British Petroleum: In the Wake of the ConocoPhillips Split

Should BP split?

The pros and cons of slicing oil giants apart

A COMPANY that rakes in profits of $5.6 billion in three months might expect congratulations. But BP’s second-quarter results, unveiled on July 26th, disappointed. Asset sales after last year’s Gulf of Mexico disaster (see picture) have hit production. A botched attempt at an asset swap and arctic exploration deal with Russia’s Rosneft has added to BP’s woes. Some investors are calling for the firm to be split up. Does this make sense?

Other oil firms, such as Statoil and Marathon, have done it. And on July 14th ConocoPhillips announced that in 2012 it would separate its profitable “upstream” oil exploration and production business from the low-margin “downstream” jobs of refining and marketing.

Jim Mulva, ConocoPhillips’s boss, outlined some compelling grounds for a corporate divorce. He reckons that it will help to bring a sharper focus to managing both businesses and that the difficulties of allocating capital internally to different types of enterprise will disappear. And investors, apparently baffled by the task of valuing integrated oil firms, will be able to work out more easily what each bit is worth and allocate cash accordingly.

On paper, the rewards look immense. JPMorgan Cazenove, an American bank, reckons that BP’s market capitalisation of $145 billion is a whopping $100 billion less than its assets are worth individually. Europe’s big integrated oil firms suffer some of the worst conglomerate discounts (see chart). Many were once state-owned national champions, which valued size over profitability. Brazil’s Petrobras is keeping the tradition alive: on July 26th it revealed plans for big spending on projects that have little to do with drilling. 

If breaking up is so lucrative, why do more oil firms not do it? In the 1990s many merged to gain the financial muscle to take part in giant energy projects in the developing world. The theory was that integrated oil companies needed to offer both oil-field development and refining to the countries that owned the oil. The exploration and production arms of these huge bureaucratic organisations cannot now hope to be valued as highly, per dollar of profit, as smaller, nimbler rivals such as Premier Oil or Tullow.

Splitting would be tricky, however. Oil firms’ jumble of less profitable sidelines—from renewable energy to shipping—might be hard to sell in one go. Analysts may put hefty price tags on refineries, but chronic overcapacity means that margins will stay thin. Rather than splitting in two, a better bet would be to sell assets one by one to Asian or Russian oil firms with deep pockets and global aspirations.

As BP’s Russian debacle showed, there are few quick fixes in the oil business. ConocoPhillips’s shares have sagged since it announced a split; Statoil still trades at a discount to the value of its assets. As Royal Dutch Shell has discovered, the way back to health is less flashy: stick to oil projects that offer the highest returns on capital. That’s what Exxon Mobil has been doing for years, which is perhaps why it is the world’s most profitable oil company.

Source: http://www.economist.com/node/21524921?fsrc=scn/fb/wl/ar/shouldBPbesplit

NUTSHELL:

This is the new debate in management, strategy, oil & gas circles? Is Vertical Integration as a business model on the the chopping blocks, is the ConocoPhillips route the next big thing for the oil and gas industry? What are the pro's and what are the con's? Let the debate continue.