward if you weren't using technology to a large degree."

Andrews nevertheless acknowledges that a company can spend too much money on technology. It is a challenge for management to know when approving a request for additional data is "additive" and when it is "just going to be interesting from a scientific perspective but not necessarily helpful," Andrews says.

"At some point we just have to drill the damn well or not."

Access to technology

Independent producers have the access they need to technology and good data, Andrews thinks: "The cost of getting one workstation is not really a barrier to entry to anybody."

And changing relationships between service companies and operators make technology accessible to companies with opportunities and capital.

"We're not on opposite sides of a table confronting each other," he says. "We're working together to achieve a common objective."

Citing an alliance with Western involving Sawyer natural gas field in West Texas, interests in which the company sold in 1995, Andrews says company personnel worked so closely together "there wasn't a very bright line between our offices." The companies are working similarly in the Lavaca County 3D survey.

The service company has skills, the operating company opportunities, Andrews notes. "We've certainly got to the point where we're jointly trying to solve a technical problem."

The next step is for the operating company to say to the service provider, "You put up your skills as your capital investment, and we put up the opportunity and some money, and we jointly develop something and share the return."

Andrews admits to having been "a little skeptical" at first about such shared approaches to technology and investment.

"But it has worked," he says. "It has just plain worked."

Hedging, accounting issues

Andrews takes a cautious view of a relatively new industry dimension that some independents have embraced and others have shunned: hedging.

American Exploration has been more heavily hedged at times in the past than it is at present because its banks insisted on it for protection against unfavorable price changes. With its recently improved financial position, the pressure from lenders has eased.

The company made money from hedging last year and lost money this year. Through swaps, it tries to hedge about half its production at prices that exceed those assumed in its plans. "To try to dampen some of the swings a little bit is a useful thing," Andrews says, adding: "It's not something that we'll micromanage. It's really a different business."

A continuing challenge for American Exploration is competing for capital as one of the minority of independent producers employing the successful efforts method of accounting, under which costs of dry holes are immediately charged against earnings. Under the other method, full cost, dry-hole expenses are written down over time against revenues from successful wells.

Andrews notes a "wide array of levels of sophistication" among investors concerning their ability to distinguish between successful-efforts and full-cost companies. For a company heavily involved in exploration, reported income is higher under the full-cost accounting method than it is under successful-efforts.

American Exploration adopted the more conservative approach when it was mostly an acquisition company that didn't incur millions of dollars in exploratory costs. "It is particularly important to find investors who understand what that means and look beyond red ink to see what value is or isn't being created," Andrews says.

"People would like to say that the only thing that matters is cash flow. But whether you're earning money is a pretty basic concept in the capitalistic world."

The future

The geographic and operational focus that American Exploration has adopted doesn't keep Andrews from thinking about future directions-geographic and otherwise.

A small group within the company, involving people not involved in current operations, seeks what Andrews calls "new concept plays." These are ideas on which the company will spend some money and which probably won't work.

"But we're looking at some things which if they did work out would mean that we'd want to acquire a lot of acreage in an area and have a multiyear, multiproject approach."

Andrews wants American Exploration to have $60 million in annual cash flow, 60 million BOE of reserves, and about 60 properties by 1998. But he remembers that meeting goals is sometimes less difficult than picking the right ones at the outset.

"In the '80s we darn sure achieved our goal" of controlling 100 million BOE of reserves, he points out. "We had terrific growth. It's just that our goal proved to be not very great when we got there."

Copyright 1996 Oil & Gas Journal. All Rights Reserved.