IPAA CHAIRMAN-ELECT: COPING AND CHANGING

Bob Tippee
Managing Editor-Economics and Exploration

The chairman-elect of the Independent Petroleum Association of America knows how to cope in a tough, volatile business.

In a word: Change.

"If we live in future shock like we live in today, with all the volatility," says Eugene L. Ames Jr., "we've got to roll with the punches and change fast."

His company, Venus Oil Co. of San Antonio, rolled with the punches to cope with the crude oil price collapse of the 1980s. And it's rolling with the punches now to deal with a natural gas price slump.

To members of the industry group he will lead for 2 years beginning at IPAA's annual meeting next week, Ames offers this advice: "Be patient. Keep treading water.

Stay alive. Don't let that window of opportunity close on you before you've made your move."

There's no shortage of opportunities in the U.S. for independent producers, Ames insists. But there are challenges, too, such as convincing investors that drilling ventures make good economic sense, changing an antidrilling mood in the nation's capital, and knowing when the producing industry's slump reaches true bottom.

For himself, Ames has set an ambitious goal for his term as IPAA chairman: to increase group membership by 33%.

"I've got my work cut out for me," Ames acknowledges. "It's tough. For every member we gain we lose one or more."

But he calls the present "a very important time when we can do some good if we have the full strength of the independent producing industry, including everybody who's involved in the industry upstream of the wellhead-service companies, drilling contractors, consulting engineers, consulting geologists, everybody."

And his smile hints that this 57 year old, lifelong oilman has more than a few changes in mind.

ADAPTABILITY

Recent history of the company Ames has headed for three decades offers a case study in changing with business conditions.

Unlike many independents, Venus wasn't stretched thin with debt when the oil market began to slide in the early 1980s.

"We thought we were ready to capitalize on the opportunities" created by the industry downturn, says Ames. "We had no idea of the magnitude of the collapse," which ultimately took average U.S. crude oil prices at the wellhead from a high of $31.85/bbl in 1981 to as low as $9.25/bbl in July 1986.

These surprises forced Venus to study the ravaged domestic producing business and to decide whether and how to stay in it. As a result, the company in 1982 reorganized as a corporation, of which Ames now is majority shareholder, and overhauled strategy.

For most of its existence, Venus had been what Ames describes as a typical independent.

The company started up in 1962, when California businessman Corwin Denney bought most of the producing properties of old Gilcrease Oil Co. and made Ames, then a Gilcrease geologist, president. Ames's father was a partner of Thomas Gilcrease and president of Gilcrease Oil.

For years, Ames and Denney, who still holds working interests in Venus properties, concentrated on operating shallow oil production in the Midcontinent region and in East and South Texas.

"We had a rule that we just never would drill anything below protection pipe," Ames says. "We certainly didn't want to do anything with much risk attached."

The strategy change of the early 1980s shifted the company's focus from shallow, safe oil plays to deep, overpressured natural gas prospects in what, to some companies, were unlikely places to drill. And the company decided to let others handle the operator's role.

"Operations were just taking all of our time, definitely costing us money," explains Ames, a geology graduate of the University of Texas. Venus, under the new strategy, sought to take advantage of its main strengths as a "pure exploration, high-tech exploration company, strongly guided by our geology and technology."

THE PAYOFF

The payoff came in the Texas Upper Gulf Coast, where Venus possessed a strong acreage position and a contrarian notion about presence of Eocene Yegua sandstones miles downdip of where the formation has produced oil since the 1930s.

According to geologic thinking prevalent in the 1970s, the Yegua sands disappeared downdip of production. Presence of the overpressured Jackson shale between what Venus considered to be deep Yegua targets and the overlying Frio and Vicksburg formations further discouraged exploration.

Venus and partners disproved the theory with a series of mostly gas-condensate discoveries that have turned the Downdip Yegua into a prolific onshore play.

One of those discoveries, Vidor Ames field, began production last year at the rates of 20 MMcfd of gas and 2,000 b/d of oil from two wells. The operator, Amerada Hess Corp., expects gross field output to reach 120 MMcfd and 1 0,000 b/d late this year.

While it was taking new geologic risks in the Yegua trend, Venus nevertheless maintained its conservatism.

"We didn't really plunge into this play," Ames says. The company worked with partners, holding fast to its preference that others operate the wells. Its capital exposure was relatively small.

Venus now operates 47 wells and participates in about 230 others. Before the strategy change, it typically operated 250-275 wells in three or four states.

Recently, thanks largely to the gas price slump, Venus has changed again. Temporarily withdrawing from deep gas drilling, it is in one sense returning to its origins.

"We're looking at several other exploration possibilities due to the fact that we think there are some pretty interesting, relatively shallow oil areas that have not been fully developed in the country," Ames says.

CHANGED CONDITIONS

That doesn't mean he's reverting to old ways of doing business. With onshore prospect costs high and drilling capital scarce, conditions have changed too much.

"In today's environment you have to high-grade," Ames says. "The only exploration well that's going to get drilled is the one that's got unquestionable seismic control and very little sand risk."

Venus, therefore, spends much money on technology and much time, in Ames's words, "condemning areas, high-grading before we do anything."

Many major companies are liquidating U.S. production interests and shunning U.S. exploration. Large companies that are exploring consider only outstanding plays.

"It's a whole new ball game for independents," Ames says. "For those who are able to move at the right time, to find the real bottom, they're going to find some tremendous opportunities."

Of course, the market bottom has been misidentified many times since 1985. Is this it? Ames thinks so.

"The next surprises are all going to be on the up side."

TIGHT MONEY

The problem for independents is finding the capital necessary to take advantage of opportunities.

Many investors, mindful of the losses sustained when crude prices slumped in the 1980s, still shun drilling investments, despite subsequent cost reductions that have greatly improved drilling economics.

"You might have longer payouts than you'd like," Ames says. "But the value of the reserves is good; it's still there. If you can go out and be successful, the return on investment can still be tremendous."

Also hurting capital formation are drilling penalties resulting from income tax laws that subject intangible drilling costs and percentage depletion charges to the alternative minimum tax (AMT).

The law that made IDCs a preference item for AMT calculations produced an unintended consequence, Ames says: It stifled drilling.

Lawmakers didn't intend to gut the industry that drills most of the wells in the U.S. and that, with major companies pulling out of the country, must operate an increasing share of total U.S. production, Ames thinks. They just didn't want independents to get rich.

"They killed us because of their reaction to what they perceived as the obscene profits of the late '70s and early '80s. The unintended consequence was to devastate the infrastructure of the industry."

POLITICAL PROSPECTS

Ames considers capital formation his No. 1 priority as IPAA chairman and links it with AMT relief. But changing the tax will be difficult.

Before Congress acts on AMT, Ames says, there must be a philosophical change among legislators and regulators.

"They have got to finally come out and say, yes, we want to have a domestic petroleum producing industry. The philosophy that has been up there for many years is, no, we do not.

"They won't tell you that. But the actual, effective policy out of the Congress and out of the regulators has been to kill the domestic industry, to stop it."

Ames talks politics from experience. He has tussled over issues as chairman of IPAA's economic policy committee, as a member of the National Petroleum Council, and as a past IPAA vice-president for South Texas. He also belongs to Texas Mid-Continent Oil & Gas Association, American Association of Petroleum Geologists, and Society of Independent Professional Earth Scientists.

A former member of the Texas Republican executive committee, Ames helped organize former Rep. Tom Loeffler's first campaign for Congress.

It is with more than a little authority, therefore, that Ames gauges political moods. And he thinks the federal government may be making the philosophical change he considers necessary.

The recent statement by Federal Energy Regulatory Commission Chairman Martin Allday endorsing the straight fixed variable (SFV) tariff design for gas pipelines was, Ames says, "one of the strongest pro-domestic production actions to come out of the government in a long time."

The statement came in conjunction with FERC's broad notice of proposed rulemaking (NOPR) on pipeline issues - the so-called mega-NOPR. A switch to SFV ratemaking from the modified fixed variable rate design FERC has favored until now would respond to the Canadian rate-tilt issue that IPAA has been pressing for several years. Canada already employs SFV ratemaking.

IPAA argues that disparate rate designs give Canadian gas a competitive advantage in the U.S. During debate over the mega-NOPR, a Bush administration official wrote a letter supporting the IPAA position, another development Ames cites as an indication of political change helpful to U.S. producers.

SFV ratemaking also would encourage pipelines and producers to enter long term contracts, Ames says.

He believes the tariff structure change will survive adjustments certain to be made in the mega-NOPR. And he worries that some small independent producers will be hurt if the rule ultimately strips transmission pipelines of their traditional merchant function, which Allday says isn't FERC's goal.

CHANGE POSSIBLE?

That FERC addressed transportation rate design at all is a sign of welcome change in the federal government, Ames says.

So what made FERC act?

The new IPAA chairman credits the Bush administration's decision supporting IPAA's insistence that rate tilt is a problem.

"Martin Allday and the FERC decided something had to be done," he says. In the mega-NOPR, they attacked many gas issues at once, recognizing that if they did not they'd never finish the job-"the real beauty of the mega-NOPR," according to Ames.

FERC's initiative probably diminishes immediate prospects for legislative reform of gas transportation and, perhaps, of an omnibus energy policy bill. Some lawmakers say there will be no energy bill because there seems to be no energy problem.

"There are leaders of Congress and the Senate-both Democrats and Republicans-who will privately tell you that we've got to have a floor price on oil at $20/bbl," Ames says. "These are people who 1 0 years ago wanted a windfall profits tax and would like to have $5/bbl oil."

But there's little impetus for legislation. Ames believes a cold winter, another disruption in Middle East supply, or an oil price jump resulting from tightening supplies might stimulate energy policy action in Congress.

One of the many issues Ames watches closely is leasing of the Arctic National Wildlife Refuge Coastal Plain. Although IPAA members would not participate in ANWR leasing, he thinks independents have strong interests in the outcome.

"If it's approved in Congress it will help the potential for drilling of other public lands," he says. And, because environmental opposition to ANWR leasing is so strong, approval would represent a step toward the philosophical change Ames seeks-"just the fact that Congress had come out and said, yes, we must develop our natural resource."

EOR INITIATIVE

An immediate concern for Ames and IPAA is the Department of Energy's recent advanced oil recovery program, an outgrowth of the national energy strategy. The program will offer cost-sharing contracts for enhanced recovery projects and technology transfers.

DOE proposes in the next 3 years to make a total of $1 0 million available to enhanced oil recovery projects using current technology and $30 million to projects using currently defined technology that's not commercial in some areas.

Last May, the agency asked IPAA to help implement the program. The association formed a task force to respond to the request and recommend program changes.

Ames welcomes the DOE initiative as a response to the related problems of declining production and lack of EOR projects.

"Of course, the reason we're not doing them," he adds, "is the price is too low and the tax disincentives."

IPAA task force members see problems with complex reporting, monitoring, and environmental requirements. Ames himself doesn't think the program offers enough assistance.

"What they really ought to do with that same amount of money is devote it all to technology transfer, existing technology, dissemination of the existing, known technology, and developing databases."

Increasingly, he explains, oil fields amenable to EOR are passing from major companies, which have technology and data in-house, to independent companies, most of which do not.

For small independents otherwise able to perform the EOR work, "the information is just not available on the reservoir."

Ames's top energy policy priority, however, is AMT relief, in line with his desire to revive capital formation for independents. Expecting to spend much of the next 2 years grappling with that and other federal issues, he has rented an apartment in Washington, D.C.

INDEPENDENTS' FUTURE

The independent producing industry has a strong future, says Ames, a Gladewater, Tex., native whose father and grandfather owned the old Gladewater Refining Co. The company processed East Texas field crude, some of it from the company's own wells.

But independents will have to change along with their industry.

Consolidation will continue; independent companies will become larger, and there will be fewer of them.

"There's a strong place and a healthy environment for the individual, for the one-man guy. But he's going to have to be a technician," Ames says. "The independent of the future is going to be a geologist and an engineer."

Independents will continue to explore U.S. frontiers, but many of the frontiers will be in areas that have produced for years. Prospects will appear below existing producing zones in traps not discernible without modern technology - in what Ames calls "frontiers at depth."

Because of the increasing technical and financial requirements, few independents will be able to work alone.

"if you don't want to be a big independent company you're going to be part of a consortium of small independents capable of tackling the big projects," Ames says.

And he expects large independent companies to continue their recent steps outside the U.S. and offshore, especially in the Gulf of Mexico.

"Ten years from now you might even see my company moving offshore," Ames says. "We're sure looking at it. Who would have thought 10 years ago that we would have been actively exploring the 15,000 ft overpressured Yegua in Orange County? Things change."

Copyright 1991 Oil & Gas Journal. All Rights Reserved.