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STRATEGIES FOR SUCCESS
IN OIL & GAS EXPLORATION

By G. Warfield Hobbs
December, 1999

As oil prices stabilize above $20 per barrel, the independent petroleum industry is gearing up once again for serious exploration. Promoters are busy ringing the door bells of risk capital providers. Happily for the drillers, investors are beginning to respond positively, albeit cautiously, to new exploration proposals.

Each exploration boom spawns a host of new companies and re-invigoration of many of the "old timers". Some will succeed - a few spectacularly. Many, however, will crash and burn when the industry goes into its next commodity price down cycle. Given the painful experience of many institutional and private investors who lost billions of dollars when oil and gas prices plummeted in the mid-1980's, investors are wisely asking how they can choose a company that will be a long term "winner".

There are a number of standard quantitative measurements used to benchmark exploration success. The most widely used include: finding costs per BOE; annual reserve and production growth rates; annual reserve replacement ratio; and return on capital employed; to name a few. However, these parameters measure a company's past, and are no guarantee of future performance. Why does one company succeed and another fail in the exploration game? How can one make "success" happen? It is not simply a matter of unlimited budgets, large staffs, huge acreage positions, or luck.

This article summarizes what Ammonite Resources Company, a firm of international petroleum consultants, believes to be the fundamental organizational and philosophical criteria for long term success in petroleum exploration. We have also included an analysis of the characteristics that will lead to ultimate failure. The conclusions presented herein are based on: our analysis of companies which have been generally perceived by petroleum industry insiders to have been successful, as well as those companies which failed; the opinions and recommendations of a number of highly successful oil and gas finders; and our own broad experience as explorationists over the past 30 years during the boom and bust cycles of the 70's, 80's and 90's.

In 1994, Ammonite was retained by a large public E&P company to assist its management in developing a strategic plan for the re-organization of its under-performing exploration division. Our task was to quantitatively analyze how the company stacked up with its peer group, and to recommend how the exploration division could be changed philosophically and organizationally so that it could become a success. In order to develop recommendations for the second part of the engagement, we interviewed active and retired senior exploration management of a number of highly successful oil finding companies. These included Occidental Petroleum, Trend Exploration, Anadarko Petroleum, and Exxon. We also talked with proven individual "oil finders" like John Masters, co-founder of Canadian Hunter; the late Norman Foster, a successful independent in the Rockies after his service as vice-president of Trend Exploration; and Roy Huffington, whose company discovered huge gas reserves offshore Kalimantan, Indonesia. The qualities cited in our 1994 study are just as appropriate today, as they were in 1994, or a generation ago. Accordingly, many of the company examples cited in this article are drawn from our 1994 study.

E&P companies which have a consistent track record of exploration success share a common denominator. This is: a) outstanding people; b) a focused strategy leveraged by a competitive advantage; and c) an aggressive commitment to the exploration process. We use the modifier "consistent" because even fools are sometimes blessed by luck. When we talk about "success", we mean a long term track record of finding new petroleum deposits.

Everyone understands the terms "people", "strategy" and "competitive advantage", but before we delve further into the qualities which lead to exploration success, let's first define what is meant by the term "exploration process". For purposes of this analysis the "exploration process" is defined as "a dedicated, long term intellectual and capital commitment to the assumption of risk and reduction of uncertainty in looking for commercial hydrocarbons where they have previously not been found".

In the paragraphs which follow, we will examine the qualities and policies which a company must possess to be successful in the exploration business. We will also analyze those qualities which lead to failure. Representative companies of the "winner" and "loser" categories are cited to illustrate the points made in this study.

PEOPLE

The most important factor is "people". The success of a company's endeavors is the direct result of the quality and dedication of its employees, in petroleum as in any other business. Management and technical staff have very specific personalities and traits in the most successful E&P companies. The optimal qualities of management and staff are as follows.

Management

· Experienced explorationists with a minimum of 15-20 years broad experience in a number of different basins with diverse stratigraphic and structural play types.

· Proven and successful "oil finders" in own right.

· Proven management and leadership experience.

· Have a thorough understanding of risk management and economics.

· Not risk adverse; must understand that dry holes are an integral part of the exploration process.

· Think positively. Oil is not found by nay sayers!

· Able to prioritize and stay focused.

· Must have an open mind without a bias against particular regions or plays.

· Able to nurture creativity of exploration staff.

· Able to identify and hire successful oil finders.

· Able to delegate.

· Excellent communicators.

· Patient.

Geoscience Staff

· Must be the very best you can identify for their particular area of expertise.

· Only employ proven oil finders for key staff positions. 10 to 20 years experience in diverse structural and stratigraphic play types with the last five years in primary play area.

· Must be creative and have good visualization skills.

· All geoscience employees must be computer literate.

· Staff must appreciate the economics of their play concepts.

· Must be good communicators.

· Supplement staff with expert contractors and consultants on an "as needed basis"

(Note: A "play" is an exploration program in a specific geographic location, or for a particular geological formation, or type of petroleum trap.)

The ideal exploration staff need not be large. Demonstrated expertise and proven "oil finding" abilities are critical to success. Ten to twenty years of experience, with at least five years experience in the employee's particular play area is recommended. Staff should be cross-trained and up-to-date with the latest exploration technologies. Computer literacy is a must as computer work stations enable a competent geoscientist to quickly access, review and process huge amounts of data. Productivity is vastly increased and overhead is reduced as one person on a work station can duplicate in a day what it formerly took a large staff weeks or even months to accomplish. The initial exploration team should number five or six persons, each a proven "oil finder" with a minimum of 10 to 20 years broad based experience in different basins with different stratigraphy and structural styles. Staff expertise in stratigraphy, depositional environments, paleogeography, structure, paleogeomorphology, well log analysis, geophysics, and reservoir engineering is essential. Without experience one does not have a basis for identifying successful analogs to new play opportunities.

What type of people make the best explorationists? Good intelligence naturally helps. More important, however, is the ability to visualize; to be creative; to be an unconventional thinker - one who can recognize opportunities where others see nothing, by pulling together seemingly unrelated facts into a coherent and rational model; to not give up the quest until they have figured "it" out; to have tireless energy and anticipation; to be a dreamer. Getty Oil Company allegedly made a study in 1980 when they were looking to hire young explorationists, which concluded that geologists who make the best explorationists were "independent thinkers", who were "anti-establishment types", and those who "did not color between the lines". This is definitely not the type of person the major oil companies worked so hard to mold into the short hair, white shirt and dark tie, "yes sir" stereotype during the 1960's and 70's.

A team approach to exploration works best. Each regional team should include one to two geologists, a geophysicist, a well log analyst and/or reservoir engineer, a drilling engineer, and a land man. Each should be familiar with the technical expertise, responsibilities and limitations of the other. Team leaders must be good communicators so that they can sell play proposals to management and potential drilling partners. It is not good enough to have a good idea; staff must be able to "sell" the exploration concept to management and partners. Mature areas and extensive development activity require larger staffs to evaluate the massive amounts of data typical of such areas. Full-time employees should be supplemented by consultants when specialized skills and local expertise are required. There are many excellent geoscientists available as consultants due to the massive downsizing which has occurred within the petroleum industry.

Staff size naturally depends on the level of activity and areas of activity. There is no set formula for optimum staffing. Two ends of the spectrum for aggressive and active exploration companies are represented by highly successful Anadarko Petroleum, and the late Norman Foster, a Denver based independent and highly successful oil finder. In 1993, Anadarko Petroleum conducted an aggressive exploration program in the Gulf Coast onshore and offshore, Midcontinent, West Texas, and in Canada and Algeria, and other areas overseas. Capital expenditures in 1993 were $264.5 million, including $97 million for exploration and $78 million for development. Thirty-two exploration wells were drilled by Anadarko in 1993. Anadarko employed 76 geologists and geophysicists, 15 of whom work on development projects. The company employed about 80 production and reservoir engineers.

Independent geologist Norman Foster, together with a team of other independent explorationists, originated, leased and sold to an unnamed investor an $18.5 million exploration program consisting of 69 wildcat wells in six different basins. Each play area had multiple prospects with the potential for a minimum 100 MMBO in aggregate. The plays included: Cambro-Ordovician objectives in the Illinois basin at depths of around 4,000 feet; Morrow prospects in the Anadarko Basin at depths between 6,000 and 10,000 feet; Minnelusa prospects in the Powder River Basin at depths around 8,000 feet; Cambrian to Mississippian age objectives to 6,000 feet in Kansas; a Railroad Valley look-alike play in Nevada at 5,500 feet; and a frontier play in Utah at about 6,000 feet. Only 14% 0f the prospects were considered "high risk"; the balance ranged from low to moderate risk. Foster's exploration team consisted of 4 geologists, 1 geophysicist, 2 reservoir engineers, 1 drilling engineer, and 2 landmen with the support of various regional contract landmen. The program was put together in less than a year. All team members were very experienced and successful independents who were working together with a common purpose. They are acknowledged experts in their respective play areas.

International prospect generation and review of outside submittals does not require a large staff, as the data and level of activity is generally much less than in the United States, particularly if a company does not to operate its overseas licenses. Amerada Hess, for example, had significant non-operated exploration and producing interests with Amoco, Mobil and British Gas in the North Sea, with the Oasis Group in Libya, and in Abu Dhabi, where Hess also operated a small field, and participated in exploration programs in dozens of countries during the 1970's. Yet Hess's total international technical group which was headquartered in New York at the time, consisted of only 11 professionals, inclusive of a lawyer vice president, a geologist exploration manager, three staff geologists, two geophysicists, two operations engineers, one reservoir engineer, and an international contracts negotiator. Hess had a London team which consisted of a resident manager who was an engineer, one geologist and one geophysicist.

Global Exploration, LLC ("Globex"), a small private company based in Dallas, was formed in 1991 to specifically look for international exploration opportunities for its owners, a small group of very successful independents from West Texas and Michigan. During the company's first three years it participated in exploratory wells offshore Holland, in Papua New Guinea, offshore Western Australia, farmed into development of a discovery offshore West Africa, and reviewed probably close to a hundred submittals located worldwide. Globex was operator of a new exploration license in the Philippines. The West African project was in production, and an Australian well had made a significant discovery. This activity was conducted with a full-time staff of only a geologist president and geophysicist exploration manager, both with more than 20 years of solid international experience. Globex makes extensive use of outside consultants.

After a strategic decision is made to pursue a particular play, management should seek to identify the most experienced and successful experts in the play. When Occidental made the decision to enter Libya, they searched Europe for the geologists with the most experience in North Africa. Hire them away from the competition if necessary. Canadian Hunter developed a reputation for "raiding" other companies for the best and brightest. John Masters made no apologies for his "raids" and countered by saying that his competitors made no accommodation to Canadian Hunter by lowering their bids in Crown lease sales! Retain and encourage technical staff by paying them well and providing incentives for success such as cash bonuses and stock options.

Staff involvement in the engineering, geological and geophysical societies is important. Participation at professional society meetings, particularly presentation of technical papers, keeps staff current with the latest exploration plays and technologies, demonstrates to others that the company is progressive and technically competent, thereby suitable as a potential joint venture partner, and facilitates the networking process in identifying opportunities and expert consultants. Presentation of technical papers also sharpens communication skills. Continuing education through professional society short courses is also important to help keep staff on the leading edge of exploration techniques and technologies.

EXPLORATION STRATEGY

Once the exploration team is in place, the successful exploration company must have a modus operandi and strategy. This should include:

· Define strategic play areas: this is a function of greatest reserve potential at least finding cost; areas of maximum potential for new discoveries; availability of leases; best economics; risk diversification; markets; special knowledge which provides a competitive edge. Development, operating and marketing costs must be carefully considered in the play selection process.

· Focus on a limited number of plays; 5-6 is a good number.

· Develop priorities, and stay focused.

· Pursue a portfolio with diversified risk, ranging from low risk/moderate reward, to modest risk/moderately high reward, to high risk/high reward. Avoid the safe low risk/low return type play as it is merely an opportunity to trade dollars. A conservative budget allocation would be 50% lower risk, 35% moderate risk, and 15% higher risk plays.

· Look for new plays in, around and under established producing areas where there is an existing operating infrastructure.

· Get into a new play in the early stages. The largest reserves are generally found in the first phase of exploration in a new play.

· Lease new plays as quickly as possible before competition drives up costs.

· Only spend what you can afford - do not explore with high levels of debt!

· Develop a play orientation to a new area rather than a single prospect approach.

· Acquire as complete a data base as possible of non-exclusive and proprietary information

· Avoid areas where: there is only a single exploratory play; new information could kill your exploration concept; the play is sensitive to oil & gas prices; where costs could easily exceed estimates; leases are hard to obtain or are not available; and where there is no end in sight to political and economic instability.

· Pace exploration costs over time to avoid "discouragement", to learn more about area over time, and thereby be able to stay in play longer.

· Exit play when you no longer have a rational for being there.

· A rule of thumb is that the exploration budget should be in the range of 0.5 to 1.0 times the development budget for an established company. If the exploration budget of a mature company exceeds this guideline, then the exploration effort is not being successful in setting up development situations.

· Always perform a detailed post-mortum on dry holes.

· Leverage staff through use of expert consultants.

· Identify area and play experts; best prospect generators in play; employ or use them as consultants.

· Focus on new play areas where: existence of mature hydrocarbons is already demonstrated; there are multiple play possibilities; there is large reserve potential (>100 MMBO in aggregate); good seismic can be acquired; the market is readily accessible; where one or more staff members have direct knowledge of area.

· Keep current of competitor activity and new opportunities in play area; good scout data is essential!

· Pursue diverse plays with a range of risk and reward.

· Identify and develop majority of own new plays, but always look at outside submittals.

· Utilize a team approach to play area evaluation.

· Think positively!

· Establish an "Exploration and Production Committee" to coordinate the exploration and development/production activity. Geologists, geophysicists, engineers and landmen should understand and appreciate each others skills, responsibilities and limitations.

· Establish a regular procedure for peer review of play concepts and matured prospects; weekly technical staff meetings are one way to do this; include geologists, geophysicists, and reservoir engineers in the process.

· Keep on top of technological developments. Send staff to continuing education courses.

· Be disciplined. Do not cut and run after the first or second dry holes in a new play, or exit because oil and gas prices have declined. See the evaluation process through.

· Develop a competitive edge in a new play by utilizing a new technology.

· Stick to conventional reservoirs.

· Thoroughly assess risk by reducing or eliminating uncertainty in your evaluation of each play element. This does not mean one must eliminate risk, but merely better understand it.

· Be patient! It can easily take five to seven years of assessment before a successful new play begins to generate revenues.

· Do not try to save money by cutting back on geology and geophysical costs. These are the lifeblood of the exploration process.

· Establish reputation as an aggressive and technically competent "player" ready to take good outside originated submittals. This will act as a magnet for good opportunities.

· Look at outside prospects on regular basis to know what the competition is doing and thinking.

· If planning to go international, build a staff of highly experienced international explorationists who have lived and worked internationally most of their careers. The initial team should consist of a geologist, a geophysicist, staff or consultant engineer, and a contracts person, each with more than 20 years experience.

Examples of Successful Exploration Plays

There are many examples of successful companies and exploration efforts that resulted in major new discoveries. Several which typify what can result from the application of the success factors described above are as follow.

Gulf of Mexico Subsalt Play: Major new oil discoveries were made in 1993 in a radical new frontier in the Gulf of Mexico beneath the regional salt sheet. Phillips Petroleum, which has not been perceived lately as a leading edge type of company, pioneered the way, with partners Anadarko Petroleum and Amoco. A highly focused team effort of geologists, geophysicists and drilling engineers, using every bit of existing data, innovative geological concepts, state of the art seismic technologies, and "vision" were able to define a viable play concept in a frontier which industry had heretofore written off as "non-prospective" and technically inaccessible. The team was able to convince a supportive and open-minded management to take the bold step of testing their "revolutionary" theories with the drill bit. The Mahogany Field discovery proved the play concept by testing up to 7,256 BO and 9.9 MMCF per day.

Haynesville Sand Play in Alabama: Conventional wisdom has been that the Haynesville was not a viable reservoir objective in Alabama. This perception was due to poor sand development and the difficult migration path for hydrocarbons from Smackover source rocks through the Buckner Anhydrite into the Haynesville. In the course of drilling a Smackover prospect in 1987, Zinn Petroleum encountered hydrocarbons in the Frisco City Sand Member of the Haynesville, and by what one must call "serendipity", discovered the Frisco City Field. Detailed well log analysis, paleogeomorphic and paleoenvironmental studies, state-of-the-art conventional and 3-D seismic studies, pioneered by geologist Robert Schneeflock and others, defined the key play elements. A number of large Haynesville fields, the largest of which has about 20 million barrels recoverable reserves, have now been made in this heretofore unproductive trend.

Yegua Sand Play in Southeast Texas: The Eocene Yegua Formation in Southeast Texas, which has been considered a mature play, yielded a string of important new oil and gas discoveries in the early 1990's. Anadarko Petroleum drilled 16 Yegua wildcat prospects in 1993, and had 11 discoveries, for an exceptional success rate of 69%. The company attributed its success to the use of an inter-disciplinary team approach in studying the complex stratigraphy and structure of the Yegua, and utilization of state-of-the-art technologies such as amplitude versus offset (AVO) seismic. Anadarko strives to reduce prospect uncertainty by thoroughly defining every element of geological risk prior to testing a prospect with the drill bit. The success rate proves the value of this exploration strategy.

Elmworth Deep Basin Gas Play in Alberta: In the early 1970's Canadian Hunter defied conventional wisdom in discovering the Elmworth Gas Field in Alberta. One of the largest gasfields in Canada was found in a 5,000 square mile area which had been written off by the majors after 40 dry holes, and in a formation which everyone had previously "proven" to be wet. In his book "The Hunters", John Masters, the co-founder and former president of Canadian Hunter, described the company's exploration philosophy and how Elmworth Field, with a potential 440 TCF recoverable reserves, was discovered. Masters is a strong proponent of the team approach with the best and brightest supplemented by expert consultants. Detailed log analysis, innovative computer mapping of regional log characteristics, regional paleogeological studies, guts, an aggressive leasing campaign, persistence, good salesmanship, and committed funding led to the Elmworth discovery.

Nevada Play: Trend Exploration and Filon Exploration specialized in frontier plays. In the 1970's they looked at Nevada to see if there could be any follow-up to the Shell discovery of the small Eagle Springs oil field in the 1950's. This isolated discovery demonstrated the presence of commercial hydrocarbons in a vast relatively unexplored basin. As a result of gathering and evaluating every possible bit of published and unpublished geological information, and making their own proprietary geological and geophysical studies, Trend and Filon's geologist Norman Foster determined that Shell had developed an incorrect model for the Eagle Springs Field. Armed with what they believed was the correct geological interpretation, they discovered the Trap Springs and Grant Canyon fields. Norm Foster attributed the success to making the strategic decision to enter a relatively unexplored basin with demonstrated hydrocarbon potential early in the exploration cycle, and having the experience and creative ability to recognize a new play concept when a prior model was flawed.

EXPLORATION STRATEGIES FOR FAILURE

The first part of this article describes the qualities which lead to exploration success, and includes examples of the results of applying the correct strategies. It would be worthwhile to now examine why some companies fail.

The bulk of the consulting work performed by Ammonite Resources during the period 1984-1990 was in the work-outs and litigation that involved virtually billions of dollars of "non-performing" oil and gas investments. We served as expert witnesses and behind the scenes advisors to large institutional investors, private investors, law firms, public utilities, the Internal Revenue Service Abusive Tax Shelter Task Force, and independent oil companies. This period was without doubt the greatest educational experience in learning "what can go wrong", and how to avoid the mistakes of the past.

The criteria for developing a corporate strategy that is guaranteed to result in a lack of consistent exploration success includes the following traits:

· Risk adverse........ "No dry holes" attitude.

· Limited exploration budget.

· Get into a play late in game.

· Exit play too soon, prior to complete evaluation of play concept and all available data.

· Entrenched bias against certain regions..... "Forget it. We've been there before".

· Inadequate risk spread among plays.

· Expect to generate prospects entirely in- house and operate everything.

· Prematurely reject new play concept on basis of early risked economic analysis.

· Repeat "old mistakes" by failing to identify and evaluate all available and relevant data concerning a new play.

· Apply old ideas in mature exploration provinces.

· Skimp on data acquisition costs.

· Poor market analysis.

· Discourage creativity through bureaucratic and/or cumbersome corporate policies.

· Pursue opportunities on a helter-skelter basis geographically with no basin or play limits.

· Reject a prospect because the lease burdens exceed an established guideline. The Indonesian production sharing contracts have only a 15% NRI on "profit" oil.

Some examples of companies which were or had every chance to be successful, but "failed" or "lost their touch" by following losing exploration strategies are described in the following paragraphs.

The Independents. Weeks Petroleum had immense income from a royalty interest in its original play in the Bass Straits of Australia. However, the company subsequently wasted its assets after initial success by not focusing in strategic play areas or balancing risk. Weeks pursued high risk frontier type plays all over world with only modest success. Controlling shareholders, principally the Weeks family, finally sold Weeks Petroleum assets to an Australian company, which then liquidated the worldwide exploration staff in the USA.

American Quasar Petroleum expended over $600+ million with funding primarily from public limited partnerships sold during the late 1970's and early 1980's. As far as we can determine, not one of the partnerships ever paid out on a cash basis. The company had poor risk diversification by focusing almost entirely on high risk/ potentially high reward prospects in the Rockies Overthrust. A major gas discovery was made in Canada in one of first drilling programs; however, it was not developed until after the company's demise, due to the discovery's remote location far from any pipeline connection to a gas market. American Quasar did not build adequate cash flow from lower risk developments. The company nearly went under in the 1980's, and was restructured as Wolverine Exploration Co. by Richard Rainwater.

Amerada Petroleum and The Superior Oil Company were two large independent companies that were among the most successful exploration orientated companies from the 1920's through the 1970's. Amerada was acquired by Hess Oil Company, a refined products marketing company; Mobil Oil took over the Superior Oil Company. The corporate culture and practices of Hess and Mobil at the time were antithetical to the creative process and aggressive exploratory drilling efforts which had made Amerada and Superior so successful. Many of the most talented explorationists of both Amerada and Superior resigned from their new employers shortly after the mergers.

Canadian Hunter was one of the most successful independent exploration companies in Canada, yet they blew $60 million on a failed exploration program in the United States in the early 1990's. How did this happen? The company assembled a team of distinguished retired Vice Presidents of Exploration from the major oil companies. There was plenty of leadership and experience, but it was all chiefs and no Indians. The company followed others into high risk plays without the creativity and thoroughness that was required. Canadian Hunter apparently failed to employ the strategies that had been so successful in Canada.

The Majors. Major oil companies go through phases of exploration success followed by periods of exploration "drought." Because of their size and diversification, the majors can weather a string of dry holes without financial ruin. In our analysis, if an enlightened management implements the elements for exploration success described earlier in this article, the major will get good results. Amoco's tremendous success in the 1970's in the Rockies Overthrust Belt and the Gulf Coast Deep Tuscaloosa Play are examples of management hiring and motivating the best and brightest explorationists, using technological innovation, taking risks, and being persistent.

The experience of Texaco, Inc's North Sea Division in London, England in the mid-1970's is a case study in how management discouraged exploration initiative. Texaco was a great company for entry level geologists in the 1970's. Rookie employees were sent to in-house and non-exclusive training programs, and given lots of hands-on experience in wellsite work, formation evaluation, and mapping. However, after the first five years, the rigid Texaco corporate culture of the period served to destroy the creativity process. Eager bright young explorationists soon became disillusioned when they found that management was unresponsive or downright negative about new ideas and procedures. It appeared that people advanced by maintaining the status quo. Senior managers sometimes rejected new ideas out of what seemed to be down right ignorance of new exploration concepts and technologies. The company was more concerned about reducing costs than finding oil. Bright young lads hired by Texaco - many of them PhD's, soon left for more fertile fields, where, with the proper support and motivation, they found their new employers significant oil and gas reserves. As a result of not nurturing new exploration concepts, Texaco's track record in the North Sea in the 1970's was rather mediocre compared with its major company competitors.

The Utilities. During the late 1970's and early 1980's, many large gas utility companies entered the upstream exploration game either as non-operating joint venture partners, or by forming their own exploration subsidiaries. For example, the Brooklyn Union Gas Company (now KeySpan Energy) formed Fuel Resources, Inc. (FRI) as its exploration subsidiary. FRI participated in about one dozen joint ventures with operators in the Appalachian Basin, Gulf Coast and Midcontinent regions during the 1980's. Like many utility owned exploration companies, FRI's results were not impressive, and the interests were eventually all sold.

Utility companies are by nature risk adverse and are driven by a regulated rate of return on their capital. Exploration risk is not in the corporate culture. The vice president of exploration of a large Appalachian based gas utility was told in all seriousness by his chairman when the exploration budget was approved, that there were to be no dry holes. Utility exploration efforts that failed generally had little in-house expertise, no strategic focus, no competitive technical edge, and were for the most part managed by persons with financial or regulatory backgrounds who had no or limited experience in the petroleum industry.

In the late 1980's and early 1990's many utility companies, faced with poorly performing oil and gas E&P subsidiaries, made the strategic decision to sell their exploration assets, or to spin them off as independent companies. To its great credit, Brooklyn Union Gas learned from its mistakes as a promoted non-operator, and established a strategic focus in the Gulf of Mexico by forming Brooklyn Union Exploration Company. An experienced management and technical team was hired; the company prospered; was spun off in an IPO; and now operates successfully as The Houston Exploration Company.

Transco Energy, a company which had expertise primarily in interstate gas transmission pipelines, made a strategic decision to enter the coalbed methane play in the Black Warrior Basin of Alabama. Transco formed Transco Coal Methane Company in 1989, and committed to a 500 well development program and the construction of a new 250 MMCF/D pipeline. The company invested over $300 million in the play; and the results were an unmitigated financial disaster for Transco. Wells were drilled in advance of the pipeline to qualify for the Section 29 Tax Credit, and on the expectation from limited early results, that each well was essentially a "cookie cutter" in a broad homogeneous regional development play. Unfortunately, everything that could have gone wrong, did. Transco's completion procedures were ineffective, gas production was below forecasts, de-watering took longer than anticipated, water production was higher than forecasted, and operating costs were significantly higher than budgeted. Further, the geology and quality of the coal reservoirs varied significantly across Transco's large leasehold. When the 250 MMCF/D pipeline was commissioned in 1990, a grand total of 11 MMCF/D flowed into the new line from 119 wells in the early stages of de-watering.

Where did Transco err? Answer - everywhere. They did not do their technical "homework" adequately and rushed headlong into the play. Transco eventually sold off all its conventional oil and gas reserves and its coalbed methane assets in 1992.

A more recent example of "betting the farm" on a single exploration play is typified by the experience of Chesapeake Energy in the Louisiana Chalk Play in the period 1994-1997. Chesapeake had significant success with drilling deep highly productive horizontal wells in the Giddings Field Austin Chalk Trend in Texas. Based on some early encouraging drilling results in the Deep Chalk Play in South Louisiana, Chesapeake assumed that the Louisiana Play was similar to the Austin Chalk in Texas, and that the potentially productive fairway extended hundreds of miles across the Gulf Coast into South Louisiana. The company acquired over 1 million acres in the play at an average cost of $125/acre, and initiated a very aggressive and very expensive deep horizontal drilling program on the assumption that it had a fantastic development opportunity with hundreds of wellsite locations. Some of the early Louisiana Chalk wells had spectacular flow rates of oil and gas - a few in excess of 3,000 BOPD and 15 MMCFGD, which fostered intense drilling activity. Unfortunately, the wells proved to decline rapidly and produce significant amounts of water. Chesapeake eventually abandoned the play as non-commercial, and was forced to take major financial write-offs that nearly broke the company in 1997.

Where did Chesapeake go wrong technically? Like Transco in the Black Warrior Basin, Chesapeake rushed headlong into the Louisiana Chalk Play on the erroneous assumption that the reservoir was similar to the Giddings Field in Texas. They were correct in getting into the play early, and acquiring a dominant leasehold position. However, they should have done more analysis of the well production characteristics before committing to such an aggressive drilling program. Further, Chesapeake should have had a more diversified exploration portfolio. The company has now established a broad portfolio of exploration and development assets.

The Fund Companies. The vast majority of the companies of the late 1970's and early 1980's that financed their exploration efforts through the sale of public limited partnerships were not long term "winners" for their investors. Several billions of dollars of Wall Street limited partnership drilling fund money flowed into the coffers of oil and gas companies during the oil boom of the 1979-1984 period. The companies ranged from small independents which were reasonably successful in their old limited areas of operations- i.e. Tom Brown in West Texas, and Callon Petroleum in Mississippi, to large "fund" companies which drilled throughout the United States, such as Apache, Dyco Petroleum, Damson Oil, Towner Petroleum, and Natural Resource Energy Management. Activity was driven by the seemingly unlimited amounts of money pouring in from individual investors. Exploration staffs were huge. Companies maintained division offices in nearly every basin. Tens of thousands of wells were drilled. However, in the final analysis, none of the "fund" companies were truly successful at finding economic reserves on a consistent basis. The former securities firm of E.F. Hutton & Company, for example, raised $1.2 billion in 135 public and private limited partnerships between 1976 and 1984 for twenty of so operating companies. As of the mid-1980's, none of the programs had paid out, or was likely ever to pay out on a pre-tax basis.

Why were the track records so poor? The answer is simple. Technical staffs were for the most part young and inexperienced; exploration focus or development of a competitive edge was rare; prospects originated in-house or bought off the street were all too often drilled without a thorough analysis of all the risk elements, nor benefit of all available data. When established companies like Tom Brown and Callon Petroleum expanded rapidly beyond their areas of expertise and began to drill significantly more wells than they had previously, they faltered badly. Many of the fund company prospects had reserves which were too limited to be economic in an environment of flat or declining oil and gas prices.

The lesson to be learned from the drilling fund companies is that success is not just a function of money, size of the staff, and holes drilled in the ground. The quality of the people, a strategic focus, and the thoroughness of the creative and evaluation processes are critical to success. Callon Petroleum has been a survivor, and is now prospering, principally by developing a strategic focus in the Gulf of Mexico.

BUILDING ON SUCCESS

A factor which many successful companies, both large and small, have in common, is a major discovery early in the company's life. The early success was generally the result of a focused exploration effort and "special knowledge". Luck sometimes happens, but one must make "luck" happen by being in the game. Occidental Petroleum started life as a drilling fund promoter, but was rapidly propelled into the "major leagues" by the Grimes Gas Field discovery in the Sacramento Valley, and then hit a "home run" in Libya. Texaco got an early start with the giant Sour Lake field in Texas. Gulf Oil got its start with the Spindletop Field discovery. Marathon Oil was anchored for many years primarily by its Yates Field discovery in West Texas. The predecessor company to Union Texas Petroleum found the giant Port Arthur Field. Legendary Texas oilman John Mecom was bank rolled by his Port Washington Field discovery in South Louisiana. Forest Oil's roots are in the Bradford oil field discovery in Pennsylvania and New York. Denver independent Samuel Gary made his fortune with the giant Bell Creek Field in Wyoming. The Cullen Interests were launched by the discovery of the Tom O'Connor Field. The East Texas Field was the foundation for the various Hunt family companies. The Belfer family participated in the giant Big Piney Gas Field in Wyoming, and used that as a springboard for forming Belco Petroleum, which was eventually acquired by Enron. Canadian Hunter's discovery of the super giant Elmworth Gas Field in Canada established the company as one of the most successful independents in Canada. Internationally, one can cite Roy Huffington for his early success in Indonesia, Triton Energy for its discovery in the Paris Basin in France; Ray Hunt in Yemen; and Trend Petroleum for its Sulawati Basin reef discoveries in Indonesia. Weeks Petroleum promoted the Bass Straits play in Australia to Broken Hill Pty. and Exxon, and received a royalty interest worth several hundred million dollars for its efforts.

A major discovery for a young company will naturally generate a very positive and upbeat attitude for both management and staff. Early success gives these companies an aggressive exploration mindset, whereby cash flow from early major discoveries can be reinvested in subsequent exploration without management dry hole "fear". Caution is required to assure adequate risk diversification to avoid wasting assets in the expectation that one can consistently find "company making" discoveries. Prudent application of the exploration principles set forth in the preceding report sections should provide the basis for preserving and building company assets.

CONCLUSIONS

Exploration success is not an accident. There are very definite organizational and management strategies than can assure consistently superior performance. Success is predictable if risk is properly managed. Likewise, there are philosophical mindsets that will assure long term failure of the exploration process.

Whether building a new enterprise from scratch, or participating with an established exploration and production company, a capital provider must perform in-depth due diligence to determine whether the investment candidate is truly a long-term winner. Review of the annual quantitative benchmarks of a company's performance over the prior few years, and evaluation of a curent portfolio of 3-D seismic defined prospects, is not sufficient to predict future long-term results of the investment candidate. One must evaluate the quality of the technical staff and management, their exploration strategies and tools, and the thoroughness of their approach to, and execution of, the exploration process. If the E&P company possesses the positive characteristics that are described in this article, then an investor can look forward to a profitable experience in their exposure to oil and gas exploration.

About the Author:
G. Warfield "Skip" Hobbs is a petroleum geologist with 30 years international and domestic experience. He founded Ammonite Resources in 1982, and is Managing Partner of the consultancy, which is headquartered in New Canaan, Connecticut. Hobbs served as the 1993-1995 Secretary of the 32,000 member American Association of Petroleum Geologists, and is the current President-Elect of the AAPG Division of Professional Affairs.