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Table 36. Distribution of Net Investment in Place by Lines of Business for FRS Companies, 1981, 1985, and 1993

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Note: Components may not sum to total due to independent rounding. Sources: Energy Information Administration, Form EIA-28, except for railroad data which were taken from company annual reports.

and gas production. As measured by share of net investment in place, U.S. oil and gas production was de-emphasized the most in the FRS companies' deployment of assets, followed by diversified businesses outside energy and chemicals. Also, the combined asset share of coal, nuclear, and nonconventional energy fell from 4.9 percent in 1981 to 2.4 percent in 1993.

The FRS Companies' Standing in U.S. Industry

In the 20 years following the Arab Oil Embargo, the FRS companies have had to adjust to major oil price upheavals and collapses. Government policy changes, both in the United States and abroad, also posed substantial challenges to major energy companies' decisionmaking. Some government policies were reactions to energy market developments while other policy changes derived from issues larger than energy alone. Being competitors in the capital markets, the FRS companies have had to contend with the turmoil

created by changes in investor attitudes and preferences. To gauge how the FRS companies fared relative to overall U.S. industry, three key areas of performance are reviewed in the remainder of this chapter: profitability, growth, and investor perceptions.

An often-used measure of profit performance is return on equity, calculated as net income from the consolidated statement of income divided by stockholders' equity (i.e., the book value of assets minus liabilities), which provides a picture of past profitability based on historical prices and costs rather than a picture of prospective profitability based on expectations. Generally, the profitability of the FRS companies differed markedly from other large U.S. industrial corporations, as represented by the Standard and Poor's (S&P) 400, only in the contexts of two oil price escalations (1974, 1979-1981) and the oil price collapse of 1986 and its aftermath (Figure 3 in Part I, Chapter 2). Although the invasion of Kuwait by Iraq brought on an oil price escalation in the latter part of 1990, the positive effects of higher oil prices on upstream income were largely offset by adverse effects.

on downstream and chemical earnings. In the 1990's, the profitability of the FRS companies and the S&P 400 has been similar, so far.

In contrast, patterns of corporate growth for the FRS companies differed from that of other large U.S. industrial companies. In 1981, 13 of the top 20 companies (ranked by total assets) on the Fortune list of the 500 largest U.S. industrial corporations were FRS companies, up from 9 FRS companies in 1974 (Table 37). In the context of escalating oil prices and rising cash flow, the FRS companies' investment outlays surged, resulting in an annual growth in total assets of 13 percent between 1974 and 1981 (Table 38). Total assets of the Fortune 500 (excluding the FRS companies) grew at a lesser 10-percent rate between 1974 and 1981. Since 1981, there has been a turnabout in trends between the two groups of companies. Although U.S. industry has restructured and trimmed capital spending in recent years, the FRS companies generally started their restructuring efforts earlier and more severely cut back capital expenditures. Total assets of the FRS group grew at an annual rate of 2 percent between 1981 and 1993, far below their growth in 1974-1981, and well below the 8-percent growth registered by the balance of the Fortune 500. By 1993, the number of FRS companies among the top 20 U.S. industrial corporations dwindled from 13 to 8: Gulf Oil was taken over by Chevron in 1984, Tenneco left the FRS group after selling its petroleum assets in 1988, and three other FRS companies fell below the top 20 threshold.

Investors had a mixed view of the strategy and performance of the FRS companies after oil prices peaked in 1981. As previously noted, one measure of investor expectations of future returns to stock ownership in a company is the market-to-book ratio. Relative to the S&P 400, the FRS companies' market-tobook ratio plunged from parity to about half the value in the early 1980's (Figure 20). This downward valuation of the FRS companies' prospects reflected the combination of lowered oil price expectations and disappointing performance in lines of business other than oil and gas production.

Although the FRS companies' market-to-book ratio began to rise in 1983, they did not benefit from the bull market in common stocks to the extent that other companies did. The gap between the two groups' market-to-book ratio generally widened through 1986.

Thereafter, the gap became narrower, indicating a favorable change in outlook for the FRS companies relative to other large industrial companies.

What caused this apparent change in outlook? No single explanation could be wholly satisfying, but a number of factors undoubtedly contributed. First, the restructuring efforts of most of the FRS companies were well under way by 1987, and the rise in the market-tobook ratio reflected investors' approval of these efforts. The sharp rise in the FRS companies' return on equity in the late 1980's (Figure 3 in Part I, Chapter 2) tended to substantiate this view. Second, the oil price collapse of 1986 reduced the value of oil and gas reserves, so that when oil prices rose from the $9-$11 range at the wellhead in the latter half of 1986 to the $16-$17 range a year later, so too did the valuation of surviving oil and gas operations. Coincident with the rebound in oil prices in the Autumn of 1987 was first a fall and then a crash in stock prices generally. However, because of favorable oil price movements, market values of the FRS companies' shares were not as adversely affected by the stock price crash of 1987. Third, investors probably took an approving view of the FRS companies' management of their debt following earlier takeovers and takeover defenses. After 1985, the growth in the FRS companies' debt about matched the growth in their equity while other industrial companies showed a marked rise in the role of debt in their balance sheets (Figure 22).

Although the capital markets' overall valuation of the FRS companies clearly improved in the latter part of the 1980's and the early 1990's, there is an indication that investors currently perceive greater risks attending the FRS companies' prospects. Until about 1985, the FRS companies' debt tended to be of the lowest risk among corporate borrowers. That is, as shown in Figure 19, the average interest rate on FRS companies' long-term debt 164 and Moody's AAA yield on corporate bonds differed little from 1974 through 1984. The Moody's AAA rating is given to corporate debt issues that have the lowest risk of default. However, by 1986, the FRS companies' average interest rate was 4 percentage points above the AAA yield, nearly 40 percent higher. One possibility is that the $9 price for oil in mid-1986 increased investors' perceptions of the volatility of future returns from investments in oil and gas. Since 1986, the interest rate differential has narrowed to less than 2 percentage points.

164 Interest and financial charges divided by the average of prior end-of-year long-term debt and current end-of-year long-term debt.

Table 37. Top 20 Companies in the Fortune 500 Largest U.S. Industrial Corporations, 1974, 1981, and 1993 (Ranking Based on Total Assets)

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dBP America became a 100-percent owned subsidiary of British Petroleum in 1987. Based on 1993 disclosures, BP America would rank 25th in terms of sales revenues.

*Name changed to ITT Corp. and primary line of business was fire, marine, and casualty insurance in 1993.

*USX (formerly, U.S. Steel) became an FRS company when they acquired Marathon Oil in 1982.

"Not in existence in year shown.

Note: FRS companies are shown in bold.

Source: Fortune (May, 1975; May 3, 1982; April 18, 1994).

Table 38. Total Assets of the FRS Companies and Fortune 500, 1974, 1981, and 1993

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Sources: FRS Companies: Energy Information Administration, Form EIA-28. Fortune 500: Fortune (May, 1975; May 3, 1982; April 18, 1994).

7. Oil and Gas Resource Development

Changes in the Global Oil and Gas

Investment Climate

The rapid increase in oil prices in the late 1970's initiated changes in the oil and gas investment climate, changes that were subsequently reversed following the oil price collapse of 1986. In the 1970's and early 1980's, expectations of continued high oil prices encouraged oil-producing countries to establish state-owned oil companies. The later decline in oil prices prompted oilproducing countries to privatize state oil companies. Similarly, high oil prices had supported high taxes on oil and gas production, and the subsequent decline in oil prices compelled governments to reduce taxes and encourage oil and gas investment.

From Nationalization to Privatization

In the worldwide oil market of the 1990's, the FRS companies are smaller players facing bigger competitors, the state-owned oil companies. Most state-owned oil companies were created shortly before the oil price acceleration of the 1970's, when governments of oilexporting countries nationalized the assets of private oil companies. Enmity toward multinational oil companies had nurtured such ambitions for years, but in general, nationalization remained more a threat than a reality until the potential of increased market power over oil prices added economic incentives to political aspirations.

Nationalization began in 1971 when Libya nationalized all of British Petroleum's holdings and 51 percent of

Occidental Petroleum's operations.165 The Shah of Iran gained control of the Iranian National Oil Company, and Iraq nationalized the Iraq Petroleum Company; both of these companies had previously been owned by investment consortia.166 Kuwait acted next in 1975, and Venezuela nationalized the assets of Exxon and Shell in 1976.167 Also in 1976, the Aramco partners (Exxon, Chevron, Mobil, and Texaco) reached an agreement to sell their holdings to Saudi Arabia, although no money changed hands until 1980. By nationalizing the assets of the major oil companies, the producing countries created the state-owned companies that currently dominate world oil production (Table 39).

The trend toward nationalization reversed when oil prices began falling in 1981. Lower prices exposed many inefficient and poorly managed operations, and many governments (outside of the Middle East) became disenchanted with the oil and gas production business and began encouraging privatization.168 In 1985, Brazil offered 7 percent of Petrobras to the private market and the British government sold Britoil.169 In 1986, France sold 44 percent of Elf Aquitaine, Britain sold British Gas, and Sweden sold Swedegas.170 After the oil price collapse, the British government sold its shares of British Petroleum (BP), and Austria, New Zealand, Chile, France, Spain, and West Germany all sold their state-owned oil and gas companies. 171 The Peruvian private investment commission recently directed Petroperu to streamline operations and make itself more attractive to potential buyers.172 Argentina's Yacimientos Petroliferos Fiscales (YPF) took similar downsizing action in preparation for its foray into the

165 Daniel Yergin, The Prize (New York: Simon and Schuster, 1991), pp. 584-585.

166 The Iranian National Oil Company, formerly the Anglo-Persian Oil Company, was majority owned by the British government. The Iraq Petroleum Company, formerly the Turkish Petroleum Company, was owned by the Turkish National Bank, Royal Dutch/Shell, Deutsche Bank, and Armenian-born financier, Calouste Gulbenkian. Source: Daniel Yergin, The Prize (New York: Simon and Schuster, 1991), pp. 185, 451.

167 Daniel Yergin, The Prize (New York: Simon and Schuster,1991), pp. 647, 652.

168 The Middle East is the exception to the privatization trend, because costs there are so low that the state-owned companies show satisfactory financial performance in spite of low oil prices.

169 Cambridge Energy Research Associates, "Oil and Politics: The Shape of Things to Come," Private Report (Cambridge MA, January 1989), pp. 4-5.

170Cambridge Energy Research Associates, "Oil and Politics: The Shape of Things to Come," Private Report (Cambridge MA, January 1989), pp. 4-5.

171Cambridge Energy Research Associates, "Oil and Politics: The Shape of Things to Come," Private Report (Cambridge MA, January 1989), pp. 4-5. 172"Petroperu Sets Out Its Stall," Petroleum Economist (June 1993), pp. 25-27.

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