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	REMARKS TO TEXAS OIL MARKETERS ASSOCIATION “RESTRUCTURING IN THE PETROLEUM INDUSTRY: THE FREE ENTERPRISE SYSTEM AT WORK” DALLAS APRIL 6, 1984 8:15 A.M.

(TIME: 15 MIN.)

I. THANK YOU.

A. IT’S A PLEASURE TO BE HERE TODAY.

B.

C.

D.

II. I’D LIKE TO VISIT WITH YOU TODAY ABOUT THE RESTRUCTURING PROCESS THAT IS NOW OCCURRING IN THE PETROLEUM INDUSTRY.

A. I THINK IT’S IMPORTANT FOR YOU—AS MARKETERS OF PETROLEUM PRODUCTS—TO UNDERSTAND BECAUSE THERE HAS BEEN A GREAT DEAL OF DISCUSSION LATELY ABOUT WHAT EFFECT MERGERS AND ACQUISITIONS WILL. HAVE ON DOWNSTREAM OPERATIONS.

B. IN MY OPINION, THE ONLY EFFECT RESTRUCTURING WILL HAVE IS TO MAKE ALL SEGMENTS OF THE INDUSTRY—INCLUDING REFINING AND MARKETING—MORE EFFICIENT AND PROFITABLE.

C. MESA IS AN OIL AND GAS PRODUCER. AND MY EXPERIENCE IS IN EXPLORATION AND PRODUCTION—NOT IN REFINING OR MARKETING.

D. BUT IT IS MY BEST ANALYSIS, BASED ON THE INFORMATION I HAVE AVAILABLE THAT MERGER ACTIVITY WILL HAVE NO ADVERSE EFFECT ON DOWNSTREAM OPERATIONS.

E. SINCE MY EXPERTISE IS IN THE EXPLORATION AND PRODUCTION SIDE OF THE BUSINESS, I’D LIKE TO BRIEFLY TAKE A LOOK AT UPSTREAM OPERATIONS TO HELP YOU UNDERSTAND WHY SIGNIFICANT CHANGES ARE TAKING PLACE THERE.

III. IT BOILS DOWN TO THIS:

A. PETROLEUM COMPANIES ARE FACED WITH A UNIQUE SITUATION.

B. THEY MANAGE DEPLETABLE ASSETS—THEIR RESERVES OF OIL AND GAS.

C. IF THEY DON’T REPLACE THOSE RESERVES EACH YEAR, THEY ARE DEPLETING THE SHAREHOLDERS’ ASSET BASE.

D. THIS IS A BIG PROBLEM FOR THE INDUSTRY AND IT HAS BEEN FOR MANY YEARS, MORE SO FOR THE MAJOR OIL COMPANIES THAN FOR THE INDEPENDENTS.

E. SINCE 1970, THE DOMESTIC RESERVES OF THE U.S. OIL AND GAS INDUSTRY HAVE BEEN STEADILY DECLINING.

F. RISING OIL PRICES MASKED THE RESERVE DEPLETION PROBLEM DURING THE 1970s.

G. AND AS LONG AS THE FOCUS WAS ON THE INCOME STATEMENT, EVERYTHING SEEMED ALL RIGHT.

H. BUT TODAY, WE HAVE STABILIZED OIL PRICES.

I. COMPANIES CAN NO LONGER DEPEND ON INCREASED PRICES TO COVER UP RESERVE DEPLETION OR THE HIGHER COST OF FINDING OIL.

J. SO THE RESERVE DEPLETION PROBLEM HAS BECOME CRITICAL, ESPECIALLY IN THE EYES OF SHAREHOLDERS AND MANY OF THEM ARE CONFRONTING MANAGEMENT.

IV. THERE’S NOTHING WRONG WITH SHAREHOLDERS ASKING QUESTIONS ABOUT RESERVE REPLACEMENT.

A. AFTER ALL, SHAREHOLDERS OWN THE COMPANY—MANAGEMENTS DO NOT.

B. AND WE’VE SEEN A LOT OF ACTIVITY IN THE OIL INDUSTRY RECENTLY THAT HAS STEMMED FROM A LARGE SHAREHOLDER WHO HAS BECOME DISSATISFIED WITH MANAGEMENT’S PERFORMANCE.

C. GETTY OIL IS ONE EXAMPLE.

          1. THEIR RESERVE REPLACEMENT FOR 1982 WAS 33%.

D. IN GULF’S CASE, THE RESERVES HAD BEEN DECLINING FOR 12 STRAIGHT YEARS, WHICH I THINK YOU’LL AGREE IS A TREND.

          1. BETWEEN 1978 AND 1982, GULF’S RESERVE REPLACEMENT AVERAGED 43% OF PRODUCTION.

V. MANY SHAREHOLDERS ARE BEGINNING TO TAKE A HARD LOOK AT THEIR COMPANIES.

A. WHAT THEY SEE IS POOR REPLACEMENT AND THAT THEIR STOCK IS TRADING AT A SEVERE DISCOUNT TO APPRAISED VALUE.

B. AS A RESULT, SOME SHAREHOLDERS IN THE INDUSTRY HAVE MADE MOVES TO FORCE MANAGEMENT TO PERFORM BETTER.

C. IN MANY CASES, THAT DISSATISFACTION HAS TRIGGERED AN ACQUISITION OF THE COMPANY.

D. AND I DON’T SEE ANYTHING WRONG WITH THAT.

E. GENERALLY, THE ASSETS ARE FLOWING FROM WEAKER TO STRONGER MANAGEMENTS.

F. AND THAT’S GOOD.

VI. WE’RE GOING TO SEE THE RESTRUCTURING PROCESS CONTINUE IN THE PETROLEUM INDUSTRY.

A. WE’LL SEE THE EMERGENCE OF NEW RESTRUCTURING TOOLS AND THE USE OF SOME THAT HAVE ALREADY BEEN DEVELOPED, LIKE THE ROYALTY TRUST.

B. BEFORE I GO ON, I’D LIKE TO SAY THAT THE CREATION OF A ROYALTY TRUST HAS NO EFFECT WHATSOEVER ON DOWNSTREAM OPERATIONS.

C. THE OIL AND GAS PRODUCTION AND RESERVES CONTINUE TO BE CONTROLLED BY THE WORKING INTEREST OWNER WHO CREATED THE TRUST.

D. THE COMPANY CONTINUES TO SELL THOSE HYDROCARBONS TO THE REFINING OPERATIONS IT UTILIZED BEFORE THE FORMATION OF THE ROYALTY TRUST.

E. NOTHING CHANGES IN THE WAY THAT HYDROCARBONS FLOW FROM THE OIL FIELD TO THE REFINERY.

F. HOWEVER, A ROYALTY TRUST IS ONLY ONE TOOL THAT MAY BE USED IN RESTRUCTURING, AND NOT EVERY COMPANY IS A CANDIDATE FOR A TRUST.

VII. BUT WHATEVER A COMPANY CHOOSES TO DO TO RESTRUCTURE ITSELF, IT ALL RESULTS IN A VERY HEALTHY ATMOSPHERE FOR THIS INDUSTRY.

A. IF A COMPANY DECIDES THAT A MERGER OR ACQUISITION IS IN ITS BEST INTEREST THEN SO BE IT.

B. SOME COMPANIES WILL FIND IT MORE ECONOMICAL TO PURCHASE RESERVES THAN TO EXPLORE FOR THEM.

C. I RECENTLY RECEIVED AN ANALYST’S REPORT FROM CYRUS J. LAWRENCE OF NEW YORK.

D. THE VICE CHAIRMAN OF THE FIRM, CHARLES T. MAXWELL, HAD WRITTEN A PIECE ENTITLED “WHO GAINS AND WHO LOSES FROM BIG OIL MERGERS?”

E. I’D LIKE TO READ YOU A PARAGRAPH FROM THAT ARTICLE THAT VERY SUCCINCTLY PUTS THE “ACQUISITION VERSUS EXPLORATION” ARGUMENT IN PERSPECTIVE.

F. MAXWELL SAYS. . .QUOTE. . .“DIFFERENT COMPANIES HAVE DIFFERENT FINDING COSTS. WE ARE CONTENT TO LET THOSE MANAGEMENTS THAT CAN BRING NEW OIL SUPPLIES ONSTREAM AT THE LOW END OF THE RANGE OF COSTS DO THEIR THING, FOR THOSE WHICH CANNOT IT MAY BE IN THE PUBLIC INTEREST THAT THEY BUY RESERVES FROM THOSE WHO CAN, AND STOP WASTING THEIR SHAREHOLDERS’ AND THE PUBLIC’S MONEY ON A FRUITLESS HIGH-COST PURSUIT.”

G. THE LAST LINE OF THIS PARTICULAR PARAGRAPH IS THE MOST IMPORTANT, HOWEVER, BECAUSE MAXWELL SAYS. . .QUOTE. . .“ALL OF THE ABOVE ARGUMENT IS HARDLY NEW. IT COMES DIRECTLY FROM ADAM SMITH’S PRINCIPAL LINE OF REASONING IN HIS WEALTH OF NATIONS, PUBLISHED IN THE LATE 1700s.”

VIII. MERGER AND ACQUISITION ACTIVITY IS SIMPLY A PART OF THE FREE ENTERPRISE SYSTEM AND SHOULD BE ALLOWED TO CONTINUE.

A. WE HAVE PROBLEMS IN THE INDUSTRY THERE’S NO DOUBT ABOUT IT.

B. BUT WE ALSO HAVE AN ECONOMIC SYSTEM THAT CAN HELP THE INDUSTRY SOLVE THOSE PROBLEMS.

C. THE FREE ENTERPRISE SYSTEM WILL PUT THIS INDUSTRY BACK ON ITS FEET—IF IT IS ALLOWED TO WORK AS IT WAS DESIGNED TO.

D. I THINK WE’LL ALL AGREE THAT CHANGES HAVE TO BE MADE IF THIS INDUSTRY IS TO OPERATE PROFITABLY IN THE FUTURE.

E. DOWNSTREAM OPERATIONS HAVE CHANGED SIGNIFICANTLY IN THE LAST FEW YEARS.

F. REFINERIES HAVE BEEN MOTHBALLED, EVEN DISMANTLED IN SOME CASES.

G. ACCORDING TO THE OIL DAILY, ANYWHERE FROM 2 TO 2.5 MILLION BARRELS A DAY OF REFINING CAPACITY HAS BEEN REDUCED.

H. AND WITH REMAINING REFINERIES RUNNING AT A UTILIZATION RATE OF 75%, THERE IS STILL MUCH EXCESS CAPACITY.

I. THE OUTLOOK FOR REFINING AND MARKETING IS FOR MORE CONTRACTION.

          1. DEMAND FOR PRODUCTS IS SLUGGISH, ALTHOUGH SHOWING SOME IMPROVEMENT.

          2. TAX-HUNGRY FEDERAL AND STATE GOVERNMENTS CONTINUE TO LOOK AT THE INDUSTRY.

          3. AND OPEC’S REFINING CAPACITY HANGS OMINOUSLY OVER THE U.S. MARKETING INDUSTRY.

IX. WE NEED MORE EFFICIENT OPERATIONS—UPSTREAM AND DOWNSTREAM—AND RESTRUCTURING WILL CAUSE THAT TO HAPPEN.

A. IN MY OPINION IT COMES DOWN TO A PRETTY SIMPLE QUESTION.

B. DO WE, AS AN INDUSTRY WORK OUT OUR OWN PROBLEMS AND GET BACK ON OUR FEET UNDER OUR OWN MOTIVATION?

C. OR DO WE TURN OUR PROBLEMS OVER TO THE GOVERNMENT AND LET THE POLITICIANS AND BUREAUCRATS TAKE CARE OF IT?

D. THE ANSWER IS PRETTY CLEAR.

E. THE PETROLEUM INDUSTRY MUST RESTRUCTURE ITSELF TO ENSURE GREATER SHAREHOLDER VALUE AND TO BECOME MORE EFFICIENT, WHICH WILL BENEFIT THE CONSUMER.

F. WE WILL UNDERGO DRAMATIC CHANGES BUT IN THE END SHAREHOLDERS CONSUMERS AND THE NATION WILL BE BETTER OFF.