Primed For Performance: Observations On The Oil Industry To 2010
Kenneth T. Derr, Chairman of the Board and Chief Executive Officer
New York, New York
WE ALL saw the news reports recently that the global population has reached six billion.
It was a moment to pause and reflect on the state of our world and our future. However, for people who invest in petroleum stocks, the take-away was simple: the world now has six billion energy consumers. And that tells us these stocks should remain a building block for investment portfolios both large and small.
Asia's coming back. China's really just getting started. And there's strong growth ahead for Latin America. Sooner or later, Russian oil demand is bound to start rising again. National oil companies from Norway to Malaysia continue to evolve into world-class competitors. And recent history suggests that this trend will mean more opportunity for companies like Chevron -- not less.
I see new investment strengthening the Middle East's central role in world oil and gas supplies. I see years and years of strong performance ahead from companies of all sizes in the energy sector. Every hard lesson the industry has learned in the last 10-to-15 years of flat prices is now hard-wired into our culture, our people and our leadership in particular.
Let me pause here and comment on the supply and demand outlook for the oil industry. We see oil demand rising 1 to 2 percent per year, and increasing by 18 million barrels a day to about 95 million in 2010. Non-OPEC supply will cover about 55 million of that and OPEC about 40 million. So with OPEC's spare capacity at about 6 million, the industry has to come up with at least another 12 million barrels a day, and that's roughly equal to a new Saudi Arabia -- plus Kuwait!
In fact, the new supply requirements are much greater than that, because most of the world's big oil fields are in decline and replacing their output could more than double the future requirements. Clearly, the industry has a tremendous amount of work to do if we're going to supply those volumes.
I know that petroleum's forecasted growth rate of 2 percent or less makes us look old and slow compared to a lot of other industries. But in fact, our challenge is as great if not greater than theirs. Meeting the new oil-supply requirements is not low-growth by any definition, and we're going to need a lot of creative energy to get it all done.
However, we firmly believe the market will justify the necessary commitments of capital, and give us solid incentives to deliver these new energy supplies. We also feel that our growth requirements will make oil a good investment.
As for OPEC, they've been quite effective this year, and I wouldn't be surprised to see that continue a while longer. But prudent companies will continue to temper price outlooks to reflect OPEC's history as well as politics and uncertainty. So we're still forecasting a long-term real price in the high-teens for the benchmark West Texas Intermediate crude over the next decade, and with inflation where it's been, that would mean levels in the $21 to $22 range by 2010.
I would qualify that by saying the only thing we can really predict about prices is volatility. We can't know for sure what's ahead, and most energy-market forecasting has a less-than-perfect track record.
Getting it wrong?
At various times in the 20th Century, we've seen confident geologic extrapolations that told us production would peak -- but it hasn't. We had the $100-a-barrel price outlooks of 20 years ago -- now mocked by the long parade of flat-price years. We had subsidized synthetic-fuel projects to help rescue America from costly oil imports – but as things turned out, imports rescued us from a costly dependency on synfuels! Ten years ago, some people said non-OPEC production would shrink and drive oil prices up – but instead it grew . . . and kept prices down!
Recently, the Competitive Enterprise Institute published a report called "Getting It Wrong." But the report doesn't just make fun of past predictions. It argues that human-kind will never run short of the ingenuity which has always helped us find new ways to meet our needs, especially energy. For proof, we need only to look at the oil and gas industry.
A history of ingenuity
Given the supply/demand outlook, I think it's fair to ask whether new technology can overcome old geology forever. And it's logical to worry about decline and depletion. But the history of ingenuity is on our industry's side.
We've refined simple seismic into three-dimensional and now four-dimensional, and if there's a fifth dimension to geophysics, I'm sure we'll find it. We've gone from drilling, to deep drilling, to directional drilling so that we take these amazing technologies for granted -- and now even horizontal drilling is commonplace. Shallow offshore platforms gave way to structures the size of skyscrapers, then to sea-floor production and floating spars. And today we're drilling wells in more than 8,000 feet of water. Meanwhile, we invented a huge new industry called LNG, turning a cryogenic marvel into business as usual. Soon, we'll launch a global gas-to-liquids sector as well.
True, compared to Yahoo and Amazon and Lucent, the oil industry may look like an "old dog" to some investors. But there's no way we're going to run out of new tricks. The fact is, there's a universe of energy opportunity out there, not just for oil companies, but for their stockholders.
What shaped our industry?
A lot of factors shaped the industry as we know it today:
- Information technology
- Mergers, consolidations and alliances
But let me mention a couple of things that I feel are especially relevant for future investors. One is the stockholder value model of management. The industry wasn't always so intensely focused on rewarding stockholders, but marketplace events during the 1980s changed that forever. And I think its clear that our company played a key role in that when in 1989, we set a public goal of being No. 1 in total shareholder return for major U.S. oil companies for the five-year period 1989 to 1993. When we met that goal, our competitors took notice.
Ultimately, the emphasis on stockholder return helped drive the restructuring that prepared the industry to face the future. As that transformation occurred, the major oil stocks during the last 10 to 15 years rewarded investors with average performance greater than that of the S&P 500. Clearly, the industry's leaders plan to sustain that trend.
The other factor I want to mention is the competitive strength of our products. No one can deny the appeal of fuel cells, electric cars, solar and the rest of the alternative technologies. But they still haven't passed a market test against petroleum. And we don't see any of them having a meaningful impact on oil and gas demand in the next 10 years. Even if fuel cells do take off, I think it's worth noting that they will probably run on gasoline.
Consider in a few words the competitive case for oil and gas: Mobility and distribution. Abundance, affordability and value. Dependability, convenience and safety. All of that, and still we're going to keep getting better at what we do!
Customer preference and government standards will keep pushing conventional fuels and vehicles to get cleaner, more efficient and therefore more competitive with the alternatives. The marketplace will ensure that consumers keep getting the best energy at the best price. And these trends will extend both the Age of Petroleum and the life of the internal combustion engine.
The climate-change solution
Of course, not everybody agrees with that scenario -- and this of course brings us to the issue of global climate change. Right now, the politics are trying to force the world to bet on the remedies even though the scientific diagnosis isn't complete. The Kyoto Protocol has gained support by framing climate change as the ultimate environmental concern.
In fact, economic health in the developing nations is a bigger environmental concern. And fossil fuels are one of the keys to helping these nations improve their economies. The under-developed world cannot afford environmental improvement until they can sustain economic growth. I think it's also essential to point out that the Protocol would impose major new costs on the U.S. economy and clearly hurt U.S. competitiveness in world markets.
I'm sure that science – in time – will help us solve the greenhouse-gas question. In the meantime, the best way to minimize emissions is through worldwide investment in natural gas, clean electric power and energy-efficiency projects.
At Chevron since 1991, we've reduced the energy required to produce and refine a barrel of oil by 15 percent. In recent years, we've made significant investments to reduce the flaring of natural gas in Nigeria and Angola. And we hope that soon our West Africa Gas Pipeline will capture Nigerian gas now being flared and sell it to new power plants in neighboring countries, supporting economic development and reducing both greenhouse emissions and air pollution.
It seems to me that projects like these demonstrate the potential to base our near-term response to climate change on ingenuity and creativity within the private sector. We can find common ground through commercial, voluntary and flexible efforts to reduce emissions. And we can do this while serving energy consumers, investors, society and the environment as well.
New frontier: differentiate
Of course, finding the right projects to address climate change is just one of many things oil companies have to do that will depend on creative management. Looking out to 2010, companies will have to find new ways to shine brighter -- partly because 10 years of intense competition has made the majors look more alike than ever.
We've faced a lot of frontiers in our industry: geologic, geographic and geopolitical. Now the new frontier is management performance. I'm talking about quality of business planning, strategy, execution, organizational capability – all of these management challenges will differentiate the great companies from the merely good ones, and the outcome will matter a lot to investors.
Great companies will of course sustain their focus on cost reduction and cost management. And they will increase their emphasis on capital efficiency, because every dollar saved creates another dollar to invest. Beating a construction budget by just 5 or 10 percent can free-up hundreds of millions of dollars. At Chevron, we've built a team of internal project-management consultants with a direct-report relationship to the vice chairman. And we intend to capture every possible benefit from superior execution of major capital projects.
Another priority is motivating our much-smaller work force. After Chevron gave stock options to all our people several years ago, an employee in San Diego told me he had changed his daily routine: He said he used to check the sports page first every morning -- but now he checks the price of Chevron stock! Clearly, he has a new reason to care about performance. But creative compensation is just one item on the list of management challenges in the area of people.
Attracting and keeping top employees is going to be harder. The high-tech jobs in the New Economy look pretty good to the science and engineering grads, so we'll have to do more to help young people see that the oil industry has a strong future. We will also have to do more to tap the expertise and creativity of our employees, because our reservoirs of knowledge may hold as much future profit as our reservoirs of oil and gas.
This is why, for example, we'll see continued emphasis on sharing best practices and using the best work processes. Every day a better idea goes un-used is a missed opportunity. Companies that can rapidly put better formulas to use globally will have an advantage. And again, it will be up to management to sustain a culture that can seize new opportunities.
Stay the course on sanctions
Of course, the spectrum of opportunity has become a lot wider over the last decade. With the collapse of the Soviet Union and the opening of so many countries, we have more prospects than ever. China. Venezuela. Kuwait. Kazakhstan. And Iran, just to name a few.
Unfortunately, U.S.-based companies still face the problem of unilateral trade sanctions. I've argued for years that sanctions put U.S.-based companies at a serious disadvantage, and that's a price neither we nor our investors should have to pay, especially now. I understand the need to influence foreign governments, but unilateral sanctions almost never achieve their stated goals. All they do is hurt American business.
So companies like Chevron will have to keep working the halls of government to convince our leaders that investment and engagement by enlightened corporations is still the best way to positively influence other nations.
Let me move now to what I believe will be the most important factor for oil stock investors in the future. Top companies must have both the potential and the plans to grow earnings, the biggest driver for stock price. In these companies, leadership ensures that the growth objective drives or influences every decision. In these companies, growth goals are clear and public both internally and externally.
Chevron's current target is 15-to-20 percent earnings growth over the next few years, which should get us back to the 7-to-8 percent long-term rate we had before the oil-price crash of 1998. In the flat oil-price world ahead, companies can only hit goals like that if they grow volume by boosting output from existing assets, by taking market share and by adding new output.
And this is why if you hold Chevron, you have benefited – and will continue to benefit – from our success story at Tengiz and our continuous investment in West Africa. You have already begun to benefit also from our recent acquisitions in Thailand and Argentina. By no accident, those deals brought us current production as well as expansion potential and good exploration prospects.
New kinds of growth
It's probably apparent to you that I'm confident in the future of the traditional industry. But I also see us growing through new kinds of opportunities.
One potentially huge area of opportunity is gas-to-liquids (GTL). And as many of you know, we expect very soon to finalize our GTL venture with the South African company Sasol, and do our first major project in Nigeria. Meanwhile, we're all aware of the new markets created by the rapid deregulation of electricity, and I think we've seen only the beginning of those opportunities. In Chevron's case -- through Dynegy -- we're now a significant player in power generation and in the trading and marketing of both gas and power. Perhaps that means that some day, you might be paying both your gasoline and electric bill to Chevron, undoubtedly over the Internet.
Of course, the Web is a whole story in itself. Now – among other applications – Chevron is using Web technology to re-invent our U.S. gasoline marketing business. Essentially, all our customer contact with dealers and jobbers will be through the Internet. And I'm sure that will be just the beginning for us – and our competitors – and this is why Chevron plans to take a leadership position in applications of E-commerce in the oil business.
The value of partnership
I'd like to turn finally to one other critical success factor, and this is being a top-quality partner. You've seen our ads – we want our hallmark known as the "symbol of partnership."
I was pleased to learn recently that Chevron and Conoco received the Best Practice Award for our Britannia project in the North Sea from the British construction industry. The award was especially satisfying since the project was done by a Chevron/Conoco team -- as opposed to the usual approach of having one company as the project operator. The judges called Britannia "an object lesson in how to achieve success in technical, commercial and human terms." I call it proof of the bottom-line value of partners working together effectively.
I know securities analysts are always inclined to discount these kinds of "soft" factors. But the truth is, great partners have an edge in operational excellence, in their ability to hold on to great assets and in developing new business.
A reputation as a solid partner can be incredibly important in difficult political situations as well. Who you are. Your standards. Your track record. How you work. Each of these can give you a real competitive edge. These are the elements of a company's character. This is going to matter a great deal to other partners, to neighbors, to the environment, to customers to government -- and ultimately to stockholders as we move into the 21st Century.
Today's partnership model
The days are long gone when oil companies can just go in, take the oil out and bring the money home. Today we work with local government, communities, hospitals and schools. You have to help local business and new development as well -- and I think our small-business loan program in Kazakhstan is one very good example. You have to stimulate foreign investment beyond your own. You have to share technology and provide training.
You have to live your commitment to incident-free operations. You have to protect employees and neighbors so you can bank the enormous human benefits of safety and drive out the costs of accidents. You have to grow the numbers of nationals who run your operations and ultimately manage your projects. This is what Chevron has been doing in Angola, in Kazakhstan and in Indonesia -- and we will continue doing these things in the countries where we work.
Early this month, I joined with the Reverend Leon Sullivan at the United Nations to endorse the Global Sullivan Principles. And we encouraged other companies to sign on. These principles of international corporate behavior deal with many factors, including the environment, human rights and corruption. It was a great honor to stand up with Rev. Sullivan, but not a great leap for Chevron, because we already respect the corporate-citizenship standards in his Principles.
Character, reputation, brand -- they all come together to show the world what your company stands for. Not just the quality of your gasoline, but keeping your word. Not just the safety of your tankers, but your ability to work in harmony with all nations and nationalities. Not just engineering, but ethics.
Advice to investors
This will probably be the last time in my career that I speak to a group of securities analysts. A month from now, Chevron will have a new CEO -- and I have the highest confidence that Dave O'Reilly and his team will continue to serve Chevron's stockholders well.
Before I go, let me offer one final piece of advice. And I want to be totally objective here. If you don't own Chevron stock, buy it. If you do own it, hold it. And if you're already holding Chevron, buy some more!
The legendary Peter Lynch of Fidelity Investments recently offered the following counsel. First, oil stocks are still a good investment. Second, he said that for oil companies and other industries as well enormous size doesn't necessarily result in an overwhelming advantage. To me, that sounds like investors will want to hold companies that want to be better than the best -- not just bigger than the biggest.
A future for oil analysts?
When NAPIA invited me to speak about the petroleum industry's future, your letter asked me to say whether I thought you should encourage your kids to grow up to become oil analysts.
That's easy -- the answer is yes. Ten years from now, there will still be a great industry to analyze. There will still be millions of energy-stock owners. And they're still going to want a lot of advice. So there will be plenty of work for oil analysts for a long time -- although anyone who goes into that line of work will probably need an advanced degree in international relations or political science.
And if your kids aren't inclined to become analysts, you should encourage them to become geologists or engineers. Our industry is going to need a lot of bright young people to help us realize our potential in the years ahead.
Updated: November 1999