Private Empire: ExxonMobil and American Power (9 page)

He had cause for concern: Between December 31, 1996, and December 31, 1997, the proved reserves of oil and liquid natural gas that Exxon reported to the S.E.C. fell from 6.34 billion barrels to 6.17 billion barrels, a decline of more than 2 percent. The amount of that decline was the equivalent of 465,000 barrels of oil production per day, annualized, a sizable amount by industry standards. During the same year, the corporation’s reported proved natural gas holdings increased slightly, but not enough to offset the fall in oil reserves. Judging by the rules enforced by the S.E.C., then, Exxon’s total oil and gas reserves shrank during 1997.

The news that Exxon had retracted a bit, at least temporarily, was hardly shocking: All of the major oil and gas companies struggled during the 1990s to replace produced reserves. To the public and Wall Street, however, Lee Raymond made no such admission. On February 5, 1998, Exxon announced in a press release that it had replaced
121 percent
of its 1997 production by adding new proved reserves—in other words, its reserves had grown, not shrunk. “This year’s strong performance is the fourth year in a row that we’ve exceeded 100 percent replacement,” Raymond declared.
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How could Exxon tell the public and Wall Street one thing and the S.E.C. another? The answer involved a catalog of legalese known as S.E.C. Rule 4-10, the binder of regulations that governed what oil and gas companies could and could not report as “proved reserves.” A purpose of Rule 4-10 was to prevent oil companies from puffing up their reserve numbers to lure share buyers and bolster their stock market prices.

One of the rule’s provisions held that “oil and gas producing activities do not include . . . the extraction of hydrocarbons from shale, tar sands, or coal.”
¹⁵
Tar sands refer to bitumen, a thick form of oil that usually has to be dug out of the ground by techniques that resemble mining, after which it is mixed with chemicals to create a liquid suitable for transport by pipeline to an oil refiner. Canada holds some of the world’s largest tar sands reserves. Exxon, through local affiliates, had been buying into these holdings under Raymond’s spur. Raymond believed it was wrong for the S.E.C. to exclude tar sands from proved oil reserve counting—and so he simply ignored the commission’s rules when he issued press releases.

The S.E.C. had enacted the tar sands rule because it wanted investors to know when a company was engaged in mining and when it was engaged in oil production—for one thing, the expense of mining was typically higher than the expense of oil drilling, so the value of tar sands reserves over time might be less than an equivalent amount of purer oil. Raymond thought this was wrong, too: The purpose of S.E.C. regulation was to ensure accurate documentation of resources, not to force companies to dance around in outmoded categories devised by bureaucrats. There was no doubt that Exxon owned the Canadian tar sands resources it claimed—outright fraud was not the issue. In any event, if Exxon’s Canadian tar holdings were included with other oil and gas holdings, the corporation’s total proved reserves had indeed gone up during 1997, not down—and this is what Raymond chose to emphasize to Wall Street and the public.

Did his defiance of the S.E.C. rules matter? Raymond might disagree with the regulations on the books, but the purpose of S.E.C. regulation was to ensure that all investors had accurate information about the companies whose shares they owned. Through fraud-inflated bubbles, Wall Street reminded the world every ten or twenty years why such regulation was vital. Raymond declared publicly each winter in press releases and Wall Street presentations that Exxon enjoyed smooth, year-to-year reserve replacement when, in fact, no such picture existed, according to S.E.C. regulations. And the corporation’s spinning did help to mask a strategic issue at Exxon, the challenge of resource nationalism and reserve replacement, which was of genuine and enduring importance.

On December 31, 1996, Exxon stock traded at $24.50 per share. On February 6, 1998, the day after the corporation issued a press release boasting of “the fourth year in a row that we’ve exceeded 100 percent replacement,” Exxon shares closed at $31.00. Exxon’s profitability was unchallengeable, but it could be questioned whether all of that 10 percent plus annual gain in stock price, which benefited Exxon executives and employees as well as ordinary shareholders, was honestly earned.

Raymond’s defiance of the S.E.C. was not illegal—the corporation’s annual 10-K filings to the commission appeared to be carefully parsed, and they broke out tar sands (or “oil sands”) as a separate reserve figure, in fine print. Rule 4-10 enforced disclosures in official filings to the commission, not in press releases or oral statements to Wall Street analysts.

Exxon’s practice of reserve spinning to the public reflected a broader mind-set of chutzpah toward Washington. The commission staff was by far the weaker party in this particular contest; for many years the S.E.C. did not have a single oil geologist on its payroll to assess the “proved reserve” claims made by the oil corporations it oversaw.

Exxon’s argumentative press releases also signaled how heavily the reserve replacement conundrum weighed on Raymond and his colleagues. The underlying challenge of reserve booking did have far-reaching consequences: It would draw Exxon to far-flung corners of the earth in pursuit of reportable reserves the corporation might previously have ignored on the grounds that they involved too much political and economic risk and dragged the company into dictatorships and other violent settings for which it was not well prepared.

“What is the one item that concerns you most, that disturbs your sleep?” the Wall Street oil industry analyst Fadel Gheit recalled asking Raymond over a meal.

“Reserve replacement,” Raymond had replied.
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J
ohn Browne ascended to become chief executive of British Petroleum two years after Lee Raymond took over Exxon. As individuals, their personal interests could hardly have been more disparate—Browne, the Soho-inspired gourmet; Raymond, the duck hunter and country club golfer. As business competitors, they faced a common challenge. As Browne put it later, “We believed governments of oil-producing nations would increasingly prefer to work with very big and influential oil companies. They did not think small was beautiful—that was clear when you spoke to them. They wanted to see a big balance sheet, global political clout, and technological prowess, and they wanted to be sure that you would be around for a long time.”
¹⁷

Moreover, the geographical distribution of Exxon and British Petroleum’s oil holdings increasingly isolated those two companies from the regions with the most promising new opportunities. Exxon’s reserves and those of British Petroleum were the most heavily weighted toward the politically safe, economically free but geologically mature oil regions of the West. About 80 percent of Exxon’s reported proved oil reserves lay beneath the United States, Canada, and Europe. British Petroleum had struck out aggressively in the former Soviet Union after communism’s collapse, but about three quarters of its assets remained in Britain and the United States. Chevron had acquired sizable reserves in Kazakhstan and Africa. Mobil owned large holdings in Africa and Asia; the majority of its reserves lay outside of North America and Europe.
¹⁸

In the autumn of 1996, at the Four Seasons hotel in Berlin, John Browne presented a plan to British Petroleum’s board of directors in which he argued that BP should seek a merger with another large international company in order to compete with state-owned oil companies and improve the geographical diversity of its oil holdings. Browne’s first choice was Mobil.

The BP chief regarded his Mobil counterpart, Lou Noto, as a like-minded cosmopolitan. Noto had grown up in Bensonhurst, Brooklyn, as the son of a labor organizer; he was a stocky, lively, charismatic business strategist with a sizable ego. He lived in Manhattan and indulged his fondnesses for cigars, Porsches, and opera. Browne found him to be a “warm, friendly person and ‘
bon viveur
.’” They smoked cigars together from time to time and talked oil.

The gigantic investments and industrial operations required to produce and refine oil meant that international companies often found it financially prudent to partner on projects, much as syndicates of Wall Street investment banks shared the risks of selling stocks and bonds. This pattern of coinvestment and coexistence meant that global oil executives kept up steady contact with one another—it was a form of continuous diplomatic relations, involving both cooperation and dispute.

BP and Mobil had embarked on a joint venture that would combine their European refining businesses. Browne introduced the idea of a full merger that would create the world’s largest privately owned oil company.
¹⁹

Noto shared Browne’s view of Big Oil’s predicament: “We need to face some facts,” he said later. “The world has changed. The easy things are behind us. The easy oil, the easy cost savings—they’re done.” Noto was “worried.” He “expected the environment to become more volatile, and more competitive, and more difficult geographically and geologically.”
²⁰

Mobil had inherited a large share of the downstream assets of Standard Oil. The corporation operated adeptly on the commercial side of the oil business—wheeling and dealing, negotiating customer contracts, maneuvering amid price volatility, and the like. It won major new upstream plays in newly independent Kazakhstan after the Soviet Union’s demise. Yet Mobil was highly dependent on the profits generated by a single large natural gas field in Indonesia and offshore properties in Nigeria; both countries were politically unstable and wracked by violence.

Late in 1996 and early in 1997, Noto and Browne held a lengthy series of secret meetings to design a full merger of their corporations; their work climaxed at a long conference in the New York offices of the law firm Davis Polk & Wardwell. Yet as a decision point neared, Noto thought that Mobil might still be better off on its own. On March 28, 1997, he met Browne in Mobil’s corporate jet hangar outside of Washington, D.C., and “made it clear that we could go no further,” as Browne recalled it. Browne felt that he had “wasted a lot of time and effort.” He flew back to London and announced to a colleague, “Well, we’d better think of something else.”
²¹

Plummeting oil prices compounded the pressures he faced. The causes of the price fall emanated from Saudi Arabia, the world’s leading oil producer, at about 9 million barrels per day of capacity at the time, and the leading source of American oil imports. After Saddam Hussein’s invasion of Kuwait, Venezuela’s government decided to break from O.P.E.C. policy and produce as much oil as possible. It looked as if Venezuela might be trying to steal some of Saudi Arabia’s American market share. The usurper attempted to almost double its oil production, from 3.2 million barrels a day to 5.5 million a day. For a while, the gambit worked; Venezuela gained more and more of the U.S. import market and replaced Saudi Arabia as America’s number-one outside oil supplier. In 1997, however, Saudi Arabia retaliated by authorizing a surge in its own oil production, a program “explicitly designed to punish Venezuela” and to establish a “deterrent,” as the industry consultant Edward L. Morse would describe it, to dissuade any other oil-rich country that might harbor similar ambitions. The Saudi production surge drove global oil prices to historic lows in 1998. By the end of that year, oil would fall to just ten dollars per barrel; adjusted for inflation, that was the lowest price the world had enjoyed since the 1960s.
²²

Disciplined Exxon could weather such a sudden price collapse. After the cost reduction binge of the 1980s, Raymond had reduced Exxon’s operating expenses an additional $1.3 billion annually in the five years until 1997. Less-efficient companies such as Mobil struggled. Nobody knew how long prices might stay so low. The long-term challenge of resource nationalism compounded the anxiety. All this coaxed Lou Noto back to the possibility of a merger.

In June 1998, he attended a meeting with Lee Raymond organized by the American Petroleum Institute (A.P.I.), the Washington-headquartered oil industry trade group. Raymond raised the possibility of a minor deal to combine Exxon and Mobil refinery operations in Japan.

“Maybe we should talk about that,” the Exxon chief said.

“That and other things,” Noto replied.

Mobil’s top Management Committee met in New York every Tuesday and Thursday. One morning that summer, Noto arrived and said, “Guess who I had dinner with last night? I had dinner with Lee Raymond.”

The news shocked his colleagues. Exxon was more than twice Mobil’s size by revenue. Layoffs would be the one inevitable by-product of such a combination, and the job losses would reach the highest ranks of the Mobil hierarchy. “There was a massive anxiety,” an executive involved recalled. They worried as well about the culture shift if conservative Exxon took charge; by comparison, Mobil had been loosely governed.

That summer, John Browne advanced a fallback plan to merge with Amoco, the offspring of Standard Oil of Indiana, headquartered in Chicago. Browne and Laurance Fuller, Amoco’s chief executive, held a series of private dinners in a back room of Le Pont de la Tour, the London restaurant, where Fuller “could smoke his cigarettes and we could all drink Puligny-Montrachet,” as Browne recalled it. “Remarkably, no one noticed.”

On August 11, 1998, they announced that their companies intended to merge, with Browne to be in charge of the successor corporation. The deal would create the largest corporation in Great Britain and one of the largest private oil companies in the world.