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# OAR Box 1669 Prepped by Charmelie Mathews



# Document

Number: 

# tyjm n-i- 7 Docket Number: 

# A-98-1 3

Printed 9/23/20089:36:49AM

Sheet 99of 110

### $ American Petroleum Institute ;•:,•.• { ~ 0 _U. i EP A'M R DOCXE T 

# H- -T- j P. 2



# Economi c State o

fth e U S Petroleu m Industr

y

Polic yAnalysi s an d Strategi c Plannin g Departmen t

Februar y26 , 199 9

/P. 3



# Economic

State of the US Petroleum Industry

JodyM . Perkin s Polic yAnalysi s an d Strategi c Plannin g Departmen t America n Petroleu m Institute

Februar y26,199 9

The contents

of this paper are for the purposes

of study and discussion

of government

legislative

or regulatory

proposals

and do not necessarily

represent the views of the American

Petroleum

Institute or any of its members.

&P. 4



## Economic

State of the US Petroleum

Industry Jod yM . Perkin s Polic yAnalysi s an d Strategi cPlannin g Departmen t America n Petroleu m Institut e Februar y26,199 9



## Introductio n an d Summar y Th e U S petroleu m industr yi s currentl yexperiencin g significan t financia l difficulties . Man ymajo r petroleu m companie s recentl yannounce d plan s t o restructur e and/o rcu t costs , sometime s b ycuttin g jobs . Thes e companie s includ e Roya l Dutch/Shel l Group , Texac o Inc. , Mobi l Corp. , Unoca l Corp. , Atlanti cRichfiel d Co. , Occidenta l Petroleu m Corp. , Kerr-McGe e Corp. , Amerad a Hes s Corp. , Chevron , Phillip s Petroleum , an d Conoco Inc. 1 

### Smalle rcompanie s als o ar e facin g financia l difficulties . Thi s pape rexamine s th e recen t event s an d longer-ter m trend s behin d thes e economi cdifficulties . I t identifie s th e followin g factors : •Decline s i n crud e oi l an d petroleu m produc t price s sinc e 1981 , includin g dramati cfall s i n 1998 ; •Th e relationshi p betwee n inflation-adjuste d crud e oi l price s an d th e profi t rate s o foi l producers ; •Decline s i n oi l an d ga s productio n activityan d employmen t withi n th e US , sinc e th e earl y1980s ; •Reason s wh yman ysmal l oi l an d ga s producers mayb e especiall yvulnerable , financially , durin g a n oi l pric e collapse ; •Closure s o fman yU S petroleu m refinerie s sinc e th e earl y1980s , an d th e declin e i n refinin g employment ; •Refiners ' hig h regulator ycomplianc e cost s i n th e 1990s , primaril yt o satisfyenvironmenta l requirements ; •Reason s wh yi t ca n b e difficul t fo rrefiners an d marketers t o pas s alon g cos t increase s t o consumers ; •Relativel ylowprofi t rate s fo rrefiners an d marketers durin g th e 1990s ; an d •Decline s i n transportatio n secto remploymen t an d profi t rate s sinc e th e earl y1980s . Thi s pape rconclude s tha t i fcrud e oi l price s remai n lo wan d othe rlong-ter m industr ytrend s continue , reduce d employment , profits , an d activitylevel s i n th e exploratio n an d productio n secto rmigh t wel l b e expecte d t o continue . I n addition , employmen t and/o rprofitabilityi n th e refining , marketing , an d distributio n sectors coul d remai n lowa s well .

1 

### Pau l Merolli , "Oi l Major

s Se t to Produc

e Mor e Pin k Slips, " The

Oil Daily, Novembe r13 , 1998 ; Lore n Fox , "Fourt h Quarte rWa

s ABruise rfo rOi l Companies, " The Wall Street Journal, Januar

y6 , 1999 , p . B10C ; an d Ann e Mari e Borrego , "Phillips Petroleu m T o Cut Staf fb y8% , Capita l Spending, " The Wall Street Journal, Januar

y7,1999 . p . A4 .P. 5

Economic

State of the US Petroleum

Industry Pag e 2 

## A n OverviewofGenera l Industr yTrend s Since 198 0 Crud e oi l prices , whic h ar e se t i n internationa l markets , hav e bee n o n a genera l declin e sinc e 198 1 (se e Figur e 1) . Price s fel l dramaticall yi n 198 6 a s th e Organizatio n o fPetroleu m Exportin g Countrie s (OPEC ) increase d supplie s o fcrud e oil . Th e shar p pric e declin e i n 199 8 wa s attributabl e t o plentifu l crud e oi l supplie s (partl ydu e t o Iraq' s increase d production ) an d a reductio n i n deman d fro m sufferin g Asia n economies. 2 U S deman d wa s lo wfo rsom e products , suc h a s heatin g oil , becaus e o funseasonabl ywar m weather. 3 Figur e 1 Price s o fCrud e Oil , Gasoline , an d Othe rU S Goods , 1980-199 8

2.2 0

•

_1.7 0 o n c a O fe 1-2 0 o 

### 5 o • o 3 ° 0.7 0

0.2 0 CP I (Excep t Foo d and ^ Energy )

198 0 198 1 198 2 198 3 198 4 198 5 198 6 198 7 198 8 198 9 199 0 199 1 199 2 199 3 199 4 199 5 199 6 199 7 199 8 Source s an d notes : Crud e oi l prices : Energ yInformatio n Administration , U S Departmen t o fEnergy , Petroleum Marketing Monthly, Decembe r1998 , Tabl e 21 . U S averag e firs t purchas e prices . Valu e fo r199 8 i s a n averag e fo r Januar ythroug h September . Price s are not adjuste d fo rinflation . Gasolin e prices : Energ yInformatio n Administration , U S Departmen t o fEnergy , Petroleum Marketing Monthly, Decembe r1998 , Tabl e 2 . U S refine rprice s o fmoto rgasolin e t o en d users , excludin g taxes . Valu e fo r199 8 i s a n averag e fo rJanuar ythroug h September . Price s ar e not adjuste d fo rinflation . Produce rPric e Index(PP h an d Consume rPrice Index("CPn : Burea u o fLabo rStatistics , U S Departmen t o f Labor , pric e inde xdat a availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21,1998] . Value s fo r199 8 ar e fo rJuly . PP I cover s al l finishe d good s excep t foo d an d energy . CP I i s U S cit y averag e excep t foo d an d energy . Fo rcompanie s tha t produc e crud e oil , lowe rprice s reduc e income . I fprice s dro p fa renough , an d sta ylo wlon g enough , companie s ar e induce d t o curtai l som e o fthei rexploratio n an d developmen t activitie s and/o rclos e thei rhigher-cos t wells . Hundred s o fnonmajo roi l an d ga s producer s wen t ou t o f busines s afte rth e pric e collaps e i n 1986. " Today , som e smalle roi l producer s ar e cuttin g salarie s an d closin g well s becaus e thei rcost s excee d th e pric e a t whic h the yca n sel l thei rcrud e oi l b ya s muc h a s a

2 Bo b Williams , "Oi l producers fac e ke yquestion : Ho wlon g wil l price s sta ylow? " Oil & Gas Journal, vol . 9 6 no . 52 , Decembe r28,1998 , p . 19 . 3 "Californi a Oi l Drillers Starin g at Extinction? " The Sacramento

Bee, Decembe r9 , 1998 , availabl e onlin e vi a http://cnnfn.news-real.com/ , [Decembe r9,1998] . 4 Energ yInformatio n Administration , U S Departmen t o fEnergy , "Oi l an d Ga s Developmen t i n th e U S i n th e Earl y 1990s : A n Expande d Rol e fo rIndependen t Producers, " Octobe r1995 , p . v . 

# HP. 6

Economic

State of the US Petroleum

Industry Pag e 3 dolla rpe rbarrel . Majo roi l companie s ar e cuttin g thei rexploratio n an d productio n capita l budgets , an d layoff s a t thes e companie s ar e tendin g t o fal l mor e heavil yo n exploratio n an d productio n operations . Fo rpetroleu m refiners , reduce d crud e oi l price s lowe rinpu t costs . However , lowe rcrud e oi l price s generall yhav e no t yielde d highe rrefiner yprofi t rates . A s show n i n Figur e 1 , price s o ffina l petroleu m product s (e.g. , gasoline ) ten d t o trac k crud e oi l pric e changes , fallin g a s crud e oi l price s decline . On e reaso n fo rthi s clos e associatio n betwee n price s i s competition , particularl ywit h finishe d petroleu m product s tha t ar e importe d an d tha t ma yno t reflec t ever ykin d o fcos t incurre d i n th e US . I n addition , consumer s o fpetroleu m product s ca n b e sensitiv e t o pric e changes. 7 (Th e competitiv e natur e o f fina l produc t pricin g ca n affec t petroleu m marketer s an d transporter s a s wel l a s refiners. ) Th e pric e decline s i n crud e oi l an d gasolin e stan d i n marke d contras t t o th e genera l pric e trend s fo rothe rU S good s an d services . A s Figur e 1 shows , bot h th e Produce rPric e Inde xan d th e Consume r Pric e Inde xfo rgood s othe rtha n foo d an d energ yhav e grow n dramaticall ysinc e th e earl y1980s . Figur e 2 show s th e declin e i n th e petroleu m industry' s employment , sinc e 1980 , relativ e t o othe r type s o fU S businesses . Petroleu m industr yemploymen t decline d i n th e exploratio n an d productio n sector , th e refining/marketin g secto r(excep t a t gasolin e servic e stations) , an d i n th e transportation/distributio n sector . Figur e 2

Petroleu m Industr yEmploymen t an d Tota l U S Employment , 1980-199 8

_2

.6 1 ,400. 0 ,300. 0 .200. 0 .100. 0 ,000. 0 ,900. 0 ,800. 0 ,700. 0 ,600. 0 ,500. 0 ,400. 0 Tota l U S

\O M an d Ga s Industr yTol a 140,00 0

199 0 100 1 196 2 109 9 199 4 196 9 199 0 199 7 199 9 109 9 199 0 109 1 199 2 100 3 109 4 190 5 199 9 199 7 199 4 90,00 0 80,00 0 70,00 0 60.00 0 

### £

I O 3

Source s an d notes : Oi l an d oa s industr

yemployment : Burea u o fLabo rStatistics , U S Departmen t o fLabor , Nationa l Employment , Hours , an d Earning s series , availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21 , 1998] . Valu e fo r199 8 i s preliminary , fo rOctober . Tota l compute d fro m dat a fo rth e followin g industr

ysectors (wit h thes e Standard Industria l Classificatio n codes) : oi l an d ga s productio n (131) , oi l an d ga s fiel d service s (138) , petroleu m refinin g (291) , petroleu m wholesalin g (517) , gasolin e servic e station s (554) , oi l pipeline s (46) , asphal t pavin g an d roofin g material s (295) , an d ga s productio n an d distributio n (492) . U S employment : For

1980-1996:

Burea u o fth e Census , U S Departmen t o fCommerce , Statistical Abstract of the United States: 1997, Octobe r1997 , Tabl e no . 619 . For 1997 and 1998: Burea u o fLabo r Statistics , U S Departmen t o fLabor , Th e Employmen t Situatio n News Release, " Tabl e A-1 , availabl e onlin e at http://stats.bls.gov/news.release/empsit.t01.htm , [Decembe r21 , 1998] . Value s fo r199 7 an d 199 8 are fo rNovember . Al l value s reflect employmen t fo rth e civilia n noninstitutiona l population . 5 "Californi a Oi l Drillers Starin g at Extinction? " 6 Merolli , "Oi l Major

s Se t t o Produc e More Pin k Slips" ; an d Borrego , "Phillip s Petroleu m T o Cu t Staffby8% , Capita l Spending. " 

# € "P. 7

Economic

State of the US Petroleum

Industry Pag e 4 Figur e 3 show s profi t trends , an d crud e oi l price s adjuste d fo rinflation , sinc e 1981 . Th e profi t rate s i n Figur e 3 ar e fo rmajo roi l companies ' domesti cpetroleu m operations . Averag e profi t rate s i n a give n yea rfo rsmalle rcompanies , suc h a s independen t refiner s an d independen t producers , ca n diffe r fro m th e averag e rat e fo rth e majors. 8 Figur e 3 show s profi t rate s fo rth e major s sinc e 198 0 an d inflation adjuste d crud e oi l prices . Durin g 199 6 an d 199 7 profitabilit ywa s highe rtha n migh t b e expected , considerin g th e leve l o fcrud e oi l prices . Reason s fo rthi s include d a dramati cincreas e i n natura l ga s price s (the yros e 4 5 percen t i n 199 6 an d ros e furthe ri n 1997 ) an d relativel ystron g profit s i n th e refining/marketin g sector. 9 Figur e 3 Profi t Rate s o fMajo rPetroleu m Companie s an d Crud e Oi l Price s Adjuste d fo rInflation , 1981-199 8

- 2.0 0

198 1 198 2 198 3 198 4 198 5 198 6 198 7 198 8 198 9 199 0 1991 199 2 199 3 199 4 199 5 199 8 199 7 199 8 Source s an d notes : Adjuste d crud e oi l prices : Crud e oi l price s fro m Figure 1 ar e adjuste d t o 199 8 dollars usin g th e implici t GN P pric e deflato rfro m Burea u o fEconomi cAnalysis , U S Departmen t o fCommerce , Survey of Current Business, vol . 7 8 no . 11 , Novembe r1998 , Tabl e C.1 . Deflato rvalue s fo r1981-199 7 ar e fo rfourt h quarters ; 199 8 valu e i s fo rth e secon d quarter . Profi t rates : For

1981-1996:

Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance Profiles of Major Energy Producers, 1987 , 1992 , an d 199 6 issues , publishe d 1989 , 1994 , an d 1998 , respectively , Tabl e B6 . For 1997: Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance

Profiles of Major Energy Producers

1997, publishe d 1999 , Tabl e B8 . Al l profi t rate s reflect domesti cpetroleu m operation s only . Al l profi t rate s are measure d a s contributio n t o ne t incom e divide d bynet investmen t i n place . Profi t rate s fo r199 8 ar e uncertai n bu t expecte d t o b e roughl y5 0 percen t belo w199 7 level s (se e discussio n i n text) . Profi t rate s fo r199 8 ar e no t ye t availabl e fo rth e dat a serie s depicte d i n Figur e 3 . However , greatl yreduce d profit s ar e likely , fo rthre e reasons . First , a s Figur e 3 shows , inflation-adjuste d crud e oi l price s fel l dramaticall yi n 1998 . Second , natura l ga s price s als o fell . An d third , refiner yprofitabilit y Energ yInformatio n Administration , U S Departmen t o fEnergy , Petroleum 1996: Issues and Trends, Septembe r 1997 , p . 70 ; an d America n Petroleu m Institute , "Cumulative Impac t o fEnvironmenta l Regulation s o n th e U S Petroleu m Refining , Transportatio n an d Marketin g Industries, " Octobe r1997 , pp . 3-4 . 8 Se e Energ yInfonnatio n Administration , Petroleum 1996: Issues and Trends, p . 142 , Figure 102 . 9 Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance Profiles of Major Energy Producers, 199 6 issu e (p . 6 ) an d 199 7 issu e (pp . 7-8) , publishe d 199 8 an d 1999 , respectively . 1 0 Natura l ga s wellhea d price s average d $1.6 8 pe rthousan d cubi cfee t i n Augus t 1998 ; averag e price s wer e $2.3 2 an d $2.1 7 i n 199 7 an d 1996 , respectively . (Th e pric e fo rAugus t 199 8 i s preliminary. ) Energ yInformatio n Administration , U S Departmen t o fEnergy , Natural Gas Monthly, Decembe r1998 , Tabl e 4 , availabl e onlin e vi a http://www.eia.doe.gov/ , [Januar y12 , 1999] . Reason s fo rth e lo wga s price s includ e a slackenin g Wester n Hemisphere deman d cause d bymil d weather . CliffEdwards , "Energ yPrice s Collaps e Anew, " Associate d Press , Decembe r8,1998 . 

# toP. 8

Economic

State of the US Petroleum

Industry Pag e 5 weakened . Analyst s hav e estimate d tha t oi l companies ' earning s i n 199 8 coul d averag e 5 0 percen t lowe rtha n 199 7 levels . Severa l petroleu m companie s poste d losse s fo rth e fourt h quarte ro f1998. 2 

## Trend s i n th e Oi l an d Ga s Exploratio n an d Productio n Secto r Th e U S oi l an d ga s exploratio n an d productio n secto rchange d greatl yafte roi l price s fel l i n 1986 . Th e sector' s activit ydeclin e i s illustrate d i n Figur e 4 wit h annua l number s o fU S wel l completions . Oi l an d ga s productio n activit ydecline d dramaticall ydurin g an d followin g 198 6 a s man yhigh-cos t well s becam e unprofitabl e an d wer e shu t down. 1 3 Activit yals o decline d significantl yi n 1998 * th e numbe ro f operatin g drillin g rigs decline d durin g 199 8 t o les s tha n hal fit s leve l a t th e en d o f1997 . 4 Figur e 4 als o show s th e declin e i n employmen t i n th e oi l an d ga s exploratio n an d productio n secto rsinc e 1982 . Figur e 4 U S Oi l an d Ga s Productio n Employmen t an d Wel l Completions , 1980-199 8

E o u

194 0 199 1 199 2 109 S 195 4 109 5 109 4 199 7 199 9 199 9 199 0 100 1 199 2 1091 ' 100 4 109 5 100 4 100 1 190 4 Source s an d notes : Employment : Burea u o fLabo rStatistics , U S Departmen t o fLabor , Nationa l Employment , Hours , an d Earning s series , availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21 , 1998] . Valu e fo r 199 8 i s preliminary , fo rOctober . Tota l compute d fro m dat a fo rth e followin g industr ysectors (wit h thes e Standard Industria l Classificatio n codes) : oi l an d ga s productio n (131 ) an d oi l an d ga s fiel d service s (138) . Wel l Completions : For

1980-1987:

America n Petroleu m Institute , Basic Petroleum

Data Book, vol . XVII I no . 2 , Jul y1998 , Sectio n III , Table s 1 an d 2 . For 1988-1998:

America n Petroleu m Institute , Quarterly Well Completion

Report. Fourth

Quarter 1998, vol . XI V no . 4 , Januar y1999 , pp . 5 an d 7 . Som e estimate s ar e subjec

t t o revision .

1 1 Refining/marketin g earning s o rprofit s ma yhave falle n b y2 5 percent , whe n compare d wit h 199 7 levels . Se e Davi d Chance , "Bi g oi l companie s brac e fo rbruta l earning s season, " Reuters Limited , Januar y12,1999 , availabl e onlin e vi a http://biz.yahoo.com/ , [Januar y13 , 1999] ; Fox , "Fourt h Quarte rWa s a Bruise rfo rOi l Companies" ; an d Pau l Merolli , "Convergenc e o fNegative Factors Combine s T o Pumme l Earning s fo rMajo rOi l Companies, " The Oil Dally, Novembe r23,1998 . 1 2 Chance , "Bi g oi l companie s brac e fo rbruta l earning s season" ; an d "Fourth-Quarte r199 8 Profit s fo r65 8 Companies, " The

Wall Street Journal, Februar

y16,1999 , p . C15 . 1 3 Energetics Incorporated , "Petroleum : Industr yo fth e Future - Energ yan d Environmenta l Profil e o fth e U S Petroleu m Refinin g Industry, " fo rOffic e o fIndustria l Technologies , U S Departmen t o fEnergy , Decembe r1998 , p . 2 . 1 4 Th e numbe ro fU S rotar yoi l rigs decline d fro m 36 1 i n Decembe r199 7 t o 152 i n Decembe r1998 . "Bake rHughe s Ri g Count, " Oil

and Gas Journal, vol . 9 6 no . 52 , Decembe r28,1998 , p . 92 . 

# 7P. 9



### Economic

State of the US Petroleum

Industry Pag e 6 Fro m th e mid-1980 s t o th e mid-1990s , majo rU S oi l companie s shifte d more o fthei rpetroleu m exploratio n an d developmen t activitie s t o location s outsid e th e US . I n 1985 , th e majors ' developmen t expenditure s totale d roughl y$2 0 billio n domesticall yan d $ 7 billio n overseas . B yth e 199 1 t o 1995 period , th e majors ' domesti can d foreig n expenditure s were mor e o rles s equal , i n th e $ 8 billio n t o $ 9 billio n range. 1 

### Th e reason s fo rthi s shift are bot h politica l an d economic . A s oi l price s declined , man yforeig n countrie s becam e more hospitabl e t o U S productio n activities . Fo rU S majors , th e profitabilityo foi l an d ga s productio n ha s generall ybee n highe ri n foreig n location s tha n domestically , sinc e a t least as earl ya s 1977. 1 6 

### Oi l an d ga s field s oversea s are typicall ylarge rtha n thos e i n th e US , an d oversea s productio n usuall yyield s highe rproductio n pe rwell . Withi n th e US , th e federa l governmen t restrict s petroleu m exploratio n an d productio n i n som e o fth e most promisin g areas (e.g. , Alaska an d th e Oute rContinenta l Shelf) . I n addition , U S environmenta l regulation s increas e producers ' operatin g costs. 1 7 

### Fo rman yyears th e cost s associate d wit h newU S field s were highe rtha n th e worldwid e average . (I t shoul d b e note d tha t th e shift oversea s has not bee n mad e b yth e majors exclusively . Man ysmalle roi l an d gas producers have initiate d oversea s operation s a s well.) 1 8 

### I n th e lat e 1990s , newtechnologie s an d favorabl e economic s allowe d U S major s t o greatl y increas e thei rdomesti cexploratio n an d productio n activitie s i n th e Gul fo fMexico , particularl yi n deepwate rareas. 1 9 

### However , wit h 1998' s declin e i n crud e oi l prices , offshor e project s are becomin g uneconomic. 2 0 

### Figure 5 shows ho

wth e majors ' profi t rate s fo rU S oi l an d ga s productio n hav e tende d t o fluctuat e wit h inflation-adjuste d crud e oi l prices . Th e relativel yhig h profi t rate s i n 199 6 an d 199 7 are at leas t partiall yattributabl e t o th e hig h natura l ga s price s mentione d earlier . I t i s likel ytha t 1998' s averag e profi t rat e decline d dramaticall yfro m th e 199 7 leve l a s inflation-adjuste d crud e oi l price s fel l below198 6 prices . Profi t rate s are on e indicato ro fpas t financia l performance . Reserve value s are on e indicatio n o f futur e financia l viability . Th e latte rmeasure look s especiall yblea k

fo roi l producers , becaus e thei r reserve s mus t b e value d wit h year-en d crud e oi l prices. 2 1 

### Anothe rimportan t tren d i n th e oi l an d gas productio n secto rha s bee n th e increase d rol e (onshore ) assume d b

yU S nonmajo roi l an d ga s producers . Som e majors sol d productio n facilitie s t o nonmajors wit h lowe roverhea d costs . Th e share ofexploratio n an d developmen t investment s mad e by nonmajors ros e fro m roughl y3 3 percen t o fth e U S tota l i n 1988-9 0 t o almos t 5 0 percen t byth e mid 1990s . I n fact , most oi l an d ga s producers ar e smal l an d privately-owned ; thes e type s ofoperation s accounte d fo rroughl y7,40 0 ofth e nearl y8,00 0 oi l an d ga s producers operatin g i n th e U S i n 1992. 2 2

1 5 

### Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, p . 54 , Figur

e 41 . 1 6 

### Thi s trend , however, di d no t hol d tru e i n 199

6 o r1997 . Se

e Energ yInformatio n Administration , Performance Profiles 1991, p . 19 , Figur

e 10 ; Performance

Profiles 1996, Tabl e B6 ; an d Performance Profiles 1997, Tabl e B8 . 1 7 

### Energ yInformatio n Administration , U S Departmen t o fEnergy, Perfonnance

Profiles of Major Energy Producers 1991, 1992, pp . 23-25 . 1 8 

### Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, pp . 4 9 an d 52 . 1 9 

### Mineral s Managemen

t Service , U S Departmen

t o fth e Interior , "Deepwate ri n th e Gulfo fMexico : An Updat

e o n America' s Ne

wFrontier, " Januar

y1998 , p . 1 . 2 0 

### Th e numbe ro

foi l and ga

s rotar yrigs offs l Decembe r1998 . "Bake rHughe s Ri g Count " 2 1 

### Publicly-owned companie s repor t such va l Arthu rAnderse n & Co. , "Oi l & Ga s Reserv e Disclosures, " (Chicago) , July1994 , pp . i , 23 , an d 74 . 22 

### Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, p . 54 ; a

m Administration , "Oi l and Ga s Developmen

t i n th e U S i n th e Early1990s, " pp . v , 11,49 , an d 52 . 2 0 

### Th e numbe ro

foi l and ga

s rotar yrigs offshor

e Texa s an d Louisian a declined fro m 12 7 i n Decembe r199

7 to 9 1 i n 2 1 

### Publicly-owned companie s repor t such valuation s annuallyt o th e US Securities an d Exchange Commission . Se e r l 22 

### Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, p . 54 ; an d Energ yInformatio n 

# < 2P.1 0

Economic

State of the US Petroleum

Industry Pag e 7

Figur e 5 U S Oi l an d Ga s Productio n Profi t Rate s an d Crud e Oi l Price s Adjuste d fo rInflation , 1981-199 8 5 0 4 5 4 0 3 5

_3 0" • I 25 - £2 0 1 5 1 0 S Crud e Oi l Pric e Adjuste d fo r nflatio n 1 .4 0

1.0 0

o •0.6 0 « 5 o

• - 0.4 0 < 0.2 0 0.0 0 198 1 198 2 198 3 198 4 198 5 198 8 198 7 198 8 198 9 199 0 199 1 199 2 199 3 199 4 199 5 199 6 199 7 199 6 Source s an d notes : Profi t rates : For

1981-1996:

Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance Profiles of Major Energy Producers, 1987 , 1992 , an d 199 6 issues , publishe d 1989 , 1994 , an d 1998 , respectively , Tabl e B6 . For 1997: Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance

Profiles of Major Energy Producers

1997, publishe d 1999 , Tabl e B8 . Profi t rate s ar e fo r majo roi l companie s only . Se e note s t o Figure 3 above fo radditiona l details . Adjuste d crud e oi l prices : Se e note s t o Figure 3 above . Nonmajo roi l an d ga s producer s ca n b e especiall yvulnerable , financially , durin g a n oi l pric e collapse , fo rsevera l reasons . First , nonmajo roi l an d ga s producer s ten d t o financ e thei roperation s mor e heavil ywit h deb t tha n th e major s do . I n th e even t o fa n oi l pric e decline , producer s wit h mor e deb t ma y hav e mor e difficult ymakin g thei rpayments . Second , fo rthos e oi l an d ga s producer s tha t specializ e i n 2 4 thi s lin e o fbusiness , poo rprofi t rate s canno t b e offse t b ystronge rreturn s i n othe rbusines s activities . Third , ver ylo wvolum e producer s ma yhav e specia l difficultie s coverin g thei rproductio n costs . (Toda y th e nation' s 436,00 0 "stripper " oi l well s produc e o n averag e onl y2. 2 barrel s o fcrud e oi l eac h day.) 2 

## Trend s i n th e Refinin g an d Marketin g Sectors On e o fth e mos t dramati ctrend s i n th e petroleu m refinin g secto rha s bee n th e closur e o falmos t hal fo fU S refinerie s sinc e 1980 . Thi s i s illustrate d i n Figur e 6 . I n th e earl y1980s , th e U S governmen t discontinue d a numbe ro fregulator yan d contro l program s establishe d i n th e 1970 s tha t ha d favore d smal l refiners . I n addition , deman d fo rpetroleu m product s decline d a s conservatio n measure s wer e undertaken . Man ysmal l o rinefficien t refinerie s shu t down .

2 3 Fo rexample , i n th e 1991-199 3 period , publicly-trade d independent s finance d 4 9 percen t o fthei roperation s wit h long-ter m debt , whil e ove rth e sam e perio d th e majors finance d 2 7 percen t o fthei roperation s wit h long-ter m debt . Energ yInformatio n Administration , "Oi l an d Ga s Developmen t i n th e U S i n th e Earl y1990s, " pp . 19-20 . 2 4 Ibid. , p . 21 . 2 5 I n total , however , strippe rwell s provid e a significan t share o fU S crud e oi l productio n - roughl y2 5 percent , excludin g Alaska an d federa l off-shore . Interstat e Oi l an d Gas Compac t Commission , " ABattl e fo rSurvival ? Th e Rea l Stor yBehin d Lo wOi l Prices, " repor t fo rannua l meeting , Decembe r1998 , p . 1 . 

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Figur e 6 Numbe ro fU S Petroleu m Refineries , 1980-199 7 35 0 30 0 25 0 20 0 15 0 10 0 5 0 Operabl e Shutdow n

196 0 198 1 198 2 196 3 196 4 196 5 196 6 196 7 196 8 196 9 199 0 199 1 199 2 199 3 199 4 199 5 199 8 199 7 Sourc e an d notes : America n Petroleu m Institute , Basic Petroleum

Data Book, vol . XVII I no . 2 , Jul y1998 , Sectio n VIII , Tabl e 4 an d footnote s t o th e table . Data fo r199 6 ar e not available . "Operabl e shutdown " refinerie s are inactiv e refinerie s tha t coul d b e full yoperabl e i n 6 0 t o 9 0 days . A s crud e oi l an d produc t price s decline d afte r1986 , petroleu m user s relaxe d thei rconservatio n measure s an d increase d demand . Man yrefinerie s successfull yresponde d t o th e increase d deman d whil e a t th e sam e tim e meetin g regulator yan d othe rchallenge s (discusse d below ) b yimprovin g efficiency , becomin g mor e flexible , adoptin g ne wtechnologies , an d upgradin g processin g units . Regulator y complianc e costs , however , force d som e refinerie s t o clos e i n th e 1990s . 6 Figur e 7 show s ho wrefining/marketin g employmen t decline d sinc e 1981 . Figur e 7 als o show s tha t refining/marketin g profi t rate s peake d i n 198 8 an d the n san k i n th e earl y1990s , t o nea rzer o i n 1992 . I n th e 1990s , refiners ' cas h operatin g margin s hav e bee n low , a s hav e return s o n equity. 2 7 Eve n whe n profitabilit yros e i n 199 6 an d 1997, 2 8 i t stil l remaine d wel l belo w1989' s profi t level . A s mentione d earlier , refining/marketin g profitabilit yweakene d i n 1998 . Wha t ar e th e cause s o frefiners ' lo wprofi t levels ? Variou s operatin g cos t increase s hav e bee n on e factor . First , refinerie s hav e ha d t o compl ywit h numerou s governmen t regulations , especiall y regulation s aime d a t environmenta l improvement . Regulator ycomplianc e cos t refinerie s roughl y$3 0 billio n i n th e 1990s . Refineries ' capita l cost s fo renvironmenta l complianc e almos t quadruple d betwee n 198 8 an d 1992 . Th e Clea n Ai rAc t Amendment s o f199 0 require d tha t refinerie s produc e oxygenate d gasolines , lowe rsulfu rdiese l fuels , an d reformulate d gasolin e (RFG) . Som e o fth e market s fo rthes e fuel s ar e extensive ; fo rexample , 3 1 percen t o fgasolin e sale s i n 199 6 wer e RFG . I n addition , som e state s als o establishe d ne wenvironmenta l requirements , suc h a s California' s standard s fo rgasolin e an d diesel . T o produc e th e cleane rfuels , refinerie s hav e ha d t o modif ythei rexistin g processes . Refinerie s als o incu r

2 6 Energetics Incorporated , "Petroleum : Industr yo fth e Future, " pp . 2-3 ; an d Energ yInformatio n Administration , Petroleum

1996: Issues and Trends, pp . 3 an d 8 . 2 7 Return s o n equityhave average d roughl y5 percent . Energetics Incorporated , "Petroleum : Industr yo fth e Future, " pp . 2-3 . 2 8 Th e relativel ystron g profit s i n th e refining/marketin g secto rwere partl yattributabl e t o stron g deman d fo rheatin g oi l an d gasolin e i n 199 6 an d cost-cuttin g an d decrease s i n cost s o frawmaterial s (e.g. , crud e oil , electricity ) i n 1997 . Energ yInformatio n Administration , Performance Profiles 1996, p . 6 an d Performance Profiles 1997, pp . 8 an d 42 . 

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### Pag e 9

Figur e 7 U S Petroleu m Refining/Marketin g Employmen t an d Profi t Rates , 1980-199 8 90 0 70 0 - 60 0 n 50 0 - - E m ploy m en t (Servic e Stations )

•a

-• _ E m ploy m en t (Excep t Servic e Stations )

R efinlng / M arkelin g Profit s 8 0

- 7 0

- 6 0 5 0 4 0 3 0 2 0 1 0 0 I - -1 0 I96 0 198 1 198 2 196 3 198 4 198 5 198 8 198 7 198 8 196 9 199 0 199 1 199 2 199 3 199 4 199 5 199 6 199 7 199 6 Source s an d notes : Employment : Burea u ofLabo rStatistics , U S Departmen t ofLabor , Nationa l Employment , Hours , an d Earning s series , availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21,1998] . Value s fo r 199 8 ar e preliminary , fo rOctober . Gasolin e servic e statio n employmen t i s fo rStandard Industria l Classificatio n cod e 554 . Employmen t fo rrefining/marketin g (excep t servic e stations ) i s summe d fro m dat a fo rth e followin g industr ysectors (wit h thes e Standard Industria l Classificatio n codes) : petroleu m refinin g (291) , asphal t pavin g an d roofin g material s (295) , an d petroleu m wholesalin g (517) . Profi t rates : For

1981-1996:

Energ yInformatio n Administration , U S Departmen t ofEnergy , Performance Profiles of Major Energy Producers, 1987 , 1992 , an d 199 6 issues , publishe d 1989 , 1994 , an d 1998 , respectively , Tabl e B6 . For 1997: Energ yInformatio n Administration , U S Departmen t ofEnergy , Performance

Profiles of Major Energy Producers

1997, publishe d 1999 , Tabl e B8 . Profi t rate s ar e fo r majo roi l companie s only . Se e note s t o Figure 3 abov e fo radditiona l details . cost s a s the ycompl ywit h regulation s designe d t o reduc e thei row n (direct ) emission s t o th e environment . Second , refiner s hav e incurre d expense s upgradin g processin g unit s i n orde rt o handl e deterioratin g qualitie s o fcrud e oils . Crud e oil s processe d b yU S refinerie s hav e becom e heavie ran d mor e contaminate d wit h material s suc h a s sulfur . Third , refinerie s hav e ha d t o upgrad e thei roperation s t o adap t t o change s i n deman d fo rthei r products . Deman d increase d fo rlighte rproduct s suc h a s gasolin e an d diese l fue l an d lessene d fo r heavie rproducts . Fo rexample , ove rth e perio d 198 0 t o 1995 , volume s o fheav yresidua l fue l decrease d fro m 11. 7 percen t o ffina l petroleu m product s t o 5. 4 percent. " 3 1 A s thes e thre e trend s hav e raise d refiners ' costs , competitiv e pressure s (e.g. , competitio n wit h importe d finishe d products , discusse d above ) hav e helpe d kee p refiners ' produc t price s low . Thi s combinatio n ha s depresse d refiners ' profits . Energ yInformatio n Administration , Performance Profiles 1996, pp . 16-17 ; Energetic s Incorporated , "Industr yo fth e Future, " p . 3 ; Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, p . 21 ; an d America n Petroleu m Institute , "Cumulativ e Impact, " pp . iii , 3 , an d 6 . 3 0 Energetics Incorporated , "Petroleum : Industr yo fth e Future, " p . 4 ; America n Petroleu m Institute , "Cumulativ e Impact, " p . 3 ; an d Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, p . 15 . 3 1 America n Petroleu m Institute , "Cumulativ e Impact, " p . 3 ; an d Energ yInformatio n Administration , Petroleum 1996: Issues and Trends, p . 15 .



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### Economic

State of the US Petroleum

Industry Pag e 1 0 Once refined , petroleu m products ente rdistributio n an d marketin g networks . Like refiners , i n th e 1990 s marketers had t o modif ythei roperation s i n orde rt o compl ywit h RFG requirement s (a s discusse d furthe rbelow) . Man yretai l outlet s als o incurre d expense s upgradin g undergroun d storag e tanks t o meet environmenta l requirement s promulgate d i n 1988. 3 

### As i s tru e fo rrefiners , marke t pressure s ca n limi t howmuc h marketers ' cos t increase s ca n b e passe d o n t o consumers . Marketin g operation s generall yhave lowprofi t rate s (o rmargins). 3 3 

## Trend s i n th e Transportation/Distributio n Secto r Th e transportation/distributio n secto rofth e petroleu m industr yencompasse s man ydifferen t facilitie s an d activities . Amon g the m are pipeline s an d bul k storag e terminal s that transpor t an d store crud e oil s an d finishe d products . Thes e facilitie s have bee n subject t o som e ofth e sam e factors as thos e tha t cause d reduce d profi t rate s i n th e petroleu m refinin g sector , suc h as environmenta l requirements . Th e distributio n an d marketin g networ k

fo rfinishe d petroleu m product s wa s develope d t o b e flexible , allowin g product s t o b e "batched " an d the n combine d whe n desired . RF G complicate d thi s network , requirin g th e separatio n of man ybatche s o fgasolin e that woul d otherwis e b e combined . Becaus e o fRFG , termina l operators sometime s hav e t o drai n an d clea n tanks betwee n produc t shipments . I n addition , terminal s an d pipeline s have recentl yha d t o compl ywit h newenvironmenta l requirement s designe d t o reduc e ai remission s fro m gasolin e and/o rothe rpetroleu m products. 3 4 

### Thes e facilitie s ca n operat e o n thi n margins . (Figure 8 shows employmen t an d profi t decline s fo r pipelines. ) Th e pric e sensitivityo fconsumers ca n limi t th e exten t t o whic h distributors ca n increas e thei r price s t o cove ran ycos t increases. 3 5



### Concludin g Remark s I fcrud e oi l price s remai n low , al l oi l producers wil l b e affected . Th e majors are more diversifie d tha n smalle rcompanies , bu t th e majors ' profit s fro m othe rbusines s activitie s migh t no t b e stron g enoug h t o compensat e i n th e even t o flowreturn s fro m oi l production . Natura l ga s price s currentl yar e low . Marketin g an d distributio n operation s ten d t o operat e o n sli m margins . Refinin g operation s wil l soo n incu r newexpense s t o meet more stringen t environmenta l requirements , suc h a s ne wstandard s fo r reformulate d fue l that wil l take effect i n th e yea r2000. 3 6 

### I n addition , reduce d Asia n deman d fo r petrochemical s i s hurtin g profit s o frefiners manufacturin g petrochemical s suc h a s ethylene. 3 7 

### Man ynonmajo roi l producers are sufferin g now . I n th e thir d quarte ro f1998 , a sampl e grou p o f independent s had , overall , negativ e earnings. 3 8 

### I foi l price s remai n depressed , nonmajo roi l producers maystruggl e financiall ydu e t o th e reason s discusse d above : lo wproductio n volumes , relianc e o n long 32 

### American Petroleu m Institute , "Cumulativ e Impact, " pp . 4 an d 27 . 3 3 

### Ibid. , p . 4 . 34 

### Ibid. , pp . 4 and 27 . 35 

### Ibid. , pp . iii , 1 , an d 4 . 3 6 

### American Petroleu m Institute , "Cumulativ e Impact " p . iii ; an d Energetic s Incorporated , "Petroleum : Industr yo fth e Future, " pp . 22 -23 . 3 7 

### Merolli , "Convergenc

e o fNegativ e Factors" ; an d Fox , "Fourt h Quarte rWa s a Bruise rfo rOi l Companies. " 3 8 

### Energ yInformatio n Administration , U S Departmen t o fEnergy , "Financia l New s fo rIndependent Energ y Companies, " Decembe r15,1998 , availabl e onlin e vi a http://www.eia.gov/, [Februar y11,1999] .

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1 5 

## I ,< Figur e 8 U S Pipelin e Employmen t an d Profi t Rates , 1980-199 8 O i l Pipelin e Employmen t 5 0

- 4 5 4 0 3 5 3 0 g

_ 2 5 _ 

### 2 0 I 1 5 1 0

- - 5 106 0 196 1 196 2 196 3 19S 4 166 5 198 6 196 7 198 6 196 9 199 0 169 1 199 2 189 3 199 4 189 5 199 6 199 7 199 8 Source s an d notes : Employment : Burea u o fLabo rStatistics , U S Departmen t o fLabor , Nationa l Employment , Hours , an d Earning s series , availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21 , 1998] . Valu e fo r 199 8 i s preliminary , fo rOctober . Oi l pipelin e employmen t i s fo rStandard Industria l Classificatio n cod e 46 . Profi t rates : For

1981-1996:

Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance Profiles of Major Energy Producers. 1987 , 1992 , an d 199 6 issues , publishe d 1989 , 1994 , an d 1998 , respectively . Tabl e B6 . For 1997: Energ yInformatio n Administration , U S Departmen t ofEnergy , Performance

Profiles of

Major Energy Producers

1997, publishe d 1999 , Tabl e B8 . Oi l an d ga s pipelin e profi t rate s ar e fo rmajo roi l companie s only . Se e note s t o Figure 3 abov e fo radditiona l details .

ter m debt , an d a lac k

o fdiversification . Eve n fo rth e man ywh o produc e natura l ga s i n additio n t o crud e oil, 3 9 th e curren t situatio n i s difficult , du e t o th e recen t declin e i n natura l ga s prices . Nonmajo rpetroleu m distributor s an d marketer s hav e alread yha d lo wprofi t rate s fo rsom e time . Environmenta l requirement s ar e i n fac t forcin g som e small , independen t gasolin e station s t o close . (Thes e type s o fbusinesse s hav e ha d a muc h mor e difficul t tim e tha n th e major s complyin g wit h standard s fo rundergroun d storag e tanks , whic h too k ful l effec t i n Decembe r1998)" " 4 0 I n sum , i fcrud e oi l price s remai n low , the n reduce d employment , profits , an d activit ylevel s i n th e exploratio n an d productio n secto rmigh t continue . Smal l oi l producer s ar e especiall yvulnerable , financially , durin g a n oi l pric e collapse . Also , establishe d trend s i n othe rpetroleu m sector s - e.g. , competitiv e pressure s an d ne wenvironmenta l requirement s - continu e t o threate n th e refining , marketing , an d distributio n sector s a s well .

A199 6 surve ybyth e Independen t Petroleu m Associatio n o fAmeric a foun d tha t th e typica l independen t respondin g t o th e surve yproduce d bot h crud e oi l an d natura l gas . Independen t Petroleu m Associatio n o fAmerica , "Profil e o fIndependen t Producers, " availabl e onlin e vi a http://www.ipaa.org/ , [Januar y8,1999] . 4 0 Jos h Whit e an d Mari a Glod , "Cos t o fReplacin g Undergroun d Tanks Sinks Som e Ga s Stations, " The Washington Post, Januar

y4 , 1999 , p . B1 . 

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, Basic Petroleum Data

Book, vol . XVII I no . 2 , Jul y1998 .

, Quarterly

Well Completion

Report Fourth Quarter 1998, vol . XI V no . 4 , Januar y1999 . Arthu rAnderse n & Co. , "Oi l & Ga s Reserve Disclosures, " (Chicago) , Jul y1994 . "Bake rHughe s Ri g Count, " Oil and Gas Journal, vol . 9 6 no . 52 , Decembe r28,1998 , p . 92 . Borrego , Ann e Marie , "Phillip s Petroleu m T o Cu t Staf fb y8% , Capita l Spending, " Th e Wall Street Journal, Januar y7 , 1999 , p . A4 . Burea u o fEconomi cAnalysis , U S Departmen t ofCommerce , Survey of Current Business, vol . 7 8 no . 11 , Novembe r1998 . Burea u ofLabo rStatistics , U S Departmen t o fLabor , pric e indexdat a availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21,1998] .

, , Nationa l Employment , Hours , an d Earning s series , availabl e onlin e vi a http://stats.bls.gov/datahome.htm , [Decembe r21,1998] .

Th e Employmen t Situatio n New s Release, " Tabl e A-1 , availabl e onlin e a t http://stats.bls.gov/news.release/empsit.t01.htm , [Decembe r21,1998] . Burea u ofth e Census , U S Departmen t o fCommerce , Statistical Abstract of the United States: 1997, Octobe r1997 . "Californi a Oi l Drillers Starin g a t Extinction?" , The

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Bee, Decembe r9 , 1998 , availabl e onlin e vi a http://cnnfn.news-real.com/ , [Decembe r9,1998] . Chance , David , "Bi g oi l companie s brac e fo rbruta l earning s season, " Reuters Limited , Januar y12 , 1999 , availabl e onlin e vi a http://biz.yahoo.com/ , [Januar y13,1999] . Edwards , Cliff , "Energ yPrice s Collaps e Anew, " Associate d Press , Decembe r8,1998 . Energetics Incorporated , "Petroleum : Industr yofth e Future - Energ yan d Environmenta l Profil e ofth e U.S . Petroleu m Refinin g Industry, " fo rOffic e ofIndustria l Technologies , U S Departmen t of Energy , Decembe r1998 . Energ yInformatio n Administration , U S Departmen t o fEnergy , Performance Profiles of Major Energy Producers, 1987 , 1991 , 1992 , 1996 , an d 199 7 issues , publishe d 1989 , 1992 , 1994 , 1998 , an d 1999 , respectively .

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y16,1999 , p . C15 . Fox , Loren , "Fourt h Quarte rWa s a Bruise rfo rOi l Companies, " The Wall Street Journal, Januar

y6 , 1999 , p . B10C . 

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fIndependen t Producers, " availabl e onlin e vi a http://www.ipaa.org/ , [Januar y8 , 1999] . interstat e Oi l an d Gas Compac t Commission , " ABattl e fo rSurvival ? Th e Rea l Stor yBehin d Lo

wOi l Prices, " repor

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, "Convergenc e o

fNegative Factor

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