BROWNE BURNS THE MIDNIGHT OIL.

BP Amoco's Sir John Browne is working overtime to get you to think differently about oil companies--particularly his own.

Most analysts seem to agree that, no matter what your expertise, trying to predict the erratic price of oil is pretty slippery business. And despite being the leader of one of the most powerful oil companies in the world, Sir John Browne, CEO of BP Amoco Plc, readily admits that even he doesn't know just where the price of oil is headed.

Certainly, the oil market has been a complicated animal in recent years. After enjoying two decades of relatively stable oil market, the world watched prices fluctuate in the last two years from as low as $10 to almost $36 last autumn. The oil and gas industry is supposed to be a relic of the so-called old economy, yet the global energy business is a $1.8 trillion-a-year industry that dwarfs information technology, defense, and the auto industry. A nostrum of the new economy is that new technology allows us to use less energy. In fact the reverse is true. Some observers estimate that much of the surge in electricity demand in regions such as California comes from the reliance on abundant servers required to keep the Internet humming. Higher power demand and recent volatility of oil prices have rekindled concern about energy's impact on world economies, and particularly how it will affect the U.S. economy in the face of a slowdown. Where oil and gas prices go from here depends on hard-to-predict events, but almost certainly big oil along with OPEC will take center stage.

As the CEO of a company likely to be right in the thick of the action, Browne is keeping a careful watch on industry trends. Recently, at the World Economic Forum, he made this striking prediction, "The amount of oil used in the next 10 years will exceed all the oil consumed in the first five decades of the last century."

He went on to say that world oil demand will rise by 2 percent a year for the next 10 years up to a peak of 90 million barrels a day, a level he says might be close to the industry's maximum capacity. Browne further estimates that with new technology allowing deep water drilling in such places as the Gulf of Mexico, this level of production might be maintained for some 30 years before known oil re serves are exhausted. (Ali Rodriguez Araque, OPEC's secretary general, predicts oil consumption will grow by one-third from present levels in the next 20 years.)

In other words, big oil is here to stay--if not in precisely the same form as it has been. As a dealmaker and visionary, 53-year-old Browne, who became CEO in June 1995, quickly set a different course. In 1998, the same year he was knighted by the Queen, he gobbled up Amoco for $54 billion and later bought Arco for $27 billion, catching his rivals off guard. The acquisitions gave the London-based giant added reserves of cleaner-burning natural gas, thereby transforming a onetime state-owned oil company--dependent on two areas, Alaska and Britain's North Sea--into a diversified mega oil and gas colossus. It also set in motion a round of consolidation that included the Exxon and Mobil merger; Total gobbling up Elf and Petrofina; and more recently the marriage of Chevron and Texaco. Through vigorous rationalization, the combined company has shaved operating costs by $4.9 billion, or about 20 percent of the total, since 1998.

With cigar in hand and reading specs perched at the end of his nose, the soft-spoken Cambridge graduate gives the outward appearance of an erudite jockey in a Savile Row suit. His command of the facts appears total, as does his disciplined attention to financial performance. The $162 billion BP Amoco boosted net income from $5.33 billion in 1999 to $11.2 billion in 2000. The company's return on average capital employed--a closely watched performance measure in the oil industry--was 23 percent last year, up from 13 percent in 1999. Browne says 40 percent of this outcome was due to underlying performance improvement and 60 percent to favorable market conditions. With a market cap just below $200 billion, BP is second only to Exxon Mobil with $276 billion and is the third largest integrated major oil company behind Royal Dutch/Shell.

Having positioned the company as environmentally friendly--something he hopes will someday not be regarded as an oxymoron--Browne continues to emphasize that natural gas is a clean-burning fuel that technology is making even cleaner.

"The oil industry is already detested by people who think we're indifferent to the environment," he says. "We must persuade our ultimate customers that this isn't true."

Sizing Up Oil's Impact

With the recent volatility in the energy markets, the price of oil has jolted the world economy. How concerned should our readers be?

Everyone is concerned because the price of oil and gas is much higher than the lows experienced in 1998. Over the 1990s, with the exception of the Gulf War, prices were volatile, but they appeared to be coming down. So the mindset was that prices would deflate well beyond real terms to the low levels we had in 1998.

It was clear at that time that this level was very difficult to sustain. OPEC, whose livelihood depends on the price of oil, was at the point where their books simply couldn't balance. They were equally concerned with some consuming governments, where it appeared that the tank take on a barrel was much higher than the cost or selling price of the barrel from OPEC. So there was a lot of grinding between the two.

I think OPEC was shocked by the way they had managed supply--they'd expanded it too quickly--and also they had underestimated, as many people did, the impact on the world slowdown of a place like Japan, which had negative growth and more consumption. So OPEC has taken this lesson very seriously and said they're determined to keep the price at a level that's good for them.

As for the future, it's impossible to tell because OPEC is a political and economic arrangement, not a cohesive arrangement. It's certainly a bit more mature and appears to be quite determined to keep the price at a satisfactory level. And consuming governments want to make sure the price is not too high; otherwise it could affect their economy.

Where do I think the price will go? It's impossible to tell and it would be foolish to make forecasts. But I think the highs of last year are not going to be experienced again this year.

What actions should our readers take? Do you figure energy will be the higher cost component relative to all the other inputs, or about the same?

All businesses approach the question of how to get a margin by looking at what they think the future selling price of their product will be, and what it will take to make their margins. Energy is one of those inputs and so is steel, as is labor--all these things.

This would be probably a controversial thing to say, but energy is still a good value for money compared with the last 20 years or so. One mustn't have very short-term memories--either for prices too high or prices too low. So my sense is, with improvements in efficiency, which take place every day, and reasonable prices for energy, it shouldn't be a much larger percentage of the cost for most manufacturers than it was before--for most businesses. Obviously for some sectors that are completely dependent on it, the cost is much higher.

Is it true that BP Amoco might be reducing its estimates for exploration and production in the coming year?

No. We're still predominantly an exploration and production company and it's one of the big differences between BP Amoco and the other majors. A very large proportion is in E&P. And we're spending about $8 billion of capital expenditure per year in this sector. We have simply restated the range we expect for building production. It's very difficult to predict when you have to do five- or 10-year fore casts out; it's wise to have a range.

But E&P is very important for us. We produce 3.2 million barrels a day of oil equivalent. In the U.S. we're the largest oil producer and the largest natural gas producer as well. It's more difficult to import natural gas than to produce it locally in the U.S., so we're sparing no effort to make sure we can keep that level of production growing into what is a very hungry market for natural gas. But the caveat, as always, is that we only produce it for a positive margin.

Do you expect the demand for natural gas to grow faster?

I would expect so. People are very concerned about the price spikes. But it remains a very good fuel--the fuel of choice for so many things, primarily for electric power generation, but also for space heating and, in certain applications, for transportation be cause it's clean and easy to use, pro vided you can get it.

Is it easier to get than it used to be?

It depends on where you are in the world. If you take a big world view, there is, in theory, almost an infinite reserve of natural gas. Not all sources have been found and some of them are in very, very difficult places, way away from the market. Gas, on the other hand, which is close to big markets, a lot of it's already been discovered. So a lot depends on the improvement in the technology to recover the reserves. New reserves are unlikely to be found in big quantities in some of the traditional areas that are producing gas.

Is it true that the further away the customer is from the source of natural gas, the higher the affect on the price of gas relative to the price of oil?

Yes. It used to be the case that gas cost six times more per unit of energy to transport than oil--roughly.

So your margin has got to compensate for that then?

You've got to do two things. You've got to save money at the production end, so it's got to be much easier to produce, which means that the fields have to be very big to get economies of scale and they have to be easy to develop and they shouldn't be too far away. That then gives you possibilities to create a positive margin.

We produce liquefied gas in a place like Australia, which goes to Japan, and it's a very positive margin business. We're looking at trying to do that in Indonesia, to take it to China, which will have a huge demand for natural gas in the future. Energy consumption is growing quickly in China, and will continue as the economy grows and more people can actually spend money and enjoy light, heat, and mobility--and the energy forms are limited.

Not Big for Big's Sake

You set off a round of industry consolidation in 1998. If energy companies will be judged on financial performance and not size or output, can size, coupled with cost-cutting, get you where you want to be?

Building the scale is not a purpose in itself. The question is what does it bring you? For us, it was clear that it could permanently change the cost structure of the company, and there fore enable us to do more in the future. Now, two years into the combination with Amoco and Arco, we've taken about 20 percent out of the cost structure of the company. That's very significant. It opens up opportunities to do new things because they're cheaper.

It also opens up the possibility of spreading know-how, which is locked into these different companies, across a greater variety of assets. The oil and gas industry is a very technology-based industry. Many people think of the industry as best caricatured by John Wayne and wildcatters, people covered with oil. But that's far from the truth.

You have a technical background?

I do, as do a vast number of people in the industry and in my company. Technology drives two things: the ability to do things more effectively, ex pressed in cost reduction, and the opportunity to do more by improving recovery from oil and gas fields.

A third thing it does is it gives you the capacity to take on things which, if you were smaller scale, you would probably not do, or you'd do it at a smaller percentage interest. We also figured that given the distributed nature of the industry, it was going to happen anyway. So it has merit both as a defensive move and an offensive move.

Having started this trend, we've gone through a lot of acquisitions and divestitures over a two-year period. We've assembled an enormous reach of assets, and extraordinary know-how in our people, and now we have to grow that base through our own efforts, organically. So we're certainly having a pause right now on major corporate transactions.

You mentioned trying to transfer the skills and knowledge from one corner of the company to other corners. That's a supreme challenge for most CEOs. How do you do that?

The single-most important thing is to remember that knowledge transfer and know-how transfer are simply part of performance. So when managing and directing the firm's performance, you have to say explicitly that this is part of the strategy and that it's very important. Secondly, you need to demonstrate that it's actually adding value--that knowledge transfer creates action that then leads to a financial result.

Thirdly, you need processes. The real processes are about behavior and a welcoming spirit and belief that people who have different ideas are good people and people who totally conform are not-so-good people. You have to have a sense that diversity in all its senses--not who you are, but what you contribute--is what matters. To that end, we have peers working and reviewing each other's activity, as well as communities of practice where engineers use the Internet to share information and collaborate.

The final thing is about targeting. You have to carry targets internally where you think there are opportunities for improvement through an exchange of ideas. They're usually operating targets, but they're expressed finally in financial targets. First you have to get the operational targets right. If you give people only financial targets, then it's unclear how they get there. You have to do it step by step. Operational targets must lead to financial targets. Financial targets must, therefore, lead to commitments about performance that you make to investors, and so forth.

Theoretically, they could be doing things the old-fashioned way and meeting the targets and you wouldn't know the difference.

I hope I would. Because I spend a lot of time not just reviewing financial targets, but actually talking through--as I do once a quarter with all the teams--how they actually got to where they're going. And most importantly, how failures took place-not for the purposes of saying, "this is bad," but rather, "how do we learn from these failures?" If you look at our projects, they're a mixed bag. You can pick things inside BP that have not worked and I see that as a good thing. If we're to search for things that really make a difference, we have to be able to do things that don't work out. But we mustn't make the same mistake twice.

We never do one-offs, because if you do one-offs you can never learn, and that's also a matter of scale. If we're a very small company and we draw one well a year, the best we can do is learn from industry experience; we can't learn from proprietary experience. There's virtually no point in having a learning culture because we couldn't do anything with it. And we go out side as well. We're partners with lots of people and we learn from them.

Kyoto: A Bridge Too Far

Your embrace of the Kyoto Protocol has generated much comment. Given that the scientific evidence of global warming hasn't been altogether conclusive, some have referred to your "green-ism" as either that of a naive opportunist or a sophisticated cynic.

Well, neither is a flattering description. It's really true to say that, first of all, hydrocarbons are going to be the principle part of energy for a very long time. There's really nothing that can take you further than a cup of oil. There's nothing better than natural gas to make electricity, all things considered. And the fact is, whenever you go around the world and speak to people, they look at their streets, they think about the future and say, "We're pumping stuff into the air, right?"

Some people think about big problems like global warming. Others think of problems that are very acute like smog in the cities and non-attainment of standards. They can see it and they can feel it and they can smell it. And they look at the oil companies and say, "You brought us this." And we don't want to be in that position. The people who buy our products should, to the extent possible, be happy to buy them.

The science of global warming is unproven, and I question whether it will ever be proven. But there is a risk there. The question is, can we keep the world powered by hydrocarbons, but do it better every day, and actually make those hydrocarbons better for people to use? So I take a very BP-centric point of view here and say we think we can. We've radically altered the shift, the mix of natural gas, which is generally better on the environment. We're reducing the output of carbon dioxide despite the fact that we're growing. And so far we've made it economically beneficial.

We're changing the nature of the gasoline products we sell well in advance of regulation to make it have less sulfur, less benzene, so that we can produce a cleaner fuel for people. We're rolling that out in the U.S. and in Europe in advance of legislation. We hope that that that will affect the way that legislation will be drawn up.

The Kyoto Protocol is a bridge too far. Do I think we should be reducing carbon dioxide? Yes, I do. Do I think it's wise to take steps just in case? Absolutely. Do I think that it should be done in a way that is limited just to one nation? No, I don't. I have great sympathy with the attitude of the U.S. negotiators, who say this can only work if we can trade permits and if we can actually reduce carbon dioxide elsewhere in the world where it's easy to do.

I don't know whether the theories about global warming will be proven true as we go forward. Many people believe the balance of probabilities is shifting, but I don't think anyone would say it is conclusive--not even the inter-governmental panel on climate change has said it's conclusive. They've said the balance of probability is shifting, but that's all. And there are wide ranges of uncertainty. But I think it's right, at this stage, to begin to take steps to begin to make a difference.

BP Amoco's Performance Under Browne's Watch
BP Amoco         4.42
S&P 500          0.87
Dow Jones       14.31
Amex Oil Index  21.28
Source: Elias Asset Management
Note: Table made from bar graph
BP Amoco By The Number
Net Income and Turnover
($ millions)
                         1999     2000
Turnover              101,180  161,826
Net Income After Tax    5,146   11,962
Source: Company Reports
Note: Table made from bar graph
BP Amoco Lines of Business
                            1999  2000
Refining & Marketing         65%   66%
Exploration & Development  19.7%   18%
Gas & Power                 5.5%    9%
Chemicals                   9.6%  6.5%
Other                       0.2%  0.5%
Source: Company Reports
Note: Table made from pie chart
From Big Oil to Mega Oil
How BP Amoco Stacks Up
                           Market cap in $ millions
EXXON Mobil                                 282,962
BP Amoco                                    193,000
Royal Outch Petroleum                       126,728
Total Fina Elf                              103,925
Shell Transport & Trading                    82,531
Chevron                                      55,735
ENI                                          53,174
Texaco                                       35,870
Note: Table made from bar graph