COVER

FIRING UP THE OILPATCH

Small producers are poised to withstand booms and busts

DEIRDRE McMURDY December 6 1993
COVER

FIRING UP THE OILPATCH

Small producers are poised to withstand booms and busts

DEIRDRE McMURDY December 6 1993

FIRING UP THE OILPATCH

Small producers are poised to withstand booms and busts

COVER

DEIRDRE McMURDY

Calgary has always been a city of dramatic extremes. Geographically, it sits at the point where the big sky of the Prairies gives way to the hulking Rocky Mountains. And in the icy grip of the harshest winter, a warm Chinook wind blowing over those mountains can produce a complete thaw within hours. The city’s principal business—oil and gas—is given to similar swings. Since oil was first discovered in the nearby Turner Valley in 1914—and especially since the big strike at Leduc near Edmonton in 1947—the energy sector has endured a relentless cycle of boom and bust caused by volatile world oil prices, shifting government policies and fluctuating demand.

Just last week, a decision by the Organization of Petroleum Exporting Countries (OPEC) suddenly pushed world crude oil prices to their lowest levels in five years. Such erratic conditions have, over time, tested the inherent optimism of the entrepreneurs who populate the industry. And while most of them take pride in their ability to survive such a business environment, they are usually as skeptical about the upswings as they are stoic about the slumps. Last week’s oil price jolt was a case in point: despite the fact that they now face a winter of weak prices and oversupply because of OPEC’s inability to agree to production

cuts, Canadian oilmen have new confidence in the fundamental—and permanent—changes that have taken place in their industry. Says Donne Traxel, president of Ulster Petroleum Ltd.: “We used to expect inflation and rising commodity prices to skate us onside if we weren’t efficient. But we’ve learned the hard way about controlling the few things that we can.”

While the whims and squabbles of OPEC leaders are beyond their control, Canada’s oil executives are better able than ever to withstand such uncertainty.

The base of the industry

has been broadened and revitalized over the past 18 months as a number of small, flexible oil and gas producers have snapped up the assets shed by a handful of lumbering giants. These so-called integrated companies, which engage in all aspects of the business, from exploring to retailing, used to dominate the industry, making it extremely vulnerable to their fortunes and failures. But as the recession has forced them to trim their operations and reduce their bloated portfolios of oil and gas properties, the lean junior companies, with virtually no debt on their books, were quick to pounce. “The huge hierarchical structures suddenly shrank,” says Gordon Stollery, chairman of Morrison Petroleums Ltd. “Industry-wide, responsibility and decision-making have now shifted from a few large hands to a number of small ones.” Taking advantage of their streamlined structures and the latest technology, the junior producers soon reaped the benefits of their new purchases, adding low-cost oil and gas production to their reserve bases. While spending on exploration and development by the integrated producers has dropped to about $1 billion a year from about $3 billion a year in 1986, drilling activity is still brisk partly because technological advances are making it faster and cheaper for the smaller companies to drill for oil and gas. According to the Canadian Association of Oilwell and Drilling Contractors, 8,117 oil and natural gas wells were completed in Western

Canada in the first 11 months of 1993, compared with 4,772 in 1992.

That surge in energy production—which coincided with a longawaited strengthening of natural gas commodity prices—easily caught the eye of equity markets that are starved for signs of growth in a stagnant economy. According to Rob Peters, chairman of Peters & Co. Ltd., a leading Calgary-based investment dealer, about $6 billion in investment capital has flowed into the industry over the past two years. Much of that is from mutual funds that are swollen with the cash of North American investors who are looking for a higher rate of interest than is now paid on bonds and other loans. “It’s the best time in 25 years for the junior oils,” says Peters. ‘There have been fundamental changes in the energy business combined with a lack of alternative vehicles for investment growth.”

The application of new technology and a staunch adherence to the so-called New Economy principles of team work and non-hierarchical management structures are at the heart of those “fundamental changes.” Even before the New Economy gurus and the jargon of employee empowerment became commonplace, necessity dictated that the junior oil producers operate as tight-knit teams. “Because of our size and structure, we can react fast,” says Ulster’s Traxel. “With the big integrateds, you have to wait for days for the layers of bureaucracy to meet—let alone make a decision.”

The heavyweights in the industry have worked valiantly to improve their reflexes, but it has been a painful and protracted process from which they are only now emerging. In early 1992, after reporting its first-ever operating loss of $36 million, Imperial Oil Ltd. announced plans to cut costs by about 15 per cent by eliminating about 1,700 jobs, freezing employee salaries and bonuses, closing 1,000 of its 4,300 service stations across Canada and reviewing the operations at its six refineries.

In Calgary, Petro-Canada, the privatized former Crown corporation, was already in the process of undergoing a painful restructuring that culminated last January in the ouster of its longtime chairman, Bill Hopper. In addition to cutting staff from a peak of 10,000 to about 5,000, the company reduced its number of service stations from 3,200 to 2,000 and sold over $1 billion in exploration properties.

According to Don West, chief executive officer of Rigel Energy Corp., which recently broke away from an international parent company, Total SA of France: “The big guys are hying to look like the little guys because the little guys are making money.” He adds that “the days of big oil and big, easy scores are over. The geological opportunities that remain in Canada aren’t suited to that style any more.” In fact, the steady depletion of the oil reserves in Canada’s western sedimentary basin has led many larger domestic producers to concentrate their exploration and development programs and spending outside of Canada.

While some of the junior companies have ventured into foreign territory—most notably Chauvco Resources Ltd.’s foray into Argentina—most are narrowly focused on specific geological areas. In the 1980s, it was common wisdom that energy companies—large and small—should hold as many small stakes in as many promising oil and gas fields as possible.

Now, however, the junior producers acquire controlling interests in known areas where they can ensure that costs and production schedules are closely scrutinized. At Ulster, for one,

Traxel has steadily reduced the company’s holdings from an average 20-per-cent interest in 100 small stakes to 15 properties in which the company owns at least 60 per cent.

The heightened emphasis on new production technology and the steady refinement of its application have also played a key role in the junior producers’ quest for increased efficiency and lower operating costs. The biggest breakthroughs are three-dimensional seismic surveys, horizontal drilling and improved drilling bit technology. Although versions of these technologies have been around for about five years, they are increasingly being refined and adapted and paired with high-powered computers. That helps exploration teams to fully assess a drill site before incurring the expense of moving in heavy equipment and teams of workers. It has also allowed junior companies to discover and develop pools that would have once been too cumbersome or too costly to exploit. Declares Rigel’s West: ‘Technology has revolutionized

the industry and driven it forward by making all sorts of reserves economic for the first time.” According to his calculations, the life of the conventional oil and gas industry in Western Canada will likely be lengthened by 15 years because of the new technology. But that shift to a technology-driven industry has, at the same time, sharply curtailed employment levels in the sector.

While much of the focus of exploration and development by the junior companies has been on oil, strong signs of life in the natural gas segment of the energy business have rekindled an aggressive interest in finding and developing that commodity as well. Since the Mulroney government deregulated the natural gas business in 1985, it has been plagued by excess capacity, inadequate pipeline delivery systems and depressed prices. “With deregulation, prices were cut in half and drilling fell to a 50-year low,” says J. C. Anderson, chairman of gas producer Anderson Exploration Ltd. “It caused a huge dislocation.”

As a result, junior energy producers, who rely on their cash flow to survive, deliberately emphasized the discovery of oil—which, despite periodic peaks and valleys, has had a relatively steady ride on world commodity markets since its last collapse in 1986. Recent asset sales, however, have reflected a shift in that focus: the selling price for natural gas over the past year has climbed from about 75 cents per thousand cubic feet to over $2. Last month, the prospects for natural gas received

another boost when San Lranciscobased Pacific Gas Transmission Co., a prime buyer of Canadian gas, completed a $l-billion expansion of its natural gas pipeline. “The strengthening of gas prices and the expansion of the infrastructure to deliver it, is what will sustain the industry’s growth through the 1990s,” says Peters, the Calgary investment dealer.

Still another factor that distinguishes the recent oilpatch restructuring is the attitude of the senior managers within the booming companies. Even though investment dealers and mutual fund managers have been tripping over one another to underwrite new equity issues and invest capital in the sector, company executives talk sternly about the growing need to “manage investor expectations” and to ensure that fickle investors do not abruptly withdraw their capital at the first sign of commodity price weakness.

Lor the most part, junior oil managers say, the frenzy and excitement associated with acquisitions and dramatic jumps in production started to cool even before last week’s oil price drop. Lor one thing, the aggressive demand and

the abundance of capital has be-

gun to drive up the price of assets. Lor another thing, the major integrated companies have largely cleaned out their portfolios and sold the holdings they no longer want. “We all agree it’s been fun, but it’s time to get down to the basics of the business, exploration and development of all the stuff that’s been bought,” says gas producer Anderson. And while the recent decline in oil prices elicited none of the panic of the past, neither have firmer natural gas prices caused euphoria. Anderson notes dryly that, overall, “the industry’s price expectations are a lot more realistic than they ever used to be.”

Despite the rapid spurt of growth in the smaller oil and gas companies, their senior managers

adamantly maintain that they will be able to avoid the same organizational sprawl that has plagued the industry’s heavyweights. “We have a flat management structure and we put a lot of work into maintaining it,” notes Morrison Petroleum’s Stollery, who has a copy of Jon Katzenbach’s The Wisdom of Teams tucked on a shelf. “As you grow, it’s easy to get bloated—you have to fight that and learn to be comfortable in managing chaos.” Even more significantly, the newly anointed oilpatch leaders claim that they have finally learned to manage the disruptive cycle of boom and bust that has historically plagued their performance. It is a claim, however, that world oil markets clearly intend to test. □