Book review: “Oil and Honor”

The Texaco-Pennzoil Wars

I’m continuing with my quest to find older, lesser-known books with finance stories from the 1980s and 1990s (as usual, feel free to post your recommendations in the comments): the ones that I have previously reviewed this year (plus some others not discussed here) are:

• “The Man Who Tried to Buy the World”

• “The House of Nomura”

• “Fidelity's World”

This time it’s Thomas Petzinger’s “Oil & Honor: The Texaco-Pennzoil Wars”: written in 1987, the book recounts the financial (at first) and legal (later on) battle for the control of Getty Oil.

The background story

Founded by J. Paul Getty, in the 1970s Getty Oil was a top 10 US oil producer, but with the passing away of the “Old Man” in 1976 internal family disputes and management struggles left the company vulnerable.

At the time the company was 40% controlled by the Sarah C. Getty Trust (established in 1934 by Sarah Catherine McPherson Risher Getty, mother of J. Paul) and 12% by the J. Paul Getty Museum in Los Angeles. The rules governing the trust where quite complex (for example, they stated that the shares in Getty Oil could only be sold “to avoid an economic loss”), with some beneficiaries getting a lot of money every year and others very little or nothing:

“On a distinctly unfestive Christmas Day in 1934, with Sarah bargaining from a position of strength, she proposed a solution. She would take back those notes and put them in a trust to be managed by her son. In effect, he would now be his own creditor, freeing his company to begin borrowing more money for the Tide Water takeover. Eventually, the trust's notes would be paid off altogether with stock in the family oil company, making the trust the largest shareholder.

But J. Paul had to abide by several severe conditions:

1. He had to put a great deal of the company stock he personally held into his mother's trust, assuring that much of his fortune would also be preserved for Sarah's great-grandchildren.

2. To perpetuate the family fortune as long as possible, the entire principal amount would remain in the trust until not only J. Paul was dead, but each of his children. Only then could the assets of the trust be divided among Sarah Getty's great-grandchildren, and by that time the 21st century would have rolled around.

3. Of whatever money the trust earned on a yearly basis - from dividends on company stock, for instance - J. Paul could receive only an amount in proportion to his mother's contribution to the trust. Any money earned on J. Paul's contribution would in turn go to his children - George II, Eugene Paul and Gordon. However, Ronald, the second son, would never receive more than $3000 in a year. J. Paul had assured his mother that Ronald would be more than amply provided for from the rich divorce settlement his mother had obtained. (He would not be, as it turned out.)

The 1970s Big Oil diversification

One of the most interesting parts of the book is the 1970s diversification of Big Oil into other businesses, pushed on one side by the fact that oil-in-the-ground was getting more difficult and costly to find (and the ‘peak oil theory’ was gaining momentum),¹ and on the other by the environmentalist movement:

“But Berg knew better than anyone that he was a caretaker between two eras. For in 1978, when the time came to designate his successor, the oil industry was being thrust from the good-old-boy era into a brave new world. Taking customers to hunting lodges and receiving fur coats from suppliers were quickly becoming bygone customs. Young oil executives were eating lunch at their desks instead of at the golf course clubhouse. The environmentalist movement was gathering momentum, with the oil industry as its main target. The Republicans had lost the White House. The quickening and deepening cycles of economic expansion and contraction were widening the gulf between the haves and the have-nots - and the oil industry had more than anybody. A tax was even enacted on those so-called windfall profits.”

With deep pockets from the high oil prices of the decade, Exxon started making motors and electronic typewriters; Mobil bought Montgomery Ward, a catalogue and brick-and-mortar retailer; Sun Oil entered the medical-equipment business.

Getty Oil was even bolder: not only it spent $630 million to acquire Reserve Oil & Gas of Denver (which, ironically, had already agreed to be acquired by a Canadian firm before Getty Oil presented its offer…), but it also entered into a real-estate partnership with Jack Nicklaus to develop suburban resort properties and into another property deal with the investment bank Blyth Eastman Dillon & Company. And then there were the even weirder ventures: in the entertainment business, Getty Oil had a stake in ESPN² and in a cable network called Premiere³; it invested $60 million for a coal mine in Utah and $70 million for another in Colorado; plus $1.5 billion to dig a new copper mine in Chile with General Electric. Last but not least, it stepped in as the white knight and splurged $570 million to acquire ERC Corporation, a major Kansas City-based insurance company, that was fending off a hostile takeover by Connecticut General.

Three different solutions to break the standstill

By the early 1980s the situation had massively deteriorated in terms of corporate governance.

Gordon Getty was one of the five sons of J. Paul Getty from 4 different wives: in his youth he had worked for the company but was not destined to run it, as he wasn’t an oilman like his father and preferred to focus on composing music. Two of his brothers held senior positions within Getty Oil, but they also had personal problems (with drugs, wives, …) and by this time Gordon was left as the sole trustee of his grandmother’s trust. As the controlling shareholder, he was on the company’s board but was constantly snubbed and ignored by management.

Three potential solutions emerged at the time, all pushed by outside investors:

1. A royalty trust, proposed by Boone Pickens: as he believed that the world was indeed running out of oil, it was a waste of the shareholders’ money to reinvest profits in a futile search; the profits, or “royalties”, earned by the existing oil fields would flow to the shareholders through the trust, whose income was tax-exempt, rather than through a corporation, whose income was taxable⁴

2. A massive share repurchase, proposed by Sid Bass: this would have pushed the trust’s stake even higher, and management was not willing to allow it

3. A full takeover by Mobil Corporation

Yet another oilman (Corbin Robertson Jr., an heir to the Cullen family fortune) came calling with an idea that Gordon Getty found particularly intriguing: they would join forces to take Getty Oil private - buying out the museum and all the public shareholders - at $80 a share with borrowed money. Gordon ultimately didn’t pursue this deal because it would have left Robertson as the majority shareholder, but the concept of going private started appealing to Gordon.

The cast of characters

It's in this situation that Pennzoil saw an opportunity and negotiated a deal with Gordon Getty, the museum and Getty Oil itself to acquire a significant stake and intending to take control of the company.

The saga revolved around several characters:

• Gordon Getty, the dreamy scion of one of the world's greatest family fortunes, humiliatingly betrayed by the board of his father's oil company, who had something to prove to the world but who in the end decided simply to deal the company away

• Hugh Liedtke, a real old-school oilman who had worked at Getty Oil with the Old Man and by then was running Pennzoil

• Sid Petersen, Getty Oil CEO, who didn’t like Gordon but knew his adversary held most of the cards

Plus the 1980s most famous bankers and lawyers working for the different parties: Martin Siegel of Kidder, Peabody; Geoffrey Boisi of Goldman Sachs; Bruce Wasserstein of First Boston; the uber-corporate lawyers Marty Lipton and Arthur Liman; … Strangely, it was one of the few deal where Milken and Drexel didn’t have their hands in!

The Pennzoil deal: binding agreement or not?

In the first days of January 1984, Pennzoil, Getty Oil, the trust and the museum hurriedly reached an agreement in principle for Pennzoil to acquire a large portion of Getty’s shares at $112.50 each, with plans to take Getty Oil private (or split the assets with Gordon Getty after one year if things didn’t turn out as expected).

But just days after this handshake deal, Texaco entered the scene with a higher offer, $125 per share, convincing Getty Oil’s controlling interests to sell to them instead. The museum decision wasn’t a surprise: it always wanted to get cash for the shares (in dealing with both companies they insisted on getting paid first, regardless of any legal or regulatory hurdle) and went for the higher offer on the table. But Gordon Getty’s choice was puzzling: in the Pennzoil deal he wanted to take Getty Oil private to run it (he was also prevented by the trust’s rules to sell the shares at will), but in the end he decided to sell the entire company to a bigger competitor:

“Gordon was either a seller (at $125, offered by Texaco, ndr), as trustee, or a buyer (at $112.50 proposed by Pennzoil), as the controlling shareholder of Getty Oil, depending on the price.”

He later explained that at the Pennzoil price he was definitely a buyer, despite the price of Getty Oil already being up a lot from the $50s before the rumours started; but at the higher price he was a seller, because oil prices were already trending down in the mid-1980s and it was his fiduciary duty to “avoid” an economic loss for the trust.

Feeling wronged (“There are stealing our billion barrels of oil in the ground!”, said Liedtke), Pennzoil sued Texaco for tortious interference, arguing that Texaco induced Getty Oil to break its existing agreement with Pennzoil.

The second part of the book is indeed entirely dedicated to the trial in Texas, which centred on a (apparently) simple point: did Pennzoil have an agreement (it was also announced in the Wall Street Journal, although everyone in the Texaco management team swore at the trial that they didn’t read the article…), or where the parties just discussing and trying to reach one (and so where free to listen to other offers)?

In November 1985, the jury sided with Pennzoil and awarded it a record-setting $11.1 billion ($7.53 billion in actual damages and $3 billion in punitive damages, plus interest), the largest civil judgment in U.S. history at the time. Marty Lipton, advising the museum, was particularly contradictory in his dealings with the different parties, and it was evident in his trial deposition. Geoffrey Boisi (working for Getty Oil) was also seen by the Texan jurors as a slick New York banker: in the end Goldman Sachs was paid $18 million by Texaco, and would have got only $9 million if the Pennzoil deal went through.⁵

Texaco appealed, but under Texas law they were required to post a bond for the full amount of the judgment before an appeal could be heard. After threatening to file for bankruptcy protection, in December 1987 the two companies settled for a $3 billion payment to Pennzoil (not covered in the book as it happened after the publication).

1. American geoscientist Marion King Hubbert predicted in 1956 that US oil production would follow a bell-shaped curve, peaking between 1965 and 1975, and then declining thereafter; he also forecasted that global oil production would peak around the year 2000

2. After Texaco acquired Getty Oil in 1984, Texaco decided to divest non-core assets to focus on its oil and gas business and sold ESPN to ABC in 1984

3. To which Columbia Pictures, Twentieth Century-Fox, Paramount Pictures and MCA agreed to give first broadcast rights for new films at prices mutually agreed upon by the studios; but HBO called this a "patently illegal" scheme, the Justice Department sued it as a price-fixing arrangement and Premiere never got off the ground

4. Moreover, the shareholders' direct ownership of the oil field enabled them to take the kind of big tax-deductions on their personal tax statements usually reserved for big corporations that own "depleting assets," such as oil.

5. It should be noted that their job was to get the highest possible price for their clients (the museum and Getty Oil’s shareholders), and they did it: in the end it was Texaco and not their firms that was responsible to pay for the judgment…