Vertical Integration of Bp
Essay by Sammie1195 • February 27, 2018 • Course Note • 1,444 Words (6 Pages) • 867 Views
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- Vertical integration of BP
- Changes that have occurred in the oil and gas industry since BP announced its merger with Amoco Cooperation in 1998:
- Strategic gaps BP was facing in 1998:
- Inadequate natural gas reserves
- Poor returns
- Weak competitive positions in the US and Europe
- Insufficient access to growth market
- Too narrow a portfolio in chemicals
- Limited exposures in the Far East
- Limited hydrocarbon renewal options beyond 2005
- Analysis of the oil and gas industry
- Incentive in the past to integrate vertically: incomplete markets, transportation shortages and unstable relationships between firms
- Due to regulation regarding monopoly, the US supreme Court broke the oil companies
- The oil industry began in the US, but the country’s share of world crude oil production declined from 60% to 10.6% in 2000 as oil was discovered in my than 80 countries by the end of the 20th century
- Originally, private companies in partnership with host nation governments developed the majority of oil production → most nations with significant reserves nationalized production and confiscated private company assets but many of the oil fields were still operated by partnerships between governments and private companies.
- Marginal tax rate fell between 50-90%
- Supply and demand
- Key determinants of demand for petroleum products were economic activity and weather
- Key determinants of supply: real exploration and production costs, technological advances and regulatory environment + price uncertainty (because oil and gas investments typically have long payback periods, executives were willing to make them only when they thought that price levels were representative of long term market conditions)
- Industry structure
- World oil consumption grew each year during 1990s
- Members of the Organization of Petroleum Exporting Countries (OPEC) held an estimated70% of the world’s 1.03 trillion barrels of proven reserves
- OPEC was formed in 1960 to unify and coordinate member countries’ petroleum policies
- Historically, OPEC had collected pricing data on a “basket” of seven crude oils → then set production quotas designed to keep this basket price between $22 - $28 per barrel
- After September 2001, however, it suspended its focus on the price band in response to the sustained weakness in markets. Enforcement of negotiated quotas was a chronic problem for OPEC. Like nonmember countries, its members could benefit if they sold additional production, and OPEC lacked a formal enforcement mechanism.
- Oil prices fluctuated substantially between 1970-2000 due to wars, increase in supply, economic crisis
- Publically traded oil companies in industrialized nation varied widely in size and organizational structure i.e. ranged from completely integrated firms to specialises in refining, marketing, exploration and production or energy service
- In 1990s, a waver of mergers and acquisitions activity created a new breed of firms termed “super majors”
- Largest of these firm is ExxonMobil
- Changing structures of companies from 1979-1999: The vertically integrated firms’ share of U.S. oil industry assets declined from 97% in the 1970s to 70% in 1999. Conversely, independent refiners in the United States increased their market share from 7% in 1990 to 38% in 1999; two-thirds of this increase came from acquisitions of assets sold by vertically integrated and formerly integrated firms.
- Business segments;
- Upstream: The processes of exploring for oil and gas, developing reserves, and bringing them to the surface with production wells were collectively known as “upstream operations.”
- The higher prices that resulted from OPEC’s supply restrictions in the 1970s and early 1980s provided companies with the funds and the economic incentive to increase reserves by focusing exploration attention on higher cost areas. At the same time, OPEC’s actions underscored the macroeconomic and security implications of dependence on risks to oil supplies. Technological progress enabled firms to reduce the cost of exploration and extraction and thereby increase the amount of reserves.
- Three major technological advances included horizontal drilling, measurement while drilling, and three-dimensional seismic analysis.
- Downstream: The refining and marketing of petroleum products were known as “downstream operations.”
- Refining margins were typically low → in an attempt to increase margins many updates were made
- During 1990s, many integrated firm selectively divested refining assets, thus facilitating an increase in market hare for the independent refiners
- BP merger activity → the company could increase profitability through cost cutting instead of relying on an increase in oil prices
- BP triggered a wave of oil industry mergers and acquisitions with its announcement in August 1998 of a $53 billion merger with Amoco → i.e. ExxonMobil merger
- Synergies of at least $2 billion were projected to come from reduction in staff, more focused exploration, streamlining businesses, improved procurement and rationalization of operation
- Strategic assessment of BP’s main challenges prior to the merger;
- Weak retailing position in US, it needed to enlarge its chemical business and it was underexposed in natural gas
- BP had a stronger position in exploration and production whereas Amoco’s strength were in its petrochemical business and US refining and marketing
- The merger occurred when oil and chemical prices were extremely low, the most accessible cost cutting measures had been taken and companies were searching for additional ways to grow and increase profitability
- BP further merged with ARCO (post ExxonMobil merger)
- BP post merger operation
- BP’s managers believed its post-merger size and portfolio of assets would provide it with the stability, risk management capability, and global reach to offer a range of services to governments that would help it gain access to significant new reserves and increase profitability
- The benefits are in both physical and intellectual economies of scale. The intellectual economies stem from a deep process of learning.
- The company’s degree of vertical integration was also significant. Lord Browne stated: We don’t really believe in vertical integration and haven’t for a very long time, but there are some benefits. The right refineries in the right geographic areas may provide a benefit. Also, shareholders invest in the agency of the management to more easily participate in portions of the industry than they can do themselves. It’s easier to invest in BP than obtain a private equity stake in China.
- Major competitors in 2001
- Includes;
- ExxonMobil Corporation
- Royal Dutch/Shell group
- ChevronTexaco Corporation
- TotalFinaElf
- The merger of BP and Amoco set off a wave of consolidation in the industry. Other large public energy companies reached merger agreements and created a new group of supermajor firms.
- One motivation behind the mergers was a belief in the advantages of spreading the risk of new exploration and production projects over a larger base.
- The supermajors were awarded higher valuation multiples than their smaller rivals, possibly implying that the supermajors were better positioned to generate higher and more stable earnings.
- Challenges and potential limits to growth
- Although post-merger cost cutting and consolidation of redundant activities provided a significant short-term benefit, one industry economist cautioned that the size of the companies could cause other problems: This merger activity makes sense from a cost-saving perspective in a depressed market, but it is difficult to manage a company with this many assets. In the long run, this should lead to inefficiencies including inertia, bureaucracy, and number of people. It could cause the company to react slowly and lose opportunities.
- In addition, the industry was tightly regulated by federal and state governments. Antitrust concerns might preclude any other major merger activity.
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