Oil

by Tom Bower

  Raymond had behaved with unusual diplomacy at the meeting, although his assumptions were privately questioned by others present. The industry’s economics, they believed, were fundamentally changing. As a tradable commodity, oil derivatives rose as fast as they fell in an “aggressively self-correcting market.” While Raymond and the OPEC countries conservatively assumed that every new crisis would duplicate past ones — Iran in 1979 and Iraq–Kuwait in 1990 — Raymond’s critics recognized that the new breed of traders responded more quickly to changes, usurping Exxon’s influence. John Browne, unlike Raymond, had understood that survival in such turbulence meant recognizing that oil prices were beyond the producers’ and the oil majors’ control. Stability depended upon assessing the profitability of each operation as “return on capital employed” by managing and reducing costs, increasing profits and production volumes and avoiding self-inflicted wounds.

  This mathematical modeling was a far cry from Ali al-Naimi’s search for solutions to Saudi Arabia’s predicament. The former shepherd, born on September 28, 1935, had abandoned his “many, many sheep” at the age of 12 to join Aramco as an office boy. His break came when he studied geology at Stanford in California, and his understanding of the shifts of oil’s history was to prove invaluable as he rose to become Saudi Aramco’s president. OPEC countries, he realized, could not uniquely determine the world’s fate. In the cause of complying with market demands rather than dictating to the globe, al-Naimi decided to end Saudi Arabia’s traditional power struggle with other OPEC members, especially Venezuela and Iran, and to apply some free enterprise to OPEC’s management. OPEC’s isolation, he decided, should end. Discreetly he summoned another conference of OPEC countries in Riyadh. He did not reveal that Luis Tellez, Mexico’s energy minister, was invited to the meeting, although Mexico was not a member of OPEC. Tellez, a 41-year-old economist without previous experience in oil, had been stung by the news about one shipment of Mexican oil that sold for only $7 a barrel. The Mexican newspaper headline “Crude Prices Shipwrecked,” echoed his fear of a national calamity. Studying his country’s plight, he realized that, contrary to orthodox teaching about markets, the traditional formula of supply and demand should not apply to oil prices. Oil was different. With unlimited supplies, prices were determined entirely by demand. Creating “supply anxiety” among the traders would determine oil prices. “Oil trades on psychology,” Tellez appreciated. OPEC’s production, he believed, should immediately be cut by up to five million barrels a day, until prices stopped falling, and should thereafter be kept at a level below demand. The 800 million barrels of oil in storage should be reduced to remove that cushion. Before flying to Riyadh, Tellez met the energy minister of Venezuela, which had reached a similar crossroads to Mexico. Nationalism was hampering both countries’ oil industries and damaging their economies. Both could either maintain their exclusive control of production, or invite investment by the oil majors.

  Foreign investment in Mexico’s oil — the country’s lifeblood — had been complicated ever since nationalization in 1938. Expressing a mystical relationship between oil and sovereignty, Pemex was a bureaucratic social security agency rather than an oil corporation. In 1981 it had spent $6 billion on capital developments, but in 1988, with 213,000 employees, it had invested just $1 billion to develop new wells. Insular and inefficient, the Mexican oil industry stagnated, producing about 2.5 million barrels a day, denying the country the potential benefit of higher prices. In 1990, there seemed no prospect of change. Pemex’s finances had been plundered to support socialism and corruption. “I want to confirm the fact,” President Carlos Salinas told parliament, “that Mexico will maintain its ownership and complete dominion over hydrocarbons.” The consequences in April 1992 were fatal. Gasoline fumes had seeped from a Pemex facility in Guadalajara into the sewers, causing an explosion that killed 205 people and injured 1,470. Mexicans linked the disaster with nationalization. In 1995 Joaquin Hernandez Galicia, the head of the Mexican oil workers’ union for 25 years, admitted, “My oil workers were corrupt, drunken and courageous.” His imprisonment for murder and stealing millions of dollars highlighted Pemex’s need for foreign technology and independent management. The nationalistic barriers cracked. Financed by $20 billion in US loans, production increased in 1995 to 2.85 million barrels a day. Falling oil prices in 1998 encouraged the movement toward privatization.

  Venezuela appeared to be heading in the same direction. Although PDVSA, the country’s national oil company, was the same size as Mexico’s and had been nationalized in 1976, it was eight and a half times more profitable, earning $2.7 billion in 1990 compared to Pemex’s $320 million. PDVSA employed 47,000 people, one fifth of Pemex’s staff. The United States bought two thirds of Venezuela’s oil exports, and all the oil majors were entranced by the potential represented by the country’s reserves of 66 billion barrels of conventional oil (5.8 percent of the world’s total), 140 trillion cubic feet of natural gas and 268 billion barrels of bitumen oil in the Orinoco, a 54-square-mile area 120 miles south of Puero la Cruz. To meet the country’s need for income from oil to repay the national deficit and reduce its austerity, President Carlos Andres Perez had spoken in 1990 about rapid privatization to increase production by 25 percent. Although a member of OPEC, Venezuela was defying demands by the more militant nations — Algeria, Libya and Iran — to cut production. The president sympathized with Washington’s argument that rising oil prices would damage the world’s economy, not least because his country needed American investment. To restore the impoverished economy, there seemed to Perez to be no alternative but denationalization. Extracting oil required knowledge and money rather than human labor, which only the oil majors could provide. With the promise that “Venezuela is the safe, sufficient and reliable bridge toward energy self-sufficiency for the Americas,” Perez urged the oil majors to invest $48 billion over five years. In contrast to the “inevitability of confrontation” in the Middle East, he added, “The United States can trust, always depend on, Venezuela as a safe supplier.”

  In June 1992, Shell, Exxon, BP and Chevron were asked by PDVSA to bid for inactive fields that, with modern technology, could be revived. The chance of attracting investment was temporarily threatened by a minister’s demand that PDVSA submit any plans to the government for approval, and after a failed coup attempt against President Perez in mid-1992 led by Hugo Chávez, a nationalist, socialist and professional soldier, the oil majors lost interest. Chávez was jailed for two years. In 1996, the same corporations whose assets had been nationalized in 1976 were again invited to look for oil on government sites. They were told that, despite OPEC quotas, Venezuela planned to double production by spending $60 billion. The inducement to sign PSA agreements was tinged by urgency. A bank had failed, and the country was mired in financial crisis. Perez’s negotiations were even encouraged by al-Naimi, who feared that prices could fall from $11 to $5. Al-Naimi was also concerned that the Western oil majors would develop alternative sources of oil, and that non-OPEC countries, especially Russia, would undercut OPEC after consumption increased. He urged the governments of Iran and Algeria to copy Venezuela and invite the Western oil majors to search for oil in their countries.

  The opportunity for the Western oil companies was unique. But they were confronted by a paradox. Although there was a surplus of oil on the market, and the promise that new technology would discover ample new reservoirs, over the previous nine years none of the major oil companies had found sufficient new oil to significantly increase its own reserves. Depletion in the North Sea and Alaska, and disappointment in Colombia, had frozen BP’s reserves. Shell suffered similar problems in Nigeria. Stagnation haunted Exxon, Chevron, Texaco, Arco and Amoco. The producing countries’ new vulnerability provided the majors with an opportunity to surmount their nationalism. Success depended upon nurturing sensitive politicians.

  This was a decisive moment for the Western oil majors. In their search for diversifying supplies, breaking through the nationalist
ic barriers in Venezuela and Mexico was a foretaste of the security that would be guaranteed by developing oil reserves across the Third World. Successfully producing oil in those countries would protect the majors from contraction, and prices would remain stable. But oil executives were rarely subtle, or gifted with a sensitive understanding of the oil producers, especially at a time when President Clinton was politicizing oil in the states on Russia’s southern border and maintaining embargoes against several major oil producers. Yet the arrival of Luis Giusti, the president of PDVSA, at the annual Latin American conference at La Jolla, near San Diego, California, where he reaffirmed that Venezuela’s oilfields would be reopened to foreign investors, sparked the sort of excitement more usually generated by rock stars. Reflecting on the new mood to denationalize, the economist Daniel Yergin, the president of the respected consultancy Cambridge Energy Research Associates, confirmed that privatization was returning: “It’s back to a high degree of interdependence,” he wrote. “Everyone wants to be on the same team now.” A wave of privatizations, including Bolivia’s in 1996, convinced Yergin that the oil majors rather than the national oil producers would dominate the industry. The national producers, he suggested, would be akin to traffic cops and tax collectors rather than significant explorers and producers. The oil majors, he believed, would become transnational entities like the IMF and the World Bank, with the Third World producers accepting the reality of their superiority. Lee Raymond accepted that analysis, and Exxon, like Shell, Chevron and Conoco, began negotiations to return to Venezuela. The country’s oil industry, they knew, was in a desperate state. Wells had fallen into disrepair, and the country was struggling to produce even 2.4 million barrels a day. Exxon, said Raymond, would fulfill its contract and would expect to be treated fairly. Venezuela’s political turmoil terminated that hope. On February 2, 1998, Hugo Chávez was elected Venezuela’s president. Ideology rather than economics propelled Chávez to reverse Giusti’s agenda and deny American corporations the chance to develop Venezuela’s oil. PDVSA was, he said, to be brought under his control and would cease to be a “state within a state.” Three trusted supporters were appointed as directors, none with any experience in the oil industry, especially the army officer appointed as the director of finance. By the end of 1998 Chávez had halted the $65 billion renewal program, which he dismissed as an “irrational” expansion of production. The Saudis could silently smile. Less oil from Venezuela would increase oil prices, which was precisely what they wanted.

  Chapter Ten

  The Hunter

  THE NEWS FROM VENEZUELA confirmed John Browne’s suspicions. Oil-producing nations were unreliable, and even if they possessed “elephants,” the pace of discovery was too slow to fulfill his ambitions.

  In a strategic review presented to BP’s directors in Berlin in 1996, Browne had eloquently explained his desire for spectacular growth. As usual, his competitive benchmark was Exxon, which owned a huge backlog of unexploited assets. By comparison, he described what he called “BP’s New Geography” as a mixed blessing. Disappointing production in Colombia was complicated by terrorism; drilling in Venezuela had proved to be too expensive; and corruption ruled out any return to Nigeria. Only Angola (Girassol), the Gulf of Mexico and Australia (the Perseus) offered unmitigated success. BP’s production of oil and gas, he forecast, would increase by one million barrels a day to 2.5 million within a decade. But that was too slow and too little. To survive, explained Browne, BP needed alliances and a spectacular acquisition. His targets were in Russia, China and America. One year after his presentation, his ambition had crystallized. “We want to overtake Shell,” he said in a newspaper interview. “Who’s BP?” was Shell’s waspish reaction. Those two words galvanized Browne’s competitiveness. His target was Mobil, the former Standard Oil Company of New York.

  Browne had been telephoned by Lou Noto, Mobil’s gregarious chairman and chief executive. Over the previous months Noto, the son of Italian immigrants, had pondered Mobil’s fate. As a middle-weight, the corporation’s chance for growth was limited. Ever since he had started in the industry in 1962, and managed Mobil’s refinery in Saudi Arabia, Noto had understood the danger of “hitting our heads against the wall.” Unless there were certain profits, Mobil would stay away from any investment. By the mid-1990s the financial scenario was not encouraging. The losses suffered by all the oil majors in the so-called “downstream” — the refineries, gas stations and marketing — had accelerated. Supermarkets in Britain and France were selling cut-price gasoline, while the refineries, producing excessive amounts of unprofitable gas rather than profitable distillates, were losing 60 to 70 cents a barrel. To reduce the losses, the majors swapped products and shared pipelines. In America, Shell, Texaco and Aramco had forged a $10 billion union of six refineries, 80 crude oil and products terminals, 17,000 miles of pipeline and 8,800 gas stations, using some oil supplied by Saudi Arabia.

  Mobil, Noto knew, also needed a partner. John Browne’s rescue of BP from near death had impressed him. A combination of the two middleweights, he calculated, could rival Shell and Exxon. He proposed a trial marriage in Europe to Browne. The merger of BP’s eight refineries, worth $3.4 billion, with Mobil’s six refineries, worth $1.6 billion, plus their marketing operations would capture 12 percent of the European market, the same as Shell and Exxon. Browne readily agreed. BP would sell two refineries, and staff would be cut by combining the companies’ headquarters. Noto had anticipated saving $400 million every year, but the savings rose to $600 million. He was only distressed by market research showing that BP was more popular among motorists than Mobil. “It still wasn’t easy yanking the signs off 23,000 of our gasoline stations,” he admitted, “and wasting $200 million just to replace the signs.” Encouraged by the collaboration, in late 1996 Noto and BP’s David Simon discussed the next stage, a merger of equals, over dinner in New York. “I’ll talk to John about it,” agreed Simon.

  For Browne, the news revived an idea he had discussed 10 years earlier while working in Cleveland, Ohio, except that he wanted BP to take over Mobil. The hunted was transformed into the hunter. Browne began attempting to persuade Noto to accept his vision. “We need to find a way into Noto,” he ordered. Research was commissioned by BP’s bankers to understand the Mobil chairman’s life and his passions. One discovery was his interest in the work of the novelist Joyce Carol Oates. Before a crucial meeting at the Hay-Adams hotel in Washington, a first edition of one of her books was bought for Browne to present to Noto as a goodwill gesture. The gift was unmemorable for Noto.

  Huge mergers were unknown in the oil industry, but Browne’s arguments were, Noto knew, irrefutable. The existing business model, Browne explained, was obsolete. Threatened by decline, the majors needed lower costs and higher profits. His arguments were supported by unpublished research produced by Doug Terreson, a Morgan Stanley analyst. Mergers among the Seven Sisters, Terreson predicted, would be necessary “to avoid being competitively disadvantaged for years to come… If without a partner you need to find one.”

  Noto’s skepticism appeared to evaporate. Not even their companies’ different cultures, he agreed, were a barrier. By February 1997 the framework of a deal had been secretly agreed upon. Noto ordered his team to scrutinize the terms. They reached a gloomy assessment. “This isn’t a merger of equals but a takeover,” Noto was told. “It’s transatlantic with tax problems. There’s got to be value.” The chairman agreed. “It’s beginning to ungel.” Noto called Browne and told him, “This deal’s got to be priced differently. Mobil’s going to disappear. Our shareholders need a premium.” Browne agreed to reconsider the price. During March the paperwork was completed, and the two sides agreed to sign the contracts on March 28, Good Friday, at the Four Seasons hotel in New York. Browne arrived on Wednesday from London to inspect the stacks of documents awaiting his signature. The following morning his aides heard whispers that Noto had changed his mind. The obstacle, some speculated, was not the price but the danger that the Fede
ral Trade Commission (FTC), the regulator, would resist a foreign takeover of American assets; others suggested that Lee Raymond had offered Noto a merger with Exxon. In reality, on the eve of the signing Noto simply wanted more money. Browne did not respond, assuming that Noto feared for Mobil’s future without BP. He was mistaken. “It’s coming apart,” Noto told his staff. “There’s not enough beef in the patty to do it.” Entering Browne’s suite the following morning, Noto told him to his face, “No, there won’t be a deal.” Shortly after, Browne flew back to London in his private jet. His failure did not sadden everyone on that flight. Some felt Browne was too radical and his pace too hectic. He dismissed their reservations. “You’d better think what we now do,” he ordered his trusted associate Nick Butler as he stepped into his car. Anticipating a rush of corporate activity, he did not want to be left behind.

  “Our next best bet is Amoco,” Browne told his fellow directors. His verdict was confirmed by John Thornton, the acquisitions king at Goldman Sachs. Browne had astutely pinpointed a more vulnerable target than Mobil. “Buying Amoco at the bottom of the cycle,” said another banker, “is a good move because the company’s valuable assets are cheap and we can squeeze more out of them.” Sharing the oil industry’s conviction that prices would remain around $10 or $11 for the next five to 10 years, everyone agreed that the risk was minimal.