POINT OF VIEW - Burlington CFO: More gas business consolidation ahead

Oct. 20, 2003
This is an interesting time in the natural gas business because the market has moved to a slightly different pricing mechanism where demand is being rationed by price as opposed to a cost-based system, as in the past.

This is an interesting time in the natural gas business because the market has moved to a slightly different pricing mechanism where demand is being rationed by price as opposed to a cost-based system, as in the past. In the future the market will balance between those two pricing mechanisms.

That is the conclusion of Steven J. Shapiro, executive vice-president and chief financial officer of Houston-based Burlington Resources Inc., who adds: "I think we are in a period of higher volatility on average higher prices, but it makes it more interesting from a company strategy point of view."

There will be times when prices are determined by the cost structure of the industry, and there will be times when prices are essentially determined by a shortage of gas and what price the marginal consumer is willing to pay for that product, Shapiro notes.

The way in which a company reacts to markets is one of the primary concerns of a CFO. Price volatility in the gas market is increasing, and seasonal factors are playing a bigger role. "I think that is one of the lessons over the last few years: that supply isn't very elastic, or is elastic only to the downside," Shapiro says.

"I think that is one of the lessons over the last few years: that [gas] supply isn't very elastic, or is elastic only to the downside."
-Steven J. Shapiro,
executive vice-president and chief financial officer, Burlington Resources Inc.
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Burlington's business strategy does not change according to which way the market is headed, he points out. The company's strategy is to differentiate itself from other operators by generating positive results in either an up or down cycle: "Whether this is a 10% return business in which we can make a 15% return or a 20% business in which we can make a 25% return, that is our goal as a company. Investors will decide when they want to own this business or not."

Shapiro says that Burlington's strategy focuses the firm's asset base and its skill set to exploit what the company does well and then aligns the culture and the organization to be that successful performer.

Burlington believes in the concept of having a high local market share in the basins where it operates, a concept it calls "basin excellence," he explains. Basin excellence means that the company has large land positions where it operates and has large gas resources in place where it can apply the engineering skills and capabilities of the organization. The firm can drive the cost structure down through supply relationships in those areas, has more access to infrastructure, and has a unique understanding of the geology there based on years of experience there.

Shapiro says that when Burlington looked at its historical results, what it found was that the basins where the company had those characteristics or thought it could achieve them, it tended to have better returns, better forward outlooks, bigger inventories, and more-repeatable, lower-reinvestment risk programs.

In basins where the company didn't have those characteristics, it tended not to fare quite as well.

"Although we don't focus on infrastructure per se, within an area, gathering systems and plants are important parts of the business, and you have to make sure that you have access to very efficient local infrastructure. Sometimes that means you have to own it; sometimes it's OK if other people own it, so long as you have a strong position," Shapiro says. "It's about being in a commodity business. To differentiate yourself, you have to do probably a dozen things slightly better to get a bigger difference in terms of total outcome."

Consolidation

At least 85% of Burlington's operations are in North America, and almost 90% of that business is gas and natural gas liquids, Shapiro says.

"When I think about the North American gas business, our core business, I do think we are going to have more and more consolidation in the business, and I think consolidation is not going to be driven so much by the desire to grow your company as much as by adding a quality set of reinvestment options that you can pick and choose from in terms of your future capital program," he contends.

He says that what is going to drive consolidation is the "reloading" of a company's investment inventory, adding to the upper end of that inventory. "At the end of the day this is a slow-growth, capital-intensive, highly cyclical commodity business with a declining resource base," he says.

Where Burlington is always active because of the decline rates in the sector, it has to grow 20%/year just to stay even in terms of reserves-production ratio, while the industry as a whole probably has to grow 25-30%/year just to stay even, Shapiro asserts.

He says he thinks the right reason for consolidation is to gain additional efficiencies both in operating programs and in capital programs, because those are the factors that will differentiate the players.

Peer competition

Burlington's outlook is that it is going to be very hard for the large independent producers in particular to grow at a pace that's much different from each other, and the way they are going to compete is on asset quality, Shapiro says.

Burlington uses return on capital employed as a measurement tool for asset quality, and much of what the company does is focused on getting ROCE right. It maintains a consistent level of drilling activity from year to year, since this is the most efficient method of maintaining long-term assets. For example, if an operator ramps up activity during commodity price spikes, it will incur price spikes from its service costs.

Another focus is on driving costs out of drilling and completion operations and out of overhead. Burlington ensures that its base exploration and production capital programs have lower decline rates, multiyear inventories, and focused, concentrated positions. All of these factors improve ROCE.

The sort of acquisitions that Burlington would be interested in making would have one or two characteristics, Shapiro says. One characteristic is that an acquired property would be in a basin where the company already has a strong position. Alternatively, Burlington would look at assets that are big enough to create their own platforms and in new basins where the company could exploit the kinds of strategies that it employs effectively. Those two types of acquisitions could come in the form of asset transactions or corporate transactions, depending on the opportunities that the company sees.

Capital spending

While capital spending industry-wide has been slow to increase, what Burlington sees companies doing is reacting to their own motivations more than any particular macroeconomic trend, according to Shapiro.

Some companies are focusing on large acquisitions. On the other hand, companies such as Burlington are trying to make sure they run the most efficient programs they can, he says.

"Ramping up programs very dramatically is not very efficient. Some companies may be opportunity-short, particularly in some of the higher-risk plays," he says.

"The onshore North America rig count is at a high level, so we are seeing the activity. We are seeing a shift in the types of rocks that are being drilled, and that's resulting in much lower uplift out of the results of the drilling program, and so we're not seeing the supply response to the high rig count that we would have in the past when we were drilling in some of the more prolific rocks of the Gulf Coast and the Gulf of Mexico," Shapiro says.

"I wouldn't make dramatic conclusions about a change in the industry. A lot of people talk about how they've achieved great capital discipline in the industry. I don't know if that's right or not. I think people are reacting to their own opportunity sets and what they're trying to achieve as a company," he concludes.

Career highlights

Steven J. Shapiro in 2002 was named executive vice-president and chief financial officer of Burlington Resources Inc., Houston, with key responsibility for the company's strategy development and execution, as well as its financial performance.

Employment
Shapiro joined Burlington in 2000 as senior vice-president and CFO. He previously served as senior vice-president, CFO, and director at one-time ARCO affiliate Vastar Resources Inc. He also served on the board of Southern Co. Energy Marketing LP, a limited partnership owned by Vastar and Southern Co. Shapiro spent 16 years with ARCO, beginning as a planning analyst and later holding a variety of positions in ARCO's coal and minerals businesses. In 1985 he was appointed vice-president of finance for ARCO Coal, later serving as assistant treasurer and vice-president of corporate planning. In 1991 he was named president of ARCO Coal Australia.

Education
Shapiro earned a bachelor's in industrial economics from Union College and a master's in business administration from Harvard University.