The global petroleum industry entered the 21st Century astride a change of titanic proportions.
Some of the biggest, most widely recognized petroleum companies in the world had merged, dramatically reshaping the industry landscape at the turn of the century. Heading this trend were some of the biggest industrial mergers in history.
Here is a brief list of just the biggest firms that had ceased to be independent companies, or that were likely to fall into that category, as the century rolled over: Mobil Corp., Amoco Corp., ARCO, Elf Aquitaine, Petrofina SA, YPF SA, and Saga Petroleum AS. The deals that would absorb these companies were all announced in 1998-99, and most were approaching conclusion at the start of 2000. And the combined value of these deals dwarfed any that preceded them.
A similar, if smaller wave of mergers swept the independent sector of the petroleum industry-particularly in the US and Canada.
Megamergers also redrew the landscape of the oil service-supply sector, with such venerable names as Dresser, Camco, Sedco Forex, and Western Atlas ceasing to function as stand-alone companies.
While the casual observer made much of the collapse in oil prices that occurred in parallel with these developments, the companies merging instead pointed to a more secular, rather than a cyclical, rationale: the need to cut costs and gain operating efficiencies in order to compete in an increasingly globalized petroleum industry. In short, size really matters in the petroleum industry of the 21st Century.
A popular question became: Who is next? Speculation centered most frequently on Chevron Corp. and Texaco Inc. (themselves the swallowers of respective competitors Gulf Oil Corp. and Getty Oil Co. in a wave of mergers during the 1980s), which were caught up in an aborted merger attempt of their own in 1999. Also cited as prospective merger candidates at the start of 2000 were second-tier majors such as Conoco Inc., Phillips Petroleum Co., and Amerada Hess Corp.
Conspicuous by its absence from this list was Royal Dutch/Shell, which before the merger of Exxon Corp. and Mobil was the world`s biggest petroleum company. Indications in early 2000 were that the Anglo-Dutch giant planned to stay above the fray and seek new efficiencies and cost reductions without resorting to merger.
Even state petroleum companies were not immune from the megamerger temptation, following the example of France`s Total SA (now TotalFina Elf) and Spain`s Repsol SA (now Repsol-YPF SA) in 1999. Said to be shopping around early in 2000 were Italy`s ENI and Malaysia`s Petronas.
Not all merger activity in the late 1990s was driven solely by cost-cutting and efficiency gains. An important merger wave was the "btu convergence" trend that married interstate gas pipelines to electric utilities and power plant operators to fuels marketers as the gas and power industries blended together in response to rapid deregulation and market liberalization of these sectors worldwide.
And not all company "marriages" were necessarily mergers or acquisitions. The trend toward strategic alliances, joint ventures, and partnerships kicked into high gear at the end of the 1990s with the shifting and blending of complementary business interests and market niches among majors, independent E&P firms, refiner-marketers, and service-supply companies.
Whatever complacency the petroleum industry had about its future was shattered by the oil price shocks of the 1970s and 1980s; the remnants of that complacency were ground into dust by the wild rides of the 1990s-not just by the price rollercoasters but also by a fundamentally different world view. That world view encompassed an increasingly globalized economy, trade and market barriers collapsing, fresh opportunities in once-untouchable lands, emerging synergies with once-alien businesses, and new ways of working and pursuing commerce through a dazzling new venue-the internet.
Above all, the new world view reflected one constant: change, often at a dizzying pace.
It took a new kind of company to accommodate such rapid change, the late-1990s merger frenzy seemed to suggest: one with the kind of critical mass to undertake massive upstream opportunities opening up in the Middle East and former Soviet Union; or one with the scope to endure low margins of the modern refining industry; or one with sufficient heft yet nimbleness to flourish in the E&P, downstream, and service-supply niches left behind.
M&A drivers
While weak commodity prices gave momentum to the M&A flurry of the late 1990s, they were not the key driver.
"Collapsing oil prices and pressure to reduce cost structures gave momentum to these mergers, particularly in the case of the integrated oils," Moody`s Investors Service noted at the end of 1999. "However, the motivation goes far beyond a desire to reduce costs at the corporate level or in the overcapitalized downstream sector. It is driven more by the competitive advantages that will accrue to the largest players-primarily in the challenge of replacing major production declines and gaining access to many emerging and politically volatile hydrocarbon provinces.
"While the petroleum industry has always been international in scope, the focus for the majors has truly shifted globally, reflecting mature production in North America and the North Sea and access to new or formerly restricted provinces, with the tantalizing prospect of others opening up. In this environment, only the largest and best capitalized of companies will be able to compete, given the large sums of capital at risk (think of Russia), the long lead times, and staying power required in many of these locales."
Adding to the pressure were the megamergers themselves. As the market saw it, some of the most effective mergers had already taken place, leaving the surviving companies to consider combinations simply for the sake of critical mass in order to compete-when such combinations might not have the best rationale from a strategic standpoint.
Perhaps most daunting-even for an ExxonMobil or a Shell-was the prospect of having to compete with what some may argue are the "true" supermajors, at least in terms of hydrocarbon assets: the state oil companies whose oil and gas reserves dwarf many times over those even of the biggest nonstate companies (Fig. 1). While some of these sleeping giants may lack the technological edge or access to capital that the supermajors can command, the gap was narrowing, especially with the increasingly global transfer of technology and transparency of national economies.
It became possible to envision the petroleum industry coming full circle to its heyday: the boom times of the "Seven Sisters" era, when a handful of giant oil companies worked closely in partnership with the governments holding the world`s biggest reserves. That situation certainly helped keep a lid on prices and encouraged massive demand growth at the time. The differences this time around would be: a bigger group of nations, notably those outside the Organization of Petroleum Exporting Countries(FSU,WestAfrica,Mexico, Brazil); a clearer understanding of reserves ownership; and a provision for gas reserves as well as for oil.
Offering a contrary view on merger drivers was Matthew Simmons, president of Houston consultants Simmons & Co. International, who believed that low oil prices had everything to do with the merger frenzy.
In early 1999, Simmons claimed that "...[T]he collapse in oil prices has been the biggest driver for many of the E&P mergers in the past 2 years...few companies can survive for long...at $10-12 oil.
"Saving $2-3 billion might not be a lot for a business combination as large as BP Amoco or Exxon Mobil, but when low oil prices suck out all of a company`s liquidity, these savings are a bridge across a deep canyon to wait out the time when energy prices finally rise, once more."
Of course, the pressure to restructure preceded the 1998-99 oil price collapse, and that pressure came mainly from stockholders dissatisfied with petroleum company returns.
Petroleum Industry Research Foundation Inc., New York, in a 1999 report said, "From 1990 through 1997, the largest US companies [defined as the 24 largest US producing companies in 1996 required to report financial and operating data under the Federal Reporting System] earned an average return on their US petroleum investments of only 6.5%. On their refining and marketing investments, the average return was only about 3%."
The seeds of all this urge to merge went back even further. Olivier Appert, senior executive vice-president of Paris consultants ISIS, in 1999 noted, "The factor that triggered the most recent developments in the oil and gas sector is undoubtedly the need to reduce costs created by the oil counter-shock of 1986. This need was intensified by pressure from financial circles and hastened by the counter-shock experienced in 1998.
"Every company firmly engaged in a cost-cutting policy. Technology added its contribution. At the same time, companies drastically restructured and outsourced entire segments of activity. In this respect, BP`s story is significant. The limit had no doubt been reached in internal cost-cutting. In a low-price context, it is theoretically not possible to further reduce costs without engaging in larger-scale operations. The dilemma for small companies is either forfeiting their independence or disappearing altogether."
That view was borne out by statistics that Simmons cited. During 1992-96, he said, there were about $25 billion worth of mergers in the US petroleum industry. But during 1997-98 alone, US petroleum activity rocketed to more than $140 billion-excluding the BP-Amoco and Exxon-Mobil mergers, which added $125 billion to the total.
Merger mania
Upon conclusion of the biggest megadeals announced or under way during 1998-99, seven of the world`s biggest petroleum companies would have disappeared into larger entities (table).
These megadeals were:
- Exxon`s $82 billion merger with Mobil, resulting in Exxon Mobil Corp., which was finalized near the end of 1999.
- British Petroleum Co. PLC`s $55 billion merger with Amoco, concluded at yearend 1998; still to be concluded at the outset of 2000 was BP Amoco`s $27 billion acquisition of ARCO.
- Total`s merger with Petrofina in 1998 for $9 billion, followed by its successful takeover of French rival Elf for $49 billion in a bitterly disputed contest.
- Repsol`s takeover of YPF for $15 billion, making the Spanish giant one of the dominant players in Latin America.
- Norsk Hydro`s acquisition of Saga in another controversial takeover involving two giants with some state holdings.
The result was a dramatic reordering of the majors` rankings according to size, at least as measured by hydrocarbon reserves. Fig. 2 shows the grouping of the three biggest in a class by themselves, i.e., the new supermajors. There is now a new middle tier of majors consisting of TotalFina-Elf, Chevron, ENI, Texaco, and Repsol-YPF. And what was once thought of as part of the second tier of majors is now a third tier: Conoco, Norsk Hydro-Saga, Phillips, USX-Marathon, and Amerada Hess.
Simmons questioned the rationale of size for size`s sake in the majors` mergers and acquisitions frenzy.
"At some size, the only exploration projects that make any difference are several billion-barrel fields; 100-200 million bbl fields hardly have any relevance for megamergers," he said. "Since the world has found only four or five of these giant fields in the past 30 years, there has to be some risk that there are few fields of size left to ever exploit...If the real world of new supply additions are a multitude of 50-250 million bbl fields, where being lean and nimble are key to making these projects an economic success, being too big could turn out to be a major economic disadvantage.
"Would it not be a classic irony if, 5 years from now, specialized spin-offs were coming out of the megamergers right and left?"
Independents
If size is what really matters in the petroleum industry in the early 21st Century, then what sort of future awaits the independent E&P company?
Anadarko Petroleum Corp. CEO Robert J. Allison Jr. addressed that question in a talk at a November 1999 oil conference in Paris.
Allison noted that 24 sizeable independent oil and gas companies merged or exited the upstream business altogether during 1996-99, including Oryx Energy Co., Union Texas Petroleum Holdings, Louisiana Land & Exploration Co., Seagull Energy Corp., Zilkha Energy Corp., and Saga.
Allison said the emphasis in this trend again was size, resulting in what he saw as the emergence of the "superindependent."
But Allison cited the same competitive strengths applying to the new superindependents that were also cited for independents vs. the majors: agility and speed.
"Nobody would argue that there aren`t significant economies of scale at the completion of a sound merger," he said. "But aren`t there also `dis-economies` of scale? Like a government, a company can get so large that it becomes difficult to administer in any focused or responsive way. Some opportunities can come and go before a giant company can get up and moving.
"An independent-even a superindependent-can shift its resources relatively quickly and efficiently, with the obvious advantages that affords."
Allison also contended that independents can still benefit from the supermajors` need for increasingly higher targets for crude oil reserve replacement and production to sustain profitability growth while their staffs continue to shrink.
Consequently, it behooves the majors to operate in proven areas with high commercial risks (such as the FSU), where their critical skills at managing political and social risk come more into play, while leaving the more technically risky-from a geologic and reservoir standpoint-areas for independents.
"Wide open to the independents-especially the superindependents-may be areas where larger, more `deliberate` companies may not be interested or perhaps have failed," Allison said. "Independents have a built-in advantage in that, for them, critical mass in a new area can be achieved on a much smaller scale. The finds they`re looking for can be smaller but still with enough concentration to be extremely profitable. Plus, they`re still being `exposed` to the possibility of a giant find."
Service-supply mergers
A similar acceleration of M&A action in the petroleum service and supply sectors also marked the 1990s.
According to Simmons, during 1993-96, about $25 billion worth of oil service company mergers took place. But in 1998 alone, another $25 billion worth occurred, with the 3 largest transactions accounting for $17 billion of the total vs. 180 for the remainder (Fig. 3).
The three megamergers were Halliburton Co. and Dresser, Baker Hughes and Western Atlas, and Schlumberger and Camco.
But if Simmons questioned the wisdom of megamergers for the majors, he argued the opposite case for service companies. He contended that, while many oil service markets had become quite consolidated, even these markets would benefit from further consolidation.
"Like it or not, a massive amount of capital will be required for the oil service industry to `deliver the goods` over the next 10 years. By the year 2009, the average offshore rig will be close to 30 years old, and the average supply boat age will be close to 35 years.
"If the industry lacks the capital and replacement cost economics to begin replacing this aging fleet, so that it is forced to try and cope with maintaining an ancient fleet, the oil service companies and their customers are asking for gross inefficiency and accidents. The oil service industry cannot let this happen. Managers need to start shoving price levels toward replacement costs and then find ways to keep them there. And the industry needs to carefully manage replacing the fleet so that the pace is not too slow and also not too fast, as few unnecessary units threaten to bring prices crashing down again."
That, Simmons concluded, was why more oil service consolidation needed to occur; otherwise, the business would continue to hover on the edge of boom-and bust conditions.
Downstream action
Consolidation within the downstream sector focused less on mergers and more on strategic alliances and joint ventures (Shell-Texaco-Saudi Aramco, BP-Mobil, Ultramar Corp.-Diamond Shamrock Corp.) and acquisitions of assets (Tosco Corp. buying refineries from BP, Exxon, and Unocal).
While most of the consolidation occurred in the US downstream sector, that trend spread worldwide as other countries` refining sectors found themselves having to compete in a global market with fewer government protections. Japan was the most noteworthy example on this score. Greater consolidation of refining capacity was expected in Europe and Australia as well.
The main driver for consolidation in refining was poor profitability, according to Bruce Burke, vice-president, Chem Systems Inc., Tarrytown, NY.
"On a simple return on replacement capital basis, the [US] industry has achieved dismal results, estimated at only 2.4% over the past 10 years...the last 5 years have been below this average."
What`s needed, said Burke, were efforts to further reduce costs in existing facilities and adding value to basic refining operations. The latter entailed such measures as optimizing links to retail marketing; integration with petrochemicals; emphasizing more-specialized, high-margin products; and cogenerating power with low-value streams.
Consolidation within US refining had been under way since 1980, but that trend accelerated in the 1990s (Fig. 4).
Burke contended that such restructuring would remain a key characteristic of both the US and global refining industries, as market growth was expected to be limited to 2%/year at best. This would heighten pressures for continued consolidation and globalization of refining companies, with joint ventures increasingly becoming the norm.
"Significant refining ventures already exist or are being developed between the US and the European and Latin American refining industries," Burke said. "Such links can be expected to grow.
"Perhaps the greatest potential exists for growing links between the US and Asia. Current depressed conditions have resulted in significant reductions in asset values, opening the door to bargain hunters. Chem Systems believes that longer-term trends toward deregulation, as well as underlying strength in the Asian region, will make links to Asia a key part of emerging global strategies for major refining firms."
Outlook
While the M&A activity of 1998-99 was unprecedented, it was inevitable, as petroleum companies finally took to heart-rightly or wrongly-that size and efficiency would provide the best competitive advantages in dealing with a low or flat price outlook for years to come.
"Size, portfolio diversification, and access to large amounts of low cost capital will help the major oil companies meet the competitive challenges of the emerging state oil companies, as well as the increasing political and capital risks inherent in `elephant hunting,`" Moody`s said. "The evolution of a three-tiered industry structure dominated by a few companies, continuing pressure from Wall Street, and converging energy trends all suggest that very significant merger activity is yet to come."
Only time would tell whether the "supermajors" and their counterparts among the independents, downstream, and service-supply companies were truly the new paradigm for doing business in the petroleum industry of the 21st Century or just another bandwagon, like the diversification and synfuels frenzies of the late 1970s and early 1980s proved.
But such massive consolidation was under way across a myriad of other industries and businesses at the close of the 1990s with the relentless globalization of the world`s economies and continued erosion of market and trade barriers. It would seem almost illogical to presume, then, that the petroleum industry should be exempt from this global transformation. As the new century dawned, it became increasingly clear that it wasn`t.
 |
 |
 |
 |
