Over the last thirty years, participation in Boy Scouts has declined by ~50%.  My children now have many more options. Back in the eighties, we stalked real coyotes and rattlesnakes through the brush—not imaginary Pokémon. While scouting was certainly entertaining, it also taught me important lessons.  One in particular often comes to mind—incrementalism.  It’s also a good lesson for our struggling energy industry.

Incrementalism means a “method of working by adding to a project using many small incremental changes instead of a few (extensively planned) large jumps.”  (Wikipedia)  This is precisely the basis for advancement in scouting.  Boy Scouts progress through seven sequential ranks—(i) Scout, (ii) Tenderfoot, (iii) Second Class, (iv) First Class, (v) Star, (vi) Life, and (vii) Eagle Scout.  Each requires increasing levels of skill and responsibility.  For example, the Star rank is achieved only after serving at least four months in a leadership position and earning six merit badges.

There are currently ~140 merit badges.  The business merit badge, for example, requires a scout to meet with entrepreneurs, start his own business, and then run it for three months.  I earned the badge by selling catalog shoes to teachers in my small town.  It worked because the nearest mall was an hour and a half drive.  There literally was no competition.  This and other scouting experiences taught me how a series of small accomplishments can build toward intermediate rewards (merit badges), and eventually, lead to even larger ones (advancement in rank).

Such incrementalism, however, is not a hallmark of the energy industry.  I once spent an afternoon sitting with Lord John Browne (former CEO of BP) in his London office.  He was vetting my plan to acquire several small exploration blocks across Africa.  At the end of our meeting, I asked him what was the most valuable lesson he learned at BP.  “Do the biggest deals possible,” he replied.  With those words, I realized that Carlyle/Riverstone was not going to fund my incremental-themed company.

To Lord Browne’s credit, it’s a truism that if two deals yield the same percentage return, the larger will be more profitable.  But what if a big deal goes bad?  I’ve spent two decades working energy projects around the world.  It’s hard to predict ex ante which ones will be successful.  Even if an asset is geologically sound, it may be lost by force majeure or self-inflicted disaster.  Acquisitions of companies similarly face uncertainty.  How many energy mergers have lived up to their dreams of synergies and cost savings?

Then there is the matter of commodity price cycles.  I just glanced at the United States government’s oil price forecasts from mid-2014.  The EIA August report stated “EIA projects Brent crude oil prices to average $107/bbl over the second half of 2014 and $105/bbl in 2015.”  Four months later, Brent was about ~$60, and the average for 2015 was only ~$52.

Buy low and sell high is easier said then done.  Dollar-cost averaging is a form of incrementalism, a “technique of buying a fixed dollar amount of a particular investment on a regular schedule, regardless of the share price.” (Wikipedia).  When an energy company makes many smaller acquisitions over time, it effectively dollar-cost averages.  Doing so helps to protect against commodity crashes.  In contrast, a company that borrows heavily to make a large acquisition may be more vulnerable to price declines, even with hedging.

For every billionaire made by Lord Browne’s “go big” strategy, there have been many more bankruptcies. The Boy Scout motto is “BE PREPARED.”  Incrementalism may not be the recipe for landing on the Forbes list, but it’s good advice for building an energy company.  A diversity of assets acquired over time helps to prepare for both price volatility and the occasional bad deal.

Boy Scouts

About the Gaille Energy Blog.  The Gaille Energy Blog discusses issues in the field of energy law, with weekly posts at http://www.gaillelaw.com.  Scott Gaille is a Lecturer in Law at the University of Chicago Law School, an Adjunct Professor in Management at Rice University’s Graduate School of Business, and the author of two books on energy law (Shale Energy Development and International Energy Development).