Newfield balances experience, technology for success in the Gulf of Mexico region

Steven Poruban
Staff writer

An initial exploration well drilled in late 1997 on East Cameron Block 287, next to Block 286, in the Gulf of Mexico found 125 ft of net gas pay in two sands. Operator Newfield Exploration Co. has since drilled four successful wells and installed a platform and production facilities on East Cameron 286/287 Blocks. Newfield expects production from the blocks to reach 30-35 MMcfed property during 1999. Photo courtesy of Newfield.

Newfield Production Growth [71,875 bytes]

Newfield Exploration Co. is competing in the Gulf of Mexico with companies that are much larger and that have much greater resources. And the company is doing more than merely surviving.

The Houston-based Newfield, launched only a decade ago, has made sizable gains from its meager beginnings, achieving total proved oil and gas reserves of 513 bcfe at yearend 1998. This level represented an increase of 18% from 1997.

Newfield achieved a drill bit reserves replacement rate of 113% in 1998, at a cost of $2.64/Mcfe. Acquisitions accounted for the remaining two fifths of reserves replaced in 1998. Additions to its proved reserves base in 1998 totaled 167 bcfe, for an overall reserves replacement rate of 188%.

Newfield continues to increase its production by an average of 28%/year, or 290 MMcfed, and it operates over 85% of its production (see chart, p. 20). The company's 1998 production of 88.5 bcfe was an increase of 20% over 1997's levels. Newfield has set a production target of 106 bcfe for 1999.

Begun as a start-up with about 25 former Tenneco Oil Co. employees under the leadership of Newfield Chairman and Chief Executive Officer Joe B. Foster, the company over the years has bolstered its Gulf Coast region assets, both onshore and offshore, and has added continually to its now-impressive seismic database.

Newfield has been a publicly traded company for just over 5 years. Foster runs the company based on a few simple and steadfast principles: employ talented people and expand the company continually through employee ownership; maintain a large seismic database and acquire the most advanced seismic technologies; operate with a low-cost structure; act as operator whenever possible; and have a good balance between acquisitions and exploration.

Also, Newfield's board of directors last week announced the adoption of a stockholder rights plan to ensure that its stockholders "receive fair and equal treatment in the event of a proposed takeover." The plan "includes safeguards against partial or two-tiered tender offers, squeeze-out mergers, and other abusive takeover tactics."

The rights will be issued Feb. 22, 1999, and will expire on the same date in 2009.

Breaking away

Newfield Exploration Co.'s genesis was primarily the result of Tenneco Inc.'s decision in 1989 to sell its upstream unit, Tenneco Oil Co., and focus its energy unit on the pipeline business.

Then director of Tenneco Inc.'s energy division, Foster wasn't keen on seeing 30 years of work at the company dissipate.

"I opposed the sale of Tenneco Oil, but, in their wisdom, they sold it anyway," said Foster.

Also, Foster wanted to look for gas and oil rather than stay behind to be a pipeliner. So he spearheaded the start-up of a new exploration and production company.

Joined by 25 former Tenneco employees, Foster also hired David A. Trice-the only non-Tenneco employee at the time-to aid in the new venture's financing.

Even in the early days, Newfield stuck to its principles. The former Tenneco employees who left with Foster were, he said, the cream of the crop.

"We were in a unique position by virtue of the fact that Tenneco Oil was selling its assets to a bunch of different companies," said Foster. "We were able to, in effect, pick and choose among what I thought were the best oil and gas finders and operators in the Gulf of Mexico for Tenneco."

When Newfield began, employees owned 40% of the stock compared with the present employee ownership of 10-12%.

One of the most "eye-opening" lessons to learn, says Foster-after starting up a new company and after working for Tenneco for so many years-was how easy and effective it was to motivate employees through shared ownership.

"It made it real easy to talk about keeping your costs low, because (it) meant you were increasing shareholder value. And it's worked out very well," admitted Foster. "The initial employees and even the subsequent employees have made a lot of money on Newfield stock, so it worked."

Growing pains

In the beginning, however, Newfield did have some big challenges to overcome.

For one, high overhead costs strained the company's initial capital, because many of the original employees were highly skilled technical specialists, mainly geologists and geophysicists.

"Our first year, overhead was about $2 million," recounts Foster. "On the first day we opened our doors, we placed orders for over $2 million worth of speculative seismic data. So half of our equity capital basically went into overhead and technology."

Newfield began with about $9 million of equity capital-$3 million from employees, $3 million from a group of Houston investors headed by Charles W. Duncan Jr., and another $3 million from a University of Texas endowment fund. (UT had just received permission to make investments in something other than dividend-paying stocks and bonds, and Newfield was of interest to it.) The university agreed to invest $3 million of equity and loan Newfield up to $3 million if the company needed it.

When soliciting initial equity, Newfield made it clear to investors that they had an exit strategy once the company went public. Therefore, Newfield ran the company from the first day of operations on the presumption that it would go public when the time felt right, giving its investors liquidity.

"That liquidity, in effect, not only served our investors well, but it served our employees well, because we had a very high degree of stock options at the time," said Foster. "We had some founders' stock, so it was in the employees' interest to get public."

Along with the initial overhead costs, Newfield was plagued by some other hard hits during its first year or so: The first three wells the company drilled were dry holes, and a rig capsized on another of the initial gulf wells.

In fact, it wasn't until May 1990 that Newfield made its first discovery-16 months after the new company began-with West Delta 20.

About that same time, Newfield made its first acquisition, the Eugene Island Block 172, from Chevron Corp. To this day, Newfield tries to maintain a good balance between acquisitions and exploration.

"We have drilled a lot of wildcats (since then, and) we've had good success in finding oil and gas, but at the same time we've acquired proved producing reserves," said Foster. "We needed to do that early on, simply to give us some cash flow to survive. If you look at the way we've added reserves, about a third of the reserves we've added have come from exploration drilling, about a third have come from the acquisition of proved producing reserves, and another third have come fromellipseexploitation drilling or the conversion of probable and possible reserves on properties that we've acquired to proved reserves," said Foster.

Calculating from that first discovery, Newfield has had a reasonable drilling success ratio of 30-40%, said Foster.

Public offering

By November 1993, Newfield had reached enough critical mass to take itself public with an initial public offering (IPO). It did so at $8.75/share, on a split-adjusted basis. Over the course of the 5 years since its IPO, the company has traded as high as $33/share, said Foster.

"It certainly has made it easier for us to run the business (since going public)," admitted Foster. "We've had better access to capital. We've not only been able to sell some additional equity, but we (also) have issued some public debt. So, it's been a net positive to me to be public.

"We follow 42 companies in the E&P segment, and only 3 of those 42 did better in the stock market (in 1998) than we did," he explained. The other companies that have outperformed Newfield have been Anadarko Petroleum Corp., Vastar Resources Inc., and Houston Exploration Co., all based in Houston.

Newfield finds one of its major strengths in the marketing of its gas. "(Newfield is) fortunate in gas marketing in the sense that I'd say 98% of our production is in the Gulf of Mexico. And most of it is near one of the major pipes," Foster said.

Newfield obtains favorable prices for its gas in the gulf due to its close proximity to the Henry Hub, saving on transportation in pipeline capacity to the Northeast.

Newfield does not have a gas marketing department, per se, but it takes bids for its gas regularly, marketing through four independent marketers, said Foster.

"The biggest issue we have with respect to gas marketing is the daily control of the gas," Foster said. The gas control function at Newfield is taken on by two people, devoting half their time to making sure that the volumes committed to be delivered get delivered and that the pipelines are ready to take what is ready to sell.

Seismic edge

When it comes to conducting operations on the Gulf of Mexico shelf, said Foster, Newfield feels it is technically on par with most of the major companies.

One of the keys to Newfield's success, Foster contends, is its substantial quantity of seismic data, especially for an E&P company of its size.

"We have over 2,500 blocks of 3D geophysical data in the Gulf of Mexico, so we're able to not just do field development using 3D geophysics, but to use 3D geophysics as an exploration tool," said Foster.

Newfield has 16 geophysical work stations, and all of its geologists and geophysicists have workstations in their offices. Newfield's 3D coverage of the central gulf is significant, explained David A. Trice, Newfield's vice-president of finance and international. "Not only do we cover our properties, but we cover regionally, so we can work that area," said Trice.

In addition to using 3D seismic, Newfield has drilled several horizontal wells and a number of extended-reach wells. The company has benefited greatly from aggressive use of logging while drilling. "Many times, we won't even run a wire line log (while drill- ing)," said Foster, "we'll simply have a log in the hole on the drill bit."

Cost management

Since the first day that Newfield was founded, one of its management's primary goals has been to be a low-cost operator.

"It's a lot easier to start a company from scratch and keep your costs low than it is to be a big company and try to trim out things that got there over the years that are very difficult to get rid of," said Foster. "We have among the lowest operating costs of any E&P operator."

In fact, in a survey late last year conducted by analyst Warburg Dillon Read of Newfield and 16 of its closest competitors, Newfield was found to have the lowest interest expense per barrel of oil equivalent produced at 34¢/boe. Warburg also estimated that Newfield would have the lowest unit operating expenses in 1999 at $2.10/boe.

"When you combine our low cash operating costs with the high realizations that you achieve in the Gulf of Mexico, we have the highest cash flow generated per unit of production of any E&P company," said Foster.

Another way Newfield controls costs is to be the operator wherever and whenever it can, especially with the large number of joint ventures in the oil and gas industry. "We operate over 600 MMcfed of gas in the Gulf of Mexico, where our net production is closer to 280 MMcfed of gas," said Foster. "We operate about twice as much as is net to us, so we (mainly) operate for other people. That gives us some economies of scale and, again, lets us keep our cost relatively lower."

Another potential financial buffer, Newfield finds, is its successful price hedging program Table 1. [42,155 bytes] "We are fairly active hedgers with respect to gas in particular," said Foster. Generally, Newfield sells about a third of its gas forward at what it thinks is a good time in terms of the pricing environment. The company places floors under about a third and lets the last third run with the market.

"The philosophy is to have about two thirds of our downside covered with hedges, but we also then have two thirds of the upside left, in the event prices go up," explained Foster.

Offshore highlights

In early 1998, Newfield announced the results from two significant discoveries off Louisiana-East Cameron 286/287 and Main Pass 256. The East Cameron blocks lie in 185 ft of water, while the Main Pass block lies in 350 ft of water. The properties "will contribute a substantial amount of income during 1999 and carry us out into 2000," said Foster.

Currently, Newfield is operating one rig offshore, which is drilling a wildcat on South Timbalier Block 107, which PaineWebber described as a "high-impact" prospect.

In July 1997, Newfield acquired a 50% working interest in East Cameron Block 286 along with the purchase of nine other blocks in the western gulf. Before beginning its drilling program, the company purchased the remaining 50% working interest in the block and acquired a farmout on East Cameron 287, which contained a portion of the prospect.

East Cameron 287 No. 1 was the first well to be drilled. It was drilled to 10,432 ft TD and found 125 ft of net gas pay in two sands. East Cameron 286 No. 5 well was then drilled 1,200 ft away from No. 1 to 11,388 ft TD, extending the discovery and finding over 140 ft of net gas pay, also in two sands. The interval at 10,740-838 ft was tested at gross rates of about 12.7 MMcfd and 48 b/d of condensate through a 27/64-in. choke with 3,380 psi flowing tubing pressure.

Newfield is operator and owns a 75% working interest in Main Pass Block 256, which lies in 350 ft of water. The block is close to Main Pass 255/259 blocks, where Newfield owns an interest.

The discovery well, drilled to a true measured depth of 11,889 ft, found 48 ft of net gas pay. About 48 ft of net gas pay was also encountered with a second delineation well drilled 2,000 ft away from the discovery well to 13,279 ft TMD. Newfield has installed a platform and completed the wells. First production is expected in late February.

During 1998, Newfield made an acquisition of a number of properties in the western gulf from a private company (see map, p. 22). One property included in the purchase was South Marsh Island 141/144. "We're drilling on those blocks now, and they will add production during 1999 and 2000 as well," said Foster.

Newfield also has eight firm wildcats on its drilling calendar for 1999.

Onshore play

While onshore drilling activity is not a major portion of Newfield's portfolio, it remains an area that continues to grow in terms of production and opportunities.

In late 1995, after a successful run in the Gulf of Mexico, Newfield began an exploration effort onshore, in Louis- iana. One reason for the transition to this onshore region was the similarity of geology and geophysics seen offshore. At the time, 3D seismic had not been used quite to the extent onshore that it had been in the gulf, Foster explained.

Newfield was also concerned about the potential for rig rates to escalate and wanted to ensure it would have an economic place to drill other than offshore.

Significant success came for Newfield's onshore endeavors in 1998 following the purchase of Rayne gas field in Louisiana. After conducting a 3D survey and evaluating drilling locations in Rayne, Newfield opted not to drill any wells in Rayne field this year. But acquiring Rayne led Newfield to the Lafayette area of Louisiana, where they acquired a 3D seismic database.

In the Lafayette area, Newfield drilled a discovery well, Gladys Garber No. 1, that extended Broussard gas field. Soon afterward, another successful delineation well, Eddie Knight No. 1, extended Broussard further.

"We still have some additional drilling to do (in the Lafayette area)," said Foster. "We have a Lafayette (well) scheduled near the Broussard field later this year."

International plays

After drilling a dry hole on Block 05/36 in Bohai Bay off China with Oklahoma City's Kerr-McGee Corp. unit Kerr-McGee China Petroleum Ltd. and Pendaries Petroleum Ltd., Toronto, Newfield continues to look for opportunities outside the U.S.

"Our hope is that we'll get another well drilled during 1999 in the Bohai Bay," said Foster. "Other than that, we don't have in hand any other international properties."

Trice explained, "We are looking in areas that are similar operationally to the Gulf of Mexico. We're primarily an offshore company. We work in Tertiary delta settings, so we've selected areas around the world that fit that same profile, so that we can use the things that we've done well in the Gulf of Mexico."

Newfield believes that its successes in the gulf can be transferred to other areas of the world with similar properties, such as West Africa and Australia's North West Shelf.

In Australia, Newfield currently has a seismic option on a block in the Timor Sea, Trice noted: "We originally had an option on two blocks, (but) we elected not to exercise that option with respect to one block. We're working the other block now."

Plans could include a 3D seismic survey on the Timor block.

West Africa, Trice contends, has been a difficult place to work. "It continues to be one of the hottest places in the world, with very little acreage available," said Trice.

Newfield is keeping an eye on Brazil for future opportunities, due to the continuing privatization of the petroleum industry in the country.

"We think there will be some significant opportunities to come out of (Brazil), but the pace of that privatization has been a lot slower than we would like it to be," said Trice.

Foster says, "Our purpose in getting involved in international is to perhaps sow the seeds for some long-term growth in some 'impact' projects over time. In the near term, we don't have to have an international discovery to make it-we can grow the company just fine in the Gulf of Mexico and onshore for the next number of years. But, over the longer term, we think that international presence would benefit us, and we think that companies like (Newfield) have a legitimate role internationally.

"The whole basis of being international is that we've got some core competencies that we've proven to be effective in the Gulf of Mexico, and we think those same competencies-3D geophysics, low-cost operations, a good drilling capability, marine operations-all those capabilities fit in a number of international locales," said Foster.

Future strategies

In 1998, Newfield spent $87 million on property acquisitions. During the current downturn, Newfield, like its peers, will have to strategically split capital spending among exploration, acquisition, and exploitation.

"In the midst of low oil prices and lower relative gas pricesellipseI think there's certainly a good deal more uncertainty about when and if oil prices will recover (than gas)," said Foster.

"I think (that with) gas prices-although they're low at the present time-there are some reasons to be at least optimistic that we'll see (improvement) before the year is out. But, nevertheless, with the kind of prices we're seeing today, we have to manage our business very carefully."

Newfield's basic approach this year will be to conduct its ordinary course of business within internally generated cash flow, explained Foster. Newfield plans to spend about $150 million this year, split 30% for exploration and 70% for acquisitions and development.

For Newfield, hedging will play an important role in protecting itself during the latest cycle of low commodity prices.

"The dilemma we have right now is that we do not see prices on the screen for the latter part of the year that look attractive enough for us to put hedges in place," explained Foster.

Newfield presently has about 60% of its gas hedged for the first quarter of 1999, about 40% hedged in the second quarter, 25% in the third, and none beyond that. Its hedges are expected to benefit its gas prices by about $8.5 million and oil prices by about $1 million, said Foster.

"Hedging added nearly $9 million worth of revenue in 1998. And if we look at our position in the first quarter of 1999, hedging would add (based on the present level of pricing) about $8 million in the first quarter," said Foster.

Newfield plans to be active in the acquisition market as well, especially in the industry's present climate of mergers and consolidations.

"We're in a position to look at attractive opportunities in acquisitions, if the opportunities present themselves. And we think that there will be more than the usual amount of opportunities show up this year," said Foster.

"Newfield enters 1999 with an outlook for growthellipseLower oil field service costs, plus our high operating cash flow per unit of production, our relatively low debt level, and our strong presence in the Gulf of Mexico and Gulf Coast should permit us to take advantage of a year of opportunity."

Joe Foster Newfield Exploration Co. Chairman/CEO. "It's a lot easier to start a company from scratch and keep your costs low than it is to be a big company and try to trim out things that got there over the years that are very difficult to get rid of. We have among the lowest operating costs of any E&P operatorellipse Newfield enters 1999 with an outlook for growthellipseLower oil field service costs, plus our high operating cash flow per unit of production, our relatively low debt level, and our strong presence in the Gulf of Mexico and Gulf Coast, should permit us to take advantage of a year of opportunity."