The Petroleum Industry's Differential Risks

This paper is to be presented at the 39th Annual Fall Meeting of the Society of Petroleum Engineers on Oct. 11–14, 1964, in Houston, Tex., and is considered the property of the Society of Petroleum Engineers. Permission to publish is hereby restricted to an abstract of not more than 300 words, with no illustrations, unless the paper is specifically released to the press by the Editor of JOURNAL OF PETROLEUM TECHNOLOGY or the Executive Secretary. Such abstract should contain conspicuous acknowledgment of where and by whom the paper is presented. Publication elsewhere after publication in JOURNAL OF PETROLEUM TECHNOLOGY or SOCIETY OF PETROLEUM ENGINEERS JOURNAL is granted on request, providing proper credit is given that publication and the original presentation of the paper. Discussion of this paper is invited. Three copies of any discussion should be sent to the Society of Petroleum Engineers office. Such discussion may be presented at the above meeting and considered for publication in one of the two SPE magazines with the paper. Abstract Business risks that plague all industries and economic functions cannot be measured precisely, but can be measured relatively. Differential risk is conceived as normal business risk compounded by the forces of nature and mankind. A broad evaluation of three major industries-petroleum, manufacturing, and utilities—indicates that the petroleum industry has differential risk characteristics that are often overlooked or misunderstood. Business risk activity requires risk capital that is available only on terms consistent with the differential risk reflected by the industry seeking such capital. The differential risk, profits, and capital requirements of Petroleum are examined and placed in proper perspective. The industry is viewed relative to its vital energy role in world economics. Introduction Following World War II, an expanding population with increasing mobility placed a severe growth burden on the Petroleum Industry. This burden was compounded by the energy requirements of both hot and cold wars. The demand generated for petroleum products could only be met by the successful commitment of large amounts of risk capital. Investors responded because of the lure and potential of profits in Petroleum compared to the many alternatives. Generally speaking, the investor's commitment has been rewarded through dividend payments and growth in capital value. While the dividend payout was not as high as other industries', the plowback of retained earnings has increased the capital value of the earlier investment. The combination of these profit sources has so far been adequate to maintain the integrity of the industry's capital. It is certain that capital demands, absolutely, just profits if it is to be available and remain committed. The prime risk of any enterprise is the partial or complete loss of capital and/or failure to earn adequate profits on the invested capital. Let me begin by saying I do not know how to precisely measure risk. But I believe the major components of physical and financial risk for any industry can be identified, isolated and compared to similar characteristics of other industries. All enterprises entail risk but, at a point, the investment risk becomes relative, one investment or industry to another. The Free World is commerce is based on a relative evaluation of alternatives by individual and institutional investors who supply the capital requirements.