Should Congress Stem the Rising Tide...

America’s domestic petroleum industry has, in recent years, become a battleground for speculative stock raids, hostile takeovers and forced breakups. Since the Federal Trade Commission, the Internal Revenue Service and the Justice Department have thus far taken essentially a hands-off attitude about these events, I am hopeful that Congress will step forward and address this serious national issue.

The full extent of the recent industry turmoil can be illustrated by noting that in 1980 there were 15 major integrated companies, almost all with conservative debt burdens, competing with each other in exploration, production, refining and marketing. But in less than five years, five of these companies have disappeared as independent entities, three others have taken on large debts and another one (Phillips) has been seriously disabled with a burden of debt of record proportions. And now Unocal has been put “in play” (as they say on Wall Street), with the possibility of a takeover or liquidation staring us in the face.

While some economists may support such moves in the name of “capital efficiency,” I believe they are misunderstanding what is actually going on in our industry. In particular, I believe they fail to understand the possible adverse impacts on the nation.

Concentrated Industry

The disappearance of so many major competitors will lead to a concentrated industry dominated by a few giants--and to one that, as in the early 1970s, is dependent upon the whims of foreign oil producers. Other industries that have followed this pattern (autos and steel, for example) have tended to become bureaucratic, inefficient and short on innovative drive--and they have found themselves at the mercy of foreign competitors.

This last point is especially important. If the oil industry is going to successfully explore America’s frontier regions--particularly in Alaska and in deep offshore waters--and also develop needed alternative energy sources, such as oil shale, it will need all the centers of creativity and entrepreneurship it can muster. In short, it will need as many strong competitors as the nation can possibly support.

Even when it is unsuccessful, the threatened takeover of a large company forces management to focus on short-term results and defensive tactics. Exploration, research and development, long-term planning and even its rational decision-making are victims of the raid.

Substantial increases in debt, incurred either to finance an acquisition (Chevron) or to defend against one (Phillips), are not healthy in an industry that has high fixed costs and is vulnerable to price swings due to forces beyond its control. Companies burdened with excessive debt service lack the cash for aggressive exploration and innovation. Companies without borrowing capacity may be unable to make needed expenditures for expansion. Companies with excessive debt are liable to failure and prone to avoid risks.

Taxpayers’ Money

The nation’s banking, savings and loan, and securities firms are greatly overextending themselves by financing highly leveraged multibillion-dollar oil company takeovers. And it’s not really their money. It’s entrusted to them by depositors, by taxpayers, by the American people.

Clearly, our banks, S&Ls; and securities firms should be concentrating on loans that create jobs and add to the nation’s real output, not on loans that benefit only speculators, takeover artists and their lawyers.

A further major drop in world oil prices, coupled with an increase in high interest rates--not unlikely events--could throw many of these high-interrest, low-security “junk” loans into default or “workout” status. That could push many large banks and S&Ls; to the brink of failure, forcing a new round of federal bail-outs.

Henry Kaufman of Salomon Brothers has pointed out that such deals removed between $80 billion and $90 billion of equity securities from the U.S. marketplace in 1984 alone--more than 4% of the total value of all U.S. stocks outstanding.

Why is this especially happening to large oil companies?

It is not because this entire group of U.S. integrated oil companies suddenly need to be “restructured,” as claimed by T. Boone Pickens in his testimony before another House committee on Feb. 27.

Damaging to Economy

If we carry that line of reasoning to its extreme, we end up with every one of the companies either being merged, liquidated, or “decapitalized” (that is, forced into a massive conversion of equity to debt, a la Phillips). This is obviously not only an impossible result with impossible demands on the credit system, but a result that, even if partly achieved, would be severely damaging to the national economy and our nation’s energy security. It removes our capability to respond if--or when--the next crisis occurs.

I believe this wave of mergers and takeovers is happening for several reasons:

- The tax system, which permits the deduction of interest on borrowed money used for successful, unsuccessful or even threatened raiding, favors debt over equity, and it favors the so-called “investor” over the businessman--the raider over the defender.

- Enormous amounts of money have become available for speculative short-term deals as a result of the move to “deregulate” financial institutions; and some of those institutions are acting foolishly, considering their responsibilities. They are buying high-risk debt with other people’s money and hoping it will all work out.

- With the emergence of “junk” financing, bidders can borrow 100% of the cost of an acquisition in advance--with little or no security--on the promise that they will bust up the target to repay the loan. This is what enables raiders to threaten targets many times their size.

- A group of professional raiders is emerging, and their interest is not in the overall health of the economy or in helping true shareholders, but only in making “quick-turn” profits for themselves.

- In the case of the oil industry, Pickens has somehow created a speculative frenzy--his modern version of a South Sea bubble--that has convinced many on Wall Street that there’s easy money to be made in attacking oil companies, and the hell with tomorrow. But this bubble--like all bubbles--will eventually collapse, leaving wreckage of ruined companies, lost jobs, reduced U.S. oil production, failed banks and S&Ls; and government bail-outs.

What is Congress’ appropriate response to this “raiding-restructuring” mania?

The most urgent need is for a quick moratorium on hostile takeovers--a sort of “cooling off” period during which the nation has a chance to pause and think about what’s going on, the speculators have a chance to realize that this speculative chain letter can’t go on forever, and Congress has a chance to make some needed changes in the tax code and possibly elsewhere.

End Tax Subsidies

The tax code should be revised to end the tax subsidies that encourage hostile takeovers. Increasingly, businessmen are realizing the need for such a step.

In addition to disallowing the interest deductions, there should be special punitive taxes imposed on “greenmail” payments, the odious but often irresistible form of legal blackmail.

There is also a legislative need to correct the general rules of the takeover game--so that we would have a “level playing field.”

In addition, I believe Congress has an appropriate oversight role in raising the merger-takeover and related issues with the proper federal agencies, especially those that have regulatory responsibility for our financial system.

Sen. William Proxmire (D-Wis.), when introducing the Corporate Productivity Act of 1985, referred to the possibility that “ . . . the bank regulatory agencies (would) jawbone and discourage banks and other financial depository institutions from making loans to finance unfriendly takeover bids. Such an approach would discourage the purchase of junk bonds by savings and loan associations and also the financing of unfriendly takeovers by banks who have been involved in the past after having curtailed some of their lending activity to the lesser developed countries.”

The Idea Is Wrong

Unocal feels quite strongly that the Pickens’ approach to “restructuring” America’s oil companies must be stopped for the simple reason that the idea is wrong, or at least being seriously misrepresented. The beneficiaries of Pickens’ actions are not America’s energy consumers, America’s security, or even the small shareholders, but rather only a handful of shareholders, and, of course, Pickens himself.

Unocal does not fit the mold of the companies that Pickens claims need “restructuring.” Our long-term shareholders know that they have been well served by Unocal’s approach to management and growth. For example, consider the following:

If, at the beginning of 1960, a shareholder had invested, say, $10,000 in Unocal stock, that stock would, at the beginning of 1985, be worth about $127,000. This stock appreciation, plus the dividends, would have yielded an annual rate of return of 15% on the initial investment. This is one of the highest returns that could have been realized by investing in any major oil company that survived this 25-year period.

By contrast, a $10,000 investment in a stock that represents an average of the remaining four U.S. international oil companies--Exxon, Chevron, Mobil and Texaco--would, over the same time period, be worth about $37,000. This stock appreciation, plus dividends, would have yielded an annual rate of return of 10.8%.

Place of Opportunity

Unocal does not view America’s oil industry as a “sunset” industry, as does Pickens, but rather as a place of opportunity--both for finding new sources of oil and gas and for developing alternative energy sources. Independent studies of our oil-finding record shows us to be among the industry’s best.

Further, our leadership in geothermal energy and oil shale development shows us to be among the industry’s most farsighted. In addition, our leadership in maintaining an efficient refining system and in developing new refining processes for producing high quality products from low-quality crude oils means that, come the next energy crisis, Unocal expects to be at the front line in providing Americans with urgently needed petroleum products.