Table of Contents

Executive Summary.................................................................................................... 2
Problem........................................................................................................................ 3
Corporate Objective.......................................................................................................... 4
Areas of Consideration...................................................................................................... 4
Resources.................................................................................................................... 12
Financial Profile............................................................................................................ 13
Competitive Advantage................................................................................................... 14
Alternative Strategies...................................................................................................... 15
Conclusion & Strategic Decision........................................................................................ 16

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Bibliography................................................................................................................ 16

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Executive Summary
Pioneer Petroleum had been formed in 1924 through the merger of
several for merely independent firms operating in the oil refining, pipeline
transportation, and industrial chemicals.
Over the next 60 years, the company integrated vertically into
exploration and production of crude oil and marketing refined petroleum
products, and horizontally into plastics, agricultural chemicals, and real
estate development. It was restructured in 1985 as a hydrocarbons-based
company, concentrating on oil, gas, coal and petrochemicals.
Pioneer was one of the primary producers of Alaskan crude, and in
1990, Alaska provided 60% of Pioneer's domestic petroleum liquids
production. Pioneer was also one of the lowest-cost refiners on the West
Coast and had an extensive West Coast marketing network.
In 1990 total revenues exceeded $15.6 billion and net income was
over $1.5 billion.

In 1990, for example, the price of West Texas Intermediate crude

during the first quarter was $21.80 per barrel, and it reached a low of about
$15.50 in mid-June. With the Iraqi invasion of Kuwait, crude prices rose to
more than $40 per barrel, but they fell to about $25 per barrel as the year
ended. The average price of West Texas Intermediate crude during 1990
was about $24.50 per barrel. Investment Details Pioneer spent about $3.1
billion on capital expenditures in 1990 and forecasted capital expenditures
of almost $4.5 billion in 1991. Some of these expenditures, like the addition
of a sulfur recovery facility and the improvement of a coker, allowed the
refineries to process the heavy Alaskan crude oil more efficiently.
Advantage: The light product yield in Pioneer's refineries was substantially
higher than the industry average investment was made in exploration and
development, as it replaced all its 1990 production with new reserves. Most
of this exploration was in the lower 48 states and the Gulf of Mexico.
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Volatility in crude oil prices was a major concern:

Investments were also directed to environmental projects, and Pioneer

anticipated spending an additional $3 billion in the next 5 years to meet the
new standards of the 1990 Clean Air Act amendments and the California Air
Resources Board's regulations. Advantage: Pioneer's gasoline were among
the cleanest burning in the industry, and its chemical unit produced about
one-third of the world's supply of methyl tertiary butyl ether (MTBE), which
was used to make cleaner-burning gasoline.
Issues One of the critical problems confronting management and the board
of Pioneer was the determination of a minimum acceptable rate of return on
new capital investments.
The company's basic capital budgeting approach was to accept all
proposed investments with a positive net present value when discounted at
the appropriate cost of capital. Overview (Pioneer Petroleum) Possible
Approaches: A single cutoff rate based on the company's overall WACC or
a system of multiple cutoff rates that reflect the risk-profit characteristics of
the several businesses

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The suggestion was that these multiple cutoff rates would determine
the minimum acceptable rate of return on proposed capital investments in
each of the main operating areas of the company and would represent the
rate charged to each of the various profit centers for capital employed.
WaCC The company's weighted average cost of capital was calculated in
three steps: the expected future target proportions of debt and equity in the
company's capital structure were estimated costs were assigned to each of
these capital components a weighted average cost of capital was
calculated on the basis of these proportions and costs.

Problem
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Institutional

Operational
What would be the better method of determining the minimum
acceptable rate of return on new capital investments?

Corporate Objective
1. To be able to determine the appropriate cost of capital to be used in
their Investment decisions.
2. To be able to finance its anticipated growth in the succeeding years
3. To be able to reduce investment risk

Areas of Consideration
Environmental Opportunities & Threats
Macro-Economic Indicators
Political
Environmental policy and politics in the United States have
changed dramatically over the past three decades. What began in the
late 1960s as an heroic effort by an incipient environmental
movement to conserve dwindling natural resources and prevent
further deterioration of the air, water, and land has been transformed
over more than three decades into an extraordinarily complex,
diverse, and often controversial array of environmental policies.
Those policies occupy a continuing position of high visibility on the
political agenda at all levels of government, and environmental values
are widely embraced by the American public. Yet throughout the
1990s environmental policies and programs were characterized as
much by sharp political conflict as by the consensus over policy goals
and means that reigned during the early to mid-1970s. As the twentyGroup 5

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I.

first century approaches, there is considerable value in looking back

at this exceptional period to understand the nature of the
transformation and its implications for the future.
Political scientists have used several different analytical and
heuristic frameworks to help explain the nature of agenda setting and
policy change over time. Among the most appropriate for
environmental policy development over the last three decades are
those advanced by John Kingdon, Frank Baumgartner and Brian
Jones, and Paul Sabatier and Hank Jenkins-Smith. To greatly simplify
their work, we can think about the rise of environmental issues on the
political agenda and agreement and disagreement over policy goals
and means as resulting from several different, but interacting, social
and political processes. Among the most important of these are
problem, policy, and politics "streams" of activities that operate
somewhat independently of each other but which also converge at
certain historical junctures. The convergence reflects the actions of
policy entrepreneurs and activists, and processes of debate and
learning that take place as differing advocacy coalitions compete.

The policy stream refers to the ensemble of policy ideas and

proposals that are developed by analysts, academics, legislators,
bureaucratic officials, interest-group representatives, and other policy
actors. They become the objects of political speeches, legislative
hearings, task-force studies, and published articles and reports. They
may also be the focus of pilot projects and experimental programs,
especially at the state and local level. In these ways proposals get
tested by the policy community for technical acceptability and political
and economic feasibility. Policy ideas that are inconsistent with the
prevailing political mood, such as recommendations during the 1970s
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The problem stream influences the policy agenda by providing

data about the state of environmental conditions and trends such as
air quality, use of toxic chemicals, or loss of biological diversity. The
data and assessments circulate among policy specialists, affecting
their perceptions and understanding of the problems regardless of
whether they produce any immediate effects on policy decisions. The
problem stream is also affected by catalytic or focusing events such
as crises or disasters, which may increase the salience of the issues
and influence the credibility of pertinent studies and reports.

to use economic incentives as an alternative to regulation, may be

dropped from consideration and relegated to the policy back burner
for warming or incubation until the climate improves-as it did during
the 1990s. (Kraft, 2000)
Economic
From November 1982 to July 1990 the U.S. economy
experienced robust growth, modest unemployment, and low inflation.
The "Reagan boom" rested on shaky foundations, however, and as
the 1980s progressed signs of trouble began to mount. On October
19, 1987 stock markets around the world crashed. In the U.S. the
Dow Jones Industrial Average lost over 22% of its value. Although the
causes of "Black Monday" were complex, many saw the crash as a
sign that investors were worried about the inflation that might result
from large U.S. budget deficits. The American housing market
presented another sign of weakness, as in the second half of the
1980s a large number of savings and loan associations (private
banks that specialized in home mortgages) went bankrupt. The
collapse of the S&L industry negatively impacted the welfare of many
American households and precipitated a large government bailout
that placed further strain on the budget.

Although the National Bureau of Economic Research has

concluded that the early 1990s recession lasted just eight months,
conditions improved slowly thereafter, with unemployment reaching
almost 8% as late as June 1992. The sluggish recovery was a key
factor in George H.W. Bush's defeat for re-election to the U.S.
presidency in November 1992. (1990-92 Early 1990s Recession,
2011)
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Although the 1987 stock market crash and the S&L crisis were
separate phenomena, they demonstrated the growing importance of
financial marketsand associated public and private sector debtto
the workings of the American economy. Other causes of the early
1990s recession included moves by the U.S. Federal Reserve to
raise interest rates in the late 1980s and Iraq's invasion of Kuwait in
the summer of 1990. The latter drove up the world price of oil,
decreased consumer confidence, and exacerbated the downturn that
was already underway.

The price of crude oil spiked in 1990 with the lower production,
uncertainty associated with the Iraqi invasion of Kuwait and the
ensuing Gulf War. The world and particularly the Middle East had a
much harsher view of Saddam Hussein invading Arab Kuwait than
they did Persian Iran. The proximity to the world's largest oil producer
helped to shape the reaction.
Following what became known as the Gulf War to liberate
Kuwait, crude oil prices entered a period of steady decline. In 1994,
the inflation adjusted oil price reached the lowest level since 1973.
The price cycle then turned up. The United States economy
was strong and the Asian Pacific region was booming. From 1990 to
1997, world oil consumption increased 6.2 million barrels per day.
Asian consumption accounted for all but 300,000 barrels per day of
that gain and contributed to a price recovery that extended into 1997.
(Oil Price History and Analysis)
Demographic
West Coast or Pacific Coast are the terms for westernmost
coastal states of the United States, usuallyCalifornia, Oregon,
and Washington. More specifically, the term refers to an area defined
on the east by theCascade Range, Sierra Nevada, and Mojave
Desert and on the west by the Pacific Ocean. The U.S.
Censusgroups the five states of California, Oregon, Washington,
Alaska, and Hawaii together as the Pacific Statesdivision
As of the 2010 Census, the estimated population of the Census
Bureau's Pacific Region was approximately 47.8 million (56.9 million
if Nevada and Arizona are included) about 15.3% (18.2% with
Nevada and Arizona) of US population. The largest city on the west
coast of the United States is Los Angeles. (States)

Since the West Coast has only been populated by immigrants

recently, compared with the East Coast, its culture is considerably
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Socio-Cultural

younger. Additionally, its demographic composition underlies its

cultural difference from the rest of the United States. California's
history first as a major Spanish colony, and later Mexican territory,
has given the lower West Coast a distinctive Hispanic tone, which it
also shares with the Southwest. Similarly, two of the three cities in
which Asian Americans have concentrated, San Francisco and Los
Angeles, are located on the West Coast, with significant populations
in other West Coast cities. San Francisco's Chinatown, the oldest in
North America, is a vibrant cultural center.
Compared to the East Coast, the West has generally been
considered less bounded by tradition and more freely engaged and
open to new ideas. The West Coast also has a proportionally larger
share of green cities within the United States, which manifests itself in
different cultural practices such as bicycling and organic gardening.
On the other hand, the French writer Guillaume Faye, comparing
California to Europe, wrote that "as super-America, California stands
out as the absolute antithesis of authentic Europe. California has set
itself up as the world centre of the simulacrum and the inauthentic, as
the absolute synthesis of cool Stalinism. An hysterical land; focus
and meeting-place for the rootless, California is the land of nonhistory, of the non-event, but at the same time the site of the constant
swirl, the uninterrupted rhythm of fashion, that is to say, the site of
tremors going nowhere, those tremors which so obsess it, constantly
threatened as it is by earthquakes." Other writers, like Jean
Baudrillard, Mike Davis, and Umberto Eco, have made related
statements on Californian culture. (West Coast of the United States)
Market Profile and Outlook
Over the next 60 years, the company integrated vertically
into exploration and production of crude oil and marketing refined
petroleum products, and horizontally into plastics, agricultural
chemicals, and real estate development. It was restructured in 1985
as a hydrocarbons-based company, concentrating on oil, gas, coal
and petrochemicals. Pioneer was one of the lowest-cost refiners on
the West Coast and had an extensive West Coast Marketing
Network. It made several investments mainly in production and
exploration. It also participated in the Government Environmental
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II.

projects like Clean Air Act. This is an opportunity for them to capitalize
its strengths since its gasolines were among the cleanest-burning in
the industry. They anticipate that promoting these environmental
projects would open up market to their products thus, growth was
anticipated.
III.

Competition
Pioneer Petroleum Corporation was one of the market leaders
in the oil business, especially in the West Coast. It was stated that the
company was one of the lowest-cost refiners at that time, making it
easy for them to be competitive. Actually, in the oil industry, price is
not the major element for competition because of the price
regulations covering it.
The group suggests that, in order to be competitive, a company in the
oil business should provide high quality of service. These can be
manifested in Pioneer Petroleum because of their exploration
initiatives, spending to comply with the new standards of the United
States 1990 Clean Air Act amendments and regulations of California
Air Resource Board, and putting up SMOGMAN service centers.
The exploration initiatives could result to lower prices of products and
therefore benefit the consumers. Complying with the government
standards and regulations assures the continuity of services to
customers, at the same time, help the environment and the
community. Putting up service centers contributes to the marketing of
the products of the company.
Considering the activities of Pioneer Petroleum Corporation, we can
conclude that they were a leader in terms of competition. The
exploration initiatives suggested their vision and competitive
advantage over the other petroleum companies. In addition to their
market position of having one third of the worlds supply of methyl
tertiary butyl ether (MTBE), which was used to make cleaner-burning
gasoline.

Technology
Since 1990, the industry has invested toward improving the
environmental performance of its products, facilities and operations.
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IV.

The Industry also have invested in technologies to produce even

cleaner fuels and meet the growing variety of state and local
mandates for fuel formulation.
Access to new technology is increasingly facilitated by the
Internet, which allows a front-line engineer to research, identify and
even procure technologies from any corner of the globe.
The U.S. government has contributed significant research and
development dollars over the years. Through the Department of
Energy, and in particular the National Energy Technology Laboratory
(NETL), research and development money has been made available
to National Laboratories, universities, consortia, and smaller
companies. Other countries also contribute to the overall technology
advancement through R&D programs. (Technology Development
and Deployment, 2006)
Useful Tools and Models

Capital Budgeting
If a company is faced with a decision whether to go or not to go
into a project or a new line of business, the decision maker can use
a method in order to have a sound analysis of the choosing which
one should be done. This decision method is called Capital
Budgeting. And under Capital Budgeting, there are two common
methods being used to come up with a decision the IRR Method
and the ERR Method. They are ruling based methods where
several factors are needed. In general, these factors are the cost of
capital or investment (I), annual costs or repetitive costs or
operational costs (C), annual benefits or revenue (A) and the
minimum rate of return or others call it the minimum attractive rate
of return (MARR). Now, assuming that the factors or values are
good representative of the possible business or project venture,
these values are being used to generate an equation as follows,
NPV (I,C,A,i) = 0;
It this equation, the factor being solved is i, which is called the
internal rate of return (IRR) or, for more complicated equations, it is
called the external rate of return (ERR). The IRR or ERR are being
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V.

solved using iterative methods. And once the IRR or ERR is

derived, it is being compared with th
e minimum rate or return using the following decision rules:

If i < minimum rate of return, then reject project or new line of

business;
If i = minimum rate of return, then either go or not to go will
do (breakeven point); and
If i > minimum rate of return, then accept project or new line
of business.

Now, this is why the minimum rate of return is critical to decision

making; if it has been derived lower than it should be, the company
might suffer the consequence of being unprofitable with an
accepted project or new line of business. At the same time, if the
minimum rate of return has been made too high, the Pioneer
Petroleum might lose the opportunity to be in a business venture
that is actually beneficial to the company but has been rejected
based from the IRR or ERR Method. This is the reason why the
minimum rate of return is an important value because it can make
or break a decision by setting it too low or even too high.
The minimum rate of return should be a value that came from
defined and known benefits/losses sensitive factors in the
company. Those factors that can trigger effect to important values,
like loan interest rates, because the money from the project might
be borrowed from the bank. And actually, that is the dilemma of the
company now, whether which rate is more sensitive to the benefits
or losses with regards to choosing a project or new business line of
the company; which is most likely the breakeven point rate of the
Pioneer Petroleum the single cut-off rate or the multiple cut-off
rate. These are being discussed in the following sections of the
paper.

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CAPM MODEL

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A model that describes the relationship between risk and

expected return and that is used in the pricing of risky securities.

The general idea behind CAPM is that investors need to be

compensated in two ways: time value of money and risk. The time
value of money is represented by the risk-free (rf) rate in the formula
and compensates the investors for placing money in any investment
over a period of time. The other half of the formula represents risk
and calculates the amount of compensation the investor needs for
taking on additional risk. This is calculated by taking a risk measure
(beta) that compares the returns of the asset to the market over a
period of time and to the market premium (Rm-rf).

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The CAPM says that the expected return of a security or a

portfolio equals the rate on a risk-free security plus a risk premium. If
this expected return does not meet or beat the required return, then
the investment should not be undertaken. The security market line
plots the results of the CAPM for all different risks (betas). (Capital
Asset Pricing Model - CAPM)

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Resources
I.

Corporate Franchise
Pioneer Petroleum had been formed through the merger of several
for merely independent firms operating in the oil refining, pipeline
transportation, and industrial chemicals. It is operating mainly in the
West Coast of the United States.

II.

Shareholders & Key Officers

Management
Board of Directors
Marketing Profile
Products
a. Oil including Alaskan Crude oil
b. Gas
c. Coal
d. Petrochemicals
Place & Distribution
Pioneer was one of the lowest-cost refiners on the West Coast
and had an extensive West Coast Marketing Network.
Promotion and Advertising
Pioneer Petroleum has been formed through the merger of
several formerly independent firms. It had an extensive West coast
marketing network.
Some investments were directed to environmental projects.
One of its anticipated spending was to meet the standards of 1990
Clean Air Act and the California Air resources Boards Regulations.
These environmental regulations provided opportunities for Pioneer
to capitalize on its strengths. Pioneers gasoline were among the
cleanest-burning in the industry. And its chemical unit produced about
one third of the worlds supply of methyl tertiary butyl ether (MTBE),
which was used to make cleaner-burning gasolines. The market for
MTBE had been growing, and the new regulations were expected to
lead to even higher growth.
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III.

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Financial Profile

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Competitive Advantage
SWOT Analysis
Strengths

Weaknesses

Market Position

Variable product prices

Extensive west coast

marketing network

Lowest cost refiners on the

west coast
Financial flexibility

Opportunities

Threats

Exploration activities

Middle East countries

Government environmental
projects

Volatile oil prices

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A rated Debt

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Alternative Strategies
1. Overall Cost of Capital
Use a single cutoff rate based on the companys overall Weighted
Average Cost of Capital
This shall be done in three steps:
1. The expected proportions of future funds sources were estimated.
2. Costs were assigned to each of these sources
3. A weighted average cost of capital was calculated on the basis of
these proportions and costs
Disadvantages
> Does not take into account
variances between different
divisions
> Subsidized the higher-risk
divisions at the expense of
the lower-risk divisions resulting to too few low-risk
investments made
> Resulted to being lagged
behind competitors which
made more low-risk
investments
> Targets set company-wide
were too low

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Advantages
> No adjustments or costs to
be incurred to implement
system
> Accounts for shared risk
among the various divisions

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2. Divisional Cost of Capital

Use a system of multiple cutoff rates that reflect the risk-profit
characteristics of the several businesses or economic sectors in
which the companys subsidiaries operated.
This shall be done in three steps:
1. An estimate would be made of the usual debt and equity
proportions of independently financed firms operating in each
sector.
2. The costs of debt and equity given these proportions and sectors
would be estimated in accordance with the concepts followed by
the company in estimating its own cost of capital.
3. These costs and proportions would be combined to determine the
weighted average cost of capital, or minimum acceptable rate of
return, for net present value discounting purposes in each sector.
Advantages
> Reflects the risks inherent
in each of the economic
sectors or industries
> More accurately describes
the position of the company
since information is specific
to each division

Disadvantages
> Implementation of new
system will entail changes
and probable costs
>Still has areas of ambiguity
(e.g. discount rate)
>Overlooked the risk
diversification benefits of
many investments

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Conclusion & Strategic Decision

Based from the ratings given to each of the ACAs using the four decision
criteria or states of nature, ACA2 had a higher score of 81.0%. This means
that the company should be using the multiple cut-off rates in order to
have a minimum rate of return that can best represent the decision
guideline in accepting or rejecting a project or new business venture.
As discussed in the case, the multiple cut-off rate system shall be done
through three steps:
1. An estimate would be made of the usual debt and equity
proportions of independently financed firms operating in each
sector.
2. The costs of debt and equity given these proportions and sectors
would be estimated in accordance with the concepts followed by
the company in estimating its own cost of capital.
3. These costs and proportions would be combined to determine the
weighted average cost of capital, or minimum acceptable rate of
return, for net present value discounting purposes in each sector.

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On top of the above steps, the management must also employ measures to
address the identified loopholes of the said approach such as (1) setting up
a budget for implementation, (2) addressing areas of ambiguity by
providing specific stipulations and (3) taking into account diversification
benefits.

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Bibliography

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1990-92 Early 1990s Recession. (2011, March 7). Retrieved November 11,
2014, from http://bancroft.berkeley.edu/:
http://bancroft.berkeley.edu/ROHO/projects/debt/1990srecession.html
Capital Asset Pricing Model - CAPM. (n.d.). Retrieved November 11, 2014,
from Investopedia: http://www.investopedia.com/terms/c/capm.asp
Kraft, M. E. (2000). U.S. Environmental Policy and Politics: From the 1960s
to the 1990s. Project Muse , 17-42.
Oil Price History and Analysis. (n.d.). Retrieved November 11, 2014, from
wtrg.com: http://www.wtrg.com/prices.htm
Technology Development and Deployment. (2006, November 22).
Retrieved November 12, 2014, from npc.org:
http://www.npc.org/study_topic_papers/26-ttg-ogtechdevelopment.pdf
(2013). The State American Energy. API.
West Coast of the United States. (n.d.). Retrieved November 11, 2014,
from Wikipedia:
http://en.wikipedia.org/wiki/West_Coast_of_the_United_States

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