intervention in energy markets. In 1993, state energy companies are moving toward forms of privatization. Foreign investment in energy is often welcome, and the tax structures of oil-producing nations are largely competitive. Belief in free markets has definitely undergone a renewal. Perhaps most surprising of all, in the beginning of the era the United States and the Soviet Union were contenders in a political and ideological cold war, while in 1993, the Soviet Union is dissolved and Communism in practice is defunct. Ironically, oil and gas prospects in the states of the Former Soviet Union have become some of the most prominent targets of investment for the FRS companies.

Throughout the two decades following the Arab Oil Embargo, the FRS companies remained major players in energy markets. Changes in U.S. capital markets and the increase and subsequent collapse in world oil prices caused the FRS companies to institute changes in corporate strategy, and in the most recent decade, to aggressively cut costs and streamline their resource development and refinery operations. This report reviews the strategies of the major energy companies in relation to energy market developments and shifts in government policies. The main findings include:

Corporate Strategy. The increase in oil prices that began in late 1973 and lasted until early 1981 dampened demand for petroleum products, limiting the growth of the FRS companies' core business. Nevertheless, consistent with managerial and shareholders' preferences of the period, the FRS companies sought to reinvest the massive cash flow stemming from higher oil prices. Businesses outside petroleum appeared to offer avenues for investment and corporate growth. Diversification beyond petroleum involved a wide range of activities, from mining and agriculture to direct mail and retailing. Unfortunately, ventures into diversified businesses often provided lower rates of return than petroleum operations, which decreased overall corporate profitability.

After reaching a peak in early 1981, oil prices generally declined. Expectations of lower oil prices reduced the prospective profitability of oil and gas production, the FRS companies' primary source of earnings. Demand by shareholders for better performance, and the threat of takeover attempts in the early 1980's spurred the FRS companies to increase investor returns. The FRS companies used cash generated by ongoing operations, transferring it directly to shareholders in the form of dividends and stock repurchases and, indirectly, by reducing corporate debt. They further redirected investment

to their main lines of business: oil and gas production, refining and marketing, and chemicals, and sold off diversified businesses. The collapse in oil prices in 1986 added to the imperative for retrenchment and restructuring, further propelling sales of poorly performing assets.

• Oil and Gas Resource Development. Before the Arab Oil Embargo, the FRS companies dominated the world petroleum market, with ownership interests in oil and gas reserves across the globe, including huge reserves in the Middle East. The increased exercise of OPEC's market power, in addition to raising oil prices, also included nationalization of significant parts of the FRS companies' assets and imposition of confiscatory taxes. The FRS companies responded to the loss of low-cost investment targets by developing oil and gas resources in relatively expensive but politically secure regions of the world, particularly the United States. The high price of oil supported the increase in the cost of developing these resources.

The oil price decline that began in 1981 and the oil price collapse of 1986 compelled the FRS companies to reduce the cost of adding oil and gas reserves. The companies adopted several strategies to accomplish this. They became more selective in choosing drilling prospects, and abandoned highcost exploration projects. At the same time, they concentrated on less risky development projects and adopted advanced technology to increase the productivity of drilling. Perhaps the most farreaching strategy adopted by many of the FRS companies', however, was the shift in resource development out of the United States and into relatively low-cost foreign regions following the oil price collapse. By 1991, the FRS companies' exploration and development expenditures directed to foreign locales exceeded U.S. expenditures, as they have in all subsequent years. This shift has contributed to increased U.S. dependence on foreign sources of oil, but at the same time it has contributed to the geographic diversity of crude oil supplies.

Downstream Petroleum. The FRS companies' downstream operations (refining, marketing, and transport) had to adapt to a rapidly changing environment following the Arab Oil Embargo. Key developments included generally deteriorating quality of crude oil supplies, substantial shifts in the level and composition of refined product demand, a variety of government policies directed toward petroleum refiners and marketers, and wide

swings in oil prices. During the two decades following the embargo, the profitability of refining and marketing was volatile. Periods of excess capacity compelled massive shutdowns and cutbacks. For example, the FRS companies' U.S. crude oil distillation capacity peaked at 15 million barrels per day in 1980 (78 percent of total U.S. capacity), but, in 1993, capacity was 11 million barrels per day (68 percent of total U.S. capacity). Multinational refiners in the FRS group made even more severe cutbacks in foreign capacity. Nevertheless, the FRS companies incurred substantial capital outlays for refining and marketing.

Capital outlays were mainly directed toward upgrading refineries to produce lighter products and utilize lower quality crude oils, while meeting heightened environmental quality standards. Over the 1974-1993 period, U.S. refiners have had to face more stringent environmental standards for refinery emissions and effluents and for refinery products, particularly transport fuels. The path of FRS refiners' environmentally-related capital expenditures tended to reflect the passage of major environmental legislation. In the mid-1970's, over 30 percent of the FRS companies' capital expenditures for U.S. refineries was for pollution

abatement. The comparable share fell to less than 10 percent in the mid-1980's. The most recent data indicate that in 1992, environmentally-related capital expenditures accounted for nearly 40 percent of the FRS companies' outlays for U.S. refineries.

Due to upgrading investments, the refineries retained by the FRS companies are much more sophisticated than those of 1974. Gasoline manufacturing capability, relative to the basic U.S. refinery capacity of the FRS companies, increased by a third over the 1974-1993 period, and the capability to utilize lower quality crude oils doubled. Gasoline marketing, after undergoing massive consolidation following the Arab Oil Embargo, became a target of FRS investment following the collapse of oil prices in 1986. Lower oil prices led to increased petroleum product demand, particularly for transport fuels. Over the period, gasoline has become a much more tailored product, with most gasoline now sold through high-volume, self-service outlets rather than through low-volume, high-service outlets. The combination of cutbacks and capital expenditures increased the productivity of FRS retail gasoline outlets fourfold over the period.

Economic Growth, Lower Oil
Prices, and Downstream
Improvements

The 25 companies reporting to the Energy Information Administration's (EIA's) Financial Reporting System (FRS) derive the bulk of their revenues from petroleum operations, including natural gas production (see the box entitled, "The FRS Companies in the U.S. Economy and Energy Markets").1 A majority of FRS companies are multinational, with over a third of the companies' assets allocated to foreign operations. Developments in petroleum and natural gas markets in the United States and abroad are of primary importance to the FRS companies' financial performance. The efforts by these companies to reduce the costs of ongoing operations through consolidation were also of importance in 1993. Overall measures of global petroleum supply and demand appear to indicate that 1993 was a stable year for petroleum markets. World petroleum consumption? and oil production3 were within 1 percent of the 1992 level. Despite the seeming absence of dynamism in 1993, the FRS companies' financial results reflected a rebound in downstream petroleum (refining, marketing, and transport) earnings from a very poor performance in 1992. The downstream recovery more than offset a deterioration in upstream (oil and gas exploration, development, and production) earnings. The FRS companies also improved bottom-line results through cost cutting and business consolidation in 1993.

Poorer upstream financial performance in 1993 was largely the result of lower oil prices, which were nearly $2 a barrel lower than in 1992. Most of the oil price decline occurred in the fourth quarter, as the Organization of Petroleum Exporting Countries (OPEC)

increased production and were unwilling to reduce crude oil production quotas at their November meeting, leading to a downward slide in crude oil prices. An unusually high level of world crude oil inventories also put downward pressure on prices during late 1993.

On the demand side, although world petroleum consumption was down less than 1 percent in 1993 compared with 1992, consumption patterns varied widely across regions. At one extreme, the economies of Southeast Asia and the Pacific Rim (apart from Japan) grew at a 7-percent clip as measured by real Gross Domestic Product (GDP), and petroleum consumption rose at an 8-percent rate. Several of the FRS companies have substantial refining and marketing operations that serve the economies of the Pacific Rim. At the other extreme, the former Soviet Union countries' collective GDP fell 13 percent, and petroleum consumption declined 19 percent. The U.S. economy was well within these extremes, with growth in GDP of 3 percent and petroleum consumption up 1 percent. Sluggish growth in Japan and OECD Europe led to reduced petroleum consumption in these regions. While global petroleum consumption was down slightly, gasoline and distillates registered 3-percent growth.5 Massive investment in refinery upgrading in recent years enabled many of the FRS companies to benefit from the growth in demand for lighter end products in 1993.

In contrast to oil demand, natural gas demand was up substantially in most parts of the world. In the United States, 4-percent growth in natural gas consumption came largely from increased industrial demand. Abroad, apart from the former Soviet Union, natural gas consumption in 1993 was 6 percent above the 1992 level. Natural gas prices were higher in the United States, reflecting the competitive nature of U.S. markets. Improvements in prices and the longer-term outlook for

"The WEFA Group, World Economic Outlook, July 1994, p. 5.11.

"BP Statistical Review of World Energy, June 1994, P. 8.

"BP Statistical Review of World Energy, June 1994, p. 22.