Arco’s Retrenchment Reflects Problems Inside and Out

Arco’s silver-haired, Texas-born top oilman stood before Wall Street analysts only five months ago and told them he was having a good time running the nation’s seventh-largest oil company.

It’s “fun,” drawled Mike R. Bowlin, chairman and chief executive of Los Angeles-based Atlantic Richfield Co., “to be the CEO of a company that replaced 164% of its reserves last year, near the top of our industry; a company that had a 3.5% production increase, again high among our peer group; and a company that completed its fourth year of increase in earnings.”

Now Arco is enduring its second major restructuring of the 1990s and Bowlin clearly is enjoying his job less.

On Thursday, Arco announced its intent to slash $500 million in costs over two years by firing 900 employees, closing 20 foreign offices and concentrating on domestic operations. Still to come are plans for trimming capital spending, reducing charitable contributions, selling some “nonstrategic” assets and perhaps even moving out of the landmark Arco Plaza, the company’s home since it relocated to Los Angeles in 1972.

“This last month has been very tough,” Bowlin said in an interview after the announcement. “But the world changed on us, and you have to respond to the economic challenges.”

How did Arco, which employs 20,000 people worldwide, fall into this dry hole?

Arco certainly is a victim of the rock-bottom crude prices that have afflicted the oil patch this year. But many of Arco’s problems stem from its own miscalculations, some of which have become apparent only in the last few months, industry watchers say.

Arco bet heavily on a high-cost international exploration program to replace dwindling Alaskan production, with mixed results. It jumped early into Russia, investing about $340 million that soon may be written down thanks to that country’s economic problems.

Even as far back as the mid-1980s, after Arco’s storied wildcatting chief executive, Robert O. Anderson, retired, Arco may have lost some of its aggressive edge, neglecting investments in the basic business.

And the Arco crew now admits to underestimating the severity of Asia’s economic ills and the associated lingering malady of cheap oil.

But Arco’s chief sin may be its middling size.

The proposed $61-billion merger of British Petroleum Co. and Amoco Corp. unveiled in August gave clear form to a once-vague idea that oil companies can’t be merely big anymore--they must be huge--to compete effectively for new projects around the world. With bigger oil companies on the prowl, Arco’s diamond-shaped logo might as well be a target on its back.

“Arco is one of those companies that is very vulnerable,” said Rothschild Inc. oil analyst Sal Ilacqua, echoing the view of many on Wall Street. Mobil Corp. is frequently mentioned as a potential suitor, and foreign oil companies could also be interested in such an acquisition, analysts say.

No Choice but to Attack Costs

To compete effectively in a time of low oil prices and to remain an independent company, Bowlin said, Arco had no choice but to attack its costs and concentrate on core oil and gas businesses. Arco will focus chiefly on Alaska, the Western United States and the Gulf of Mexico while remaining in the Britain’s North Sea, China, Venezuela and Algeria.

“This is not a change in direction,” Bowlin insisted. “We are not going back to being a domestic oil company. We are going to grow our international exploration and production operations.”

At the same time, “we have to live within our means,” he said.

Much has changed in the oil patch since Arco’s cheery analysts meeting. Oil prices have remained stubbornly low. On the New York Mercantile Exchange, where futures contracts for crude are traded, the benchmark “sweet light” crude has been bumping between $13 and $16 a barrel for months, about 30% less than at this time last year.

Prices are low because the world is awash in too much oil thanks to overproduction by the Organization of Petroleum Exporting Countries and underconsumption by ailing economies around the world.

Arco’s earnings, which were down 57% in the first six months of the year, are extremely sensitive to movements in oil prices because the company does little else. For every $1 change in the price of crude, Arco’s per-share earnings move 45 cents, compared with an average of 23 cents among other large integrated oil companies, according to investment firm CIBC Oppenheimer & Co.

As a result, Arco frequently is first in the industry to announce layoffs and cost reductions. Shell Oil Co. just announced plans to lay off more than 700 workers, and Occidental Petroleum Corp. recently said it would eliminate 260 of the 395 jobs at its Bakersfield oil and gas drilling operation.

But Arco is plagued by more than just a commodity price headache.

“Arco is suffering from the oil industry blues,” said Fadel Gheit, senior energy analyst at Fahnestock & Co. in New York. “Unfortunately, there have been some missteps on the way that made things even worse.”

The international quest for oil and natural gas has yielded mixed results at a high cost, analysts said. Arco’s international revenue remained essentially flat at about $3.4 billion from 1995 to 1997, while U.S. revenue grew to $15.2 billion from $12.5 billion.

Frank Knuettel, PaineWebber’s oil analyst, said Arco was doing too many things in too many places--29 countries in all.

Arco’s foreign exploration and development programs have been a disappointment in South America and a disaster in Russia.

The ambitious Latin America strategy that Arco hoped would turn into 160,000 barrels of crude daily by 2005 is now more modest. A $3-billion project in partnership with Venezuela’s state oil company, Petroleos de Venezuela, or PDVSA, to refine so-called heavy oil is on hold indefinitely because the Venezuelans are unable to meet their end of the financial terms.

Analysts expect the company to write down the value of its $340-million investment in Lukoil of Russia this year because of Russia’s depressed economy and stock market, incurring a significant charge, said John Hervey, an oil analyst at Donaldson, Lufkin & Jenrette in London.

“At first their Russian investment appreciated three times, but now it’s underwater,” Hervey said.

“They’ll have to write off a big chunk of their Russian investment. It will be a long time before they get their money out of there,” said David Pursell, vice president of research at Simmons & Co., a Houston-based investment bank.

Bowlin defended his company’s foreign forays.

“We have had success internationally,” he said, adding that Arco was first to enter China and is a major oil and gas producer in Indonesia.

But international costs are high because Arco was trying to expand the business quickly, Bowlin said. Arco must compete in an industry that overall has reduced finding and development costs by 60% in the last decade.

“What we’re doing is responding to an external environment in which we must absolutely reduce costs,” Bowlin said.

To do that, Arco must exit some countries and is closing 20 foreign offices as well as shrinking others, he said. Bowlin declined to name the countries because “we must contact those host governments first,” and because in some cases Arco has assets to sell.

Despite the depth of the cuts to the international operations--$330 million of the projected $500 million in cost savings will come from exploration and production, primarily outside the United States--Arco is not becoming a domestic oil company, Bowlin said. Its costs are lower--in the bottom 25% of oil companies--in its domestic exploration and production as well as gasoline refining and marketing, he said.

“Now is the time to focus on a few of those markets where we can achieve a leadership position,” Bowlin said. “We will be a niche player.”

One thing Bowlin inherited when he took Arco’s helm in 1995 was a legacy, starting in the mid-’80s after the departure of Anderson, of less aggressive investment in the core business.

Management instead preferred to mine its cash generated by operations for other investments, including a generous philanthropic program under statesmanlike Chief Executive Lodwrick Cook.

For all but two of the last 13 years, cash flow per share, which represents how much money the day-to-day business is generating, far exceeded capital spending per share, which indicates how much money is being reinvested in the business for future growth.

That left Arco with a somewhat stodgy image in some quarters of the exploration world, a reversal of the entrepreneurial culture under Anderson.

“I’m not going to try to dodge that [question], but I wasn’t chairman or CEO so I don’t know all the things that went on, but I know the results,” Bowlin said. “We were looking for another way to step up earnings through financial engineering, and we just weren’t putting money in the base oil and gas business sufficient for us to grow.”

Cook did not return telephone calls seeking comment.

Thursday’s restructuring announcement was presaged by the departure of several top executives, three of whom had been promoted with much fanfare only months before.

William E. Wade Jr. was named president in January and said he regarded the new job as “a near-perfect way for me to spend the remaining years of my Arco career.”

The 56-year-old executive retired suddenly Oct. 1 along with Executive Vice President Anthony Fernandes, 53. Executive Vice President Michael E. Wiley, 48, was named president and chief operating officer.

A week later, Senior Vice Presidents John Cheatham and Stephen Mut, who were promoted last spring and transferred with their families to run foreign operations out of London and Caracas, Venezuela, respectively, left the company.

“I regret the hell out of that,” said Bowlin, who is 55 and has no plans to retire. He described those who left as good friends, and all had long careers at Arco.

Arco also said it will get rid of its two corporate jets and the 20-person division that maintains them.

The company’s retrenchment will hit Los Angeles hard.

Arco has been a dominant downtown presence since 1972, when Arco Plaza’s twin towers opened on a block that was once the site of the Richfield Building, a 12-story Art Deco gem. Richfield Oil Corp. merged with Atlantic Refining in 1966 to become Atlantic Richfield. The company was based in New York until 1972.

The company has been a prominent corporate citizen, donating to a host of local charities and causes through its Arco Foundation.

Now, not only is Arco laying off 370 employees downtown--including about half its headquarters staff--but it is also seriously considering vacating Arco Tower, where it occupies 11 of 51 floors.

Bowlin said consolidating employees into a single building, possibly the Arco Center products division headquarters at 333 S. Hope St., is a “definite possibility.” Executives will certainly leave their plush offices on the two top floors of Arco Tower, Bowlin said.

In addition, charitable contributions will probably be reduced, he said. The Arco Foundation spent nearly $14 million in each of the last two years, much of it matching employee gifts to nonprofit organizations. Between $5 million and $6 million of that was spent in Los Angeles County.

Bowlin said the company remains mindful of its corporate responsibility to the community, where it sells more gasoline than any other retailer.

‘Nonstrategic’ Assets Will Trim

Arco is the undisputed leader in California gasoline retailing, with a 20% market share. It consolidated its position in 1996 with the acquisition of the Thrifty discount gas chain, one of Arco’s last Southern California competitors.

“We haven’t changed the values that have existed through several CEOs. We’re still a good corporate citizen,” Bowlin said.

Arco’s now more aggressive capital spending program will probably be trimmed, Bowlin said. Details will be available in the next several weeks, he said.

Some “nonstrategic” assets will be sold, he said. Coal operations in Australia, a petrochemical plant in Louisiana and aluminum operations in Kentucky are on the list. So far this year, Arco has sold its U.S. coal operations and its interest in Arco Chemical Co. Last year, it sold its half-ownership of Lyondell Petrochemical Co.

The Arco that remains will focus on its best businesses, Bowlin said.

“We are going to improve our profitability while maintaining our ability to grow,” he said. “We have an ample portfolio of growth projects.”

“Right or wrong, we’re in the oil business,” Bowlin said. “We’re not in the chemical business; we’re not in the aluminum business. And we’re going to concentrate our capital and our resources on this business.”