VideoOil. This year it has truly meant black gold for both producers and refiners of crude. With prices nearing $50 a barrel over the summer, the industry has reaped the benefits of record high profits — and taken lots of criticism for the same.
Los Angeles-based Occidental Petroleum Corp., which in 2003 produced the equivalent of 547,000 barrels a day, has been a top beneficiary. Its second-quarter earnings, announced in July, were up 55 percent over last year, to a record $581 million. Meanwhile, its stock price roared to a 52-week high of $53 in September.
But CFO Stephen Chazen knows how double-edged such success can be. Since energy prices are inextricably linked to economics, they have been blamed for all that is wrong in the economy. Companies, including Wal-Mart, have charged that overheated energy costs have caused weak sales. Economists warn that continued high prices could mean more inflation, fewer jobs, and instability in the stock market.
Although oil companies do not set the prices — national oil companies and the countries that run them do — the 58-year-old Chazen insists that the problem "will fix itself. If energy prices are too high, people won't pay them, the marginal demand will decline, and the price will fall. If it is $45 or whatever, that is not a sustainable price. It will fall over time." Still, he concedes, "the national oil companies have gotten used to the higher prices."
What Chazen does control is how Occidental spends the windfall. Overseeing the "capital program is the most important job of financial management," he maintains. And since all oil companies are racing to replenish an ever-diminishing supply, much of that spending must tap new reserves. To that end, Occidental may soon be the first oil company allowed back into Libya — where the company's tycoon-founder, Armand Hammer, made the first of several discoveries in 1966 — now that relations with that former rogue nation have thawed. Thanks to the tight supply of oil in the United States, Occidental is also keen to expand its domestic focus — where it has concentrated for the past several years.
At the same time, Chazen and his oil-company counterparts are still reeling from the scandal involving overstated energy reserves at Royal Dutch/Shell Group. In July, Congress held hearings addressing how oil companies tally their energy holdings, and the Securities and Exchange Commission is seriously considering requiring independent auditors to review those reserves. To Chazen, the crux of the problem lay in the decentralized nature of Shell's organization. And while he expects some added regulation, he is confident that Occidental's procedures are above reproach. Still, he says, Shell "certainly has not done the industry any favors."
Recently, Chazen — who is rumored to be a candidate to succeed CEO Ray R. Irani now that Occidental president Dale Laurance is retiring due to health issues — sat down with CFO deputy editor Lori Calabro to discuss the reserve controversy, his hopes for Libya, and why higher oil prices "will bring out more supply."
Let's start with what everyone wants to know: this summer we saw crude oil at almost $50 a barrel. How high will it go?
We don't know. Certainly by historic measures, these are high prices. The average over the past 5 years has been about $29. Over the past 10 years it's been about $25. But inflation-adjusted, [today's prices are] still much lower than they were in the 1970s. In the late 1970s, oil got to over $40 per barrel, which would be about $94 in today's dollars.
What's changed?
For many years, there was a lot of excess capacity. National oil companies, such as Aramco — which really control pricing — stopped investing in new capacity, because it was too expensive. Like every government, [their owner-countries] had to choose between spending a billion dollars drilling a well or a billion dollars building schools and roads and paying the Army. Not surprisingly, they picked schools, roads, and paying the Army. But then demand rose more sharply than people thought, mostly in China. And when you have small disruptions — such as the decreased oil supply from Iraq and Venezuela and the threat of interrupted production from Russia — which are natural in the oil business, you get spikes in the price. So we're going through a period of abnormally high prices.
What prices do you use for your own budgeting and forecasting?
Normally, we predict prices in the mid-20s. Because it's such a volatile business, we use three cases: a low-case price, a mid-20s case, and a high-20s case. But our ability to predict is nil.
The Energy Information Administration said they expected $37 a barrel through 2005. Where do they get their numbers?
They're making them up. If you look at the EIA and the International Energy Agency, they have an unbroken record of failure to [accurately] predict prices. It is very difficult, because you have to predict the marginal price. No one knows if the world economy is going to be good or not or if the Chinese are going to break the economy or not. What is relatively easy to predict is the supply. But there again, people forget that the existing supply declines and that as your base-load declines, you have to bring on new capacity. It's not like a chemical plant, where you just keep on producing the stuff.
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