Falling oil prices squeeze the profit from US producing wells

These are hard times for American oil companies. The 50 percent drop in crude prices since December, says Chevron Corporation vice-chairman Kenneth T. Derr, ``cuts our income in half -- with all the obvious ramifications.''

Right now, those ramifications mean ``earnings are going to be demolished,'' says Mr. Derr. There are going to be cutbacks and layoffs industrywide -- and especially keen ones at San Francisco-based Chevron, the second largest integrated oil company in the United States after Exxon.

In the past week, Exxon, Chevron, Occidental, Amoco, and most other major oil companies have announced sharp cuts in their capital and exploration budgets.

Chevron's, according to a memo to employees by chairman George M. Keller, will be a 30 percent reduction -- from $5 billion to $3.5 billion. Keller also has asked department heads to prepare for ``a 10 to 15 percent reduction in both regular and contract manpower.'' This could be more than 9,000 layoffs among the 61,000 worldwide employees.

And more such cuts could occur if low oil prices persist, company officials say.

The price plummet, of course, hurts oil companies more than most other businesses or than the general US public, which, by contrast, should prosper in a period of cheaper energy costs, zestier economic growth, and lower inflation and interest rates.

Now Big Oil's plight tugs at the heartstrings of few consumers, weary of years of rising prices. Nevertheless, what happens to the oil companies ultimately could have an impact on the high-priority goal of energy independence for the US.

Oil companies are now making investment decisions that will lead to less oil produced in the US, erosion of proven reserves, and greater dependency on imported oil.

``When things go to pot, as they have,'' says Derr, oil companies ``turn the lever and stop spending.'' This is not simply belt-tightening to preserve cash flow, says Derr. It is also a recognition that ``projects at $25 oil don't look good at $15 oil.''

Hardest hit will be the ``stripper wells'' -- those producing less than 10 barrels per day and often requiring water, steam, and carbon dioxide injections to get the crude out of the ground. These will quickly be ``shut in'' economically.

Chevron economist John W. Dewes says the loss of stripper wells and the termination of some new oil projects could decrease US output by 250,000 barrels per day this year alone. The US currently pumps about 8.5 billion bpd.

By 1988, Dewes estimates, US crude production may have declined 600,000 barrels to 1.2 million bpd from current levels, and there could be many business failures in the oil industry.

``If the period of low prices is prolonged,'' Dewes told the Senate Energy Committee last week, ``the US industries will have difficulty recovering, as many of these impacts are not easily reversible.''

What would change all this would be an agreement among the members of the Organization of Petroleum Exporting Countries to limit production and firm up prices. There were some hints of progress toward such an agreement from OPEC ministers meeting in Geneva this week.

But oil-industry experts say even if OPEC nations can devise a plan, discipline among them is again likely to break down due to the compelling financial needs of member countries and of non-OPEC oil producers.

No one expects the glut to go away easily.

It is this air of uncertainty, as much as the 50 percent drop in prices, that will cause oil companies to, as Derr puts it, ``operate on the basis of the pessimistic curve'' for the foreseeable future.

When making investment decisions, Mr. Derr says, oil companies will remain leery even if prices begin creeping up again.

``The fact that we've had the downside is going to be in the minds of people for a long time. There's going to be concern about lack of stability'' and that will keep exploration, testing, pipeline building, and refinery construction curtailed.

All to the good, says veteran oil analyst Sanford Margoshes of Shearson Lehman Brothers. The cutbacks in the oil industry ``make tremendously good sense'' in light of the price drop.

``Should prices turn up -- and I believe they will do so soon and rapidly -- then the companies are going to reassess,'' Margoshes says. Meanwhile, price volatility ``heightens the awareness of uncertainty'' for oil firms, making them ``more alert and more realistic.''

At $15 per barrel, notes analyst Charles C. Cahn Jr. of Sanford C. Bernstein & Co. in a recent report, the top 10 US oil companies would see earnings decrease by as much as 65 percent.

Those in the biggest trouble, Mr Cahn says, would be the highly leveraged firms such as Phillips, Texaco, and Mobil. Next worse off would be Atlantic Richfield, and Unocal. They'll all probably survive, but earnings and dividends might be impaired.

Weathering the storm fairly well, says Cahn, would be Amoco, Exxon, Chevron, and Amerada Hess. And in the best position of all is Royal Dutch-Shell, which is virtually debt free.

Shell, British Petroleum, Exxon, and some others might use the opportunity to acquire oil companies that are facing hard times, industry sources say.

Mr. Derr at Chevron agrees that this is likely to occur in the next few months. Chevron might participate, he indicates. But acquisitions probably won't be astounding in size, given the debt load Chevron still carries.

Chevron has worked hard mid-1984 to reduce the $13.3 billion debt incurred when it took Pittsburgh-based Gulf Oil. Gulf had been under siege by corporate raider T. Boone Pickens at the time and welcomed the Chevron acquisition, the most expensive corporate takeover in history.

Mr. Derr was instrumental in integrating Gulf into Chevron. During 1985, Chevron (formerly known as Standard Oil Company of California) succeeded in knocking $6 billion off its debt by selling its stake in Gulf Canada, networks of gasoline stations, refineries, and other operations, and paring the work force.

Derr says the merger allowed the two firms to achieve ``economies of scale'' and doubled Chevron's hydrocarbon base ``without doubling the cost basis behind them.'' But both he and chairman Keller say they have no regrets about the expensive Gulf acquisition, even though obviously it would look better if oil prices had remained high.

It was, says Derr, ``a once-in-a-lifetime purchase'' that will prove its value when oil prices turn up. And, he asserts, ``the price of oil is going to turn up.''

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