Downstream oil engineers take their place at the top

closer to a success.

The engineers in refining and petrochemicals were expected to be conservative and risk averse. Things had to work consistently and for a long time, because the alternative was potential human and environmental disaster. They were like a football team grinding out a running game, gaining a few yards on each play.

Adding to the challenge, the downstream business could be cyclical, depending on the price of oil and natural gas, their feedstocks. Depending on the market, downstream returns could be feast or famine even with consistent operations.

The strategy at Royal Dutch Shell from 2004 to 2010 was simply “more upstream, more profitable downstream.” More detailed metrics followed, but the drivers were to find “elephant” fields — often defined as more than 500 million barrels of oil — whether in Alaska, the Gulf of Mexico, central Asia, Russia or Brazil.

The downstream businesses had the unglamorous job of focusing on cost, improving technology and minimizing downtime.

This strategy literally blew up for BP when its Texas City refinery exploded in 2005, killing 15 and injuring 180. An independent commission led by former Secretary of State James A. Baker III placed the blame squarely on BP management’s decision to cut costs excessively and create unsound risks.

For years, most investors favored integrated oil companies that explored, produced, traded, refined, transported and sold products at retail gas stations. There was portfolio diversification inherent in each company to mitigate volatility. But by 2010, activist investors wanted to build portfolios according to their own risk tolerances, not rely on a company to do it for them. Under this pressure, large companies like ConocoPhillips and Marathon broke up into separate upstream and downstream companies. Many expected this to favor the exploration side of the business, but often the downstream companies turned in better returns.

When oil prices collapsed in late 2014, the industry was largely blindsided. The boom in previous years created a dynamic of finding oil at almost any cost, whether overseas, in the Arctic or the relatively new “shale play” in North Dakota and in West and South Texas. Hail Mary passes became the norm. These were exciting times. The noise level at the Petroleum Club in downtown Houston was deafening. If it meant taking on unprecedented levels of debt, so be it. The big collapse of 1986 and the shorter-lived one in 2008-09, associated with the nation’s financial collapse were seen as the result of dynamics that no longer applied.

In any case, OPEC was expected to solve the problem. The member countries had skin in this game and they had used production cuts to sustain prices. They could deal internally with members who cheated. There was a nagging concern that OPEC might let prices collapse in order to weed out the bothersome but productive small players in the shale play. But that wasn’t the prevailing view. Some companies even saw the initial collapse as an opportunity to pick up assets at bargain prices and staff up with professionals laid off by other companies.

But the knives kept dropping for more than two years. Over-indebted companies shed staff, leases and equipment and many took bankruptcy.

For the companies that survived, investors and boards demanded a more conservative approach to protect the balance sheet. This involved technical innovation at the field level, dramatic cost cutting (including what they paid service providers) and unyielding attention to cash flow. As boards sought new leaders, they considered their track records, skill sets, operational experience and alignment with the new industry realities.

Several majors have shifted leadership to engineers who ran downstream operations. Shell had already made this shift following a grave challenge from the Securities and Exchange Commission in 2004 about its reported global reserves. An “explorer” was replaced by Jeroen van der Veer, who had run the company’s petrochemical business. He was succeeded in 2014 by Ben van Beurden, also a downstream executive.

Something similar happened at Total, Exxon Mobil and now Chevron. To be sure, these career executives should not be pigeonholed as technocrats. They have been groomed for years with a variety of assignments so they can build a strategy for their time of leadership. But don’t expect too many Hail Mary passes in the next couple of years. Instead, we’ll probably see a ground game with increasingly solid returns.