Pennzoil Switches On Its Searchlightby
Days after Thomas M. Hamilton took charge of Pennzoil's oil-exploration unit in 1991, he knew he was in trouble. Almost every geologist had been laid off or quit, leaving few promising fields. The company was looking frantically for acquisitions to maintain reserves. And instead of trying to cap the problems, Pennzoil's managers bucked responsibility up the line, sending Hamilton a two-foot stack of field-by-field drilling reports every Friday morning. "What do I want these for?" he finally snapped. "The last thing I should be doing is sitting in Houston telling our operators how to run their fields."
Yet that's just what Hamilton had to do. Decades of dealmaking by founder J. Hugh Liedtke had vaulted Pennzoil to near-major status, but the steady buying camouflaged mediocre performance at finding and developing oil and gas reserves. Worse still, the legal maneuvering surrounding Liedtke's crowning achievement--the $3 billion 1988 settlement from his courtroom victory over Texaco Inc. for busting his proposed takeover of Getty Petroleum Corp. in 1983--had caused management virtually to neglect day-to-day operations.
"NEW BALL GAME." Now, Chief Executive James L. Pate, who succeeded the retiring Liedtke as chairman last May, is trying to make Pennzoil as effective a prospector in the oil field as it has been in the courtroom. A soft-spoken former economist who came to Pennzoil in 1976 after a Commerce Dept. stint in the Ford Administration, the 59-year-old Pate has sold off laggard units and strengthened the company's balance sheet. Most important, he has put Pennzoil back on the exploration trail, spending $255 million since 1992 on ambitious plans to develop new fields abroad. But with cash short and rivals restructuring, too, skeptics say Pennzoil still lags. "They have cut costs, but so has every oil company," says Bear, Stearns & Co. analyst Frederick P. Leuffer Jr. "Whether Pennzoil is improving relative to the industry remains to be seen."
Certainly change was needed: Six years after its windfall, Pennzoil has little to show. Roughly $350 million went to buy the Purolator oil-filter business--since sold for $206 million. With an additional $2.2 billion, Liedtke bought a 9.5% stake in Chevron Corp. By 1992, Pennzoil traded half its Chevron shares--then worth roughly $1 billion--for 139 aging oil fields in the Gulf of Mexico. That doubled reserves, but performance remains lackluster. Analyst Robin Shoemaker of Lehman Brothers Inc. estimates that operating earnings for 1994 will hit $289 million on sales of $2.5 billion--less than the $328 million Pennzoil earned in 1991 on similar sales.
Pate has wasted little time cleaning Pennzoil's slate. In October, he O.K.'d a $500 million write-down that included everything from back taxes on the Texaco settlement to losses on the sale of a sulfur-mining subsidiary and bad real estate investments. That scarred 1994 results: Shoemaker expects net earnings on continuing operations to plummet 70%, to just $24 million. Yet even excluding one-time events, Pennzoil's net margin, at 1%, is well below the industry average of 3.9%. Still, disgruntled investors, who watched Pennzoil's stock sink from 97 in 1987 to 45 today, applauded. "It's a new ball game now," says analyst Alan D. Gaines of Gaines Berland Inc. "Pennzoil can go back to being an exploration company rather than a litigation company."
To get there may take more hard choices. Although Pennzoil's debt-to-capital ratio should fall from 66% to 52% by 1998--when Pennzoil's remaining $900 million in Chevron shares will be swapped to reduce debt--the improved balance sheet masks another problem: Operating cash flow isn't enough to meet capital investments and the $120 million dividend. Although asset sales and new equity made up the difference in the past, Leuffer expects Pennzoil's cash-flow shortfall to top $350 million for 1994 and 1995--even though capital spending abroad fell to $28 million last year. "Their capital needs are increasing, and they don't have the money," says Leuffer. "They can't afford that dividend."
But Pate insists rebuilding performance will be enough. Improving returns at Pennzoil's $900 million oil and gas business will be vital; with roughly one-third of revenues and earnings, it's the key to the company's future. Liedtke counted on inflation and high crude prices to keep asset values and deals rising--and dismissed an exploration staff that he thought unnecessary. "But the environment has changed dramatically," Pate says. "Now operational performance is everything."
Pate's game plan is simple: Squeeze more production out of existing fields while selling off less promising properties to fund long-term exploration. For now, Pennzoil is concentrating on overseas sites such as Azerbaijan and Qatar. Down the road, new technology could also unlock huge reserves deep in the Gulf of Mexico.
PENNY-PINCHING. Hamilton, a well-regarded former head of British Petroleum Co.'s international exploration effort, has made some progress. Pennzoil's costs for finding and developing a barrel of oil topped $8 in 1989, while U.S. majors spent around $5. By selling the least productive sites and trimming the portfolio from 800 fields to 500, Hamilton has lowered costs to $5.40. Now, he aims to cut that to $4.35.
At the same time, Pennzoil must rebuild shrunken reserves; in recent years, it has replaced just 60% of annual production with new reserves. In 1994, new drilling boosted reserves slightly, to 448 million barrels of oil. More improvement should come from the long neglected fields Pennzoil bought from Chevron. Take the South Marsh Island gas field 80 miles off the Louisiana coast. Early last year, Pennzoil replaced eight aging structures with a 1,200-ton platform. The $70 million investment is paying off: New wells and more modern technology have increased production from 15 million cubic feet of natural gas per day last year to 95 million cubic feet today.
Hamilton is also trying to create a more decentralized, operations-oriented culture. To increase flexibility to cope with volatile crude prices, he wants field personnel to make cost-benefit trade-offs on-site--such as whether to fix damaged wells if prices don't justify the investment. Still, tales of penny-pinching are easy to find in the Oil Patch, where 500,000 jobs have been lost in a decade. "Pennzoil is doing the same things as everyone else, only later," says a production manager at one rival. "They do a good job on their high-priority fields but have been pretty neglectful of others."
CRITICAL SALES. Pennzoil is also a latecomer to the global oil scene. While it has signed deals to develop fields in Qatar, Egypt, and Azerbaijan, overseas barrels are less than 1% of its total. Without the financial or technical muscle of the majors, "it's a difficult call as to whether they'll be successful overseas or not," admits retired board member Douglas J. Bourne.
Other problems could also crimp Pate's plans. Warm weather has slashed natural-gas prices and cut the value of fields, hurting efforts to sell $250 million worth of domestic properties this year. If those sales are delayed, cash could quickly dwindle--forcing Pate finally to cut Pennzoil's dividend or trim development spending. But Pate says the dividend will stand. "I'm not saying there won't be negative cash flow next year--or even the year after that," he says. "But we're going to do what's needed to get our growth machine going." So long as Pennzoil wins no more landmark lawsuits, it might get there.
PATE HAS POLISHED PENNZOIL...BUT FACES A GUSHER OF CHALLENGES
-- Sold ailing businesses and refocused company on three key areas: motor oils, oil and gas exploration, and Jiffy Lube oil-change outlets.
-- An October settlement with the IRS ends 12 years of legal wrangling over Texaco. With the Getty-Texaco affair behind it, Pennzoil can concentrate on improving operations.
-- $303 million in new equity, restructured debt, and a $500 million write-off last fall give Pennzoil its strongest balance sheet in years.
-- Company has little foreign presence. Pennzoil must boost motor oil sales abroad and prove it can develop new fields in Azerbaijan and Qatar as cost-effectively as more experienced rivals.
-- Pennzoil must shrink exploration costs and hike production from aging oil fields. Otherwise, cash to fund hefty dividends and ambitious foreign exploration will dry up.
-- After years in which oil exploration lagged behind dealmaking, Pate must create a more decentralized, operations-oriented culture.