Oil

by Tom Bower

  The announcement of the merger on December 1, 1998, was marked by a joint public appearance by Raymond and Noto. Raymond, despite his efforts to remain invisible, wantonly antagonized analysts and journalists. His comment about the “awesome” size of the new organization, and his claim that it represented a “seismic shift” in the industry that would enable the new ExxonMobil to stare down Saudi Arabia, lacked credibility. His description of the savings envisaged — he mentioned cutting capital spending by $400 million in 2000 — confirmed that he favored retrenchment rather than expansion. No one took seriously Noto’s remark that “This is not a combination based on desperation.” The next hurdle was Congress. Both chairmen expected that the $10.5 million they had spent during 1997 on lobbying in Washington would be rewarded. The FTC presented a greater problem. Raymond and Noto knew that the obstacles to completing the partial reunion of Standard Oil would be substantial, but felt that by hard bargaining they could be reduced to merely irritating. “I’m not interested in your views of how we ought to deal with the FTC,” Raymond abruptly told a questioner during his presentation.

  Robert Pitofsky, the FTC’s thoughtful chairman, was finalizing his requirements for BP’s merger with Amoco. He had decided to be obliging. Although there was an overlap in the wholesale and retail selling of gasoline in 30 states and nine metropolitan areas, Pitofsky only ordered that 134 gas stations and nine terminals be sold, and that 1,600 gas stations be given the opportunity to switch suppliers. Nothing, Browne could smile, had gone wrong. But merging Exxon and Mobil was on a different scale. Raymond had already fired an intimidatory shot. Creating the world’s biggest private corporation, he knew, would provoke alarm. “Big is not necessarily bad,” was a favorite defense he deployed, and on this occasion, considering Shell’s size and BP’s expansion, his appeal to the “national interest” appeared unassailable: “The merger will mean that ExxonMobil will be able to compete in the same scale as the largest foreign firms.” Creating the world’s biggest private oil corporation, however, offended Pitofsky’s belief that competition was critical to the industry. He began the largest investigation in the FTC’s history, knowing that Raymond offered no concessions. Nothing, Raymond insisted, should be sold. Inevitably, Exxon hired the best lawyer. Rick Rule, the former head of the antitrust division of the Justice Department, knew that Pitofsky had the power to seriously meddle in the merger, but left him in no doubt about the consequences. Exxon, said Rule, would engage in a battle. Shrewdly, Raymond endorsed the threat, so that Pitofsky “knew the problems if we went to court.” By the end of the negotiations the combined company agreed to sell many assets, including 2,431 gas stations, especially in California, but clung to pipelines and refineries that appeared to be in jeopardy. “The level of concentration in the US,” Pitofsky concluded, “will set off anti-trust alarms.” Frustratingly, he separated America from the world market.

  The two mergers, BP-Amoco and ExxonMobil, had set the herd heading in the same direction. “To survive in this new situation,” said Thierry Desmarest, the chairman of France’s Total, “all companies are struggling.” Total, ranking ninth, merged with Petrofina of Belgium. Peter Bijur, Texaco’s chairman, and Ken Derr of Chevron admitted that they were considering mergers. Shell was particularly interested in Chevron, whose reserves, after success in West Africa and the Caspian, had increased by 60 percent since 1995. A major obstacle for the herd was Pitofsky, who had become suspicious of oil chiefs speaking about efficiencies while “their motive may be to eliminate competition.” John Browne was not listening.

  BP’s purchase of Amoco was completed at 9 p.m. on December 31, 1998, and celebrated at a party in Britannic House, BP’s London headquarters. Browne and his team were euphoric. “We’re on a roll,” exclaimed one. “An upwards trajectory.” “The magic years,” agreed another. The Amoco executives invited to join the celebration were less exuberant. Surprised by the modesty of Britannic House, they had become suspicious of Browne, and suspected that BP had underestimated the strength of Amoco’s natural gas reserves. Mindful of Browne’s scorn for engineers, some recalled Shell’s complaint that BP had appeared uninterested in the quality of engineering when the two companies had collaborated on the Mars rig in the Gulf of Mexico. Financial engineering seemed to be Browne’s priority.

  Privately, Browne was grateful that the hiatus around the merger concealed BP’s vulnerability to the unexpected fall of oil prices. The company’s profits fell by 23 percent in the first quarter of 1998, from £755 million to £582 million, and they would also drop in the second quarter. To those criticizing his preoccupation with BP’s share price, Browne replied: “People say we are too focused on immediate results, I say to you there are 40 quarters between me and retirement and every one of them matters.” Like all the oil majors, he spent another $2 billion buying back shares instead of investing in additional exploration. BP’s high share price was critical to his next coup. The prelude had been performed in the midst of the Amoco negotiations.

  In January 1999, Mike Bowlin, the chairman of Atlantic Richfield, or Arco, had telephoned Browne, whom he knew from American Petroleum Institute (API) meetings. “I think we should get together and see if we can combine.” “Why are you interested?” Browne asked. “We’re a takeover target,” replied Bowlin, “but the shareholders will only agree to a sale if they’re paid a premium and the employees receive generous provisions.” Bowlin’s explanation was precisely what Browne had expected. America’s oil majors had reached a crossroads. With oil at $10, the weak could not cope. Just like Texaco’s chairman Peter Bijur, Bowlin, a human resources director promoted to run an oil company, was vulnerable. For years Arco, ranking as the seventh-largest oil company, had drifted, not least when it bought The Observer newspaper in London. Shareholders had received high dividends only because the directors approved unsustainable loans. With declining funds, Arco’s investment in exploration had fallen from $1.6 billion in 1998 to $950 million in 1999. The losses had increased over the previous three years after the nationalization of its oilfields in Venezuela and a succession of dry holes across the world, especially in Algeria. Millions of dollars had been lost by Chuck Davidson, Arco’s legendary explorer, drilling dry wells in the Mars field in the Gulf of Mexico; Shell’s subsequent success in the field humiliated Arco. The company’s problems had been aggravated by its loss of an 8 percent stake in Lukoil after expectations did not materialize. Battered by that litany of woes, Bowlin feared that if the merger frenzy evaporated before Arco’s fate was resolved, the company’s shares would be squeezed and the full extent of its disarray would be exposed. Politely, Browne did not question Bowlin’s unconvincing pitch that if BP didn’t bite, Arco had an alternative suitor. “I’ve got to finish Amoco and think about it,” he said. “I’ll come back to you.”

  Before returning Bowlin’s call, Browne summoned a meeting of BP’s executives and professional advisers at a hotel in Hampshire. The industry’s predicament appeared to have deteriorated. Philip Verleger, oil’s guru, would call it the “Third Oil Shock.” The first had been the aftermath of the Arab–Israeli war in 1973; the second followed the fall of the Shah in 1979 and Iraq’s invasion of Iran, which paralyzed 6 percent of the world’s oil production. The third, according to Verleger, started at the end of February 1999, when WTI, the light sweet crude sold from Cushing and used for pricing on the New York Mercantile Exchange, was selling at $12 a barrel. The common theme of all three “shocks,” he explained, was a period of economic growth stretching oil supplies to the limit. Then suddenly the boom stopped and demand for oil shrank. The mood was encapsulated by The Economist’s immortal front cover on March 6, 1999: “Drowning in Oil,” it read, and the magazine forecast that the price of oil would fall to $5 a barrel. During that month, OPEC ministers were due to discuss an increase in prices. In a choreographed performance, they announced that daily production would be reduced by 2.1 million barrels a day. The cut would be welcomed by the oil majors, which were equally anxious to
earn a higher income. Economists calculated that the inevitable price increase would cost consumers $480 billion in one year, but that the “New Economy” of advanced technology, flexibility of labor, increased efficiency and low inflation could absorb higher oil prices. Days later, Brent oil rose to $15. Experts speculated that the oil majors might have overreacted to the low prices by dismissing thousands of their workforce. Adding to the confusion, Mark Moody-Stuart explained that Shell would only consider projects “which fly at $14,” and would let them “sleep easy in their beds at $10.” If prices rose to $40, he said, there was a danger of recession. Oil at $50, he concluded, was “highly unlikely.”

  John Browne suffered from no uncertainties. After the ExxonMobil merger his lust for BP to rank as number one had grown. By taking over Arco, he had previously explained to his intimate circle, BP would once again be America’s biggest oil producer. Capitalized at $187 billion, it would outrank Shell’s $175 billion to become the world’s second-largest oil major. Shell, he added, would be vulnerable to a takeover by BP. Combined, BP-Shell would overtake ExxonMobil, his ultimate ambition. Chevron and Shell were identified as rival bidders for Arco, but as both owned gas stations and a refinery on America’s West Coast, they would incur costly divestitures to obtain the FTC’s approval, while BP had already sold its only refinery in the region. After reading a schedule of Arco’s assets compiled by Byron Grote, BP’s vice president of exploration and production, Browne declared the prize to be breathtaking. Arco’s two refineries and 1,700 gas stations on the West Coast would complement BP’s 16,000 service stations in the Midwest and the East. In the upstream, Arco’s wells in the Gulf of Mexico and the North Sea were profitable. The company was a critical supplier of natural gas to Asia from reserves in Malaysia, Thailand and especially at Tangghu in Indonesia, with 20 trillion cubic feet of natural gas. The jewel was Arco’s share of Alaskan oil. The huge reserves of the North Slope were split between BP in the west and Arco in the east. Uniting the two areas would save substantial sums and offer an additional financial advantage. After BP had failed to honestly declare the value of natural gas from Arco’s Alaskan fields it had used to pump crude oil out of the ground, Arco had been awarded $40 billion in damages. Buying Arco would remove that liability.

  The discussion of BP’s executives in the Hampshire hotel was not harmonious. Alaska’s economy depended entirely on oil, and the ownership of their resources was a particularly sensitive matter for the local population. Browne was warned that Alaskan politicians were opposed to a single operator on the North Slope. The merged company would control 860,000 acres there, but Alaska’s law forbade a single company leasing more than 500,000. Although Browne conceded the possibility of having to relinquish some acreage, he expressed confidence that Tony Knowles, Alaska’s governor, would change the law out of self-interest. Several voices cautioned that after Exxon’s merger with Mobil the FTC might object to further consolidation: Robert Pitofsky had warned that further mergers would be minutely scrutinized. “You’re tempting fate,” one voice pronounced. Browne ignored the warning. Having won the FTC’s approval on Amoco in a record four months with little divestiture, he was committed to an encore. He wanted control over nearly all Alaska. American law, he believed, would bend to BP’s desires. In any case, hinted Browne, it was a win-win situation. Either the merger would be approved, or in the unlikely scenario that it was not, a rival would be blocked from doing the same. Doug Ford, the former Amoco director appointed to the BP board, did not voice his doubts, merely observing, “Everyone thinks it will be a piece of cake because the FTC let Amoco through.” With the dissidents silenced, the executives agreed that BP’s opening bid for Arco would be 26 percent above the share price, valuing the company at $26.8 billion. “We’re buying at the bottom of the market,” smiled Browne as he contemplated exchanging BP’s highly valued shares for an underperforming company.

  All of Arco’s directors would be expected to resign. That condition suited Bowlin. Like his fellow directors, he was also focused on the prospect of a large payoff. Before leaving Los Angeles, he had admitted to his anxious board, “BP is the only game in town. I’ve got no cards to play.” Steeled for difficult negotiations, he was taken aback by Browne’s attitude. Within minutes of sitting down alone with him at BP’s headquarters in London, he realized that Browne was “hot to do the deal. It was like Sherman riding into Georgia.” Bowlin asked for a 45 percent premium. Browne counteroffered 26 percent. To Bowlin’s surprise, Browne did not even question the huge severance payments for Arco’s executives. Bowlin enjoyed another surprise after Browne arrived at his Los Angeles office near the Beverly Hills Hotel on March 24, 1999, to finalize the details of price and timetable, and to sign the heads of agreement. “I don’t want to let them get out of the deal,” Bowlin had told his lawyers. Bowlin’s lawyers had anticipated that Browne would object to the contractual terms committing BP to pay an onerous penalty if the deal fell through. Instead, he signed with a smile. BP was locked in.

  Over the weekend, news about the deal leaked into the media, and negotiations were accelerated. Browne was untroubled. The public announcement of the bid on April 4 raised Browne’s profile into the stratosphere. He accepted the invitation to stand in the spotlight. By any measure, he was leading a global juggernaut ranking alongside Silicon Valley’s giants. “Its emphasis on growth and shareholder value,” commented Philip Verleger, “has paid enormous benefits to the BP shareholders.” BP’s flexibility and lack of bureaucracy, added Verleger, outshone its competitors. Unmentioned in Browne’s public pronouncements was ExxonMobil, which was still substantially ahead of BP at $243 billion. Hailing the creation of “the largest oil output of any non-state company,” Browne spoke about “a compelling strategic and geographic fit of quality assets” and “the immense potential it offers for future growth. In Alaska in particular, the synergies we can achieve from combining our operations will greatly increase the competitiveness of the state in the face of uncertain oil prices and provide a strong incentive for significant investment in existing and future fields.” Browne staked his reputation on executing the merger. Not everyone in Britannic House was sure he had taken Alaska’s history into account.

  Richfield Oil had established Alaska’s first commercial oilfield at Swanson River in 1957. Renamed after a merger as Atlantic Richfield (Arco), the company discovered oil in the east of Prudhoe Bay. The next hole it drilled was dry, and the directors offered Exxon a 50 percent share of all their remaining leases across the North Slope in return for financing drilling of the next well. Exxon’s profits in return for the risk were probably the biggest in oil’s history. BP, which owned a substantial portion to the west of the bay, struck oil soon after. To limit costs, Arco became the operator for all the owners on the east of the Slope, and BP on the west. They shared the ownership and maintenance costs of the Trans-Alaska Pipeline System (TAPS), which opened in 1977, linking Prudhoe Bay with the tanker terminal at Valdez. For the first 10 years, the oil companies prospered. Production in 1979 reached 1.5 million barrels a day, the authorized limit, from 218 wells. To sustain that production, the companies drilled more wells, until in 1988, the peak year, 690 wells were needed to produce the same amount. Ten years later, producing the same volume required 870 wells. By 1999, production had fallen to 35 percent of 1988’s output. The state’s income, which had risen from $793 million in 1982 to $5.7 billion in 1991, fell to $2.1 billion in 1998, with the certainty of continuing decline. Under the banner “No Decline after 99,” Arco used improved technology to extend the field’s life beyond its expected death in 2000, but, contrary to the original forecast that the North Slope contained 13 billion barrels of oil, the companies anticipated extracting only 11.4 billion by 2018.

  Alaskans hoped that the oil majors would find new reserves. Anticipating failure, BP refused to search, but Arco spent $300 million drilling a succession of dry wells, aggravating its financial distress. Alaskan politicians feared that the state’s economy, depen
dent on oil, was jeopardized. Before the Exxon Valdez spill, Congress had been on the verge of approving a lease to explore for oil in the protected Arctic National Wildlife Refuge (ANWR), but thereafter the attempts were repeatedly blocked, and finally vetoed in 1995 by President Clinton. Without access to the ANWR, the oil companies refused to build a pipeline to transport Alaska’s 25 trillion cubic feet of natural gas to the United States. Browne’s solution was a merged company controlling 78 percent of the resources of the North Slope, which would save $200 million annually. “We must do more for less,” Julian Darley, BP’s director in Alaska, explained. Browne hoped that his pledge to finally build the natural gas pipeline costing at least $5 billion would sway the doubters.

  But local politicians were unconvinced. Arco had a good reputation on environmental issues and for its care for workers’ welfare. BP’s reputation, by contrast, was not enhanced by squabbles about maintaining the pipelines and contributions toward local charities. In October 1999 the company had admitted the illegal release of hazardous material and the inadequate supervision of a contractor on Endicott Island off Prudhoe Bay, and had had to pay $22 million to settle the criminal and civil charges. Infractions were common among all oil companies’ operations, but Browne had not considered local sensitivities. To move on to the next target he needed rapid completion of the takeover, and he refused to contemplate any delays. On September 1, 1999, he told shareholders that his discussions with the “various regulatory authorities are moving constructively ahead.” He added, “All this gives me great confidence that we can meet our target to complete the deal before the end of the year.” Shareholders of both companies overwhelmingly approved the plans, although Browne ought to have realized that his optimism was misplaced, as he knew from his conversations with Pitofsky that the FTC was hostile.