The Future of U.S. Independents

The future looks good. It just looks different.

That, in a nutshell is where I'd like to end up today in terms of my thoughts on the future of independents, or the non-integrated exploration and production companies in the United States.

When I was asked to spend a few minutes with you on this topic, I was eager to do so because of the excitement I feel by being part of the independent sector of our U.S. energy industry--especially when I think about the promise--and yes, the challenges--of a growing domestic natural gas market in the future. The near-term future at that.

I'd like for you to take several things into account as we visit today.

First, my impressions of the future of independents are just that--impressions. No one really knows what our future is to be. But all of us have ideas, and I'll take a risk and share mine with the hope they'll stimulate some discussion --even disagreement--that will make for an interesting session and perhaps help us all to think more clearly about the future.

Second, please remember whom I represent, and with whom I am perhaps most familiar. It's the large independents.

The Domestic Petroleum Council is a national trade association representing 22 of the largest United States independent natural gas and crude oil exploration and production companies.

Most DPC members are publicly-traded corporations, and most have international operations or interests. In fact, at last count, DPC companies had interests in more than 25 countries around the world.

The DPC companies are leaders in developing and applying technology necessary to find and produce oil and gas onshore and offshore, including in deep water in which our companies have some one thousand Gulf of Mexico interests, including a number of operatorships.

A recent Deutsche Bank analysis found that in 1998 DPC companies drilled some 70% of independent wells in the United States, and nearly half of all wells drilled.

Maybe that's an appropriate lead-in to the substance of what I want to say today. It is that independents have extremely important roles today in the United States and will have them in the future. But in my opinion those roles will be based on independents' abilities to adapt and change to increasingly take advantage of significant niche, or more focused, opportunities.

We've all seen the changes that independents have gone through over the past decade or two. From a personal perspective, I began my energy career with the medium-sized integrated Sun Company, or "Sun Oil" as it had been known since even before Spindletop.

When I joined Sun in 1978, it had just gone through a "dis-integration" phase, setting up numerous subsidiaries with business line responsibilities. In the upstream we had Sunmark Exploration Company, Sun Gas Company that I worked for, and Sun Production Company. Although not truly "independent", each was supposed to act that way. Then, as a partial response to the oil price drop of the mid-eighties, and to gain efficiency, the upstream companies were merged into one: Sun Exploration and Production Company. In 1988 we were spun off to become, at that time, in some respects the largest US independent, later renamed Oryx Energy Company.

But the industry continued to change, and Oryx was eventually acquired by Kerr-McGee. In fact, as President of the DPC I saw our membership shrink to 16 members in 1999 in large measure because of mergers and acquisitions among our companies, and the uncertainties caused by the disastrous drop in oil prices in 1998. Principal merger examples were the Kerr-McGee/ Oryx and Burlington Resources/ Louisiana Land and Exploration ones. (My suggestion at the time that if a member bought another it would owe us a three-year dues exit fee fell flat.)

But we also saw Devon Energy buy PennzEnergy, and a number of our members buying properties from integrated companies and independents alike--getting bigger to do more of what they do best.

Which brings me to my first real point about the future.

It seems to me that a principal niche role for independents in the US will continue to be in the acquisition of properties no longer of as much strategic importance to the major integrated companies as they themselves grow larger and have need to focus on larger projects.

A corollary here: There will also of course be, and there are today, independent acquisitions of properties from smaller independents. There are also numerous purchases of, or mergers with, smaller independents themselves, where there are cost, operational and other advantages to be gained-or perhaps where the acquiree hasn't found one of the niches we're discussing.

Large and small independents will continue to be able to come out on top this way because of their comparatively low-cost structure, their historical presence and experience in geographic and geologic areas, and their willingness and ability to find enough value in more focused projects and operations.

It seems to me that another very significant related point is that independents will also continue to have wonderful niche opportunities to explore for, develop and produce natural gas and oil resources in areas, or even fields, in which the major integrated companies have less interest. Again, that reduced interest may be because of the size of the discoveries that the major integrated companies need, whether to supply their refineries or to provide the volume of cash flow their structure demands.

Is there evidence of these trends in independent activity? Sure.

Look first at who is producing most U.S. natural gas. The just-completed National Petroleum Council gas study finds that nearly three quarters of our 1998 natural gas supply came from independents. With projections of a demand increase of one-third or more over the next decade, I'd say that the independents' future in natural gas is bright indeed.

That is especially true for the larger independents that are able to bring financial strength with their high technology application--the same technology that the majors have--to search for and produce gas from the increasingly important non-conventional formations like tight sands, Devonian Shale and coalbeds as well as from conventional formations. This holds true for oil as well.

Is there evidence of a shift toward a growing domestic role for independents in general and the larger independents in particular? Yes again.

One of our member companies, Devon Energy, not long ago did some very interesting work on this subject. Devon compared publicly-reported 1982 and 1997 reserve data from the integrated companies and utilities with that of all publicly-reporting independents, broken down by the 20 largest and all other independents. The findings were stunning. Devon found that ownership of US reserves by the integrated companies and utilities had dropped from 89% in 1982 to 71% in 1997--a reduction of 20%. Reserves held by small independent companies rose from 5% to 10%, a 100% increase. But the largest 20 independents had a 217% growth in their percentage of reserves, to 19%. We're waiting for a new analysis of the DPC companies by Deutsche Bank, but I expect their share to be even greater using 1999 data.

One other interesting piece of data came from the Devon work: the total number of publicly-reporting independents below the top twenty fell between 1982 and 1997 from 319 to152.

That brings me to another future point.

It seems obvious that we'll have fewer independents as our industry consolidates in the U.S. But I don't know how many fewer. I am not one to predict an extinction of the smaller producers. I just don't believe it given the cost, geographic and niche roles I mentioned. As one smaller company owner whom I respect tremendously put it recently, "Who else is going to operate those thousand wells in the Illinois Basin?"

As another said: "We're like amoebas--if the opportunities are there in the future, we'll grow and multiply."

Trending against that prediction may be a lack of required skills and training--and the interest of our young people in getting it or applying it in the oil or gas patch. I've not investigated the trend, but we hear and read about our premier engineering and geoscience schools having fewer such graduates--and most of those seemingly to be going into non-hydrocarbon-related fields like environmental management.

But, my point remains--while there will undoubtedly be fewer independents in the future, small independents as well as large ones will continue to have important -- even crucial -- niche opportunities and roles in this country.

I've been focusing to this point on the United States. But let's talk international for a moment. I said that DPC companies are involved in more than 25 countries around the world. Let me put a finer point on that. They are increasingly sought as partners by countries and companies overseas. I am frequently called by embassy representatives and sent conference or solicitation material by those wanting to know more about our members or wanting them involved in some international activity.

In talking with member company executives, I find that there is growing realization that these companies are high-tech, that they are low-cost operators, and that they are nimble--they can move quickly when an opportunity arises.

I also want to go back to a point I made earlier about those opportunities. Overseas as well as domestically, it seems to me that independents will not so much compete in what historically has been a major integrated-dominated sector, as they will fill out the picture. They will find size, location and expertise niches.

Let me give you an example. At last year's Africa Energy Ministers Conference, a representative of another of our DPC companies, Burlington Resources, showed a dramatic field size distribution curve of what he termed "somewhat hypothetical" oil field sizes in West Africa.

His point was to show that along the curve an independent like his would be far more interested in, and willing to apply its financial and technical resources to, the search for more-probable smaller fields than might a "super major" integrated company. That point was not lost on the energy ministers.

A caveat: While I am referring primarily to the large independents of the DPC, clearly international activity is not theirs exclusively. Some smaller independents have found very interesting and lucrative international niches also. I was visiting just last week with a Michigan family independent who was telling me about projects in West Africa and the Philippines.

Finally, a couple of brief thoughts on additional possibilities about the future of independents.

I think the trend toward "contracting out" for services in order to focus on core competencies must continue. We see our large independents doing this not only for things like legal and human resources support, but also for even field operation. The question for smaller independents may be whether the have additional niche opportunities in the future as contractees as well as contractors.

Another corollary here: As independents seek to save money on the services they need to buy, I'll be interested in following the future of partnerships with service companies, including those with equity participation in exploration and production projects.

Last of all, in an area for which I have little feel, but much interest, I am watching the future of independents, perhaps more overseas, moving into arrangements involving mid- or downstream projects. Providing gas to a jointly owned electric generation or petrochemical plant, for example. I hear a bit about such projects, and suspect that we'll see more. Then the question may be to what degree, in such cases, we may have blurred the definition of the "independent" itself.

I hope these thoughts have been of interest.

I look forward to your comments and questions.

Domestic Petroleum Council contact: Bill Whitsitt, 202 544 7100