Sunday, September 28, 1997

Energy's independent producers rising to become near-equals of the majors

By HILLARY DURGIN Houston Chronicle

HOUSTON -- For Bobby S. Shackouls, running one of the largest independent oil and gas companies isn't enough. He wants to be in the same league as the majors -- and he's well on his way to reaching that goal.

Burlington Resources is about to close its $2.5 billion acquisition of Louisiana Land & Exploration Co., ranking it third in domestic natural gas reserves after Amoco Corp. and Exxon Corp.

The addition of key deepwater prospects in the Gulf of Mexico and properties overseas gives Burlington both the mass and the marketing muscle to make it competitive with both independents and major oil companies.

"We wanted to create what we considered the first super independent," says Shackouls, president and chief executive officer at Burlington. "That's a company that has all the assets of a major," he noted. "But on the other hand, we'll be able to operate with the mindset of an independent."

Independent oil and gas companies, once considered niche players within the industry and on Wall Street, have finally come into their own.

In the past few years, as these companies have grown, management has become more sophisticated, and technological advances have improved business prospects.

And while independents have long wrestled with the stereotype of being self-promoting swindlers and small, unstable candidates for investment, they are finally shattering that image.

Ten years ago, "You had this J.R. Ewing perception," says Mark Jackson, chief financial officer at Forth Worth-based Snyder Oil Corp. "People would look at people in the oil industry as that type of person unless you were an Exxon."

Today, "There's a much higher confidence level in the group. They are more sophisticated, they are global players a lot of the players have good track records, (and) the people that weren't successful have been merged into stronger companies."

In 1996, for example, domestic exploration spending by the independents far outpaced that by the major oil companies. Now their outlays nearly equal that of majors within the United States.

And this year, many of the independents, which have aggressively expanded overseas and led majors into international projects, are stepping up spending abroad.

Over the past 10 years, the number of independents with more than $100 million in equity capital has gone from a handful of public companies to more than 65, based on the universe of companies followed by Merrill Lynch.

Independents are further increasing their size and scope as they embark on a new round of mergers and acquisitions. Besides Burlington's acquisition, these include Mesa's recent acquisitions of Parker & Parsley Petroleum Co. and Chauvco Resources Ltd., and the hostile takeover bid by Union Pacific Resources Group for Pennzoil Co.

In the past five years, the market capitalization of the top 25 largest independent oil and gas companies has more than tripled to $55.9 billion from $17.4 billion in 1992, according to John S. Herold, a Stamford, Conn. based energy research and consulting firm.

Five years ago, only a handful of companies had capital worth more than $1 billion, including Anadarko Petroleum Corp., Burlington Resources, and Enron Oil & Gas Co.

Now this recent wave of mergers is ushering in a new group of "mega independents" with capital in the $5 billion to $10 billion range.

"My observation is that there is a new target amongst the bigger independents," says Eric Grubman, co-head of Goldman Sachs & Co.' energy and power group in New York. "I don't think the goal is 1 to 2 billion dollars anymore. People are saying this is the age of the super independent and the goal is 5 to 10 billion dollars."

"It's not to get big just to be big," he notes. "They feel that to generate superior returns they need to venture into the frontier areas and in order to do that, they feel like they need to have bigger balance sheets."

Burlington Resources, for example, has been on an expansion drive since it was spun off from the Burlington Northern Railroad Co. in 1988. It has grown by picking up properties in the San Juan Basin, which are concentrated in New Mexico, and in the Gulf of Mexico as majors have sold U.S. oil and gas holdings.

But those sales have slowed, and the company realized it needed to place more emphasis on exploration to continue to grow. Over the past four years, it has increased its annual exploration budget to $250 million in 1997 from $20 million in 1993.

Louisiana Land & Exploration Co. offered a rich selection of prospects with bigger rewards -- and higher risks -- than Burlington possessed. These included promising deepwater plays in the Gulf and projects overseas in Venezuela, Algeria and the North Sea, where Burlington had not ventured.

After the deal closes, Burlington's natural gas reserves will total 7.7 billion cubic feet, ranking it second in worldwide reserves among independents behind Unocal Corp. Compared with both majors and independents, the new company will rank third in domestic natural gas reserves after Amoco Corp. and Exxon Corp.

The same strategy is driving other deals.

"Companies that are cash-rich and drilling-opportunity-poor (are) seeking the exact opposite, and those make the best combinations," says Wayne Andrews, oil and gas analyst at Raymond James & Associates in St. Petersburg, Fla.

For Burlington, this transaction was a way to increase its size and bolster its financial strength, enabling it to better compete against fellow independents and major oil companies.

The independent mindset at Burlington and other companies is a focus on keeping operations lean. It has allowed them to grow aggressively by profitably operating properties that were sold by major oil companies, which were losing money on them.

"They've managed to really profit and really make money on these properties," says Aliza Fan, an oil and gas analyst at John S. Herold Inc. "By keeping costs down and working those properties, they've been able to reinvest their cash flow into their business."

At the same time, the exploration and production sector has become a magnet for capital. Investors are now targeting this group as a vehicle for growth, Fan says.

In addition, the industry has finally come out from under the pall cast by the shady deals of the eighties. Gone are the aggressively marketed limited partnership deals in which mom and pop investors fell prey to swindlers looking to pour their cash into questionable oil and gas prospects.

And while there always will be promoters who hype their stock by raising false hopes about a well with a huge potential payoff, these big companies don't rise and fall on a single well.

In 1996, spending on U.S. exploration by independents came close to equaling domestic exploration spending by the majors, according to a recent survey by Arthur Andersen.

The majors accounted for 51 percent of total domestic spending of $21.6 billion in 1996. Compared with the independents, their share has declined since 1992 when the majors spent $8.1 billion for 61 percent of the total.

"Most of the independents have their costs under control They can focus more on growth," says Victor Burk, managing director of Arthur Andersen's worldwide energy industry service group in Houston.

The biggest U.S. spenders among the independents in 1996 were Union Pacific Resources, which spent $694 million; Burlington, whose spending declined to $432 million; and Enron Oil & Gas, whose spending totaled $384 million.

Independents no longer are limiting their operations to the United States.

While their domestic spending is increasing at the fastest pace, independent oil and gas companies are speeding the growth of their international spending as well.

They plan to increase international spending by 20 percent in 1997, well above the 13 percent gain they posted in 1996, according to a Salomon Bros. analysis of 1997 worldwide oil and gas exploration and production spending.

At Apache Corp., for example, which has increased its international operations through several recent acquisitions, the company plans to more than double spending internationally to $265 million in 1997.

In 1996, the company merged its operations with Phoenix Resources Cos., expanding Apache's operations in the western desert of Egypt and giving it a broader expanse of undeveloped, potentially rich acreage .

But as companies get bigger, it is becoming harder to find deals large enough to equal their performance in recent years.

"It's going to be very difficult for the large-cap companies to repeat the kind of performance they've had without having a sizable exploration side to their business," says Snyder's Jackson.

The biggest payoff for investors over the next five years is going to come from small and mid-sized companies where a discovery of a field holding 100 billion cubic feet of gas, for example, can have a significant impact, he contends.

"There's a lot of opportunities for growth from making the right acquisition and from exploration."

Snyder also is looking to add key areas for oil and gas production, either domestically or internationally, and has more than $400 million earmarked for an acquisition.

While these companies are experimenting with a new identity as steady-growth companies, their fortunes remain tied to the prices of oil and especially natural gas.

"You (have) got to be ready for a pretty volatile, pretty tumultuous ride in the stock," analyst Andrews says.