Case Study of Financial Strategies for Two Large, Independent Oil Companies
Authors: David Amiel , Carson G.P. , Black J.M. , Kipp J.M. 
Published: December 2007

This paper is a case study of two major independent U.S. companies and howthey reacted to a boom-and-bust environment. It compares the strategicfinancial and technical decisions made for survival. One company managed toimplement the steps required for survival; the other chose to responddifferently, resulting in its ultimate demise.

Introduction

Historically, independent oil producers have relied heavily on financialinstitutions, such as commercial and investment banks, to finance ongoingoperations. Conventional financing of existing reserves frees working capitalfor exploration activities and reserve acquisitions. Recent declines in oil andgas prices, coupled with excess gas deliverability, have prices, coupled withexcess gas deliverability, have reduced companies' cash flow from operationsand consequently reduced the present value of their assets. The reduction ofcash flow and present value caused lenders to require loan repayments. Thesepaydowns were necessary to bring the loans paydowns were necessary to bring theloans within specific asset and cash-flow coverage ratios required by bankunderwriting parameters. parameters. Companies that anticipated the reductionin their borrowing capacity scaled down oil erations by reducing overhead andselling unprofitable operations. Companies also converted short-term, variable-rate loans to longer-term, fixed-rate debt or to equity. Thesecompanies, by taking the often-difficult course of action, managed to survivethe lean times and position themselves to move forward during an upturn. Because of their inability to react to market changes, continued expectationsof high oil and gas prices, and/or lavish expenditures on risky prices, and/orlavish expenditures on risky projects, other companies did not survive thedownturn. projects, other companies did not survive the downturn. Before the1973 U.S. oil embargo, conditions in the oil and gas industry were stable. Theindustry appeared unconcerned about the future because prices were predictableand production allowables were increasing. Under these conditions, existingprofit margins were acceptable. But the 1973 oil embargo altered many investorsto the potential for profit from oilprice increases. By 1975, Arab light oilprices were above $10/bbl compared with prices were above $10/bbl compared witha pre-embargo price of slightly more than $21/bl. Prices stayed fairly leveluntil mid-1979, when oil prices more than doubled again in less than 2 years. The natural gas industry did not see corresponding price increases because ofdifferent market dynamics. price increases because of different marketdynamics. Gas supply in the U.S. came principally from domestic sources. Regulatory constraints kept interstate prices artificially low, thusstimulating demand. Supply interruptions during the cold winter of 1976–77resulted in pipelines scrambling for secure sources of gas and prompted the U.S. Congress to begin legislation that culminated in 1978 with the Natural Gas Policy Act (NGPA). Meanwhile, drilling for gas in the unregulated intrastategas market increased so rapidly that by 1977 the capacity to produce exceededdemand, and the gas bubble started to take shape. Discounting this, by the timethe NGPA was signed into law, its built-in price incentives to increase supplyprompted investors (who hoped to share in the rewards) to provide the industrycapital with which to drill. Investors were also lured by the tax regulationsof the period, which were structured to encourage the period, which werestructured to encourage the search for new energy supplies. With higher pricesand increased drilling, the demand for energy loans expanded rapidly. Bankswithout experience in oil and gas lending joined old-line energy lenders. Evenveteran lenders were caught up in the euphoria of rising prices. Competitionfor loans caused some banks to liberalize or to ignore the traditional lendingguidelines that had served them well for many years. Rosy price forecasts, thegreed for quick profits, the U.S. tax environment, and profits, the U.S. taxenvironment, and the availability of easy money contributed to the rapid growthof the energy sector until its collapse in the early 1980's. Companies reactedin various ways to the downturn. Some implemented the steps required forsurvival, while other reacted differently, resulting in their ultimate demise. The two companies chosen for analysis, Apache Corp. and Peter-Lewis Corp., wereselected for a number of reasons. Because both were publicly traded, corporateinformation was publicly traded, corporate information was readily available. The public participated through limited-partnership investments, whilefinancial institutions provided loans. While the wisdom of hindsight is not aluxury afforded prognosticators, several early warning signs should have beennoted. The intent of this paper is to identity the conditions that can affect acompany's operations and to analyze management s responses.

JPT

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