CONFERENCE REVIEW / SEVENTH ANNUAL PACESETTERS ENERGY CONFERENCE
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DAY 3, THURSDAY, SEPTEMBER 24, 1998
Panel 1 - Herold's Top 1997-1998 Dealmakers
Executives from four of Herold's top 1997-1998 dealmakers; Atlantic Richfield Co., Occidental Oil & Gas Corp., Tesoro Petroleum Corp. and Union Pacific Resources discussed their deals and lessons from them.
Donald R. Voelte, Senior Vice President of Atlantic Richfield Company, discussed how their upstream transactions fit ARCO's strategic goals, noting that Arco focuses and seeks scale in specific focus areas. ARCO's E&P focus areas are the Gulf of Mexico and Alaska in the U.S.; SE Asia (incl. China), Latin America, North Sea and North Africa, internationally. R&M's focus is primarily the West Coast (US). Voelte believes that ARCO's recent transactions are consistent with its strategies while increasing its producing and reserves base. Through the Union Texas purchase, ARCO achieved an immediate 14% production gain of 135 MBOE/D and a 14% reserve increase of 570 MMBOE. This transaction also provided ARCO with an estimated $130MM cost savings from consolidation. ARCO's 25% interest in the 10-12 TCF gross reserve Block A-18 Joint Development Area of Malaysia/Thailand was acquired for a $150MM down payment and agreement to develop Triton's interest in the block. ARCO also traded its heavy oil California assets for 60 MMBOE of Vastar's proved reserves in its Gulf of Mexico focus area.
Senior Vice President Business Development Casey Olson of Occidental Petroleum outlined his Company's towards a simple more focused growth oriented organization. The "Elk Hills" purchase was the major catalyst for this change, and the trigger to dramatically redirect assets in the lower 48, yet increase reserves. The divestitures of the non-core U.S. assets reaped a tidy $825MM or $5.71/BOE while the sale of Dutch North Sea and Venezuelan assets returned about triple their cost. In addition, the major strategic Oxy/Shell swap (adding producing property interests in Colombia and Yemen in exchange for future development acreage in Malaysia and the Philippines) realized a nice increase in production and accompanying $100MM in current cash flow while avoiding future capex of $1.8 billion. Olson admonished: "Watch this face, we're not done yet."
Union Pacific Resources' Dick Eales, Executive Vice President, spearheaded UPR's deal making activities in 1997-1998, in particular, the failed hostile takeover bid for Pennzoil in 1997 and subsequent successful friendly takeover of Norcen of Canada. Eales also discussed smaller acquisitions made by UPR in 1997 and its current de-leveraging program. Consuming much of 1997, the hostile takeover bid for Pennzoil ultimately failed due to UPR's inability to strike down the poison pill defense of Pennzoil. Eales noted that little over 60% of Pennzoil's shares were tendered but had to be returned. Several lessons were learned from the failed takeover bid. First, avoid unsolicited offers. They are expensive, time consuming and unlikely to succeed. Second, if you must make a hostile takeover, make an all cash offer. UPR's hostile takeover offer failed, in part due to an initial $84/share cash offer for only 51% of the shares, leaving the door open for criticism that the offer was inadequate. Third, if you try a hostile takeover, be prepared that your target company will take you into a court battle that will expose you to a legal discovery process and make public all your internal memos, as well as possible associated embarrassment. The lessons learned from the failed hostile takeover, plus a number of small acquisitions UPR made in 1997 totaling $376MM, prepared the UPR acquisition team well for the eventual friendly takeover of Norcen in Canada. Norcen became available for acquisition in November 1997. UPR made initial calls in December 1997 and signed the deal in January 1998. Although, the Norcen acquisition accomplished UPR's objectives of growth through acquisitions, it was financed largely with debt. The resulting debt has since hurt the stock price of UPR. To de-leverage the company, UPR began an aggressive divestiture program in early 1998, selling off $250MM of non-core assets and hopes to finish the program ahead of schedule.
William Van Kleef, Senior Vice President and Chief Financial Officer began his discussion of Tesoro Petroleum Corp. by noting the 1995 financial restructuring of debt, which left Tesoro with three undermanaged business units and an appetite for acquisition. With management issues taken care of, an acquisition strategy to complement Tesoro's existing asset base, match core competencies, focus geographically and be earnings accretive was formed. After studying market conditions, Tesoro initiated two refining acquisitions to complement their existing Alaska refinery. Located in Hawaii and the U.S. West Coast (Anacortes), the acquired refineries were purchased for $535MM (less than 5.0x historical EBITDA) and provided Tesoro with 203,000 b/d refining capacity (total now 275,000 b/d). An estimated $25MM in synergies is expected to lower the overall cost structure of Tesoro's downstream operations. Company's three refineries will be run as an integrated system, to take advantage of each refinery's strength. Tesoro has now become the second largest independent refiner and third largest jet fuel supplier in PADD 5. These acquisitions have also resulted in a tripling of total corporate revenues to $3.0 billion and total assets to $1.8 billion. Pro-forma EBITDA (including expected synergies) of $215MM is more than double the pre-acquisition level, but debt/capital is now 45% versus 26% prior to these purchases. Tesoro plans to make tactical acquisitions in the U.S. and has commissioned TOTAL NA to explore additional acreage in Bolivia to take fuller advantage of the Bolivia to Brazil pipeline expected to be completed in early 1999. Spearheaded by Bolivia, net proved reserves have increased 2.5-fold since 1995 with further growth expected.
JSH Analysts: Olga Kovalenko, John Parry, LJ Tyler, Brendan Voege, Michael Wang
Panel 2 - Global Midstream -Aggressive Expansion to Continue?
Growth through consolidation and integration was the key theme among the Global Midstream panelists. As this year's representatives presented three different perspectives on the challenges facing this business sector. The investment community articulated on the current industry dynamics driving consolidation among the players. A leading integrated domestic energy player demonstrated ample proof of how integration is shaping his company.
Internationally "cross-border integration" was the central issue for an Argentinean energy company. John E. Olson, Senior Vice President, at Sanders Morris Mundy stressed that significant growth in the midstream sector would not be achieved internally, but would be driven only through M&A activity. Olson believes that an investor could do well in this sector. He stressed that industry consolidation will present buying opportunities from future acquisitions and divestitures as companies position themselves to become leading integrated energy natural gas companies. Value creation would occur from the gas gathering, processing and marketing business segment. For example, Olson estimates that Enron Corp.'s expected EBIT will triple within five years. This EBIT growth will be driven by the gas midstream businesses which are targeted to contribute 55-57% of total. The tradeoff to growth will come at the expense of profitability, as the remaining survivors compete for the market share. KN Energy typifies the emerging trend of integration in the gas midstream sector. David Ries, Vice President of Business Development, stressed that in order for the company to stay competitive in today's deregulated market, the midstream expansion must continue. It is not enough to be just an E&P company producing natural gas, to insure long-term success requires integration from the wellhead all the way to the customer. Gas production, gathering, processing, transmission and distribution are all vital business elements of a modern integrated midstream energy company.
To achieve integration, the acquisition path has been part of KN's growth strategy, as evidenced by their recent MidCon acquisition, which provided the company with a new base of regulated assets and $100MM in annual cost savings. Building upon a strategy which is dynamic, KN is capitalizing on changes in the electric utility industry. Partnering opportunities are emerging for integrated gas energy companies, as KN to fill the increasing demand to provide natural gas to fire turbines generating electricity. The gas demand for power generation is expected to at 10 TCF per annum by 2020.
Internationally, "cross-border integration" is the game in town in South America, as articulated by Steven Crowell, CEO of Pluspetrol Resources Corp. In South America midstream gas integration is not limited to an vertical business integration, but rather is evolving into a multinational integration business organization. Driving the growth in gas midstream businesses in South America are increasing political stability, market liberalization, a competitive/dynamic environment and an increasing privatization of state owned companies. With GDP expected to grow at 4 to 4.5% over the next ten years, and energy demand expected to exceed economic growth, this creates greater return opportunities in the gas midstream sector. This growing demand for natural gas will also necessitate a greater demand for natural gas infrastructure in South America ranging from gathering and processing facilities to transmission and distribution pipelines. To expand the market for Bolivian and Argentinean gas production, Pluspetrol undertook a power generating project in 1996, the Tucuman Power Plant, located in northwestern Argentina. The plant is located in close proximity to an important gas pipeline, which is connected to the national grid. The facility is currently being converted into a combined cycle plant (460MW). The Atacama Project where Pluspetrol hold 16% WI includes a construction of 920 km gas pipeline from northern Argentina to Chile and the construction of two power plants in Chile. It was noted that the success of these cross-border energy ventures is dependent on the successful cooperation of participating national governments.
JSH Analysts: Lou Gagliardi, Ivana Vrankova, Chris Foreman
Panel 3 - International E&P - The Right Geography & Geology
When the strategic question of country selection arises, the three companies on this international panel ranked geology above geography. The companies, all independents, were willing to accept substantial political risk if it meant exposure to prolific hydrocarbon producing areas; in other words sacrificing a little geography in order to receive top geology. This perhaps results from the fact that the international exploration game is typically dominated by the majors, so world-class assets are available only if company management is politically fearless with its capital.
Monument Oil & Gas, is a U.K. independent E&P company that earns its current cash flow from its U.K. operations, but its growth story is in its international programs including the Caspian area (onshore), Pakistan, Algeria, and Colombia. Of all its international areas, Monument is most active in Turkmenistan, where production from the Burun field is expected to increase from 6,000 b/d at acquisition to 26,000 b/d by year-end. Current Burun production is over 18,000 b/d but production is projected to reach 40,000 b/d in 1999, before hitting transportation constraints. Transport and operating expenses on the field are $9.50/bbl and DD&A is $3.00 with Burun oil receiving a premium price to Brent. Monument has recorded exploration successes this year in Pakistan, Algeria and Colombia.
International E&P is a large part of Santa Fe Energy's growth strategy. Santa Fe's niche strategy is to focus on small exploration targets that would not typically show up on a major's radar screen. Santa Fe prefers proven basins, with existing infrastructure (so its discoveries can be brought on production quickly), thus capitalizing on their core competence of project management. Unlike Monument, Santa Fe prefers to operate its new ventures and generally prefers quality fiscal terms. Santa Fe has made eight international exploration discoveries so far this year in Gabon, Indonesia, Argentina, and China which are expected to boost international production from a current rate of 27,000 b/d to 40,000 b/d in the year 2000.
Seven Seas Petroleum, the third and smallest speaker on the panel, is 100% exposed to Colombia. The company admits Colombia is a difficult place to operate with rebels and one of the world's worst fiscal regimes, including a 50% back-in clause by Ecopetrol, the national oil company. Seven Seas principal asset is its 57.7% interest (before Ecopetrol back-in) in the world-class Emerald Mountain discovery. The Phase I pipeline construction is expected to be completed 3Q 1999 at gross 50,000 b/d, with Phase II scheduled for mid-2000 at a rate of 250,000 b/d. The company also has a high potential deep test scheduled this year.
JSH Analysts: Andy Byrne, Lou Gagliardi, Dan Pratt
Panel 4 - M&A Equity Transactions - Creative Deal Structures
Jeffrey Clarke, Chairman of COHO Energy, Inc., discussed the past, present, and future acquisition strategies of COHO Energy. Company's core strategies involve maintaining a concentrated reserve base, focusing on low-risk field development, and obtaining a dominant working interest. COHO was able to build a concentrated area of operation in Mississippi, through a series of bold and creative acquisitions. The company's Laurel field serves as a prime example of this strategy as they acquired a field producing 25 BOE/D and 15 years later turned it into a field that is producing 3300 BOE/D. COHO demonstrated this bold strategy as they acquired "high-impact international exploration potential" in Tunisia. COHO acquired a 50% interest in 1.4MM acres of the Anaguid permit and will be looking to commence drilling before the end of the year. Citing a need for flexibility as key component of growth, COHO Energy embarked on perhaps its boldest move, an equity-for-cash deal with Hicks, Muse, Tate & Furst for $250MM. This new cash-on-hand will enable Company to go forward with its "aggressive and defensive" strategy in pursuing opportunistic acquisitions in the current low commodity price environment, which Clarke sees continuing for another 18 months. COHO will look to accomplish its core strategies by seeking opportunities to concentrate its assets and obtain future exploration potential.
Joseph Wm. Foran, founder, President, Chairman and CEO of Matador Petroleum Corp., discussed a recent assets for equity swap transaction with Spirit Energy. In the recently completed assets-for-equity swap, Matador exchanged a 35% common stock interest for Spirit Energy's southeast New Mexico assets with 16 MMBOE of proved reserves. Spirit Energy also received 4 out of 12 board seats. In this deal, Spirit Energy receives an equity growth vehicle in an aggressive, low cost local operator, equity accounting treatment and reserve growth with $0 finding costs and $0 overhead. Spirit Energy plans to exit via a future IPO. For Matador, it gained a platform for high impact growth, quality production, cash flow and prospective inventory. Matador also gets strategic insights and assistance from Spirit Energy, as well as equity ownership in friendly hands. Foran says that the key to a successful creative deal structure is: the deal must be executed by creative, reasonable and practical people; there must be a relationship with sellers born of necessity for deal consideration other than cash; and both parties must have clear objectives, and appreciation for each other's needs and parameters.
Staying true to the theme of the panel, Greg L. Armstrong, Chairman & CEO of Plains Resources, Inc. discussed some of the combinations of equity deals that Plains has been involved in over the last ten years. Most employed permutations of warrants, common stock, preferred stock and other performance based considerations. Armstrong warned that although these are excellent ways to creatively enable acquisitions, you must be prepared to walk away if the cost is too high as a poor acquisition can saddle a company for many years. The most unique strategy he discussed was what he called a "Quasi-rights" deal wherein he suggests going directly to the largest shareholders and raising capital in exchange for more equity thereby avoiding the costs and difficulty of new issuances. Armstrong ended by noting that Company had grown its reserves from 1.4 BOE/share to 9.2 BOE/share and that "just getting bigger is no good, we've got to be getting better, too".
Jim Funk of Shell Continental Co. (Shell E&P) outlined the several options faced by his group in managing its portfolio of mature E&P assets: Continue to own and operate in order to maximize value to the company; retain base production while sharing the upside with another operator or full-service contractor; geographic alliance for scale and synergy; partial sale to efficient operators; trade for equity position; and sell for cash (with or without an upside option). If the decision is for a partial sale or trade for equity, Shell seeks operators with proven capabilities, a shared vision, and the prospect of a good working relationship after the transaction is completed. And, of course, any deal must offer a "clear value proposition." Funk described examples of two recent SEPCO deals that resulted in the sale of 50% of isolated, mature fields while retaining the operatorship. The first involved the sale of South Texas properties to Enron Oil & Gas while the second covered its Shelf properties to Ocean Energy. In its biggest deal to date, SEPCO sold all its Louisiana properties, including acreage and seismic data, to Texas Meridian Resources for a combination of cash, preferred stock and common stock, giving Shell a 49% position in TMR. This provided Shell representation on TMR's board and the ability to monitor TMR's stewardship of the properties. Another asset-for-equity deal, about to be closed, involves the sale of Shell's remaining isolated Alaska properties in the Cook Inlet to Cross Timbers for two million shares with a guaranteed valuation of $20/share. If the market price is less than $20, Shell gets the difference in cash. These latter two deals highlight, in Shell's mind, a new and different way of thinking for a major oil company, while at the same time recognizing that its enthusiasm for equity may now be on the back burner in view of current market conditions. Shell says it may have to invent some new approaches to selling its Montana properties, including the Cedar Creek anticline.
JSH Analysts: Bill Knasel, Michael Horsch, Charley Andrew, Michael Wang
Panel 5 - A New Lower Level for Oil Prices? - Leading Petroleum Price Prognosticators Air Their Views.
With the aid of value-added overhead slides, but without the use of a crystal ball, our esteemed panelists ventured forth and offered opinions on the recent state of oil prices as well as likely scenarios for the near future. Panelists were in general consensus that oil prices are inherently unstable and were likely to remain so, but added that OPEC still has a key role to play in managing or attempting to manage the delicate supply/demand balance.
Tom Wallin, Group Editor of Energy Intelligence Group, quickly answered the title question put to panelists with a resounding "No", pointing out that prices are likely to remain volatile as the willingness of OPEC to support quotas was bound to vary. Wallin estimated a current surplus global inventory of some 165-195 MMbbls. At these levels, he believes the estimated surplus is likely to remain for some time even with an anticipated winter drawdown. After stating that prices do seem to have hit bottom, Wallin cautioned that while there are reasons to believe prices will recover from current levels, they still could revisit lows of the recent past.
George Littell, Partner of Groppe, Long & Littell, opined that oil price forecasting is indeed a tough business with fundamentally unstable prices due to inelastic demand and low variable costs of production. Littell outlined the average crude price since 1860, highlighted by two long periods of stability (1878-1915 and 1935-1972, respectively) following the formation of Standard Oil and prorationing by the Texas Railroad Commission. Littell believes that OPEC led by Saudi Arabia has been a poor substitute for the TRC, citing the oil price shock in 1973, the "buyer's panic" of 1979-80 caused by the Iranian revolution, the decline in Saudi production from 9.8MM b/d in 1979 to an average of 3.5MM b/d in 1985, and its present policy of "8.0MM b/d and hope for the best" beginning in late 1993. Littell concludes that the current drop in oil prices is a temporary phenomenon, with a likely transition from a Saudi run OPEC to one led by Iraq on the near horizon, and suggests monthly OPEC meetings would be optimal for supply adjustments based on market demand and inventory build.
The last of the price prognosticators, Philip K. Verleger, President of PKVerleger LLC and the Brattle Group, immediately loosened up the audience by facetiously referring to the number one rule to follow as an Economist: "Never put a number and a date on the same page". Industry watchers were reminded to heed the lessons of the past, particularly those learned in the economic depression of 1929-1933. Verleger believes that the serious economic downturn in Asia (and possibly U.S. and Europe to follow) poses the danger of pulling down oil prices for an extended period. As a basic tenet, "It's Inventories" rings as true as "It's the Economy, Stupid", suggests Verleger. Verleger estimates that 1MM b/d of consumption has been knocked out by the collapse in Asian demand (suggesting OPEC needs to take another 1MM b/d off the market) and believes that current consensus estimates of Asia Pacific growth still may be overstated. Furthermore, the tendency of oil prices to revert to the mean over the past ten years would suggest a price range of $17-$21/bbl for the near future.
With the presentations completed, moderator Jeff Roberts of Madison Energy Advisors put panelists on the spot with aninformal poll of oil prices over the next five years. The anonymous responses ranged from relatively bearish escalating prices of $15-$20/bbl, with one call for $24 oil in 1999. Let's hope so.
JSH Analysts: Chris Sheehan, LJ Tyler, Chris Foreman |
