Diversification efforts were undertaken in the context of sharply rising cash flow with the expectations of growth and profitability. Investment targets were chosen in part for their expected growth in future demand and in part for the opportunities to transfer expertise developed in petroleum and chemical operations. Overall, diversified businesses did provide a channel for corporate asset growth. Excluding railroad assets, net PP&E in the other nonenergy line of business increased by over 600 percent between 1974 and 1981 while, in total, the FRS companies' other lines of business registered net asset growth of 153 percent. However, the profitability of the other nonenergy line of business proved to be disappointing. The rate of return in this line of business fell continuously over the 1974-1982 period (Figure 16). Both early diversifiers and late diversifying companies exhibited a falling rate of return, with late diversifiers suffering negative returns more often than not (Figure 17).

A number of factors contributed to the generally poor performance of the FRS companies' diversification.

efforts. Economic recessions in 1974-1975, 1980, and 1981-1983 undoubtedly had negative effects on profitability, but these effects were transitory and cannot account for the continuous decline in the rate of return on diversified assets. A more likely explanation is that projections of future profit flows were not realized because of overoptimistic expectations and/or subsequent market developments that ran counter to projections. Managerial expertise may not have been as fungible as had been premised. The sheer size of the larger FRS companies inhibited the flexibility of response to competitive pressures in nonenergy markets. Whatever the causes, businesses outside energy and chemicals became prime targets of retrenchment and restructuring throughout most of the 1980's (reviewed in detail in the next section).

Most of the FRS companies had significant asset commitments in chemical operations in 1974, reflecting the close and often integrated relationships between the manufacture of many chemical products and the refining of hydrocarbons into petroleum products.

Following the economic recession of 1974-1975, demand for chemicals grew. The FRS companies' capital expenditures for chemical operations rose from $1.0 billion in 1974 to $2.7 billion in 1977 (Table 26), reaching 11 percent of total FRS capital expenditures, share not surpassed until the late 1980's. However, the escalation of oil prices following the Iranian revolution in late 1978 raised chemical feedstock costs. The consequent rise in chemical product prices had an adverse effect on demand, which, together with earlier capacity expansions, put a squeeze on profit margins. Rates of return in chemicals (Figure 16) fell below that of the FRS companies' overall return. In response, the FRS companies trimmed back their capital expenditures for chemicals in 1978 and 1979, to about 6 percent of total capital expenditures. The profitability of the FRS chemical operations continued to decline, reaching an all-time low during the economic recession in 19811983, the most severe U.S. economic downturn since the Great Depression. Until chemical demand and chemical profitability surged in the second half of the 1980's, the FRS companies' capital expenditures for chemical operations remained at about 6 percent of overall capital expenditures.

Energy sources outside petroleum also became attractive investment targets for most of the FRS companies, particularly in the context of the 1979-1981 oil price escalation. Sharply rising oil prices tended to lift all energy prices, as substitution of other fuels for petroleum tended to increase the demand for them and the expected stream of future profits from investment

in their development and production. Coal production and nuclear fuel production became clear areas of future growth, as the bulk of planned electrical generation capacity was directed toward use of these fuels. Less-developed energy sources, such as synthetic fuels, were attractive because the FRS companies' expertise in petroleum technologies might be employed to develop nascent technologies for economic production of unconventional fuels. For example, technological mastery of petroleum extraction and refining should be applicable to refining hydrocarbons extracted from coal or oil shale. Similarly, in the 1970's, most of the FRS companies had long-standing research and development capabilities that could be expanded to encompass invention and innovation in the area of emerging energy sources. Also, investment in the development of nonpetroleum energy sources could be a hedge for the major petroleum companies against the possibility of a greater erosion of petroleum demand should oil prices follow an even steeper trajectory than envisioned during the oil price escalations of 1974-1981, as well as a hedge against possible oil embargoes.

Among the fuel sources outside petroleum, coal production was the primary investment target during the 1974-1981 period (Figure 18). Coal had a ready and growing market, particularly in electricity generation, both in the United States and abroad. Further growth in coal demand was a likely prospect, given the expectations at the time concerning the future upward course of oil prices. Surface production of coal in Western areas, with its large investment requirements to attain economies of scale, proved especially attractive to some cash-rich FRS companies. On the East Coast, metallurgical-grade coal producers were finding growth in industrial markets abroad. The FRS companies' capital expenditures for coal operations rose from $0.2 billion in 1974 to a peak of $2.8 billion in 1981. Over the same period, their U.S. production of coal (bituminous coal and lignite) rose from 87 million tons (14 percent of total U.S. production) to 155 million tons (19 percent of total U.S. production).

Most of the growth in FRS coal production came from newly entering companies. In 1974, six FRS companies reported production of coal in the United States. Then, beginning mainly in 1977, eight additional companies joined the ranks of FRS coal producers. These entrants accounted for 79 percent of the increase in total FRS coal production during the 1977-1981 span (Table 28). Mergers and acquisitions played a minor role in the FRS companies' growing presence in the U.S. coal industry; the value of coal-related acquisitions in the 1974-1981 period was 29 percent of FRS capital expenditures for coal. Another point of interest is that

a number of FRS companies acquired coal reserves during the period but never produced any coal. By 1980, 37 percent of the FRS companies' U.S. coal reserves (and 50 percent of their Western coal reserves) were owned by nonproducers.

Alternative energy has encompassed a range of energy sources of varying commercial viability. The rise in oil prices, which began in late 1973, elevated the profit potential of theretofore excessively costly energy sources. Also, production subsidies for some forms of energy and the anticipation of subsidies for others attracted the interest of some major petroleum companies. The upswing in capital expenditures for alternative energy was somewhat belated, not beginning until 1980 (Figure 18). Over the previous five years, capital expenditures for alternative energy averaged about $400 million annually, with over 75 percent of the expenditures directed to Canadian tar sands development and production (Table 29). The emphasis on tar sands reflected this line of activity's financial viability which was made possible by the combination of high oil prices and Canadian government subsidies. Over this period, tar sands accounted for 92 percent of FRS companies' revenues from alternative energy sources.

From 1979 to 1982, the FRS companies' capital expenditures for alternative energy quadrupled, with oil shale development accounting for 90 percent of this growth. Since the late 19th century it has been known that refinable hydrocarbons could be extracted from oilbearing shale rock. Also, it was known that the oil shale resources of the United States are vast. The challenge was to develop processes to profitably transform oil from shale into refinery inputs consistent with environmental quality standards. Expectations of continually rising real oil prices appeared to offer the prospect of profitable development of oil shale processes. The FRS companies' capital expenditures for oil shale development jumped from $23 million in 1979 to over $300 million in 1980 and 1981 and totaled $1.0 billion in 1982. In 1982, 11 FRS companies reported capital expenditures for oil shale projects.146 However, technological disappointments and downward revisions of oil price expectations led to termination of most oil shale projects. After 1982, capital expenditures rapidly plummeted to nil and the only oil shale project to survive was Unocal's Parachute Creek operation. This project was shut down in 1990 due to increased costs relative to Federal price guarantees.

Like coal production, the growth prospects for nuclear fuel appeared rosy in light of projections of electrical generation capacity in the 1970's. Although a few FRS companies were involved in nuclear fuel processing, most of the FRS companies' interest in nuclear fuel was in uranium production. In 1974, only two FRS companies reported uranium production. By 1977, the FRS companies accounted for 48 percent of total U.S. uranium production. In 1980, the year of peak output of uranium, 11 of the FRS companies reported production. Capital expenditures for nuclear activities showed a sharp increase as well, peaking in the 1978-1980 period (Figure 18). However, the nuclear industry became plagued with economic difficulties. As noted in the 1982 edition of this report,"

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The problems of the nuclear industry in the United States in the 1980's, which include high levels of inventories, lower than anticipated growth in electricity demand, cost-increasing

construction,

delays in nuclear plant plant cancellations of nuclear plant construction, and foreign competition in nuclear fuel inputs, have led U.S. industry, and the FRS companies in particular, to a pattern of consolidation and retrenchment in nuclear operations.

Over the next three years, capital expenditures for nuclear activities plunged to near zero. All FRS uranium producers eventually withdrew from the industry, the last being Chevron in 1991.

The primary focus of the FRS companies' massive upswing in capital expenditures during 1974-1981 was oil and gas production. Sharply rising oil prices correspondingly increased the expected profitability of investments to discover and develop additional oil and gas reserves, as well as increasing the cash flow from ongoing oil and gas production operations. Over the period, the FRS companies' worldwide oil and gas exploration and development (E&D) expenditures 148 grew nearly fourfold, reaching $45.4 billion in 1981 (Table 30). However, investment targets changed over the period.

After a sharp rise following the Arab Oil Embargo of 1973, world oil prices (adjusted for inflation) were actually somewhat lower for the year 1978 than 1974, as

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were U.S. oil prices at the wellhead.149 Nevertheless, the earlier surge in oil prices was sufficient to attract added investment. In the United States, E&D expenditures of the FRS companies rose from $8.7 billion in 1974 to $11.8 billion in 1978 (Table 30). All of the increase in the FRS companies' U.S. spending during this period was directed toward onshore targets, both in Alaska and the lower 48 states. The lack of spending growth for offshore locales was in part a reflection of the U.S. Department of Interior's Outer Continental Shelf (OCS) leasing policies at the time. The Department of Interior auctions the right to explore OCS tracts (i.e., leases). The bidder offering the highest bonus (above a minimum acceptable level) is awarded the lease. Prior to 1983, the Department of Interior selected the tracts to be auctioned from nominations made by companies active in the OCS. A then-record offering (5) million acres) of OCS leases was made in 1974, resulting in successful bonus bids of $5.0 billion.150 In the following years, OCS bonuses were considerably lower and did not surpass the 1974 level until 1979.

The Department of Interior's OCS policy had a dual effect on offshore expenditures. First, expenditures for

OCS acreage (lease) acquisition were lower. Lease acquisition expenditures have typically been a large share of offshore expenditures. For example, over the 1977-1981 period (1977 is the earliest year for which data of requisite detail are available), acquisitions of offshore acreage by FRS companies, mainly through the payment of OCS lease bonuses, comprised 41 percent of offshore exploration and development expenditures. The comparable share for onshore expenditures was 9 percent. Second, with less offshore acreage to explore and develop, drilling and other related upstream activities (exploration, development, and production of oil and gas) were reduced.

Abroad, the FRS companies' targets of upstream investment clearly shifted to politically secure Canadian and European locales and away from oil-producing areas of potential and actual political turmoil. The FRS companies' exploration and development expenditures for Canada and Europe more than doubled between 1974 and 1978 while total expenditures for the remaining areas changed little. The main area of growth was the North Sea. Higher expected oil prices and the vast potential oil and gas reserves of this region were