CHEVRON'S DAVE O'REILLY: PUMPED UP
He beat Beijing in the battle for Unocal. Now he's emerging as the new voice of Big Oil in America.
(FORTUNE Magazine) – Dave O'Reilly isn't taking a vacation this summer. In fact, the Chevron CEO isn't even taking a day off to savor one of the biggest wins of his career. Less than 24 hours after beating China's CNOOC and buying Unocal in the hardest-fought, most bitter takeover battle in years, the only pause O'Reilly allows himself is a few moments to congratulate the company's seven top managers at their biweekly meeting. "It's day one," O'Reilly tells his lieutenants as they gather around a horseshoe-shaped, blond-wood conference table in the company's ultramodern San Ramon, Calif., headquarters. "We got the company. Now we've got to make it work."
Indeed they do. Shareholders are still smarting over O'Reilly's disastrous decision in 2001 to invest $1.5 billion in Dynegy, the faltering power company, and doubts persist about whether Chevron can deliver the new oil and gas production it has been promising ever since it acquired Texaco that same year. But on this hot August morning, the Dublin-born O'Reilly is enjoying a bit of good luck: Crude prices are soaring, and by the end of the day they will stand at just under $66 a barrel, an all-time high. At many of Chevron and Texaco's 9,000 service stations across America, drivers are anteing up nearly $2.75 a gallon for gasoline. For Chevron's U.S. refineries, which O'Reilly ran for much of the 1990s, that's like a license to print money.
Critics won't soon forgot how Chevron whipped up anti-China sentiment and benefited from political favors on Capitol Hill to win Unocal, but O'Reilly isn't looking back--or apologizing. That's not his style. And no matter what you think of his tactics, this much is true: While other CEOs have been fretting about the growing Chinese threat to American business, O'Reilly cleaned Beijing's clock in this round.
"There's nothing personal about it," O'Reilly told FORTUNE in his only face-to-face interview since the deal closed. "I don't see any reason why this should affect the relationship with CNOOC. They're on a growth trajectory, and we'll see other opportunities to work together."
Besides adding 1.7 billion barrels of oil and gas to its reserves and boosting Chevron's daily output by 400,000 barrels, or about 15%, Unocal has yielded a less noticed dividend for O'Reilly and his company. With the biggest oil merger in years under his belt--and with legendary Exxon Mobil CEO Lee Raymond set to retire at the end of this year--O'Reilly is poised to become the new face of Big Oil in America. Although Exxon remains the largest U.S. oil company, CEO-designate Rex Tillerson isn't well known. BP's John Browne is prominent in Europe, but Chevron and O'Reilly have the momentum. Chevron, which ranks No. 6 on the FORTUNE 500 list, had revenues of $148 billion in 2004. This year, Wall Street is looking for the newly combined company to generate revenues of roughly $200 billion and earnings of $14 billion.
Numbers like those give O'Reilly extra credibility in an industry where $5 billion firms are considered little more than wildcatters. And in industry, period: Chevron earned more last quarter than Hewlett-Packard did in all of last year. On issues like conservation and climate change, he has been staking out a public position somewhere between the green posture of BP's Browne and the what-me-worry? stance of Exxon's Raymond. In July, Chevron unveiled an expensive ad campaign linking high oil prices to the voracious appetites of new consumers like China and India. One ad features a letter, signed "Dave," bluntly stating, "One thing is clear: The era of easy oil is over.... Demand is soaring like never before."
Despite driving the kind of gas guzzler only a Big Oil CEO could love these days--a Cadillac Escalade--O'Reilly is calling for new conservation and efficiency efforts. "It's comfortable and safe," he says of his SUV, which gets about 14 miles a gallon. "But if we all made decisions to press for more efficient SUVs, wouldn't it be better? 'Couldn't we have our cake and eat it too?' is what I'm saying."
O'Reilly, 58, is also taking on a more public role within the clubby ranks of the world's five biggest oil companies, or the supermajors, as they're known in the oil patch--Exxon, BP, Royal Dutch/Shell, Chevron, and Total. In both his public comments and internal decision-making, O'Reilly has been confronting the key dilemma facing these giants: how to boost production and find new reserves when the world's best assets are increasingly in the hands of state-owned firms.
With the addition of Unocal, Chevron has leapfrogged France's Total to become the world's fourth-largest supermajor, and it now has the biggest Asian resource base of any Western oil company. Chevron also now controls more acreage in the Gulf of Mexico than any of its rivals. But even without the Unocal deal, this would be a critical moment for the company. After watching production decline in each of the five years since he became CEO, O'Reilly says 2006 will be the "transformational year" in which Chevron finally starts pumping more black gold out of the ground.
It's about time. Since O'Reilly took over, Chevron's output has dipped by 12%, to 2.5 million barrels a day. By contrast, archrival Exxon's volume has slipped by only 1.4% during the same period, to 4.2 million barrels a day. So far, higher oil prices have camouflaged this steady erosion, but O'Reilly insists that a series of new projects stretching from the Gulf of Mexico to Angola and Central Asia will reverse the trend just in time to catch the wave of higher commodity prices.
"The next couple of months are very critical," O'Reilly says. "One thing you learn about bringing two companies together is that the tone is set very early on, and if you're going to be successful, you need to come out of the gate quickly."
When O'Reilly first heard in late June that CNOOC had topped Chevron's offer for Unocal by $2 billion, he was in Bangkok with Unocal CEO Charles Williamson. They had just spent the day meeting with employees of both companies and managing the integration process that began in early April, when Unocal had accepted Chevron's initial bid of $16.4 billion. Appropriately enough, O'Reilly was with Williamson again on Aug. 2, this time in Boston, persuading Fidelity and Putnam to support the Chevron deal, when Williamson got the call with news that CNOOC had surrendered.
The six weeks that elapsed between those two phone calls marked the most politicized takeover battle in U.S. history. The chairman of the House Energy and Commerce Committee, Joe Barton, labeled CNOOC "a front for the Chinese Communist government." And the final blow to CNOOC's bid wasn't Chevron's decision to sweeten its offer by about $500 million on July 19 but rather an amendment, inserted into the energy bill just before its final passage on Capitol Hill at the end of July, that would have required the Departments of Energy, Defense, and Homeland Security to spend four months studying "China's global energy pursuits" before federal approval of CNOOC's offer could be granted.
The author of this little-noticed but crucial piece of legislation was GOP Representative Richard Pombo, whose Northern California district happens to be home to Chevron headquarters. Pombo, who has received $23,000 in campaign contributions from Chevron's employee political action committee since 1992, denies that this was a political favor and says, "I would have had the same concern if CNOOC had been up against any American oil company."
Back in San Ramon, some Chevron executives are treating the machinations in Washington like water under the bridge. "I think we played fairly, and we won a hard-fought transaction," says Peter Robertson, the vice chairman of Chevron and O'Reilly's hard-charging point man throughout the battle. "I think that we will continue to work well with China. The Chinese view this as an exercise where they learned something, we learned something, and we move on." Two months ago Robertson was singing a very different tune. He told FORTUNE then that Chevron was "up against the Chinese government" and complained that CNOOC "clearly isn't a commercial company."
O'Reilly, for his part, cleverly took the high road during the struggle and kept his public comments limited. Looking back at the debate, "it seemed to hit a raw nerve," he says. "There were a lot of issues going on, and so I was surprised. I saw people in Washington [say things] I hadn't heard of before."
In the weeks before the deal was done, much of O'Reilly's time was spent meeting privately with large institutional shareholders. O'Reilly says he never went to Capitol Hill to lobby members of Congress, nor did he speak to any by phone. "Basically, that's what we've got a Washington office to do." He insists that Chevron's problem isn't with China's global ambitions but with the state-subsidized loans CNOOC was relying on in its bid for Unocal. "Our argument was a level playing field. And it still is. It could be a government company from any country. It's not a China-specific issue."
Chevron still has extensive partnerships with CNOOC in Indonesia, Australia, and offshore China, but neither O'Reilly nor Robertson has spoken to CNOOC chairman and CEO Fu Chengyu since CNOOC dropped its offer. And CNOOC declined to comment on its future relationship with Chevron. Will the Chinese giant or its state backers retaliate as Chevron steps up its own Asian expansion? "I don't know," says O'Reilly, who, unlike many CEOs, often admits he doesn't have all the answers. "I hope not. We'll be checking in with them as a matter of our routine review of our partnership together, and we'll find out. I'm optimistic," he says.
Just as all airline pilots seem to sound like Chuck Yeager, oilmen often talk as if they were raised on a West Texas rig. For instance, Chevron's head of exploration and production, George Kirkland, is a Florida native, but his accent is pure Pecos River. The lean, 6-foot-2 O'Reilly hasn't gone that far, but he's lost any echo of his youth in Ireland and the years he spent at Dublin's University College, the famed Irish institution where he studied chemical engineering before joining Chevron in 1968. Unlike most of the Texan-wannabes, O'Reilly didn't start in the oil-production part of the business, known as the upstream. He worked mainly in the less glamorous downstream, overseeing businesses like chemicals and U.S. refining and marketing.
O'Reilly minimizes the importance of upstream vs. downstream in his path to the top, but it's clear that his experience as a marketer left a lasting impression. At a time when energy-industry leaders seem to be the only people not talking about high gas prices, O'Reilly is tiptoeing into the public debate.
The CEO's public pronouncements are hardly radical, "but they're a lot more than others have done," notes veteran Houston energy banker Matthew Simmons. "Chevron is beginning to break ranks with the rest of the industry, which has been arguing that high prices are unsustainable and that there are no long-term supply issues." Simmons would like to see O'Reilly go even further and address whether we could be nearing the long-feared peak in oil production. If he were to raise that and other industry taboos, like the threat of exponential growth in demand, "O'Reilly would have a real chance at filling the void we now have. One of the odd things about the energy business is that it doesn't have a leader like Bill Gates or Jack Welch. And this is an industry that really needs public-policy leadership."
O'Reilly won't predict where oil prices will go next--he knows better than that--but he says that while $65 is too high, $25 isn't coming back. If prices were to retreat, he says, $30 to $40 is more likely. He argues that the current spike in oil prices is fundamentally different from past spurts because it's driven by demand rather than by supply disruptions like the Arab oil embargo or Saddam Hussein's invasion of Kuwait. And even though high oil prices tend to slow consumption and spur new production, O'Reilly says, "we're still in a much tighter supply/demand balance than we were for much of the last 20 years."
Still, nothing makes O'Reilly madder than the suggestion that the Unocal acquisition is premised on oil staying at the $65-a-barrel level. Even at $35, he says, this transaction would pay off handsomely. Besides, natural gas accounts for 60% of Unocal's current energy production, so the relentless focus on high oil prices as a justification for the merger misses the point. The real upside for his company, he says, is that Unocal strengthens Chevron's hand in three critical energy provinces: East Asia, the oil-rich Caspian region, and the Gulf of Mexico. It also brings synergies to existing Chevron and Unocal projects.
In Central Asia, for example, Unocal's 9% stake in the just-opened Baku-- Ceyhan pipeline gives Chevron a new outlet to the Mediterranean for the approximately 240,000 barrels of oil it produces every day in the Caspian. Linking Unocal's Indonesian gas reserves with Chevron's $10 billion-plus Gorgon gas project in Australia will enable the company to increase sales to natural-gas-hungry countries like Japan, South Korea, and of course, China.
O'Reilly has some serious catching up to do as Chevron's older assets rapidly falter. In the first half of 2005, the company's U.S. fields pumped 16.5% less oil and gas than they did in the same period last year. Overseas operations fared better but were still down 2%. The company attributes about half the drop to one-offs like the sale of Texaco assets, Hurricane Ivan, and turmoil in Nigeria, but there's little doubt that new gushers are desperately needed. "Production volumes remain weak," J.P. Morgan analyst Jennifer Rowland told investors after the latest quarter's results came out.
That should start changing very soon, O'Reilly says. This year will be the nadir, and in 2006 output will turn around as new fields in Kazakhstan and in deep water off Angola come online. Looking further out, O'Reilly is promising that the completion of megaprojects in offshore Nigeria, the Gulf of Mexico, and near the northwest Australian coast will deliver production increases of at least 5% annually through 2009.
Five percent may not sound like much, and in sectors like tech, it's not. But with current daily production (including Unocal's) standing at nearly three million barrels a day, fulfilling that target will mean pumping 600,000 barrels a day more in 2009 than Chevron does now. That's like having to go out and buy another Unocal. Simmons, for one, is skeptical. "It's not impossible, but it's highly challenging," he says. "The production rate of the new projects has to be astonishingly high to move the needle."
Although O'Reilly says there's very little that keeps him awake at night, Chevron does face challenges that could cause Wall Street to lose some sleep. The biggest question is whether Chevron can make that goal of 5% compound annual growth in the years ahead. The company does have a history of promising more than it can deliver in terms of daily production, says Deutsche Bank analyst Paul Sankey. Back in 2001, Chevron predicted it would pump roughly 2.8 million barrels a day by in 2004. Its actual output last year came in at 2.5 million barrels. Given where oil is trading these days, that kind of shortfall is doubly painful for shareholders. "Like the last couple on the dance floor, Chevron and Texaco made a lot of promises when they merged," Sankey says. "Not all of them came true." As for Unocal, Sankey adds that its track record for meeting production targets was simply "atrocious."
Indeed, other analysts now say they're worried that the Unocal fields won't turn out to be as productive in the short term as Chevron hopes. "Operations at some of Unocal's Indonesian assets have been a little bit unpredictable," says Nicole Decker of Bear Stearns. And in countries like Nigeria and Venezuela, Chevron increasingly faces what oil insiders call 'above-ground risk,' better known as political dangers. In Nigeria--the company's source for roughly 130,000 barrels a day last year--Chevron is dealing with both tribal unrest and the threat of a multibillion-dollar back-tax claim from the Nigerian government.
O'Reilly does have one big ace up his sleeve--money. Chevron's piling up profits at a rate of more than $1 billion a month, and it's sitting on over $12 billion in cash. And O'Reilly is opening the spigot for new projects a bit wider than many rivals. While BP's upstream budget is expected to rise 5% next year, says Decker, Chevron is hiking outlays by more like 15%. "We're spending more time and more focus and more effort on our exploration," O'Reilly says. "That's ultimately what fills the pipeline for the really long term."
The CEO is convinced that undertaking technologically daunting, hugely expensive projects is the only way the supermajors will be able to counter state-owned oil firms that can rely on cheap financing and abundant oil in places like Saudi Arabia, Mexico, and Kuwait. Five years ago Chevron had fewer than five projects with budgets of more than $1 billion. Today it has more than 20. "There really are a handful of companies that do what we do in the world today," he says.
Not all of Chevron's big bets in the past have turned out to be well timed. It acquired Gulf just as oil prices were peaking in the mid-1980s, for instance. Still, sitting in his sunny office with its views of the golden East Bay hills the day after he spent $17 billion on Unocal, O'Reilly doesn't show the slightest sign of buyer's remorse. Then again, he says with a knowing laugh, "this isn't a business for the faint-hearted."
REPORTER ASSOCIATES Doris Burke and Patricia Neering