For the past century, the picture of this country in terms of the supply and costs of its energy has been one of bright sunny days. Now and then a few clouds have appeared over certain areas ? there was, for example, the great oil shortage scare just after World War I, when it was thought that this country's oil resources were being exhausted. By and large, however, there was unrelieved sunshine. Within the past year, in contrast, we have seen for the first time the gathering of ominous storm clouds all around the horizon. It is possible that the storm can sweep down upon us from any direction, or even from all directions at once. During this year there have already been certain isolated thunderstorms, so to speak. There are some who say we shall never see the sun again, at least for the next decade or so, and that the storms will be upon us within the next year or so.
It's time to give that metaphor a rest, but at least it sets the mood. What I'm talking about, of course, is the Great Energy Supply Crisis of 1970. The truly extraordinary thing about the crisis is not so much that it has occurred, but that it developed with such extreme rapidity and, in so doing, was unforeseen and unforeseeable.
Now to say this to a group of oil men may verge on the foolhardy, but I think at least I have gotten your attention. How can I say that it was unforeseen and unforeseeable when the petroleum industry has been crying the alarm for years about inadequate incentives and the decline in the reserve position? How can I say it was a rapid development when exploration activity has been tumbling for many years?
As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private statements by any of its employees. The views expressed herein are those of the speaker and do not necessarily reflect the views of the Commission or of the speaker's colleagues on the staff of the Commission.
The Structure of the Securities and Exchange Commission
The Exchange Act of 1934 created and established the Securities and Exchange Commission. The Commission, as now organized is divided into three principal divisions. The Division of Trading and Markets conducts much of the investigative and enforcement work for the Commission, has regulatory responsibility with respect to stock exchanges, administers the registration requirements of investment advisors and broker-dealers and exercises surveillance over them. Registrations under the Public Utility Holding Company Act of 1935 and the Investment Company Act of 1940 are administered by the Division of Corporate Regulation, which also partially administers the Investment Advisers Act of 1940. All registrations of public offerings, reports, and proxy material under the Securities Act of 1933 and the Securities Exchange Act of 1934 (except with respect to registered investment companies), are reviewed by the Division of Corporation Finance, the largest division of the Commission. This Division is subdivided into 15 branches, each with a Branch Chief and its own group of analysts, attorneys, and accountants. An Assistant Director supervises each group of three branches. The Office of Engineering, composed of three sections, Oil and Gas, Mining, and Valuation, is attached to this Division.
At the present time registration statements, reports, and proxy material required under the 1933 and 1934 Acts are filed with the Division of Corporation Finance. After fees have been paid, and a filing has been accepted, it is assigned to a Branch. When received in the Branch, it is assigned to an analyst or attorney for examination and review.
"Sitting Ducks: Many physicians prove to be inept in investment matters," says a recent article in the Wall Street Journal (August 17, 1970). It goes on to cite examples of poor investments they have made in real estate, tax shelter schemes, business ventures, commodities, and common stocks. An official of the S. E. C. says doctors are invariably among the victims of stock fraud cases and they are particularly prone to making bad investments in schemes offering tax shelter. Their penchant for bad investments is not surprising. It arises generally from two companion factors: high income and long busy workdays. According to an official of the American Medical Association, doctors average about $32,000 a year, with incomes of $100,000 from lucrative big city practices not uncommon. After long days at their practice I and time for family and social life, most doctors have little time left to study investments.
Although the comments above were made about physicians, they apply equally well to dentists, other professional people, and business executives who work long hours and have high incomes. An investment area where they frequently bungle is tax shelter schemes. Many are "snowed" or dazzled by glowing statements from oil drilling program representatives about deductibility, tax savings, leverage of investment dollars, and the prospect of multiple return. They get so carried away with this sort of appeal that study of the prospectus inherent risk and intrinsic value of the investment are overlooked.
Oil and gas drilling programs are now offered publicly by over 150 different companies. Of the $1.70 billion total for programs filed with the S. E. C. in '69, approximately $.50 billion was sold. There are no figures as to what part of this was bought by doctors, dentists, and others in the professions, but several program sponsors contacted on this point said it was about half.
The amount of publicly offered Oil and Gas drilling programs has been growing by leaps and bounds over the past three years and new registrations in 1970 indicate that it will be a bigger year than the $1.7 billion registered in 1969. There has been increased emphasis by the oil operators offering these programs to register their programs early and shift money raising to the first half of the year, thereby providing more time for efficient spending of these funds in the last half. However, with the high number of registrations (many for the first time) the registration time is becoming longer and investors don't appear to be cooperating, since money raising is going very slow this year.
Selling these programs has undoubtedly been on an increase in the number of relationships between drilling program companies and prestigious investment banking firms to help place the program. However, failing to raise the expected amount of money in the first half may create the undesirable situation of high registrations in the last half to offset the shortfall. This would then force accelerated year-end drilling to spend the higher amounts of money in the 1970 tax year, under a "drill we must" atmosphere. This can cause lower quality prospects to be drilled, which is often to the detriment of both the oil operator and the investor. Although the 1969 Tax Act favors the oil investment over other tax sheltered investment, there are certain threats from various areas which may thwart the drilling program activities sufficiently to cause reduced investment in these programs in the future. These potential deterrents, which are all interrelated, are such things as, oil operator abuses of the procedure, further governmental regulations, Investor disenchantment, and possible tax revisions in the future that might adversely affect the tax advantages of this type of investment. The pattern for this hard money raising period seems to be that those companies with a "good track record" and an experienced in-house sales force or significant ties with investment banking firms with oil expertise are raising 50-75% of the total amount they registered.
Computer utilization, commonly referred to as time-sharing, is a logical outgrowth of the fact that present day computers have such large capacities and speeds that they are difficult to keep up with. Why not a method whereby many usuers are feeding data and problems to a central processor unit at the same time, each paying only for the amount of time he actually uses the facility. The comparison to an electric power utility or a gas company is obvious. Certain economies of scale are of benefit to all and like electric power it is there to use only as one needs it.
Briefly, a complete time-sharing system consists of a user's terminal, a phone line to a local vendor and a multiplexing system to field many calls at once to a buffer and a central processor unit, quite often in a distant city.
When I was asked to undertake this assignment, my first reaction was to feel that it would be very presumptuous of me to address this particular group on this subject. After all, consultants have been using computers in their evaluations for years. Discounted cash flow calculations by a computer are routine inclusions with almost every consultant's report. Also flash, material balance and gas solution drive calculations are especially suitable for solutions by computers.
Briefly, I was originally exposed to computers in a college course on Statistics. Prior to this I had long felt that they could be used economically by my predecessor company in the property acquisition field. However, not having an inhouse computer, I prevailed on them to let us experiment with time-share. Since most time-sharing vendors will give you a 30 day cancellable contract, and since the monthly fixed charges are quite low (about $200), they condescended to humor me.
"The human proclivity for capturing an ever larger fraction of the total flux of the energy of the earth, and eventually for tapping the large supplies of stored energy, has had the effect of continuously upsetting the ecological equilibrium in the direction of an increase in the human population." ? M. King Hubbert in "Energy Resources," A Report to the National Academy of Sciences ? National Research Council.
The worldwide population and energy explosions are like the hen and the egg. However, today, the question "Which came first?" is academic. Experts tell us that by the year 2000 United States population will be up 40 percent (to about 280 million people), and our energy needs will be up 40 percent per person (to about 315 million Btu).
Recently, the population and energy explosions have been joined by another ? worldwide pollution of our environment. A start has been made on pollution but much more must be done, as we shall see. Industry can, and will, supply the needed energy, but the problem is complex and will require careful planning. Periodic inventories of all energy available at current prices and operating conditions must be made.
In order to keep up with the fast-changing energy industry of the future we must learn to think in terms of the energy available from each fuel ? Btus instead of tons, cubic feet or barrels. Such terms as "reserves" must have the same meaning throughout the industry or costly miscalculations can result. Here are three examples of what is already happening.
First, the Atomic Energy Commission (AEC) has announced that by 1980 nuclear power plants will be generating about 25 percent of the nation's electric power ? yet the total U.S. reserves of uranium ore available at today's prices and technology are about one-fourth the requirements of the planned reactors.
Mr. President, ladies and gentlemen it is a privilege to have the honor of addressing you this afternoon.
It is always a pleasure to be in this great state and this most fascinating of all American cities. This is the only convention city in the country where they give you a chance to make expenses.
We recently detonated a nuclear device underground with the aid and cooperation of the Atomic Energy Commission as part of its Plowshare Program and I am happy to say that, as in all of more than 200 such shots to date, this one has been conducted without evidence of any hazard or possible harm to any living being.
Dr. Edward Teller has called Project Rulison the first thoroughly practical use of nuclear energy for peace. This sets this apart from all other underground nuclear detonations, but it does not mean that we could have accomplished such a use of nuclear energy without Project Gasbuggy and all of the preceding underground nuclear tests.
Our purpose, as was that of El Paso Natural Gas at Gasbuggy, was to attempt to stimulate the almost impermeable rocks of the Mesaverde formation containing vast stores of natural gas and totally resistant to now known conventional well stimulation techniques.
I believe it is unnecessary for me to explain how rapidly the demand for natural gas is mounting, and how desperately the gas industry and the government are facing the problem of meeting both present and future requirements for this perfect fuel. Gas is recognized as the cheapest, safest, cleanest, and most convenient energy in the history of human endeavor.
Despite the barriers thrown in the path of explorers by puzzling and emotional changes and interpretations of the law and incomprehensible decisions of the federal judiciary, including the Supreme Court, the search for gas in this country has never been greater. Nothing could inspire such a herculean effort to find new gas, except the knowledge that we are running out of supply.
The purpose of this discussion is to set forth some broad, general guidelines concerning the preparation of petroleum engineering appraisal reports. First, let me state that I feel that no engineering society or group of engineering societies should dictate the style or format of an engineering report to either the engineer preparing the report or the client for whom the report is prepared. The engineering report may consist of anything from a verbal report on the telephone or a xerox copy of work notes to a formal report bound in red leather with gold engraving. The report should adequately cover the scope of engineering work and be in a form which is in accordance with the function of the engineering report. The form of this report should be based on an agreement between the client and the engineer concerning what the client requires for his purpose, the availability and cost of data and data preparation, the amount of information available and pertinent to the study, and the amount of money that the client is willing to pay for engineering work. If, in the preliminary discussions concerning the scope of work and the nature of the engineering assignment and subsequent report, the engineer feels that he cannot do an adequate appraisal with the information available or for the amount of money the client is willing to pay for the work, or for any other reason he feels that his professional conduct would be compromised in this assignment, he should turn the work down and make such recommendations as he feels advisable to the prospective client. It is obvious in the case of a number of extremely small interests of low value that extreme detail work is not justified either from an engineering standpoint or an economic standpoint.
It is a pleasure to talk to you today about an increasingly important part of the oil and gas industry-the funded companies. It is my thesis that this approach to financing industry activities will grow to major significance and that its eventual size and importance may well depend on the ability of you petroleum evaluation engineers to create new concepts for evaluation of properties at all stages of their development.
Mr. Calhoun's paper surveyed both technical and ethical considerations in evaluation in the form of guidelines. Mr. Evans has given us all something to think about with his projections of the nearly overwhelming problems of meeting energy demands from available and known resources. His chart on estimated needs for all forms of energy forcefully displayed much of what I had intended to say on that subject. However, I do want to discuss what this huge growth in demand may mean in terms of the capital requirements of the oil industry and the problems associated with attracting this needed capital.
The Chase Manhattan Bank estimates that demand for oil and gas in the United States is growing at a rate of 500,000 barrels per day per year and in the Free World at a rate in excess of 3 million barrels per day per year, rates that cast grave doubts on the industry's ability to meet estimated demand by 1980.
The United States will require two-thirds more oil and 100 percent more natural gas in the 1965-1980 period than in the 15 years immediately preceding. They estimate that at least an additional $2.8 billion must be added each year for the next 10 years to the $4.4 billion average expenditure on domestic exploration and development for the decade ending in 1967.
My purpose here is to explain the position and viewpoint of the oil lenders and to tell you the broad basis on which Citibank makes oil and gas loans. My remarks will be directed principally towards the non-recourse, ABC type oil loan. When I refer to oil loans I am including gas, distillates, and plant products.
What makes those bank engineers so conservative? How many times have we all heard that query?
Let me quote from Shakespeare's Hamlet: "Neither a borrower nor a lender be; for loan oft loses both itself and friend".
The economy of our country would still be back in the colonial stage if this quotation had been adhered to by our ancestors.
Let me rephrase the quotation in what I believe should be the modern version: "Neither an UNSAFE borrower nor an UNSAFE lender be; for an unsafe loan oft loses both itself and friend".
Banks are service oriented organizations and when we try to meet a customer's loan request our problem is fairly simple in concept. We must design an oil loan that will permit the customer to accomplish his purpose, profitably, and we must make sure that the loan is a safe loan for the bank.
This can be a delicate position to be in. In acquisition financing if the loan size is too small the customer may not be able to make his purchase in a competitive situation. If the loan is too large the bank may lose money. If, to accommodate a customer, a bank makes a loan that is too large, this may make the customer happy initially but usually will make both the customer and the bank unhappy in the long run. Management of both the bank and the customer company always want to know how specific loans or purchases are performing compared to their forecast. If a loan (and purchase) gets very far behind the original forecast it becomes a matter of embarrassment to the banker and the customer. When this happens the customer is usually more comfortable doing his banking business where the atmosphere is less embarrassing. In other words, a bank cannot always win doing what the customer desires.