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It's allowing independents to muscle their way in--and forcing Big Oil to change tactics

Call it ''drilling by the data bit.'' Before Jack L. Messman launched a hostile takeover of Pennzoil Co. on June 23, he compiled every piece of available data on Pennzoil's fields around the world. Using computer programs that help pinpoint hidden oil and natural gas, the CEO of Union Pacific Resources Group Inc., the largest independent oil and gas company in the U.S., concluded that Pennzoil was sitting on far more reserves than even it realized. The result: a $6.4 billion bid that was changed to an all-cash offer on Oct. 6. ''Technology is what's driving this business today,'' says Messman, a former computer company executive turned oilman.

Indeed, the oil industry is closer to a high-tech industry than the commodity business it once was. The majors no longer dominate simply on the basis of their extensive reserves, refineries, and distribution networks. The new winners are the independents and oil-service companies that lead in the key technologies driving down the costs of exploration and production (table).

To compete, the big oil companies are being forced to change the way they do business. Some, such as British Petroleum Co., have been able to make the jump into the new era by embracing advanced technology. Other companies are shifting more of their resources away from refining and into more profitable exploration and production. And struggling oil giants are attempting to use alliances and mergers to acquire the skills and technology they need to flourish.

SPECIAL SERVICES. To be sure, the new economics of oil has brought great benefits to the entire industry as a combination of new technology, cost control, and a spurt in oil prices enables many companies to report lush profits. Exxon Corp., for example, earned an astounding $6 billion in the first nine months of 1997 alone, up 19% from the comparable period a year earlier. Mobil Oil Corp. reported a 12% gain, on top of a 25% profits increase for 1996.

But the short-run profitability of the big companies belies the challenges they face. Many of the crucial technologies for finding and extracting oil now come from service companies or boutique suppliers. The two largest service companies, Halliburton and Schlumberger, with their grip on delivering seismic, sensing, and well-management technologies, are becoming as integral to oil as Intel and Microsoft are to the computer industry. Since the end of 1991, Halliburton has delivered a total return twice that of the Standard & Poor's 500-stock index. Schlumberger, while not doing quite so well, beat the S&P by about 40% over that stretch.

Moreover, the service companies are looking to extend their high-tech lead. In just the past year, Halliburton has spent nearly $1 billion to acquire or buy stakes in the leading provider of seismic-interpretation software; a sensor company that uses nuclear magnetic resonance to sniff for oil, gas, or water; and the developer of remote-controlled valves allowing multiple fields to produce simultaneously from a single well.

For the first time, small independents and state-owned oil companies have access to much of the same technology as the majors. ''If you go back 10 to 20 years ago, the Seven Sisters were the developers and controllers of all technology. Improving access to that technology has changed the playing field,'' says Robert P. Peebler, chief executive of seismic software developer Landmark Graphics Corp.

INTO THE DEEP. The result has been the rise of feisty newcomers such as Union Pacific Resources, British-Borneo Petroleum Syndicate, and Newfield Exploration. Newfield, for example, a 1989 startup that specializes in using 3-D seismic technology to explore for oil, is a significant producer in the Gulf of Mexico and is now drilling off the China coast. Just three years ago, independents weren't even a factor in the industry's hottest sector--deepwater oil exploration. But earlier this year, independent oil companies grabbed 39% of the available offshore drilling rights in the Gulf of Mexico being auctioned off by the U.S. government. The independents also have been adept at exploiting finds that the majors overlooked or considered depleted.

The more nimble of the big oil companies are shifting to take advantage of the new technology, concluding that their future lies in oil and gas production rather than refining. Companies such as Royal Dutch/Shell Group and BP are reducing assets in low-profit refining while pouring billions into lucrative exploration and production projects. Texaco Inc. wants to raise its production by 9% a year--to 1.7 million barrels a day by 2001. And Conoco Inc. now plans to derive 75% of future revenues from increased production of oil and gas, up from 63% historically.

''THIRD WAVE.'' Other companies are seeking a jump-start by making acquisitions and alliances designed to give them access to new reserves and technologies. Consultants McKinsey & Co. says the industry is now starting ''a third wave of mergers, acquisitions, and alliances'' that could lead to supermajors with revenues in the $50 billion-and-up range. Mobil, which has had a dismal exploration record, last year acquired fields and exploration skills by buying Australia's Ampolex Ltd. Amoco and Texaco have tapped low-cost independents for joint exploration ventures, opening access to fields the majors couldn't hope to exploit profitably, while Shell is setting up dozens of business alliances with a wide range of partners. ''We think the collaboration results in having better technology,'' says Shell Oil Co. CEO Philip J. Carroll.

And Big Oil companies are focusing on the largest, most complex projects--ones that are out of reach of the independents. Exxon, for instance, has proposed spending $15 billion to develop Russian offshore fields. Shell and Mobil are spending $3 billion in Peru alone. ''A lot of what the smaller, focused companies do is something we've chosen not to do,'' says Amoco CEO H. Laurance Fuller.

The stock market is starting to recognize the industry's high-tech transformation. The price-earnings ratios of many oil companies, while still lower than the S&P's, have been on the rise. Many of the majors are putting a greater emphasis on boosting return to capital rather than maximizing cash flow as they did in the past. Traditional measures of success, such as the size of proven reserves, are becoming less meaningful as companies move toward the same type of just-in-time strategies that other industries have adopted. ''People would criticize Ford if it had 10 years' worth of inventory. Our inventory is reserves. The new way is not to build reserves but to get them out right away,'' says Messman.

If he's right, the winners in oil's high-tech era won't be the big, vertically integrated Goliaths that have dominated the scene for the past four decades. Rather, it will be those companies best able to use new technologies to stay nimble and profitable in the face of a long-term trend of falling real prices. And that seems to fit oil's new breed just fine.

By Gary McWilliams in Houston

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Updated Oct. 23, 1997 by bwwebmaster
Copyright 1997, Bloomberg L.P.
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