Part VI – Becoming a Drilling Contractor – The Three for One Deal

DanPedrottiGen6One June evening in 1974, while I was relaxing in my back yard pool, I was called to the phone to speak to Leo McCloskey, a petroleum engineering partner with Frank Morrison, a geologist, in Mormac Operating Company. He wanted to discuss an opportunity to become involved with drilling rigs. Rigs were really getting scarce and Mormac felt that if they were to continue drilling their deals they had to own a drilling company. I met with Frank and Leo the next day, and they proposed that I become their chief geologist as a third interest partner in purchasing Bagget Drilling Company, a small contractor in Eagle Pass Texas. Bagett had three shallow beat up drilling rigs. After discussing this with other former drilling contractors, I was advised against such a move, but being venturous and as I would not consider abandoning my own partner, I talked to Bill Miller. I found him to be very enthusiastic. I then told Mormac that they could have two geologists for the price of one, but that Bill had to be included. They were not too hot on the idea at first, but when they ran into difficulty with their financing, they agreed to include us for a third if we would finance one of the rigs. Bill and I had to use our Charamousca production as additional collateral to secure the loan. Each partner, including Mormac’s CPA, Gordon Lansford, put up $1,000.00, financed the rest and the five of us founded Cinco Drilling Company. Originally we referred to the venture as broken mast drilling company as all three of the rigs were barely more than junk, but after five years with Jack Holden as superintendant we owned five of the finest rigs capable of drilling wells in the 5,000 to 10,500 foot range in South Texas, a fleet of trucks for moving them and a yard in Alice, Texas.

All did not go great for Cinco. When we finally got our rigs up to par, we leased two of them to Jack Stanley’s Trans Texas Company that was drilling in the Lobo Trend of Webb County. This contract was secured by a $200,000.00 letter of credit and we were paid promptly until one morning at our Cinco Directors’ Meeting, I asked if the letter of credit was still in effect. Our company president assured me that it was, but I wasn’t convinced. I asked him to go get it, and sure enough it had expired the day before. That was the last payment we received and after shutting down and moving our rigs out we filed mechanics liens only to be told by Mr. Stanley’s Boston judges that the liens would not be honored. This nearly broke Cinco, but somehow we held on. We had declined to move a rig onto the DCRC to drill for Clinton Magnes as we were sure he would not pay and might even confiscate it behind locked gates, so we did dodge that bullet.

Mormac, being a two thirds owner, ran the company and maintained the executive offices in their suite in the Vaughn Plaza (now the American Bank Plaza). Thus all the operational problems, the calls in the middle of the night and minor financial difficulties came to Leo and Frank. Bill and I were basically directors and called upon only when major problems arose, so although we weren’t making any money, our notes were paid and we didn’t feel the stress of the many day to day decisions, so in 1978 when Mormac was ready to sell out. At first we were not to keen on the idea.

It turned out that Frank Morrison had an old college friend who was now a Vice President of Delhi International Oil company. Delhi was an active oil and gas company that went to Australia and discovered huge oil and gas fields on concessions covering over 50,000,000 acres. Their net Australian reserves in 1978 totaled 680 billion cubic feet of gas and 56 million barrels of oil. Their problem was getting most of this production to market, as it was located in remote parts of the country. They had plans to build pipelines, get the wells on production and to reinvest the income from these fields back in the United States through the purchase of drilling rigs to be used to drill their way into good deals.

Cinco was the perfect vehicle to accomplish this plan. When they approached us and described their company assets it was pointed out that Delhi owned the equivalent of 10 barrels of oil for every outstanding share of stock. The original plan was for Delhi to assume our bank debt and pay us a nominal sum for the equipment and blue sky, but when I realized that their stock was selling for $7.00 to $8.00 per share and that at $10.00 a barrel the stock had a potential value of $100.00 and knowing that banks were projecting $100.00 per barrel oil, I suggested that we do a stock exchange instead of a cash deal. My partners’ initially thought I was nuts and that Delhi would not consider such a transaction. However, I insisted that we propose it and low and behold they thought it was a great idea. Delhi immediately acquired a large block of their stock owed by investors in Canada for $6.00 per share and traded it to us at $8.00. Well we did see our stock trade for over $100.00 per share after two three-for-two splits. Fortunately In September, 1981 right before oil prices collapsed CSR, an Australian based company, bought Delhi International for $78.00 per share and we sold out with them, thus ending our brief but exciting venture in the drilling business. Not a bad return on our $5,000.00 capital investment.

The eighties started out strong with oil selling for $50.00 a barrel and natural gas around $10.00 per mcf. Much like this year there was no end in sight and banks were loaning on the possibility of $100.00 oil, but by early 1982, red lights were flashing. The election of Ronald Reagan brought about a reduction in the maximum income tax rate to 50 percent and eastern investors were leaving the business. Just in the nick of time the three-for-one concept came along. Some lawyer back east devised a scheme that allowed the write off at the rate of $3.00 for every $1.00 spent on IDCs. I am still not exactly sure how this worked, but an operator would have to be the completion partner who put up the tangible completion costs so that the investor who got benefit of all the intangible drilling costs actually made money with a dry hole. Needless to say the drilling dollars poured in and spawned a whole new group of promoters, such as King Resources, who had unlimited budgets. The situation created some wild Decembers as all the tax money had to be spent before the end of the year. We would be signing drilling contracts, participation agreements and escrowing millions of dollars well into the night on New Year’s Eve. Most any deal that was put together was sold. Unfortunately this scheme was short lived as congress got wind of it and passed legislation to outlaw the practice.

Then in 1985 the oil industry was called upon to win the “Cold War.” History chronicles how Texas oil fueled both World Wars I and II, the Korean War and Vietnam. Now with President Reagan realizing that high oil prices were funding Russia’s Military threat by providing the hard dollars they could not otherwise obtain, he determined to dry up the source by destroying the value of oil on the world market. He did this by making a deal with Saudi Arabia to open the spigots creating a glut of oil on the world market and breaking the back of OPEC . It was a brilliant strategy. The “Cold War” ended, the wall came down and our domestic oil industry collapsed along with the Savings and Loans who were riding the prosperity of high energy values. So the cold war was won on the backs of the finest cadre of Geologists, Geophysicists and Petroleum Engineers our industry had ever employed. Then when we begged congress the help our domestic industry develop our own reserves and save this great human resource, they laughed and many of our brilliant young scientists ended up changing careers, teaching and some mowing lawns. Thus our industry lost our most important asset and now we are importing well over half of our oil from people who despise us.

No one expected the collapse to last for a decade, but it did. Next month I will describe survival in the eighties and early nineties on $3.00 oil and $1.00 natural gas. It wasn’t fun, but some of us eked by, some left the industry and others made fortunes.

Dan Pedrotti

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