It May Be Time for Texaco to Cry Uncle

The long and bitter legal battle between Texaco and Pennzoil is almost over, and whichever side you were on--either as shareholder or simply as a user of the oil industry’s products--the most interesting questions you can ask are what the fight was all about and whether anyone other than the lawyers can make a buck on it

The immediate story is that Texaco’s lawyers will appeal to the U.S. Supreme Court, following the Texas Supreme Court’s decision Monday not to review a lower court’s award of more than $10 billion to Pennzoil--a judgment that drove Texaco earlier this year to seek protection from creditors under the bankruptcy laws.

But a settlement may be in the offing, because the appeal to the federal court is likely to be not only lengthy but inconclusive. That is, even if the U.S. Supreme Court decides in Texaco’s favor--next June at the earliest, and possibly not till next fall--the probable remedy, say lawyers involved, would be to send the case back for a new trial in the same Texas courts where the company has found no relief to date and which its executives have denounced as lacking in integrity.

Texaco shareholders might prefer to settle. “We naturally support the company in its resistance,” says Dennis O’Dea of the Chicago law firm Keck, Mahin and Cate, which represents the shareholders’ committee in Texaco’s bankruptcy proceedings. “But as a second line of effort, we would like to participate in the bankruptcy proceedings on ways to work toward a negotiated settlement.” Shareholders have missed two dividend payments--with no promise that they will be paid later--since Texaco filed bankruptcy in April. The missed dividends are worth $365 million.

Fight Over Oil Reserves

So what was the fight all about? Ultimately, it was about the pressure on oil companies in the new age, when opportunities to discover sizable deposits of oil and gas are practically disappearing. The truth is, the industry that only a decade ago was thought to be the richest on earth, has become almost an uneconomical proposition. Drilling for oil today costs a company about $7 a barrel, according to John S. Herold Inc., the Greenwich, Conn., oil research firm. But with oil fetching less than $20 a barrel, that means little if any profit when production and distribution costs are taken into account.

And that means that the surest way for an oil company to survive is by acquiring another company’s reserves. That was why Shell acquired California’s Belridge Oil in 1980, why Chevron acquired Gulf Oil and why Pennzoil made a deal in 1984--when oil was $27 a barrel--to buy 1 billion barrels of Getty Oil’s reserves for about $3.60 a barrel.

But the deal was upset when Texaco bought the whole Getty company for $10.2 billion--and got all of its reserves at an average price of less than $3.50 a barrel. Pennzoil sued and won the $10-billion award for contract interference, and Texaco has appealed the award for the last two years.

So what would the end of the fight mean? It all depends on the settlement. It could make Pennzoil, which has less than $2 billion in annual revenue, a highly prosperous firm. Yet Texaco, which has almost $32 billion in revenue, could put a moderate settlement behind it and remain a giant of the industry.

In terms of stock value, analysts such as Frederick P. Leuffer of the Cyrus J. Lawrence brokerage firm calculate that each $1 billion Pennzoil receives would be worth $20 a share to its price, and each $1 billion Texaco pays out would deduct $4 a share from its price. On Tuesday, after the Texas Supreme Court decision, the price of Pennzoil--which like all other stocks had fallen in the recent crash--rose more than $10 a share to more than $65. The price of Texaco fell about $3 a share to $31.

But those prices reflect the market’s weariness with the whole argument rather than any estimate of a settlement. For at $65 a share--the company’s estimated breakup value--the market is giving Pennzoil no premium for any payment it might get from Texaco. But at $31 a share, it is penalizing Texaco as if it stood to pay the whole $10 billion to Pennzoil. Analyst Leuffer and others see a market opportunity in such a discrepancy.

But caution: It is an opportunity only if a settlement comes about in the reasonable future. Before Monday’s decision, the latest settlement reports were that Pennzoil had demanded $4 billion from Texaco, and that Texaco long ago had offered $2 billion to Pennzoil.

With lawyers’ bills now approaching $100 million, and missed dividends nearing $500 million, a settlement begins to look cheap.