(FORTUNE Magazine) – THE PARTY DAYS that oil brought to Texas are over -- probably for good, most Texans admit -- and the hangover in the state's economy is taking its sweet time to end. Though the state is trying to swear off oil, the cure will take $ years, and things may never be as much fun as before. Are the unpleasant economic changes out of control or can some indefinable Texas spirit wrangle up renewed growth? Texans are putting on their spurs. ''This,'' says a local economist, ''is a testing time for cowboy capitalism.'' Oil seeps into almost every nook of the state economy, and the Texans being tested include everyone from bankers and real estate developers to high school tuba players. The stakes are big. Texas produced some $290 billion of goods and services last year, or roughly 7.5% of the gross national product. About 22% of what the state produces is tied to energy and petrochemicals, making Texas five times more dependent on the oil and gas business than the country as a whole. Until the oil boom ended, there seemed no limit to how high the Texas economy -- and Texas real estate prices -- could go. Near the end of 1981 the number of drilling rigs in operation nationwide peaked at 4,530. Six months later the bust was on in earnest, and drilling rigs fell idle. Within 18 months 116,900 oil industry jobs were lost in Texas. A big bank in West Texas, the First National Bank of Midland, failed because of bad energy loans in 1983. InterFirst Corp. in Dallas, the state's biggest bank holding company, lost $443 million to bad loans the same year and isn't out of the gully yet. Nowadays working rigs are down to 1,821. So dentists have returned to drilling teeth instead of wells, and auto workers-turned-roustabouts have gone back to Detroit. But Texas won't return to old notions of normal because the state's oil and gas are running out. Production has declined steadily since 1972, when a record 1.3 billion barrels of oil and 9.6 trillion cubic feet of gas were removed from the ground. And the economics of the business has seriously deteriorated, as two facts make clear: the state produced a third less oil and gas in 1984 than it had in 1972, while drilling increased threefold. Finding new reserves is becoming so difficult that many small oil companies will be unable to keep going. Stronger operators will have to improve their ways of doing business. Says Ray Hunt, 42, president of Hunt Oil Co.: ''We'll never go back to the good old days of the oil industry.'' Hunt Oil is a still- healthy company that Ray Hunt owns independently of half-brothers Nelson and Bunker, whose fortunes are squeezed between oil and silver. Ray Hunt is expanding operations overseas and is trying to improve his company's oil- ! seeking technology. Lest anyone mistake the oil industry's doldrums as something cyclical, Hunt says: ''We're not going through a downturn. We're going through a fundamental restructuring.'' The flashy wealth of the oil patch cities of East and West Texas once overshadowed the steady growth of the state's diversifying midsection, but no more. Economic diversification has become almost a state religion. Those preaching the new creed point to Dallas, Fort Worth, Austin, and San Antonio, which lie along Interstate 35, a north-south route that runs through the center of the state where, J. R. Ewing notwithstanding, little oil and gas have been found. These heart-of-Texas cities thrive on a mix of services, tourism, high-tech industries, plain old Sunbelt growth, and a goodly dose of hype and real estate speculation. ''The haves of ten years ago are becoming the have-nots,'' declares Edward McClelland, a vice president of RepublicBank in Dallas, the second-largest Texas bank company. ''And the have-nots are becoming the haves.'' He is speaking geographically. Some Texan haves are bestirring themselves to seek opportunities in the new economic era. Among them is Clayton W. Williams Jr., an oilman-rancher-banker-developer in the West Texas city of Midland and practically a microeconomy unto himself. Hardly the button-down type, he often sports a Stetson, boots, and a silver belt buckle not far from the size of a hubcap. His Midland office includes a stuffed bighorn sheep and several bearskin rugs. Williams took on about $400 million of debt during the inflationary, oil- boom years of the late Seventies, but now he's scaling way back. ''I paid $40 million in interest last year,'' he says. ''I'm not smart enough to keep doing that.'' He held a livestock sale last year in the atrium of his Midland bank (named ClayDesta National Bank, after himself and his wife, Modesta) and draped each cow with a $6,500 string of pearls ''to make them look pretty.'' The sale raised $362,000. He is selling four of his 12 ranches and a million acres of oil leases. He's hanging on to his best million acres. WHILE WILLIAMS is chopping up his land-based businesses, he's diversifying into a brand-new business: telecommunications. Annoyed at Southwestern Bell's slowness in wiring his ClayDesta Plaza office buildings in Midland in 1982, he decided to do the job himself. ''It worked out so well, I looked into it some more,'' he says. He discovered that banks and oil companies in the sprawling expanses of West Texas wanted high-speed digital connections for their computers and phones, but no one had gone after their business. Now he's formed his own long-distance telephone company, ClayDesta Communications, and is building a $40-million network of microwave towers to connect such cities as El Paso, Amarillo, and Abilene. His system will reach the rest of the country through existing equipment.

Not all Texans adapted as quickly as Williams to the restructuring of the oil business. When the downturn came three years ago, some old-timers thought they'd seen this kind of thing before. They laid off employees, sold inventory, sometimes even issued expensive preferred convertible debt, just to buy time. They adopted a slogan, ''Stay alive till '85.'' As the hoped-for turnaround year arrived, however, the price of a barrel of Texas oil tumbled from $28.60 to $25.20, surprising almost everyone and snuffing out hope. The price climbed to $30 in March but since then has drifted down to $27.85. ''I get a greater sense in the past three months of people saying, 'We're tired. We just want out,' '' says L. E. Simmons, a partner in Simmons & Co., a Houston firm that specializes in mergers of companies selling supplies and services to the oil industry. ''These companies have done everything they can to reduce costs, but they can't go any further. It's like a person who weighed 400 pounds and reduced his weight to 190. He just can't get down to 150 pounds, which is where he has to be to compete.'' Fewer than 10% of oil field service companies are profitable, Simmons estimates. Scores of midsize oil service companies, those with annual revenues between $10 million and $100 million, are in trouble. Bigger and smaller operators have mostly escaped the hardest blows -- the big ones because of economies of scale, the small ones because their lack of corporate overhead makes them low- cost producers. Strong service companies are picking up the infirm. Schlumberger recently bought a drilling outfit. Other large service companies have been forced into strange-bedfellow arrangements. Faced with sagging demand for boats to ferry supplies and equipment to offshore oil rigs, former competitors Zapata Corp., Houston Natural Gas Corp., and Halliburton Co. junked their oldest boats last year and put the rest into a jointly owned fleet that is as big as any in the Gulf of Mexico. IN THE OIL INDUSTRY'S free fall to rock bottom, the refinery and petrochemical businesses in the southeast corner of the state around Beaumont, Port Arthur, and Orange have had the hardest landing. One economist calls this once booming section ''the frost belt in the Sunbelt.'' Beaumont is where the Texas oil industry took off, with the discovery of the huge East Texas field called Spindletop in 1901. For years the three-city area was known as the Golden Triangle, and unionized workers at the refineries earned high salaries. But foreign competition, declining demand for gasoline, and the mergers of giant oil companies have tarnished the triangle. Bernard Weinstein, an economics professor at Southern Methodist University in Dallas, has studied the impact of the oil recession. In three years, he says, the triangle's 42 largest employers have eliminated 13,000 jobs, or a third of their total work force. ''There's still a 25% overcapacity in the industry,'' he says. ''A lot of the layoffs have been in the small refineries. The big ones are still to come.'' A Wall Street Journal printing plant opened in Beaumont in 1983, but attracting other industries has been tough. ''The place is expensive, the air is polluted, and there's a history of labor conflict,'' notes Thomas Plaut, head of economic forecasting for the Bureau of Business Research at the University of Texas at Austin. ''It's a terrible place.'' The locals seem to agree. Workers are leaving so fast that one resident estimates his house is dropping in value by $1,000 a month. Houston is faring better than Beaumont, but it's got its own share of trouble, especially in real estate. For a few years so many buildings went up in Houston that locals used to joke that the state bird should be the crane. When drilling was hot, no one could build office space fast enough to meet demand: it takes about six white-collar types -- engineers, accountants, lawyers, and the like -- to back up one roughneck on a rig. Now Houston has a 33-million-square-foot oversupply of office space; the empty buildings are known as see-throughs. The vacancies amount to a third of Houston's total space -- more than all the modern high-rise offices in Boston -- and will take five years to work off at the current absorption rate. Some developers are so desperate for tenants that they're offering 2 1/2 years' free rent on a five-year lease. And some are beyond desperation. The Warwick Post Oak, an elegant but often empty Houston hotel designed by architect I. M. Pei, has been foreclosed by its lenders. Houston oil and gas bankruptcies in 1984 were down 30% from 1982, according to a study by Price Waterhouse, but real estate bankruptcy filings rose from 89 three years ago to 257 last year. The state's big banks tried to diversify into real estate loans from energy loans after the downturn, but may have just switched headaches. Three years ago Dallas's RepublicBank had 22% of its loans in real estate and 18% in energy. By last year energy made up only 13% of RepublicBank's loans, and real estate lending had swelled to 33.5%, with nearly half the money going to Dallas projects. Between 1982 and last year, Allied Bancshares in Houston almost doubled its real estate portfolio. Despite a barn-burning economy that has been growing 6% a year for a decade, Dallas is staggering from the pace of office construction. The growth was fueled in part by the 11-year-old Dallas/Fort Worth Airport, which is bigger than Manhattan Island. Corporations fleeing the frost belt moved headquarters to the likes of Las Colinas, an extravagant planned community near the airport. But Las Colinas has never managed to fill its office towers. DALLAS has 76 million square feet of office space, with 19 million square feet empty, reports M/PF Research, a local real estate tracking firm. Another 16 million square feet is on the way, and the city faces a four-year oversupply. Says James Moran, a Dallas developer, ''We've got to take the cranes down for a while.'' Energy loans remain a bigger problem for the banks than real estate loans, but Wall Street is braced for bad news from both. Says James J. McDermott Jr., a banking analyst at the investment firm of Keefe Bruyette & Woods, ''The Texas banking market is still a mine field.''

The five biggest Texas banks have an average of 3.99% of their $73 billion in loans classified as nonperforming, vs. a national average for large banks of 3.5%. None of the banks is believed in danger of collapse, but bad news keeps spilling out. Earnings of Texas Commerce Bancshares in Houston plunged 36% in the first quarter -- the first drop in 17 years -- largely because of $32 million of nonperforming loans to one of its directors, oilman Patrick Rutherford. Houston's First City Bancorp of Texas acknowledged in April that two of its directors, including former Treasury Secretary John Connally, were involved with unpaid energy or real estate loans totaling $13.7 million. InterFirst Corp. keeps running into new problems. It is stuck with $797 million in nonperforming loans -- 5.1% of its portfolio.The bank faced a $40.6-million net loss for the first quarter, but sold off enough real estate to post a $15.1-million profit. In May, Moody's, the bond-grading outfit, lowered its rating of the bank's senior debt from A-2 to Baa-1. But a revived Texas economy, one less dominated by land and oil, is starting to emerge. There are signs of new thinking even in Beaumont. At Lamar University, the only state university in the region, enrollment is up 16% from three years ago, to 16,000 students. ''It used to be that kids would quit school at 16 to go work on the refineries,'' says Weinstein. ''Now it's clear that your good old boy with little education is unemployed and can't transfer his skills.'' Another significant shift: three years ago, with refinery jobs still beckoning, chemical engineering was a more popular major at Lamar than electrical engineering. Today the reverse is true as students prepare for high-tech jobs. ''We're seeing a retooling going on among young people,'' Weinstein says. The change is tied in part to a string of calamities that would give a Biblical scholar pause. Recalls Meg A. Wilson, an aide to Texas Governor Mark White: ''In the past few years we had the oil price bust, the peso devaluation tied to oil problems in Mexico, and a drought in West Texas that was the worst in 30 years. The grapefruit froze, and then the recession hit.'' She adds: ''I'm not sure which was the straw, but a realization set in that land and oil and gas would not carry the state.'' JUST AS TEXAS began to imagine it had incurred the wrath of God, Admiral Bobby Inman, former head of the National Security Agency, announced in 1983 that he was establishing the Microelectronics & Computer Technology Corp., a research consortium better known as MCC. MCC's mission, says Inman, is to gather top scientists from companies around the country to develop advanced computers. Dozens of cities competed for MCC, but Inman settled at Austin after Texas business leaders coughed up $30 million to improve the state university there. Inman's choice set off a rush among real estate developers and technology companies betting that Austin might rival Palo Alto and suburban Boston as a research center. In less than a year Austin's supply of office space is expected to increase by nearly half, to 15.5 million square feet. The city doesn't have enough water, highways, or sewers for its expanding population, but the high-tech hordes keep pouring in. Within 15 years, 3M Corp. expects to have 5,000 employees in Austin, and Lockheed Corp. is planning to move in about that many in the same period. Other cities hope to catch Austin's development fever. ''It's phenomenal,'' says Meg Wilson. ''People started seeing that aspects of the state's economic base had been overlooked.'' Houston is looking at everything from underused oil field toolmakers to the Johnson Space Center for ways to diversify. ''Ten years ago people used to say, 'Oh boy. An astronaut. Let's have him over to dinner,' '' says a business leader. ''Now everyone is thinking of ways to capitalize on outer space. We didn't have to think about that when oil was doing well.'' Leading the effort to diversify the local economy are Houston developers looking for ways to fill up office space. Real estate-related companies put up nearly half of a $6-million budget for the Houston Economic Development Council, an organization formed with the backing of the chamber of commerce. The council is looking for companies to invest in Houston. One launch pad for would-be diversifiers might be the giant Texas Medical Center, a 350-acre collection of five universities, 11 hospitals, and 14 other institutions. With 50,000 employees, the medical center is Houston's largest employer. Trying to light the fuse is Harvard H. Hill Jr., 48, head of venture capital financing for Criterion Capital, a $20-billion investment fund based in Houston. The medical center could be the nucleus of a sort of Silicon Valley of medical technology companies, he believes. ''It has 20 times the potential of the Johnson Space Center,'' says Hill. He concedes that progress toward commercialization has been slow and complains that the directors of the complex's institutions are ''parochial,'' more interested in winning research grants than in developing spinoff companies. But Dr. Richard Wainerdi, president of the Texas Medical Center, says each college and hospital makes its own policy, ''and the climate is changing. There will be spinoffs.''

Laboring to become the Bobby Inman of Houston is George Mitchell, chief executive of Mitchell Energy & Development Corp. Last year he started a $5- million venture capital fund within his oil company to finance start-up companies around Houston. Mitchell donated 100 acres of company land north of the city for companies spinning off from the medical center. He also gave 100 < acres to help start the Houston Area Research Center (HARC) in 1982. HARC has already won $7.1 million in federal contracts to develop powerful magnets for an atom smasher. ''Now I want to create an MCC of oil exploration,'' says Mitchell. Bobby Inman persuaded Congress to allow joint scientific research by competing corporations without fear of antitrust suits. Mitchell thinks oil companies should collaborate on research to refine exploration techniques. Even cities with still healthy economies have developed silicon fever. Dallas and Fort Worth business leaders, annoyed that they lost out to Austin in the competition for MCC, put up $5 million for a robotics center at the nearby University of Texas at Arlington. They hope the seed money will accelerate a high-tech future. San Antonio wants to piggyback on the boom in Austin, 70 miles away. Figuring that Austin will attract research and development types, San Antonio hopes its ample supplies of cheap labor will lure the manufacturing plants that it expects Austin's R&D to call into existence. Despite the hoopla, few Texans expect high technology to fill the gap caused by a permanently shrinking oil and gas industry. ''To think we can offset a 100,000 decline of oil jobs in Houston in three years is pie-in-the-sky thinking,'' says Mitchell. ''A lot of the work we're doing will take ten years.'' Richard Perryman, an economics professor at Baylor University in Waco, agrees. ''Traditional high-tech industries such as space, medicine, electronics, and so forth make up only 2% of the state economy,'' he says. ''Between now and the end of the century oil will drop from 22% to 16%, but high technology will grow to only 3%. New-job creation will have to come elsewhere.'' Long-term growth of the state will likely come from a shift to a service- based economy. ''Texas, if it rides just on oil and gas, will become an Appalachia,'' says Dallas's Ross Perot, a high-tech billionaire who sold Electronic Data Systems, a computer service company, to General Motors last year. ''With services, it can be a rich state.'' But it's not clear yet whether the state is well equipped to make the transition.The state's educational system and tax structure leave many people skeptical, including Perot. Texas ranks 46th among all states in Scholastic Aptitude Test scores. Worse, the SAT score gap is widening rapidly. Last year Perot headed a long and bitter battle with legislators to reform the state's elementary and high school systems. A lot of money was being spent on buildings and sports, he decided, and not enough emphasis was being put on learning. Now a state law says that a high school student flunking any course cannot participate in extracurricular activities during the following six-week grading period. About a quarter of Texas students were suspended from football teams, high school bands, and other after-school doings. Perot was so unpopular that automobile bumper stickers appeared bearing the message ''Warning -- I don't brake for Ross Perot.'' Perot is undeterred. ''We look smart because God put so much wealth under the ground,'' he says. ''But our children are going to grow up in a world of rapid change. The average person will change careers five times. For that he needs a fully developed intellect.''

PAYING for the educational and other costs associated with an evolving economy is getting tougher, though, and tax problems caused by declining oil and gas reserves are already handicapping efforts to diversify. Texas has never had a personal or corporate income tax, and nearly a quarter of the state's tax revenues come from levies against oil and gas as they are removed from the ground. With dropping energy prices and production, the take is declining, and state legislators had to scramble to cover a $1-billion revenue shortfall in the next two years. Looking for ways to save money, the legislators proposed a 26% cut in the state university system's budget. That prompted Bobby Inman to grumble that he might have settled in another state if he'd known that promises to improve higher education in Texas would fade so quickly. The university budget was left alone, and other cuts were substituted, along with some revenue increases. But Inman says the fuss scared off one superstar California professor who had planned to move to Austin. Inman estimates that the University of Texas is already a year behind in announced plans to attract top college teachers. The university says Inman's estimate is correct. Even if oil dried up tomorrow in Texas, however, it has permanently altered the state in ways that will probably help it thrive. The oil legacy goes beyond the obvious stuff, like giant airports, big financial institutions, and art museums donated by billionaires. There really is some intangible mixture of arrogance and entrepreneurship born of Texas oil wildcatters that makes Texans willing to take risks in the belief that they can accomplish anything. Clayton Williams builds his own telephone company, Ross Perot takes on state-education reform, and Houston real estate developers band together to lure high-tech start-ups into see-throughs. Texas may be running out of oil, but Texans sure aren't running out of energy.