Private Empire: ExxonMobil and American Power (26 page)

As Wall Street focused in on reserves and as ExxonMobil implemented O.I.M.S., Raymond tightened and made uniform the corporation’s reserve counting rules. The system’s stated goals included objectivity and rigor: “A well-established, disciplined process driven by senior-level geoscience and engineering professionals . . . culminating in reviews with and approval by senior management. Notably, no employee is compensated based on the level of proved reserves.” Such bonus incentives for managers involved in reserve counting had apparently contributed to Shell’s overstatements; ExxonMobil eschewed them even before the Shell scandal broke.
¹⁵

By all accounts, Raymond genuinely wanted order and accuracy. In financial management, for example, to complement O.I.M.S., he created the Controls Integrity Management System, or C.I.M.S., a financial audit and risk management system designed to identify and root out managers who cut corners, massaged revenue reporting, or fiddled with expense accounts. Many corporations tolerated split contracts or other gray-area accounting practices designed to smooth out quarterly earnings reported to the public, so that shareholders might see a picture of stability. At ExxonMobil under Raymond, such accounting manipulation could be a firing offense. Raymond would also order employees terminated over tiny expense irregularities.

On oil and gas reserve counting, however, the ExxonMobil system tolerated more flexibility. S.E.C. rules effectively allowed oil companies to manage the timing of announcements of new proved reserves. This helped ExxonMobil control when new proved reserves were revealed publicly, and by doing so aided its effort to portray a steady story of year-by-year reserve replacement for Wall Street. ExxonMobil’s internal rules held, for example, that for reserves to be counted as proved, the corporation’s management must have authorized investment for their development. This meant, as a practical matter, that the Management Committee could adjust the annual timing of proved reserve additions by synchronizing investment decisions. “The key to reserves, among other things, is when you can actually book them,” an executive involved with the process said. “You can’t and you shouldn’t book reserves until you’ve really made an investment to develop the reserves. So consequently, if you’ve figured out a way to manage the system properly, consistent with the continuity of capital budgeting, you can have a pretty smooth reserve identification over time.” As the Wall Street analyst Mark Gilman put it: “If you are conservative about when you book reserves during the development of projects, in effect you create an inventory going forward” that can be declared as new proved reserves as the timing of reserve replacement announcements requires in order to present a smooth picture.
¹⁶

There would be nothing illegal or even improper about this managed timing if it were linked to a rigorous internal counting system, such as ExxonMobil possessed; if the counting conformed to S.E.C. rules; and if the results were communicated honestly to investors and the public. Characteristically, ExxonMobil’s internal system might have been the most rigorous in the industry, although neither the S.E.C. nor any other regulator had the capacity to confirm that through auditing. Also characteristically, the corporation rejected the precepts of government regulators and communicated in public on its own terms.

Besides the S.E.C. rule that prohibited the counting of oil sands, the other regulation that galled Raymond was the one dictating how a corporation should determine whether proved reserves were economically viable. The S.E.C. held that the viability of reserves should be judged against prices on the last day of the year, December 31. Raymond thought that was dumb: ExxonMobil ran its business by thinking about price ranges and averages, not one arbitrary day’s price. So in public and to Wall Street, he used his own system of average prices to calculate whether reserves should be counted.

After the Shell scandal, the S.E.C. issued new “guidance” to ExxonMobil, saying that it should use the year-end pricing rule, at least in commission filings. Raymond now grudgingly reported the S.E.C. number alongside his own. For the first two years, the consequences of following S.E.C. regulations were highly unfavorable, amounting to a total reduction in ExxonMobil’s proved reserves of oil and gas liquids of 1.27 billion barrels. Even as he noted the S.E.C.-mandated numbers, Raymond went right on issuing press release claims that ignored the rule. With other industry executives, he also initiated a Washington lobbying campaign to have the rules changed.
¹⁷

In some later years, if ExxonMobil had followed the S.E.C. rules, the corporation’s reserve replacement figures would have been higher than under its own system of counting—it would have looked better. The corporation ignored the advantageous swings in the same way that it ignored the disadvantageous ones. Overall, the two rules ExxonMobil seemed to find most onerous—the oil sand prohibition and the pricing formula—deprived the corporation of the claim that it had smoothly replaced reserves, year after year, since Raymond became chief executive. The picture under S.E.C. rules, instead, although it was not one of disastrous decline, was one of volatility, which implied a degree of change and insecurity in the reserve arena. This in turn happened to reflect a broader truth about the challenges confronting major international oil corporations.

Raymond certainly had a case on the merits: The S.E.C. prohibition of oil sands could be regarded as outdated, and the pricing rule could be dismissed as too arbitrary. Investors might benefit from revisions that better aligned S.E.C. regulation with the rising importance of oil sands. ExxonMobil’s position would have been more defensible, however, if it had communicated to investors and the public more forthrightly, in alignment with S.E.C. regulations, while it petitioned for regulatory change. “Exxon seems incapable of simply stating, ‘We did not replace all of our reserves this year, but we have a heck of a lot of reserves anyway, and we convert them into cash at a more efficient and consistent rate than any of our competitors,’” wrote Steve LeVine, the journalist and analyst who first called attention to the gaps in ExxonMobil’s public reporting. “Nope, it has to say that it’s replaced its reserves for [ten years straight] when, legally speaking, it hasn’t.”
¹⁸

The dodge reflected on how the need for reserves pushed the corporation toward higher-risk frontiers: Chad, Equatorial Guinea, and deep ocean waters where drilling technology and safety procedures had to be reengineered on the fly. The reserve replacement conundrum pushed the corporation, too, toward unconventional resources like the Canadian oil sands, where innovation and uncertain new drilling techniques would be required to make money at the rate ExxonMobil executives and shareholders expected and where the environmental risks were higher than normal. It also led Lee Raymond to reflect regularly on whether it might be possible to find a new way back into the huge oil zones where abundant crude could make reserve-counting rules irrelevant, as they had been for Exxon and Standard Oil for so much of the twentieth century, when the corporation was awash in equity oil in the Middle East.

Above all, any global oilman thinking big coveted access to Saudi Arabia.

Nine

“Real Men—They Discover Oil”

L
ee Raymond had always believed that he could rationalize the $81 billion Exxon paid for Mobil by driving operating costs down enough to justify the combination for shareholders. Assessing the true long-term value of Mobil’s sprawling oil and gas assets was difficult, however—and that would determine the strategic payoff from the merger. The long-term value of Mobil’s holdings would be a function of many factors—not just how much oil and gas actually lay in the ground when all the wells were drilled, but also the evolution of global markets, geopolitics, and the advent of new technologies that might unlock value from reserves previously thought to be worthless. After the merger, Exxon’s geologists, engineers, and marketing specialists tore through Mobil’s business divisions on a quest to understand the assets they had taken on. Gradually, they came to appreciate the astonishing value of one asset they had not comprehended adequately at the time of the merger deal: Qatar’s North field.

Raymond would eventually quip in private that the North field alone was probably valuable enough to justify the full Mobil merger price, and that everything else that came with the company—all its oil and gas fields in Africa, Asia, and the former Soviet Union—were a bonus. That was an exaggeration, intended in jest, and yet “it would be fair to say that we did not totally appreciate what the scale of it might be,” Raymond recalled.
¹

Qatar protruded into the Persian Gulf from the desert landmass of Saudi Arabia; on maps, it looked like a small spruce tree. It was a featureless, flat, barren, sandy, humid kingdom without oases or other natural greenery. At the turn of the twentieth century, Qatar’s native population of impoverished fishermen, pearl divers, and Bedouin Arab herdsmen numbered perhaps five or ten thousand. Even by comparison with the other sparse, isolated emirates of the Arabian peninsula—Saudi Arabia, Kuwait, Bahrain, Oman, and the United Arab Emirates—Qatar had been a backwater. A single family, the Al-Thanis, had ruled the peninsula since 1825. Japan discovered a method for synthesizing pearls during the 1930s, which caused a crash in the global pearl market, leaving Qatar even more isolated and poor. Around the same time, the emirate’s Persian Gulf neighbors discovered and pumped oil, but Qatar lagged. It had been endowed with more natural gas than oil and it lacked the leadership and skills to exploit either profitably. The Al-Thanis feuded among themselves; in 1995, one of the king’s sons, Hamid Bin Khalifa Al-Thani, overthrew his father bloodlessly. As late as 1990, the emirate remained a ramshackle, underdeveloped place, whereas in oil-engorged Saudi Arabia booming revenue after the 1970s paid for California-style freeways, industrial ports, airports, skyscrapers, ornate princely palaces, and shopping malls.

Geologists knew that Qatar’s North field held natural gas—lots and lots of gas. It held so much gas that it was not easy to estimate the full amount accurately—800 trillion square feet eventually became a common estimate, the equivalent of more than 130 billion barrels of oil. By comparison, Mobil’s highly lucrative gas field in Aceh, Indonesia, held only about 17 trillion square feet, equivalent to just under 3 billion barrels of oil. For all practical purposes, the size of the North field was infinite; it would last for generations, probably beyond the point when fossil fuels would be a dominant source of energy supply for the world economy. After the Mobil merger, Lee Raymond organized a natural gas task force. The paradox its members confronted was that while the North field’s abundance was assured, little had been done to develop it profitably. Why had other corporations failed, and what might ExxonMobil do differently?

The natural gas industry differed from the oil business in that, during the postwar period, the main challenge had not typically been the search for new fields. The problem instead was to profitably exploit the largest natural gas reserves that were known to exist but were geographically “stranded,” that is, physically disconnected from commercial markets. Pressure and heat formed and trapped natural gas beneath the ground by processes similar to those that formed oil. Much of the world’s gas was mixed up with, or “associated” with, oil deposits. Qatar’s North field was a mother lode of “nonassociated” or freestanding natural gas. There were a handful of proven, concentrated areas of large nonassociated gas reserves in the world: in Qatar, Iran, and Russia. The latter two could use some of their gas domestically, and Russia exported gas to Eastern Europe, where it was a critical source of heat and electricity. Qatar’s gas, on the other hand, was sitting thousands of miles from any customers that might burn it. It would be prohibitively expensive and politically impractical to connect Qatari gas by pipeline to large population centers in Europe or Asia.

As an energy source, gas had many attractions. It could heat homes, cook food, power turbines to produce electricity, fuel automobiles if the cars were configured properly, and be used to make chemicals and other industrial products. Gas also emitted considerably fewer greenhouse gases than oil or coal when burned. Qatar’s case illustrated one of gas’s major liabilities, however: Its form made it difficult to transport. Oil was a remarkably easy fuel to move around. It sloshed easily into storage tanks; it streamed cooperatively down pipelines; it poured smoothly into supertanker holding bins; it poured out again into refinery pipelines; it flowed out the other side of a refinery as gasoline; and it spilled into tanker trucks for delivery to retail stations. Gravity was oil’s friend. The natural tendency of gas, on the other hand, was to dissipate into the air; gravity was its enemy. Engineers could design systems to transport gas by pipeline easily enough, but for many decades that had been the only practical way to move it from a field where the gas was pumped out of the ground to facilities where it was burned. This meant gas-fired electricity plants, for example, had to be located within economical piping distance of a gas source, whereas an oil-fired plant could use oil from halfway around the world.

For Qatar, rich in gas but bereft of oil, in the first decades after the Second World War, all this had amounted to an equation that kept the emirate locked in poverty. The only semimodernizing economies within easy pipe distance—Saudi Arabia, Iran, and Iraq—had plenty of their own gas. Qatar also lacked even the basics of a manufacturing economy of its own, such as freshwater and a skilled workforce.

It had been known since the early twentieth century that, as a matter of chemistry, natural gas could be converted into a liquid and then, after transport, be reconverted into a gas for burning. This process might solve the problem of a stranded-gas holder like Qatar: Its gas could be turned into liquid, loaded into oceangoing tankers, shipped to populated markets, and then reconverted into gas for commercial use. The technology to accomplish this conversion and reconversion at a large scale was unwieldy, however. Britain and Algeria signed the first major commercial liquefied natural gas contract in 1961. A huge refrigeration plant in Algeria cooled that country’s stranded gas into a liquid; ships carried the liquid gas to Britain; and a reconversion plant turned it back into a fuel for electricity. Indonesia soon moved into the L.N.G. industry with energy-starved Japan as a customer; Mobil became the operating partner in Aceh. For years the profitability of Mobil’s L.N.G. business in Aceh was an exceptional success, however. It relied, effectively, on Japan and South Korea, which were industrializing very rapidly but had few hydrocarbons of their own; they were willing to pay high prices for secure L.N.G. supplies. The technology Mobil employed to fill these contracts was very costly, and it seemed that it would be some time before those methods would be economical enough to deploy worldwide.

Exxon had a troubled history in the L.N.G. business before the Mobil merger. The corporation had built, relatively early on, an L.N.G. plant in Libya and a reconversion terminal at La Spezia, Italy. The Libyan plant proved to be balky and trouble-prone. In the early 1970s, Exxon’s Italian subsidiary became embroiled in scandal when the unit’s president, Vincenzo Cazzaniga, was accused of setting up a web of hidden bank accounts to funnel almost $50 million of Exxon’s revenue to Italian political parties—including a small amount to the country’s Communist Party—to win tax and other favors. Exxon eventually entered into a consent decree with the Securities and Exchange Commission over the matter; the affair soured the corporation’s executives on their Italian subsidiary, and their L.N.G. investments languished.
²

Mobil had stumbled into its gas partnership with Qatar during the 1990s. A substantial number of the oil industry’s big success stories were the product of luck, not brains. Oil executives had flown in and out of Qatar for years, but none of them could think of how to commercialize the North field. Royal Dutch Shell led the global L.N.G. business by the 1990s. Mobil was a second-tier but significant player, because of Aceh. Shell negotiated access to the North field but pulled out in a dispute over financial terms. British Petroleum and the French giant Total moved in afterward and negotiated to build an initial pair of L.N.G. “trains,” the industry term used to describe the giant refrigeration complexes that converted gas into liquid form for sea transport. The consortium struggled with some of the technical challenges; British Petroleum pulled out. “They had it on a golden plate, but they rejected it,” Abdullah Bin Hamad Al-Attiyah, Qatar’s energy minister, remembered. The Qataris realized there was hardly anyone else in the global oil industry but Mobil who could do the work they wanted. “They came immediately,” recalled Al-Attiyah.
³
Lou Noto slipped into the Total deal as a partner, but he also won the exclusive right to build future Qatari gas trains. He structured a long-term sales contract for Qatari gas with South Korea as the customer and handed off the whole project to Lee Raymond at the time of the merger.

The North field challenge played to Exxon’s strengths: budget- and performance-conscious management of gargantuan engineering projects, combined with profit-maximizing financial planning. In Mobil’s L.N.G. group Exxon also acquired technical expertise it otherwise lacked. After 2000, ExxonMobil committed to multibillion-dollar investments to develop huge new L.N.G. gas trains from the North field as an exclusive 25 percent partner with Qatar Petroleum. Its engineers found that the emirate’s natural gas was of unusually malleable quality—relatively easy to liquefy or to process to separate out other industrial products. This made it cheap to produce. The projects Raymond authorized in Qatar were designed to be profitable if the natural gas they produced sold at just three dollars per thousand cubic feet. Within a few years, prices soared as high as fifteen dollars. ExxonMobil’s direct gas sales from Qatar took place under long-term contracts, so the corporation did not reap all of the benefit of this windfall on spot markets, but its gas-derived profits soared nonetheless. Also, the corporation’s share of profits from auxiliary products manufactured in Qatar, referred to as gas liquids, would soon exceed $1 billion annually. Only ExxonMobil, Raymond boasted to Wall Street analysts, had figured out how to unlock the value of Qatar’s bounty.

Gas figured increasingly in the search by ExxonMobil to replace the oil and gas reserves it pumped and sold each year. The sheer scale of ExxonMobil’s reserve replacement challenge—its need to find and book oil and gas in equivalent or greater amounts to that which it pumped out and sold—now meant that the corporation “had to find a Conoco every year,” as Raymond put it.
⁴
(In 2001, ConocoPhillips had worldwide revenues of almost $40 billion.) The scale problem was genuine, but it also sounded more and more like an excuse—nobody had forced Exxon and Mobil to merge, and Raymond had advertised the combination as full of strategic advantage. In any event, ExxonMobil’s total portfolio was shifting away from oil toward gas. In 2002, the corporation pumped slightly less oil than it did in 2001; in the first half of 2003, oil production fell slightly again. For Wall Street, ExxonMobil counted oil and gas reserves as a single number, as “oil equivalent barrels.” Analysts converted gas reserves to equivalent barrels of oil with formulas accounting for energy content and price. Yet the truth was that gas was less profitable than oil, equivalent barrel by equivalent barrel. Oil prices averaged about 30 percent more than natural gas on an energy equivalent basis after 1995, and the United States Energy Information Agency projected that this gap would widen into the future. Gas production could be more costly. Customer markets were less flexible, less interconnected. Yet because of resource nationalism and the depletion of accessible supplies in the United States, oil was harder and harder for ExxonMobil to own. The slow migration of ExxonMobil’s reserves from oil to gas did not show up clearly in the numbers the corporation reported to Wall Street—and certainly not in the numbers it emphasized in public and investor presentations—but over time, the higher proportion of gas investments could threaten the corporation’s impressive record of profitability.

Raymond lobbied in Washington to ensure that the United States had enough big import terminals to handle liquefied natural gas ships. Forecasts by the Bush administration’s analysts at the nonpartisan Energy Information Agency suggested that the United States had only about twenty years’ worth of natural gas supply left under its soil, government analysts then believed. America would soon need to import gas just as it already imported oil. In the United States, in 2003, gas supplied about a quarter of the country’s energy supply, to generate electricity, heat water and homes, and fuel industrial processes.
⁵
ExxonMobil supported a National Petroleum Council study in 2003 that made recommendations to the Bush administration to expand the industry.
⁶