The news last October of Chevron's proposed acquisition of Texaco for $36 billion in stock was hardly surprising to industry analysts. The planned merger — which would streamline projects and save some $1.2 billion annually — was considered the most logical path for both companies if they hoped to compete against Exxon Mobil, Royal Dutch/Shell Group, and BP Amoco. In fact, these three "supermajors," with 1999 revenues of approximately $161 billion, $105 billion, and $83 billion, respectively, are themselves the result of recent merger activity.

The trend toward these larger companies underscores a new reality in the United States. At the center of this change is the fact that U.S. oil reserves have diminished from an estimated 39 billion barrels in 1970 to 21 billion today. The gushers that made Texans in ten-gallon hats some of the wealthiest Americans in history are a thing of the past. Now the big strikes lie elsewhere. The wildcatters of today travel the globe from Angola to Kazakhstan to the deep waters off the coast of Brazil in search of "elephant fields" with flow rates measuring in the thousands of barrels per day. Finding and developing such a site, however, is a long-term proposition that often requires years of complicated research, negotiation, construction, and drilling before a drop of oil or a penny of profit is produced. The capital required to initiate and to sustain this far-flung activity makes being big a necessity.

But while the supermajors grab headlines and rack up revenues in the billions, a number of smaller U.S. companies — some publicly traded, others privately owned — refuse to be overshadowed. However modest their comparative size, their market share still reaches into the billions of dollars. And with oil and gas prices rising steadily, business, if not exactly booming, is certainly looking up for these small yet significant players.

According to Bradley W. Fischer (61st PMD), president and CEO of Houston-based CMS Oil and Gas, the consolidation of corporations such as Chevron and Texaco has certain advantages for its smaller competitors. An exploration and production company founded in 1967, CMS employs 180 workers in the United States, South America, and Africa. "Some of these mergers facilitate the purchase of properties that are no longer strategic to the supermajors," Fischer remarks. "Niche plays become very important."

"I tend to think that small and focused is the name of the game," agrees Matthew R. Simmons (MBA '67), president and chairman of Simmons & Company International. Established in 1974 as a specialized investment bank to the oil service industry, his Houston firm now employs 110 professionals and covers all aspects of the energy business. "One idea that I believe will be discredited is the mega-merger theory — that Texaco was too small to be relevant."

"Fortunately, there are still strategies that allow a smaller operator to be continuously profitable so long as he or she is both a technician and an economic analyst," states George B. Kaiser (MBA '66), president and CEO of Kaiser-Francis Oil Company, a private concern based in Tulsa. "Analytical skills are indispensable when it comes to understanding and projecting pricing cycles and creating intelligent and innovative venture structures and decision trees."

"It's an exciting industry for anyone who has a technical, commercial, and financial background," says James T. Hackett (MBA '79), president, CEO, and chairman of Houston-based Ocean Energy, Inc., a company that employs 1,150 workers worldwide and trades on the New York Stock Exchange. "The role of intellectual capital is more important in this business than any other, except perhaps the pharmaceutical and computer science industries. Oil is a hugely volatile commodity that very few people want to play in, so there are still tremendous opportunities for niche players."

Such optimism could be considered another prerequisite for entry in an unpredictable industry that has surfaced only recently from a twenty-year depression. "The overall return is inadequate for the risk," concedes Kaiser, "yet the very nature of the challenge — the high variability of results — draws many players who believe they can beat the odds."

Advances and Advantages

Technological advances made since the early 1990s continue to play an important role in exploration and production for all oil and gas companies, regardless of their size. Important for smaller firms are the relatively recent developments of 3-D seismic data acquisition and horizontal drilling techniques that increase the speed and accuracy of locating and tapping pockets of oil. "On the one hand, this technology enables us to find reserves more cheaply and with a higher level of success," observes Bradley Fischer. "But it accelerates recovery rates to such an extent that it creates a treadmill situation—we have to run very hard just to stay even with existing production levels."

Information technology is also used to sift through geological data in the public domain. Fischer, who refers to this practice as "data mining," notes, "With the help of a sophisticated screening model, you may find some small yet lucrative plays that others have overlooked. Our company has had some success with that strategy in Texas."

Even so, Fischer notes that the biggest opportunities for future growth lie outside the United States. "Like the supermajors, we have to be global in our orientation — albeit on a smaller scale — and that includes how we manage our human resources. It can be a challenge to find skilled, multilingual employees who are willing to reside in foreign locations." Although CMS Oil and Gas has been involved in projects abroad for over twenty years, Fischer observes that his company must compete for human capital with larger, more established concerns as well as other small companies that have begun to set their sights on discoveries overseas. "We don't have very many people," he says, explaining that the business of oil exploration is more capital intensive than people intensive. "But those we do have are given a great deal of financial responsibility."

James Hackett of Ocean Energy does see a few advantages for smaller companies when it comes to the considerable challenges of oil exploration in foreign countries. "Some of the governments are quite small, and they like dealing directly with the person who makes decisions in the company," he explains. "There's more flexibility involved than there would be with a larger corporation, and we can also be quite creative in how we structure deals." When constructing a single pipeline, for example, it is often necessary for a company to negotiate with multiple countries, each with its own laws, cultural differences, and political sensitivities.

Those complications, says HBS professor emeritus Robert B. Stobaugh, are part of what makes oil such a demanding yet fascinating field of research, whether the subject of study is a single deal or the entire industry's movements. "There are many interrelationships that involve economic, political, and human factors," comments Stobaugh, coeditor with Daniel Yergin of the 1979 bestseller Energy Future. "One of the biggest unknowns right now is what Saddam Hussein will be allowed to do. Most people think that his reserves are very, very large. If he were free to expand the production and export of oil, that would definitely bring down prices."

Supply and Demand

"Econometric models are not very good at predicting either supply or demand in the oil industry," Stobaugh observes. "A little less than two years ago the price of oil was $10 or $11 a barrel. Now it's up around $30. Very few people predicted that, and those who did were not believed.

"The demand for oil is a derivative of the different economies that you're selling into," he continues. "For example, no one was able to foresee the recession in Asia. On the supply side, oil production has a very long lead time, particularly the big fields." Stobaugh also notes that politics factor into the equation. "If bans were dropped on drilling in Alaska's Arctic National Wildlife Refuge and areas offshore, there would be an impact on supply after about eight years or so. That's about how long it would take to bring those fields on line."

Global politics holds greatest sway in the short run. "The biggest variation on supply depends upon the decisions of two or three people in the oil business— that's the leader of Saudi Arabia and the president of Mexico, principally," Stobaugh explains. Recent higher prices paid by consumers at the gas pumps aren't the work of OPEC alone, he says, but the result of a collective decision to reduce production made by Saudi Arabia, Mexico, Norway (which has large-scale projects in the North Sea), and Venezuela.

"This is an interesting time in the business," remarks Bradley Fischer. "The supply and demand equation is coming back into balance after many years of low prices. That situation creates a host of competitive pressures for us, such as shortages in manpower, materials, and services. And practically speaking, the consumer will be seeing higher prices."

Matthew Simmons puts it more bluntly: "We are in the early stages of a severe energy crisis. Our tankers, rigs, pipelines, and refineries are at capacity. It's going to take about a decade for us to catch up with the ever-increasing demand for energy." Simmons uses a well-known Boston construction project for a dramatic analogy: "You would be hard-pressed to live in Boston and not notice the Big Dig. Yet if you circled the area it covers on a city map, the mark would hardly be visible. Developing the infrastructure to sufficiently increase our oil capacity would be the equivalent of someone telling us we have to expand Boston by 30 percent over the next ten years. Oh, and at the same time, you have to rebuild the city, brick by brick."

The End of an Era?

With much of the industry focused far from the origins of the storied U.S. "oil patch" culture so well-known for its rugged individualism, tall tales, and thrilling discoveries, is there any tradition or romance left in the pursuit of one of the most precious resources on earth?

"The difficult margins we've had to deal with over the past fifteen years have made us put aside the cowboy hats and boots and adopt more of a green eyeshade approach to running the business," observes Bradley Fischer. "But there's still a lot of excitement in this industry. We're all working as a team to beat the odds, and when we have a commercial success, it's like hitting a home run."

"The era of the swashbuckler with a hunch who hits it big and goes broke on alternating Sundays has been the stuff of movies for a long, long time," says George Kaiser. "The rewards are generally granted to those who do their homework, though luck still plays a major part."

"Sometimes God will fool you," agrees James Hackett. "You'll think you have something, and the readings confirm it, but when you drill down it's gassier than you thought, or it's full of water. In this business, you never have it figured out. Unlike other industries, you can't manufacture endless quantities of the product on a predictable cost curve."

As the hunt for oil goes on, even optimists agree that the search will only present more challenges in the future. Consolidation, in fact, will continue to be as much of a factor for smaller companies as it is for the supermajors of today's headlines. "Over the past five years many established, long-term corporations have gone out of business or merged with other companies," says Fischer. "The process is being driven in part by the inability of smaller companies to source capital — the equity markets exited this business for the most part when oil prices fell to such low levels in 1997 and 1998, and banks slowed down their lending as well."

"If smaller companies can grow off an established base, they can continue to be an important element of the picture. But if they aren't able to grow, they'll probably be bought," notes Hackett. Ocean Energy's most recent merger was with Seagull Energy in 1999, and Hackett foresees more such activity in the future. "Within the next three years, I can envision Ocean Energy being twice the size it is now, through either internal or external growth," he predicts.

The hope, of course, is that consolidation will heighten efficiency and increase a company's ability to locate new sources of oil, resulting in more control over oil supply and savings for consumers. But for the moment, it seems gasoline prices in the United States will continue to creep inexorably toward the $2 a gallon mark while the rising cost of heating oil and natural gas sends consumers in the frigid North diving for their down comforters.

"If you could ever create a model in which the world worked well and energy was free, it would be like eliminating disease," remarks Matthew Simmons. "There's a deeply embedded sense in our culture that we'll never have another energy crisis, but I'm afraid we're about to enter what will be a painful chapter in American history. Before long," he predicts, "we'll discover that what happens in the energy industry is far more important than the ups and downs of the Internet."

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Oil Lingo

3-D Seismic: A technique to acquire a three-dimensional image of the earth's interior by projecting sound waves from geometrically spaced points at the earth's surface.

Barrel: As the standard unit of measurement of liquids in the petroleum industry, it contains 42 U.S. standard gallons. Abbreviated to "bbl."

Christmas Tree: A multivalve device that channels fluid flows from a well into a pipeline.

Duster: A dry well.

Elephant: A "real big" oil field. Definition changes according to who is doing the bragging, but the generally accepted range is a field that will ultimately produce 100-500 million barrels of oil. "Hunting for elephants" refers to exploration for such fields.

Go-Devil: A scraper that is run through the pipeline to clear out loose objects and clean the wall of the line. Also called a "pig."

Horizontal Drilling: A recently developed drilling technique whereby the drill bit is directed horizontally through the earth, allowing for a faster oil recovery rate.

Mud: A lubricating mixture of clays, water, and chemicals pumped in and out of the well bore during drilling.

Mud Log: A record of geological formations penetrated during drilling that includes technical details of the operation.

Mud Logger: On call 24/7 to analyze rock cuttings from a well that is being drilled.

Pay Zone: The stratum of rock in which oil and/or gas is found.

Plugging: The process whereby a well that is no longer needed is filled with concrete and abandoned. Often referred to as "p&a" — plugged and abandoned.

Roughneck: A hand working on the drilling rig floor.

Roustabout: Crew member who handles the loading and unloading of equipment and assists in general operations around the rig.

Royalty Oil: The landowner's share of net oil production, taken in the form of crude oil rather than in cash.

Slug Catcher: A metal vessel that separates liquids from natural gas.

Snubber: The most dangerous job in the oil field. A worker who controls a high pressure well while replacing old equipment.

Spud: To begin drilling a well.

Stripper: An oil well that produces a limited amount of oil, usually no more than ten barrels a day. Sucker Rod: A string of connected metal tubes about two inches in diameter that is used to pump oil out of the ground.

Tool Pusher: Supervisor of the rig.

Wildcat: An exploration well drilled in unproven territory, without direct evidence of the contents of the underlying rock structure.

Worm: An inexperienced/ new worker.

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