December 1999
Special Focus

Independents must balance at-odds goals to make acceptable returns

December 1999 Vol. 220 No. 12  Feature Article  Index WHAT'S AHEAD IN 2000 Independen

December 1999 Vol. 220 No. 12 
Feature Article 



Independents must balance at-odds goals to make acceptable returns

D. Nathan Meehan, General Manager, Exploration and Production Technology, Union Pacific Resources, Fort Worth, Texas

I don’t live in Houston, so most of my neighbors and friends are not in the oil business. Few of them actually have a good idea about what is involved in the exploration, development, production, refining and transportation of oil and gas. They see us for the first time at the gasoline pump, where prices are always "too high." I have always worked on the upstream side of the business and can certainly empathize with my neighbors. Bill Tammeus, in Toronto’s national newspaper once said, "Oil prices have fallen lately. We include this news for the benefit of gas stations, which otherwise wouldn’t learn of it for six months."

It seems that those same gas stations learn of increased oil prices more rapidly. And the question we face on the upstream side is not unrelated. Prices for oil field services and supplies fell along with the rig count and oil and gas prices. But oil and gas prices have risen steadily and are now quite healthy. Activity levels have risen, but only slowly.

So, what is going on? Don’t E&P companies usually overreact to high prices with an exuberance the rest of the market reserves for Internet IPOs? Won’t we all go on a buying and drilling binge to create growth to satisfy Wall Street?

Well, maybe we have learned a lesson. This wasn’t a year I want to repeat anytime soon. Our stock cratered, along with most others in the spring, only to stage a long recovery as product prices climbed. Large domestic independents have not fared well as investments. Over the last five years, the S&P 500 has returned 25.5% annually. Ten-year bonds have yielded 8.45%, while a group of seven large-capitalization E&P companies (the mega-independents) have yielded 7.5%. Basically, this group has destroyed shareholder value with inadequate returns. What is needed to make acceptable returns should include:

  • Good commodity prices
  • Excellent capital efficiency (low F&D costs)
  • Leadership and execution
  • Great assets
  • Low operating costs
  • Big discoveries
  • High reserve replacement.

Unfortunately, for the mega-independents, several of these demands are at odds with each other. Big discoveries and high reserve replacement rates may not support capital efficiency, especially given good commodity prices and the corresponding higher capital costs. We can never actually predict commodity prices. And prices will never remain high because the cure for high prices is high prices. As an industry, we overreact to price cycles.

I belonged to a health club for a while that had a large weightlifting section. Muscular men and women lifted "free weights" there, looking with disdain on the section of the club filled with every kind of weight machine and aerobic exercise equipment. The hand-painted sign on the wall read, "Get Big or Go Home!"

This motto has been a kind of de facto goal of independents that continually seek growth through drilling and acquisitions. Whether they have reserves of 150 million boe (bbl of oil equivalent) or 2.5 billion boe, another 50% is what they need for "critical mass." If we insist on such growth during the high price cycles, our capital efficiency will suffer. Higher rig rates and bigger lease bonuses don’t add any reserves.

Similarly, the acquisition of great assets may strain healthy balance sheets and reduce flexibility. Enough successful drilling activity leads to high production rates, requiring very large discoveries to maintain growth. The mega-independent then concentrates greater effort internationally where the opportunity for "gambler’s ruin" is significant. Even the most successful mega-independent has difficulty funding the number of large international ventures that all major oil companies pursue.

So where does a company go now? For UPR, it is clear that the balance sheet needs to continue improving. We have substantially reduced debt and must continue to do so. We need to maintain the dramatic cuts in operating costs achieved this year. The focus has to be on profitability and capital efficiency. We need to stick with what we do best – exploitation through technology applications, primarily in North America.

Successful exploitation companies maintain a large inventory of drilling opportunities, are experienced and active drillers and operators, are able to fund large programs from cash flow and retain their key people well. At UPR, the technology focus is to attempt very substantial innovations in an environment where experimentation is encouraged. It is to partner with technology companies that want to test new tools and approaches. For the large independent, knowing what technology to use among existing technologies is probably a better goal than being able to invent new technology. This requires an experienced staff that communicates well across business and functional groups.

One thing that works in favor of the exploitation company is that "big fields just keep getting bigger." Horizontal wells will double the recovery from all vertical wells in the Austin Chalk. Infill drilling in tight, heterogeneous gas fields has added enormous natural reserves at low incremental costs.

The foregoing leads to the question of what is to become of the large independents. While UPR hasn’t been acquired or merged away, it barely resembles the Champlin Petroleum of 1976. It will be a very different company in another ten years. Success in 2000, and beyond, for the mega-independents will be a greater challenge than in the past. Clear strategies, implemented flawlessly, and more than a little luck will be required. Old companies will have to "destroy" the status quo and invent the future or other companies and other forces will do it for them.


MeehanD. Nathan Meehan has worked for 23 years at Union Pacific Resources where he is general manager, Exploration and Production Technology. His areas of expertise include hydraulic fracturing, horizontal wells and reservoir characterization. He earned a BS in physics from the Georgia Institute of Technology and an MS and PhD in petroleum engineering from Oklahoma University and Stanford University, respectively. Dr. Meehan has been chairman of the SPE Well Testing Committee, was named a Distinguished Member of SPE, served as an SPE Distinguished Lecturer, serves as an at-large director for the Society and received the 1999 Lester C. Uren Award for outstanding contributions to petroleum technology. He is a director of Pinnacle Technologies, is a registered Professional Engineer in Texas, Louisiana and Oklahoma and is a member of the Interstate Oil & Gas Compact Commission. Dr. Meehan has authored numerous technical articles and a book. He can be reached on the web at:

What's ahead in 2000

Industry needs a culture change to address its problems
 ball Forrest A. Garb, Forrest Garb & Associates, Inc.

Investing in core assets to produce sustainable high returns
 ball Rolf M. Larsen, Statoil

Big challenges in the new millennium
 ball Paul L. Kelly, Rowan Companies, Inc.

Technology will pave a path to prosperity
 ball Peter D. Kinnear, FMC Petroleum Equip. & Systems Div. and PESA

Independents must balance at-odds goals to make acceptable returns
 ball D. Nathan Meehan, Union Pacific Resources

Mixed year ahead for UK continental shelf
 ball Alexander G. Kemp, University of Aberdeen

Demand for marine services remains volatile
 ball Donald "Boysie" Bollinger, Bollinger Shipyards, Inc., and NOIA

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