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500 N.E. Multnomah St., Suite 1500
Portland, Oregon 97232-2045
(503) 731-6600
Fax: (503) 230-9045

Public Company
Employees: 2,200
Sales: $919.9 million
Stock Exchanges: New York Toronto
SICs: 1041 Gold Ores; 1044 Silver Ores; 1221 Bituminous Coal & LigniteSurface

NERCO, Inc., is a Fortune 500 company that produces and markets low-sulfur coal, oil, and natural gas. NERCO had also been involved in gold and silver mining, though the company was working to divest its precious metals holdings.

Pacific Power & Light Companylater PacifiCorp Inc.created NERCO in 1977 when federal laws mandated the development of federal coal leases, forcing PP&L to dispose of 1.4 billion tons of Wyoming and Montana coal reserves. PP&L chairman Don C. Frisbee appointed utilities lawyer Gerard K. Drummond president of NERCO and charged him with developing PP&Ls uncommitted coal reserves and reinvesting cash flows.

The assets Drummond had to work with at that time were a 50 percent nonoperating share of the Decker mine in southeastern Montana, a two-thirds interest in the Jim Bridger mine near Rock Springs, Wyoming, and management of the David Johnston mine near Glenrock, Wyoming. NERCO also had several long-term contracts with major coal burning utilities in the Midwest and Southwest.

Drummond reorganized NERCO into a holding company with four operating companies: NERCO Mining Company, the companys center piece and over the long term its most stable component; NERCO Coal Company, which would invest in eastern coal; NERCO Minerals Company, which would invest .in minerals and precious metals; and NERCO Oil & Gas, Inc., set up to explore for oil and gas reserves.

Our diversification strategy is intended in part to overcome the reality that a natural resource company faces in eventually depleting finite resources, Drummond explained in NERCOs 1984 annual report. More important, this strategy allows us to apply our technical knowledge and management abilities to other businesses that offer attractive growth opportunities.

Drummonds first attempt at diversification did not prove to be a success. He bought heavily into a Wyoming-based uranium exploration and development company. Two years later he joined with Union Carbide Corporation to explore and develop uranium resources in New Mexico. When the bottom dropped out of the uranium market in 1980, NERCO ended those activities.

Coal was the next area on which Drummond concentrated. In 1978 NERCO acquired surface mines in Indiana, Alabama, and Tennessee. In 1980 the company completed the Spring Creek Mine, a southern Montana facility with an annual capacity of 10 million tons.

Drummond also decided to diversify into precious metals. NERCO acquired gold and silver rights in eastern Oregon in 1980. The next year the company purchased Resource Associates of Alaska, Inc., an expertise-laden exploration company that held mineral rights to five million acres in Alaska. In addition, in December of 1982 NERCO agreed to buy Occidental Petroleums Occidental Minerals Corporation, an outfit which held half interest in the Alligator Ridge Gold Mineone of the countrys ten largestand a controlling interest in the Candelaria silver and gold minethe countrys largest open-pit primary silver minein Hawthorne, Nevada.

NERCO did well in the first years after its organization. Revenue rose from $72.1 million in 1977 to $215 million and $372.1 million in 1980 and 1981, while income rose from $12 million to $46.1 million and $29.1 million, respectively. The one cloud on the horizon was a dispute about a long-term coal contract. A subsidiary of Houston Industries, Inc. sought to halt deliveries from Spring Creek. Houston claimed they were having combustion problems, though the coal met contract specifications. NERCO temporarily provided replacement coal, but the dispute remained.

In 1982 NERCO entered the oil and gas business when they acquired Clements Energy, Inc. (CEI), a small exploration company based in Oklahoma City. Almost immediately CEI ran into financing problems. Before the company could redirect its fund-raising efforts, it lost much of 1983 to the problem. NERCO officials later stated in the companys 1984 annual report that their timing was poor in buying CEI.

Already the countrys fifth-largest coal producer, according to Coal Age, NERCO added reserves, people, and barge and rail loading facilities to its eastern coal operation in 1983. Its strategy was to discover customer needs, then develop products and services to meet those needs.

In its minerals business, NERCO moved away from risky exploration. Its new strategy was to buy undervalued properties and improve their operating efficiencies. To this end, the company acquired two open-pit Nevada silver and gold mines and lowered Candelarias silver production costs 16 percent to under $6.00 per ounce.

Though 99 percent of revenues still came from the coal business, at the end of 1983 company officials were happy to report progress in diversification. Total revenue for the year reached $415.4 million, while income topped $38 million.

1984 proved to be another good year. NERCO made a major metals acquisition; went public in August, selling ten percent of its shares; and signed several new coal contracts. Overall earnings topped $54 million, and return on equity reached 20 percent.

At NERCO Minerals, low metals prices made long-term investment properties available. For a total of $40 million, the company purchased interests in the Taylor Silver Mine in Nevada, the DeLamar Silver Mine in Idaho, and the Victor Gold Mine in Coloradoacquisitions that made NERCO a top five U.S. silver producer and one of the top ten U.S. gold producers. Unfortunately, low prices also kept the companys metals off the market, forcing NERCO Minerals to store, rather than sell, 3.5 million ounces of silver and 40,000 ounces of gold.

NERCOs western coal operation landed several long-term utility contracts and broke into the industrial market with four new sales contracts, including a 550,000 ton-per-year contract with American Crystal Sugar Company. Overall, the western operation sold 21.3 million tons of coal, two-thirds of which it mined itself.

In the East, NERCO acquired mines, reserves, and coal handling facilities in West Virginia, Kentucky, and Indiana. The company began to make headway in the area, signing supply contracts with Ford Motor Co., Alabama Power Company, and the Tennessee Valley Authority. Sales of 3.4 million tons of coal in 1984 nearly doubled 1983 levels, while revenues increased to about $98 million from $48 million the previous year.

At NERCO Oil & Gas, exploration results improved, following a rough start-up period. The company lowered finding costs and secured a higher level of industry participation. Of 48 wells in which the company participated, 24 were expected to be productive.

Drummond faced several problems in 1985. Total earnings dropped a disappointing 20 percent to $43.4 million. Oil and gas operations lost $35 million on exploration; low prices kept mineral production off the market; a new gallium arsenideused in the electronics industryoperation turned in unspectacular results; and the western coal operations were hit with lawsuits from long-term coal customers. The City of Austin in Texas and the Lower Colorado River Authority jointly sought to void a two million ton-per-year agreement with the Decker mine, while Detroit Edison sought restitution and damages for amounts overpaid in prior years.

Drummond and other executives took what actions they could. The measures included replacing the oil and gas management, cutting personnel, and reducing exploration in favor of development drilling and production purchases. In minerals, they reduced operating costs, hedged prices, and began selling inventory to provide cash for operations. To make the coal operations more efficient and reduce overhead, they combined the western and eastern subsidiaries into NERCO Coal Corp., headquartered in St. Louis, Missouri.

There was some good news in 1985, however. Despite lawsuit-related contract terminations, NERCO Coal sold 27.9 million tons of the product, up from 24.7 million tons the previous year. The company also signed multi-year contracts with American Crystal Sugar Company, Western Sugar Company, and Wisconsin Public Service Corp.

NERCO also continued making strategic acquisitions and investments. It purchased the remaining interest in the DeLamar silver and gold mine and opened the Antelope Mineits tenth surface coal mineon the southern edge of Wyomings Powder River Basin. In addition, a joint operating agreement was formed with Mitsubishi, creating the MitNer Group to market coal and coal services internationally.

In 1986, NERCO Coal resolved one of its legal disputes. For a $29 million payment, the company agreed to lower rates to the financially-strapped Platte River Power Authority in Colorado. Wrangling continued, however, in other cases, including a dispute in which Utility Fuels withheld approximately $35 million. Despite these problems, yearly coal sales increased, driven in part by the newly opened Antelope Mine.

Flagging prices kept NERCOs minerals business in the red during 1986. It continued to expand, however, obtaining new reserves and lowering costs. The company paid $47 million for the Con gold mine in the Northwest Territories of Canada. Operating costs throughout its system were lowered with such measures as dropping the cost of an ounce of Candelaria silver from $5.95 in 1984 to $4.84 in 1986.

The oil and gas business also lost money in 1986. Management cut costs by putting the subsidiary under the direction of the minerals division and cut risk by moving from exploration to development. It also acquired undeveloped reserves in West Virginia and participated in a joint venture with its parent company, PacifiCorp Inc., to encourage cogeneration.

1987 was a good year for NERCO. The coal arm of the business resolved its legal disputes, minerals were profitable, and although both the oil and gas and advanced materials operations lost money, the company as a whole increased revenue six percent to $632.3 million, while income rose five percent to $60.1 million.

NERCO Coal cut deals with most of its legal adversaries. It lowered prices to Utility Fuels in exchange for a $106 million payment, replaced Louisiana Power & Lights 20-year coal contract with a 25-year natural gas agreement, and early in 1988 settled with the Lower Colorado River Authority/City of Austin for a cash payment. In February of 1988 the company agreed to let Commonwealth Edison of Chicago purchase in-ground reserves rather than take delivery.

The Wall Street Transcript gave Drummond and NERCO its 1987 Coal Industry Bronze Award. Editors concluded, Despite the fact that this company has faced some very difficult contract negotiations and litigation, management has responded calmly and decisively, maintaining a clear focus on operation and profitability.

Rising commodity prices led NERCO Minerals to its first profitable year since 1983. Overall gold sales were up 39 percent to 153,000 ounces and silver sales were up almost 74 percent to 9.1 million ounces. In addition, the company lowered its extraction cost for silver eight percent to $4.06 per ounce and added reserves by exploring at mine sites and building a carbon-in-leach plant at Alligator Ridge.

On the downside, gallium arsenide wafers were a small drain, and oil and gas lost $6.7 million on $14.1 million in revenues. Despite losses, the oil and gas subsidiary continued acquiring reserves, spending $65 million on production and low-risk properties on the Gulf Coast.

In 1988 NERCOs oil and gas business finally recorded a profit, earning $9.5 million on revenues of $88.9 million. Much of the jump came from $284 million in natural gas acquisitions. Included among the acquisitions were a 55 percent interest in Northern Louisianas Black Lake Field for $150 million, as well as more of the same field purchased from Hunt Petroleum for $35 million, and Enrons interests in Louisiana and Texas acquired for $90 million.

Despite the fact that coal was still king70 percent of NERCOs revenues were generated from the coal businesslosses of volume from contract settlements meant the company had to intensify marketing efforts. It sold its first steam coal to Japan, began constructing a new dragline at Antelope, and exploited a Venture Fuels joint venture with Detroit Edison to deliver Spring Creek coal to Minnesota Power & Light and other new customers. Minerals also remained profitable in 1988, but because of lower silver sales, revenues fell 24 percent to $100.1 million while income fell to $5.3 million.

The company continued to grow in 1989. Newly-appointed NERCO Inc. president Lawrence E. Heiner, formerly president of NERCO Minerals, could be proud of revenues which reached $711 million. In addition, income hit $68.1 million, and return on equityearnings per share plus stock appreciationhit a fantastic 63.5 percent, chiefly because of share appreciation.

The appreciation was caused by three factors. A 5.16 million share offering made the stock more visible. Investors expected natural gas prices to riseNERCO was among the top 40 U.S. producersand company watchers anticipated pending air quality legislation would increase demand for low-sulfur coal.

NERCOs three main businesses were all up over the previous year. Gas sales jumped 94 percent, while oil sales rose 16 percent. Combined oil and gas revenues of $151.1 million were 70 percent above 1988, while income of $31.1 million tripled the previous years. In December of 1989 the company announced a $162 million purchase of natural gas and oil interests off the shores Louisiana and Texas.

At NERCO Minerals sales were up43 percent for gold and 22 percent for silver. Increased sales and lower extraction costsespecially at the underground Con mine, where gold extraction costs fell 23 percent to $230 per ouncepushed revenues up 21 percent to $121.1 million and boosted operating income 8 percent to $9 million.

NERCO Coal Companywhich still accounted for 61 percent of earnings and represented stability for the companypaid $35 million for the Bright Coal Groups rights to 44 million tons of low-sulfur West Virginia coal. The company also completed a 75 cubic yard dragline at Antelope and replaced a fleet of haul trucks with a coal conveyor system at the Jim Bridger Mine.

The one down side of 1989 was the closure of non-core businesses. These included the short-lived Cascade Information Resources, Inc., and the gallium arsenide operation, Spectrum Technology, Inc., for which it took a $7.9 million pre-tax charge.

In 1990, NERCO had another excellent year, reaping $827.7 million in revenues and $167.5 in income. Coal sales increased 13 percent to 36.1 million tons, natural gas production rose to a record 69.2 billion cubic feet, and gold production reached 181,100 ounces. Despite these results, however, NERCOs stock price fell 16 percent due to the markets belief that decreased prices for some of NERCOs commoditiesparticularly natural gas and silverwould negatively effect the companys earnings potential. In fact, during 1990, natural gas prices were soft, gold prices fell to their lowest point in 4 years, and silver reached a 15-year low, falling below $4 per ounce, prompting the suspension of mining at NERCOs primarily silver operation.

The situation worsened in 1991 as spot prices weakened for the companys products, and the recession and weather reduced market demand. Compounding these factors, NERCO incurred substantial debt, funding an acquisition that led to increased interest expense. Though both revenue and income continued to rise, the market, in light of these developments, sent stock prices down another 13 percent.

Faced with this tough operating environment, Lawrence E. Heinerwho had been elected chief executive officer that yearrestructured NERCO in order to reduce costs. In an effort to lower debt and future risk, he also sold or transferred several assets. The main problem the company had to deal with was falling prices for both gold and silver. NERCO cut silver sales in half as mineral revenues fell 18 percent to $91.4 million and income fell 96 percent to $.4 million. Management considered selling the precious metals operation but continued to increase capacity, commencing production in the Colorado Cripple Creek District, beginning an autoclave project at the Con mine, and initiating a new cyanide recycling system at DeLamar.

At this point, the other business concerns seemed basically healthy. NERCO Coal set a production record for the third consecutive year and retained a healthy $135.9 million in profits from revenues of $530.5 million. It settled a labor dispute at Decker and a contract dispute with a Wisconsin utility. It increased international sales and transferred ownership of Bridger Coal Company and Glenrock Coal Company to Pacifi-Corp. Since Federal air quality legislation was making low-sulfur coal the countrys preferred fuel, NERCO Coal also sold two of its higher sulfur operations in Indiana.

NERCO Oil & Gas made a major acquisition in 1991, paying approximately $500 million for the offshore assets of Union Texas Petroleum Holdings, Inc. These new holdingswhich increased natural gas production 44 percent and added 41 percent in proved reservesmade NERCO a top 20 U.S. independent natural gas producer and one of the largest independent producers in the Gulf of Mexico. The acquisition also raised revenues 39 percent to $297.7 million, while boosting income 22 percent to $62.4 million. To reduce delivery exposure, NERCO also sold its 25-year gas supply contract with Louisiana Power & Light for $75 million.

Early in 1992 conditions worsened for NERCO as high reserves, a week domestic economy, and the warmest winter weather in more than 100 years drove natural gas prices to a 12-year low. The situation caused a downgrade in NERCOs credit rating, which in turn resulted in higher credit costs.

In the first quarter of 1992, the company reported a net loss of $172.8 million and was forced to take a non-cash, after-tax $150 million write-down of the carrying value of its oil and gas assets. The company worked to reduce debt, strengthen its balance sheet, and position itself to improve its credit rating.

Selected assets in all three of its business units were divested, and the sale of the entire minerals subsidiary was under consideration.

Prices recovered strongly during the second quarter, but in the third quarter the company reported a loss of $25.7 million associated with the sale of several non-core oil, gas, and coal assets at depressed prices. In addition, NERCO had finally decided to divest its minerals operations and was working toward that end. Due to the depressed minerals market, the companys third quarter report predicted such a sale could result in a pre-tax loss in excess of $150 million.

Principal Subsidiaries

NERCO Coal Corp.; NERCO Oil & Gas, Inc.; NERCO Minerals Company.

Further Reading

Green, Peter, Dan Jackson, and Paul C. Merritt, Nerco Tops 20-Million-tpy Mark, Coal Age, October 1982; NERCO Says Profit Fell in 4th Period on Units Loss From Operations, Wall Street Journal, January 30, 1986; Annual Reports, 1986-91, Portland, OR, NERCO Inc.; NERCO, Inc., Wall Street Transcript, December 12, 1988.

Jordan Wankoff