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	“THE U.S. PETROLEUM INDUSTRY RESTRUCTURING FOR EFFICIENCY AND VALUE” LOS ANGELES JANUARY 30, 1985

12:00 P.M.

THE FOCUS OF MY REMARKS TODAY WILL BE THE RESTRUCTURING OF THE U.S. PETROLEUM INDUSTRY, WHY IT MUST BE DONE AND WHAT BENEFITS WILL COME FROM IT.

UNFORTUNATELY, THIS PROCESS—ESPECIALLY THE MERGER AND ACQUISITION SEGMENT OF IT—IS PERCEIVED TO BE A PROBLEM BY SOME IN THE MEDIA, THE PUBLIC AND EVEN MANY OF MY INDUSTRY COLLEAGUES. NOT ALL GROUPS, HOWEVER, SEE IT THAT WAY. THERE IS ONE GROUP THAT IS STARTING TO UNDERSTAND IT AND THEY LOVE IT — THE STOCKHOLDERS. IN REALITY, THE RESTRUCTURING IS NOT A PROBLEM, ITSELF, BUT THE RESPONSE TO A PROBLEM.

THE OIL INDUSTRY IS CURRENTLY RESPONDING TO CHANGING ECONOMIC AND WORLD OIL CONDITIONS. BY WAY OF THE FREE MARKET, THE INDUSTRY IS TRYING TO CORRECT IMBALANCES AND SET ITSELF ON A MORE EFFICIENT AND PRODUCTIVE COURSE.

IT IS VERY IMPORTANT TO UNDERSTAND THE WORLD OIL PICTURE IN ORDER TO PLACE THE U.S. PETROLEUM INDUSTRY IN THE PROPER PERSPECTIVE. AND, OF COURSE, THE DOMINANT FEATURE OF THE WORLD OIL PICTURE IS OIL PRICES.

WE HAVE A GREAT DEAL OF INSTABILITY IN THE OIL MARKET CURRENTLY, BROUGHT ON BY THE CONTINUING PRESENCE OF THE GLUT AND A WORLDWIDE OVERCAPACITY OF REFINING. WHILE THE UNITED STATES REFINING SECTOR IS CONTRACTING, AND AT THE SAME TIME UPGRADING ITS ABILITY TO PROCESS LOWER GRAVITY CRUDES, THE OPEC COUNTRIES, PLUS EGYPT AND MEXICO ARE PLANNING TO INCREASE THEIR REFINING CAPACITY OVER THE NEXT THREE YEARS BY AT LEAST 1.2 MILLION BARRELS PER DAY.

UNTIL THIS GLUT OF CRUDE AND REFINING CAPACITY IS WORKED OFF, THE INSTABILITY IN PRICING WILL REMAIN, AND IT COULD CAUSE A SIGNIFICANT DECREASE IN THE PRICE OF OIL.

PRICE STABILIZATION IS NECESSARY FOR U.S. EXPLORATION ACTIVITY TO BE AGGRESSIVE. OUR FINDING COSTS ARE UNACCEPTABLY HIGH IN RELATION TO THE PRICE OF OIL AND GAS. THE U.S. INDUSTRY IS MUCH MORE MATURE THAN THOSE IN OTHER COUNTRIES. OUR DOMESTIC INDUSTRY IS FURTHER ALONG IN DEVELOPING OUR EXPLORATION PROSPECTS. OF ALL THE WELLS DRILLED WORLDWIDE, OVER 80% HAVE BEEN DRILLED IN THE LOWER 48 STATES. OUR FINDING COSTS ARE HIGHER AND WE SIMPLY DON’T HAVE AS MANY PLACES TO LOOK FOR OIL.

PHIL OXLEY, THE PRESIDENT OF TENNECO SAID IT VERY WELL IN THE OCTOBER 15 ISSUE OF THE OIL AND GAS JOURNAL: “WE ARE REALLY WITH OUR BACKS TO THE WALL TO THINK OF PLACES DOMESTICALLY WE COULD LOOK WITH A REASONABLE DEGREE OF SUCCESS.” OXLEY PAINTS A BLEAK—BUT REALISTIC—PICTURE.

HE SAYS THAT THE EAST COAST JURASSIC TREND HAS YIELDED ONLY DRY HOLES, THE HUGELY PROMISING MUKLUK STRUCTURE OFF ALASKA HAD ALL THE RIGHT INGREDIENTS BUT OIL, AND IT’S UNLIKELY THAT DEEP GULF OF MEXICO TRACTS CAN CONTAIN ENOUGH PRODUCTION TO JUSTIFY BOTH DEVELOPMENT EXPENSES. HE IS EVEN PESSIMISTIC ABOUT THE ECONOMICS OF U.S. ENHANCED OIL RECOVERY PROJECTS.

THE PROSPECTS PICTURE PLACES US IN A POSITION LIKE NO OTHER PRODUCER IN THE WORLD. AND THAT MAKES OUR RESERVES PICTURE UNIQUE, AS WELL.

REPLACING OUR DOMESTIC RESERVES ON AN INDUSTRYWIDE BASIS IS ALMOST IMPOSSIBLE. AND FOR SPECIFIC COMPANIES — ESPECIALLY THE MAJORS — IT IS VERY DIFFICULT. IN FACT, IT IS ALMOST IMPOSSIBLE.

THE INDUSTRY AS A WHOLE HASN’T REPLACED ITS DOMESTIC RESERVES SINCE 1971. IN 1983, IT ONLY REPLACED 63% OF THE OIL PRODUCED AND THE MAJORS COLLECTIVELY ONLY REPLACED 57%. THE INDEPENDENTS, ON THE OTHER HAND, REPLACED 121%.

THE RESERVES PROBLEM BECOMES CRITICAL, BECAUSE FOR PUBLIC-OWNED COMPANIES, THE RESERVES REPRESENT THE SHAREHOLDERS PRIMARY ASSET. WHEN THOSE RESERVES AREN’T REPLACED, THE ASSET BASE IS BEING ERODED. AND THAT FACTOR PLAYS A VERY SIGNIFICANT PART IN THE UNDERVALUATION OF OIL COMPANY STOCKS ON THE MARKET CURRENTLY.

SHAREHOLDERS ARE LOSING VALUE, AND THE MARKET RECOGNIZES IT. THERE’S NO QUICK FIX TO THE PROBLEM. YOU CAN’T INCREASE YOUR EXPLORATION BUDGET IN AN ATTEMPT TO REPLACE RESERVES NOT ONLY BECAUSE IT ISN’T ECONOMIC BUT BECAUSE THE PROSPECTS AREN’T THERE. BUT THERE ARE A LOT OF OTHER WAYS TO REALIZE THIS VALUE FOR SHAREHOLDERS.

RUSSELL MILLER OF ALEX BROWN & SONS PUBLISHED A REPORT IN APRIL 1984 THAT DEFINED RESTRUCTURING VERY WELL. HE CALLED IT CREATIVE MANAGEMENT OF MAJOR ASSETS TO MOVE THE MARKET PRICE OF THE STOCK CLOSER TO APPRAISED VALUE. A MERGER IS ONLY ONE WAY TO ACCOMPLISH THIS, SAYS MILLER.

OTHER WAYS INCLUDE ASSET SPIN-OUTS, SUCH AS AT KN ENERGY; ROYALTY TRUST DISTRIBUTIONS, AS MESA AND OTHERS HAVE DONE; AND ASSET SALES COMBINED WITH AGGRESSIVE STOCK REPURCHASE PROGRAMS, WHICH IS THE PLAN PHILLIPS WILL IMPLEMENT.

REMEMBER, THE PHILLIPS SHAREHOLDERS ARE GOING TO MAKE $2 to $3 BILLION. THAT’S WHAT IT’S ALL ABOUT — MAKING MONEY FOR STOCKHOLDERS.

THE COMMON DENOMINATOR IN ALL THESE ACTIONS IS CREATIVE MANAGEMENT OF ASSETS. THERE IS GREAT VALUE TO BE REALIZED IN THESE COMPANIES, BUT IT WILL TAKE AN INNOVATIVE APPROACH TO BRING THAT VALUE OUT. IT WILL CALL FOR MANAGEMENT TO VIEW THEIR COMPANIES IN A DIFFERENT LIGHT THAN BEFORE. IT MAY ALSO CALL FOR ANALYSTS TO VIEW COMPANIES DIFFERENTLY.

PAINE WEBBER ANALYST R. BRYAN JACOBOSKI DID JUST THAT IN A RECENT REPORT ON EXXON HIGHLIGHTED IN THE DECEMBER 24 ISSUE OF BARROWS. HE ANALYZED EXXON ON THE BASIS OF EXCESS CASH FLOW POTENTIAL AND ESTIMATED THAT EXXON COULD REPURCHASE 300 MILLION SHARES OF ITS OWN STOCK THROUGH 1990 EVEN WHILE SPENDING $7-$8 BILLION ANNUALLY FOR EXPLORATION AND CAPITAL INVESTMENT. THE RESULT WOULD LIFT EXXON’S PER-SHARE EARNINGS TO AN 11% COMPOUND ANNUAL GROWTH RATE. WITHOUT THE BUYBACK, ITS PROFITS WOULD ONLY BE ABOUT 5% A YEAR.

JACOBOSKI POINTS OUT WHAT MANY PEOPLE—EVEN THOSE IN THE PETROLEUM INDUSTRY—FAIL TO SEE. THE MAJORS HAVE TREMENDOUS CASH FLOW BUT LIMITED INVESTMENT OPPORTUNITY. BY RECHANNELING THAT CASH FLOW, THEY CAN REALIZE VALUE FOR SHAREHOLDERS. BETTER UTILIZING YOUR ASSETS IS VERY REALISTIC, AND THERE ARE A VARIETY OF WAYS TO GO ABOUT THIS.

EVEN S0, THERE IS A LOT OF RESISTANCE TO THIS APPROACH, AND IT’S RIDICULOUS TO THINK THAT THERE’S ANY WAY TO STOP IT. IF IT MAKES ECONOMIC SENSE, IT’S GOING TO HAPPEN. IF IT DOESN’T, IT WON’T. WORLD OIL MARKET AND ECONOMIC FORCES ARE TRIGGERING RESTRUCTURING AND THOSE FORCES ARE T00 POWERFUL TO OVERCOME. YET, WE STILL HAVE MANY INDUSTRY PEOPLE WHO DON’T SEE THE URGENCY TO GET ON WITH THIS TRANSFORMATION.

I SEE TWO BASIC REASONS FOR THAT. FIRST, MANY OIL COMPANY EXECUTIVES DON’T KNOW THEIR ASSETS WELL. THEY DON’T SEE THE POTENTIAL VALUE BECAUSE THEY DON’T SEE THE POTENTIAL IN THE COMPANY, ITSELF. RESTRUCTURING WILL REQUIRE THAT WE ALL BECOME BETTER ASSET MANAGERS.

SECOND, MANY OF THESE EXECUTIVES FAIL TO RECOGNIZE THE URGENCY OF THE DECLINING RESERVE BASE BECAUSE THEY AREN’T SUBSTANTIAL SHAREHOLDERS THEMSELVES. IF THEY WERE, THEY WOULD UNDERSTAND THE LOSS THAT SHAREHOLDERS ARE SUFFERING. GULF WAS ONE OF THE WORST EXAMPLES OF SHAREHOLDERS LOSING VALUE, BUT THERE ARE OTHER SIMILAR CASES IN THE INDUSTRY.

AS RESTRUCTURING TAKES PLACE WE’RE GOING TO SEE A LOT OF CHANGES—INCREASED EFFICIENCIES, HIGHER PRODUCTIVITY AND BETTER VALUE FOR SHAREHOLDERS. AT THE SAME TIME, WE’RE GOING TO SEE THE INDUSTRY CONTRACT. THAT’S GOING TO BE MOST EVIDENT IN INDUSTRY EMPLOYMENT. BUT WE MUST REMEMBER THAT THERE ARE MANY WAYS TO RESTRUCTURE AND THAT NOT ALL OF THEM HAVE TO LEAD TO JOB LOSS. IT’S EASY TO POINT THE FINGER AT MERGER AND ACQUISITION ACTIVITY AS THE CAUSE FOR SO MUCH JOB LOSS IN THE INDUSTRY. AND THERE’S NO DOUBT THAT WHEN YOU BLEND TWO COMPANIES THE SIZE OF CHEVRON AND GULF TOGETHER, YOU’RE GOING TO HAVE OVERLAP AND, THEREFORE, LAYOFFS.

HOWEVER, A STUDY BY JOHN REES OF SYRACUSE UNIVERSITY SHOWS THAT MERGERS AND ACQUISITIONS DO NOT LEAD DIRECTLY TO SIGNIFICANT JOB LOSS IN THE INDUSTRY. HIS STUDY ON THE GULF COAST ECONOMY SHOWED THAT EMPLOYMENT CONTRACTION THERE COULD NOT BE DIRECTLY LINKED TO M & As. REES SAYS THAT THE CONTRACTION WE’RE SEEING WOULD HAPPEN REGARDLESS OF MERGERS AND ACQUISITIONS.

THE OIL INDUSTRY IS SIMPLY RESPONDING TO AN UNPRECEDENTED PERIOD OF EXPANSION WITH A PERIOD OF CONTRACTION. WHAT THAT TELLS US IS THAT THIS IS NOT GOING TO BE A PAINLESS PROCESS, BUT IT IS ONE THAT MUST TAKE PLACE. THE INDUSTRY’S HOPE FOR THE FUTURE LIES IN RESTRUCTURING ITSELF NOW.