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Volume 6-14 Article "The Changing World Petroleum Industry - Bigger Fish in a Larger Pond" by Peter DaviesPeter Davies is Vice President and Chief Economist of BP Amoco plc, London and Honorary Professor at the CEPMLP at the University of Dundee Paper presented to the British Institute of Energy Economics Conference St. John's College, Oxford. 21 September, 1999. 1.Introduction The world petroleum industry is widely considered to be large and mysterious. Oil is the world's most internationally traded commodity and the three largest petroleum companies in the world are all amongst the world's 10 largest private corporations by market capitalisation. The sense of mystery stems more from history than the present time, but the perception continues to be widely shared. However, the most remarkable characteristic relating to the oil industry is probably the fact that its industrial structure had remained largely intact for some seventy years or so, despite a wide range of global changes in markets, geopolitics and technology. This period of constancy appears to have come to an abrupt end during 1998/99 as a period of corporate consolidation was launched. The first move was the merger of British Petroleum (BP) and Amoco. This has been followed by the proposed acquisition of Mobil by Exxon and a number of other consolidating moves. This paper attempts to analyse the reasons for the previous enduring stable structure of the industry and the causes of the period of change. It also attempts to consider the driving forces that could shape the industry in the coming years. 2.What is the Petroleum Industry? This paper will address the structure of the international private petroleum industry. This was the competitive playing field in international petroleum for the period through the 1980s and into the 1990s. The petroleum industry can then be simply defined as the set of private sector companies who explore for and produce crude oil and natural gas and refine and market oil products as their main source of business. Some companies undertake all of the above functions - the integrated companies. Others undertake only one or some of them; these are usually referred to as independents. Some integrated companies are also involved in other areas of business. For example, many, but not all, are producers of petrochemicals and other chemical products. The industry can then be categorised as follows: MajorsLarge integrated players. Traditionally this comprised Exxon, Royal Dutch/Shell, British Petroleum (BP), Mobil, Chevron and Texaco. Prior to 1984 this group also included Gulf Oil. They were known as the "Seven Sisters". Chevron acquired Gulf Oil in 1984. To some degree a group of slightly smaller integrated companies could be added to this list, e.g. Amoco and Arco and, since their privatisation, Total, Elf and ENI. Other IntegratedThis group is similar to the majors but smaller in size and with less geographical reach. It comprised companies such as Amerada Hess, Conoco, Diamond Shamrock, Marathon, Occidental, Philips, Unocal and Ultramar. IndependentsThese are yet smaller companies, most of whom specialise in a single segment. They include, for example, Anadarko, British Borneo, Enterprise, Kerr McGee, Lasmo, Ramco, Saga and Talisman. This definition of the petroleum industry thus explicitly excludes all state owned petroleum companies. It has only been in recent years that state-owned producing companies have moved outside their home countries and invested internationally, usually in the downstream. These include large state producing companies such as Saudi Aramco, Petroleos de Venezuela, Pertamina of Indonesia from OPEC and non-OPEC state producers such as Statoil of Norway, Petrobras of Brazil, Pemex of Mexico and Petronas of Malaysia. This definition of the petroleum industry also specifically excludes electricity companies and most gas marketing companies. Until the 1990s the electricity industry was distinct from the petroleum industry and was dominated by state-owned and private utilities. Gas marketing was similarly a utility business with the exception of gas transportation in the United States. The changes in these industries and the resulting blurring of industry boundaries during the 1990s is discussed in section 5.3 below. A key theme of this paper will therefore be that this traditional definition of the industry has become too narrow. The petroleum industry is progressively including state companies and, to some degree, gas marketing and power companies. There has also been the entry of players who specialise in one segment of the value chain (e.g. gasoline retailing) even where this is not their major focus of business. 3.Emerging Forces for Change During the 1990s 3.1.Structure and Forces Prior to the 1990s The structure of the private sector oil industry remained extraordinarily stable, with a few key players - the Majors - prevalent from the 1920s until the late 1990s. Over this long period of time the major private oil companies showed a remarkable degree of resilience to changing market conditions. Each company succeeded in more or less retaining its position within the private sector hierarchy, at the forefront of the private petroleum industry. Figure 1: Up until the demise of Gulf Oil in 1984 the private sector oil industry was characterised by a core of seven firms - the "Seven Sisters." At the head of the group was Shell and Exxon with the others a division below. From 1950 the Majors consistently increased their asset base. Up until the first oil shock growth was steady but post 1973 a new phase emerged, characterised by more erratic patterns of expansion. Most of the Majors again substantially increased their assets in the 1970s, aided by the rising oil price induced revenues. Those that conspicuously failed to replace lost Middle Eastern assets were soon to become troubled. The failure of Gulf Oil to replace Kuwaiti production and its subsequent demise was evident. Figure 2: The nationalisation of upstream assets in the Middle East and elsewhere were fundamental blows to the Majors who had been the leading players in most of the Middle East and other OPEC member states. However, the Majors survived (with the eventual exception of Gulf Oil) and to some degree prospered. They remained at the forefront of the private sector industry through the 1970s and 1980s for several reasons: Downstream assets were largely left intact Most majors had substantial US oil and gas production assets. The discovery and development of North Sea and Alaska created a new upstream portfolio of strategic assets. 3.2.Sources of Competitive Advantage The 1990s proved to be a period when forces began to build which eventually led to important changes in the structure of the industry. The leading positions of the Majors had been reinforced for a long period by their deep rooted sources of competitive advantage. These were reflected in a set of ‘strategic assets' that advantaged the Majors relative to other private sector players. Many of these assets were inherited from the past, having been acquired and developed in earlier decades. They tended to be large, profitable, cash generating, not easily replicated and long lasting. These included: Upstream: these were mainly large, low cost oil and gas fields. Initially they were mainly in the Middle East. They were then partially replaced by large North Sea and Alaskan fields. Downstream: the main strategic assets are advantaged refineries and significant retail positions in key markets. Most of the industry's refining assets, at least in OECD countries, were commissioned prior to the 1980s. Capacity growth has subsequently tended to be incremental rather than in the form of greenfield expansions. Equally, many retail networks were also initially established in the past. Advantaged real estate and scale economies had been secured. Petrochemicals: strategic advantage in petrochemicals has tended to stem from technology, location and feedstock access. Again these positions had often been initially established in the 1970s and earlier. Corporate: in a world of imperfect and heavily regulated capital markets, financial strength proved a source of competitive advantage. Equity funding from corporate balance sheets provided the main source of finance for much of the industry, especially in countries where creditworthiness was questionable. These strategic assets were sustained by a number of key characteristics that were predominantly incorporated in the Majors, for example: 1. Technical skills and the ability to innovate: the Majors have not tended to develop and retain proprietary technologies (except in petrochemicals). However, they have remained at the forefront in their abilities to apply the best technology and innovate in new applications. 2. Highly effective logistical skills: these have been especially valuable in a business where transportation costs have been critical and where development projects are large and capital intensive. 3. Reputation and relationships: the Majors had critical strong relationships with both home and host governments, suppliers and customers. 3.3.New Competitive Forces The 1990s witnessed a build up of forces that has eventually led to a restructuring of the industry through consolidation. The forces covered a wide range of aspects of the business. They affected each business stream and introduced new sources of competition at both a corporate and sectorial level. The main elements included: natural maturity of previously advantaged fields. The "endowments" of the Majors, especially in the upstream began to erode. Big fields such as Prudhoe Bay, Brent, Forties, Statfjord, Ekofisk etc. matured and began to decline. Equally the onshore and shallow water offshore of the Lower 48 states of the United States was also in decline. The producing assets were, in total, replaced in volume terms, but usually only by fields which were less profitable due to smaller size, higher costs and, in some cases, less favourable taxation regimes. Figure 3: Declining US Oil Production tighter ex post upstream fiscal terms for new fields and new provinces the entry of state oil companies into downstream markets both within their home countries and elsewhere (e.g. Saudi Aramco, PDVSA, KPC) the privatisation of previously state owned oil and gas companies e.g. Total, Elf, ENI changing geography. The fastest growth occurred in non-OECD markets, especially Asia. These markets were often closed to international investors or incumbent firms proved advantaged. international financial markets deregulated, giving many private and state oil companies increased access to capital intermediate commodity markets developed which effectively disintegrated the oil industry on an operating basis. This gave the opportunity for new entrants to enter specific parts of the previously integrated value without being disadvantaged. Timothy Bleakley, David S. Gee, and Ron Hulme of McKinsey have termed these new players "petropreneurs". Examples include: Tosco, Valero, Clark and Petroplus in refining in the US and Europe Hypermarkets such as Carrefour (France), Tesco and Sainsbury (UK) and Walmart and Costco (US) successfully entering the gasoline retailing business. Williams and Koch growing rapidly in the pipeline and terminal business the success of new upstream independents such as Apache At the same time, and partly as a result of a number of these factors, the real price of oil and refining margins fell on a trend basis as supply growth outpaced demand growth. Petrochemicals margins also fell. A renewed deep downswing in the chemicals cycle developed as capacity expansions yet again exceeded demand growth. Figure 4: Declining Prices and Margins The pressure of these forces can be seen by the fact that the petroleum industry was relatively unsuccessful in generating earnings growth and in achieving above average returns for shareholders. Analysis by Terreson and Coppola of Morgan Stanley Dean Witter shows that oil and energy sectors lagged the S&P 500 in terms of earnings per share and EVA during the 1990s. This applied to the Majors, even though they performed better than service companies or independents. Figure 5: Returns in the Oil Industry 3.4.Initial Responses The industry attempted to respond to deteriorating performance in several ways: 1. Cost cutting. Cost reductions at corporate levels and in operating assets was the prime response. To some degree this represented the stripping out of high cost structures that had cumulated and prevailed during the era of high oil prices from 1973-86. Head office headcounts were slashed. Contracting out of non-core services became prevalent. Upstream costs were successfully reduced, often through operating and technological innovation. Technological advances included horizontal drilling, subsea completions, floating production systems, seismic data processing etc. The North Sea saw the introduction of "alliancing" between partners and contractors in order to prevent duplication and high costs. The UK government even supported cost reductions through its CRINE (Cost Reduction in the New Era) initiative from 1992. 2. Portfolio Restructuring: non core businesses were shed as petroleum companies went "back to basics". Most coal and minerals operations were sold. BP sold its animal feed business, BP Nutrition. Mobil sold Montgomery Ward. Texaco sold its chemicals business which it considered to be non-core. Arco exited almost all non-US activities and spun off its chemicals operations. Underperforming assets were also sold. For example BP sold three US refineries - Ferndale (Washington), Marcus Hook (Delaware) and Lima (Ohio). At the same time, some companies also entered new sectors that opened in face of deregulation. US gas marketing attracted Chevron (through shareholding in Dynergy) and Shell who purchased Tejas. In these markets they met new competitors such as Enron (who grew mainly out of gas pipelines), power utilities such as Duke, Southern and Pacific Gas & Electric (PG & E) and innovative new players such as the internet power traders, Utility.com. Others invested in the electric power sector, mainly generation and usually IPPs. Shell bought Intergen as its vehicle. Amoco and Texaco created power divisions. In power generation they faced competitors in the form of existing utilities, deregulated utilities anxious to invest nationally and internationally and new power sector companies. In the majority of instances these investments have either proved unrewarding or slow to generate adequate returns. 3. Focus on New Growth Areas: US companies in particular sought new business opportunities outside their core US markets. Many US upstream companies invested in the UK North Sea e.g. Amerada Hess. Most companies declared a strategic intent to invest in Asian growth markets. Few had any success. Newly opening areas such as Azerbaijan, Russia, Kazakhstan, Angola and Yemen attracted many companies, although success proved scarce. Angola proved the most successful with Elf, Exxon and BP Amoco leading the discovery of a number of large low cost fields in the deepwater. The Former Soviet Union proved to be particularly challenging. 4. Financial Management: shareholder returns were enhanced in several cases through share buy back schemes. Exxon consistently bought back its own shares for over a decade and rewarded shareholders despite limited earnings growth. Amoco, Mobil and Texaco also bought back shares. Cost cutting, portfolio highgrading and shareholder buybacks were the most successful responses. Attempts to grow organically generally proved less rewarding. Regardless, as figure 5 shows, in total the petroleum industry continued to underperform relative to the S&P 500. 3.5.Sectorial Consolidation As it became progressively clear that the four strategic responses outlined in section 3.4 above were insufficient, a number of companies began independently of each other to develop and implement a new strategic response through structural change - sectorial consolidation. Downstream oil operations in mature markets were proving to generate inadequate returns despite initiatives to cut costs and prune portfolios. The first major move was by BP and Mobil who announced in February 1996 that they intended to merge their European oil refining and marketing assets and lubricating oil operations. This received approval from the European Commission in August 1996. This permitted BP plus Mobil to cut costs through elimination of duplication (usually two head offices in each European country). They also increased retail market shares at national and continental levels so that the BP-Mobil JV was able to compete on equal terms with Shell and Exxon who previously each had European average retail gasoline market shares of 13% compared to BP's 8% and Mobil's 4%. This was a successful merger of two complementary sets of assets. Promised cost savings have been achieved and profitability enhanced. This merger was followed by Shell and Texaco (plus Star, the US downstream operations of Saudi Aramco) merging in 1998 into two regional companies Equilon on the US West Coast and Motiva in the rest of the US, mainly in the south and east. Dual branding (Shell and Texaco/Star) has been retained. Ultramar and Diamond Shamrock and Ashland and Marathon also effected US downstream mergers. In the US upstream low profitability triggered a merger between the Permian Basin assets of Shell and Amoco to create ‘Altura'. A number of proposed downstream mergers fell through before implementation. Shell and Texaco failed to complete a European merger. Similarly Philips and Ultramar Diamond Shamrock abandoned their proposed US downstream merger. It was either clear that cost savings were not easily identifiable or new management structures could not be agreed. 4."Mega Mergers": A New Era for the Petroleum Industry These sectorial mergers, while in some cases successful in increasing profitability at the micro level, were insufficient to have a fundamental impact upon corporate level profitability and returns. The BP-Mobil European JV was an exceptional fit of assets. However, it could not be replicated either by other sets of players or in other geography or sectors. Corporate transformation thus required a greater response. The first corporate level move was the merger between British Petroleum and Amoco to create BP Amoco. This was announced in August 1998 and the deal was completed with full regulatory approval on 31 December 1998. This created a new "super major" approximately equal in size to Exxon and Royal Dutch Shell. The merger had both a cost saving and strategic rationale. A cost reduction of $2 billion was promised when the deal was launched, mainly through the elimination of duplication, but also through greater contracting out of services and the introduction of a strongly performance based culture to former Amoco assets. Sir John Browne, Group Chief Executive of BP Amoco, announced in August 1999 that annualised $2 billion cost savings would be realised before the end of 1999 - well in advance of the initial two year goal. The merger of BP and Amoco had a number of startegic rationales. First it solved many of the strategic portfolio dilemmas of the two separate companies. BP had for many years been aspiring to increase the size of its gas business which was the smallest of the majors. Amoco was the largest N American natural gas producer. It was also in the midst of commissioning its Trinidad LNG project which was widely seen as the lowest cost and most innovative LNG scheme in the world. Amoco had long been seeking a rebalancing of its portfolio with access to growth outside N America. BP provided the lead position in the UK North Sea, the world's most successful frontier exploration company and an international downstream oil business. Both companies also had the opportunity to merge their chemicals operations into a larger business that is close to the forefront of the world bulk chemicals industry (indeed a sectorial chemicals tie up had previously been considered). Similarly, the merger of the two companies' US refining and marketing operations provided the opportunity to reduce costs and improve profitability. The contiguous, rather than overlapping, mix of downstream assets severely limited the need to divest assets to obtain regulatory clearance from the US Federal Trade Commission. The merger of the two medium large companies to make a large "super major" offered a further potential gain. Both companies had previously felt inhibited in holding large shares of material growth options. The new size of the company offered "reach". This implied both the ability to retain a large share of a growth option and the ability to chase a wider range of options at any one time. The financial markets evidently agreed with the strategic rationales and believed the targets set out. Accordingly, both BP and Amoco shares traded at a premium following the initial announcement of the deal and later the closure. The BP Amoco merger was followed by a series of other deals that have further transformed the structure of the petroleum industry. Most importantly Exxon and Mobil announced in December, 1998 their intention to merge. If approved by the regulatory authorities this will create the largest petroleum company in the world, approximately 30% larger than BP Amoco (+Arco) or Shell. The rationale is again cost saving with the expectation that Exxon's corporate cost culture will rapidly squeeze costs out of Mobil's operations. As of writing (September 1999) regulatory approval has not been obtained in either the US or Europe. It is widely believed in the press that the EC will approve the deal subject to undertakings. FTC approval is likely to require divestment of some US located assets. Approvals are expected before the end of the year. The French company Total also responded aggressively. First it announced in December 1998 its merging with Fina of Belgium. This was primarily a European downstream and chemicals merger. It was approved by the EC in March 1999. Total/Fina then launched a bid for French rival Elf in July 1999 which was eventually accepted by Elf after Total raised its bid by 10%. The joint group will become the fourth largest petroleum company in the world (even after probable divestment of some of Elf's chemicals assets). Meanwhile, Repsol of Spain acquired YPF of Argentina. Low oil prices were not a primary driver of these mergers. The main objective was to enhance performance and profitability, whatever the external environment, and to create or access growth options. Low oil prices, nevertheless, increased the urgency to improve performance. Chevron and Texaco announced publicly in May 1999 that they were also discussing a possible merger, building on their very long standing Caltex joint venture. They had previously stated that they did not feel it necessary to enter a merger. Talks broke down, reputedly because of an inability to agree management structures. Enterprise and Lasmo, two UK based upstream independents, similarly entered into merger discussions in January 1999. These broke down by the end of March. Low oil prices had been a more important driver of this proposed deal. On 1 April 1999 BP Amoco announced its intention to acquire Arco (Atlantic Richfield) in a paper deal then valued at US$26.8 billion. This potentially provides BP Amoco with a US West Coast refining and marketing presence, an increased share of Alaskan exploration and production and a set of Asian natural gas assets. The deal is still under consideration by European and US regulators. 5.New Drivers of Competitive Advantage 5.1.The Industry Has Changed This set of deals will, if completed, establish a new petroleum industry structure. The rankings of companies in terms of market capitalisation, production and reserves has changed significantly. A new group of three super majors (Exxon-Mobil the largest, followed by BP Amoco (+Arco) and Royal Dutch Shell) are the largest companies with Total-Fina/Elf fourth in terms of market capitalisation. This contrasts with the previous grouping of the 6 remaining "sisters". Table 1: Petroleum Company Market Capitalisations (US$ billion) 1 January 1998 9 September 1999 Shell 191.0 Exxon + Mobil* 280.3 Exxon 150.9 Shell 221.8 BP 75.8 BP Amoco + ARCO* 215.3 Mobil 56.6 Total FINA + Elf* 98.1 Chevron 50.6 Chevron 64.0 ENI 45.5 ENI 48.0 Amoco 41.5 Repsol + YPF 38.3 Elf 32.2 Texaco 37.2 Texaco 29.8 Conoco 18.1 Total 26.6 Philips 13.5 ARCO 25.7 Petrobras 13.3 Source: Datastream * Assuming pending transactions completed 5.2.Changing Industry Boundaries The change to the industry structure has in fact been more profound. Section 2 above had defined the private petroleum industry as it had existed in the 1980s and into the early 1990s. The boundaries were clearly defined. Competition from players outside the industry - namely those whose main business was not petroleum production, refining or marketing - was limited. The oil price rises of the 1970s had attracted some non traditional entrants to the E&P business (e.g. ICI and RTZ in the UK North Sea). They were not, however, successful and duly exited. Section 3 detailed other changes that have taken place within the industry during the 1990s. These have had the effect of redefining the industry boundaries, structure and definition. The key forces of change have been: The disintegration of the industry at an operating level. Previously vertical integration had prevailed from the well head to burner tip or pump. Back in the 1960s companies generally supplied their own refineries in their own ships and then provided gasoline to their own retail sites. This is no longer the normal case. Intermediate markets have now been established and deepened along the value chain. Spot, forward and futures markets have been developed. Spot crude markets initially emerged as a result of the changing ownership structure of OPEC oil from the 1970s. It was accentuated by the growing availability and reduced cost of information which lowered transaction costs and limited the value of operational integration. The net result has been that barriers to entry have fallen along all of the chain and, as section 3.3 highlighted, new specialist entrants have emerged in most segments. Deregulation has had the effect of opening up previously closed sectors to competition. This has been particularly prevalent in the US and UK natural gas transportation and marketing businesses and the electric power sector. Deregulation is becoming an increasingly global phenomenon. The boundary between the old petroleum industry and the new deregulated gas and power industries is now indistinct. The net result is that the boundaries of the petroleum industry have now changed. The industry should now be considered to include: state companies such as Saudi Aramco, PDVSA etc. who operate commercially and on equal terms with private companies in a number of international markets new refiners such as Tosco and Valero who operate exclusively within the domain of the old industry. hypermarkets (such as Tesco, Carrefour) who have attained a substantial share of a gasoline market even though gasoline retailing is only a small part of their business. gas companies such as Enron who is a gas producer and transporter but is also a leading gas marketer and trader, power generator and power retailer Table 2: Market Capitalisation of Selected Private Energy Companies US$ billion as of 9 September, 1999. Excludes State owned companies. Rank Company Country of Head Office Market Capitalisation 1 Exxon + Mobil US 280.3 2 Royal Dutch/Shell UK/Neth. 221.8 3 BP Amoco + ARCO UK 215.3 4 Total FINA + Elf France 98.1 5 Chevron US 64.0 6 ENI Italy 48.0 7 Schlumberger US 38.5 8 Repsol + YPF Spain 38.3 9 Texaco US 37.2 10 Tokyo Electric Power Japan 31.1 11 Enron US 30.2 12 Korea Electric Power S. Korea 25.3 13 BG UK 24.6 14 Halliburton US 22.4 15 Endesa Spain 21.4 16 Duke Energy US 21.0 17 Kansai Electric Power Japan 19.1 18 Southern US 18.4 19 Conoco US 18.1 20 Chubu Electric Power Japan 13.6 21 Phillips Petroleum US 13.5 22 Petrobras Brazil 13.3 23 Iberdrola Spain 13.3 24 Norsk Hydro Norway 12.1 25 CLP Holdings Hong Kong 11.8 26 Baker Hughes US 11.7 27 PG & E US 11.5 28 Scottish Power UK 11.1 29 Gas Natural Spain 10.9 30 Texas Utilities US 10.8 31 Centrica UK 10.6 32 Unocal US 10.3 33 USX-Marathon US 10.3 34 National Grid UK 9.8 35 Electricidada de Portugal Portugal 9.8 36 Consolidated Edison US 9.7 37 National Power UK 8.9 38 Edison International US 8.7 39 Dominion Resources US 8.7 40 Public Service Enterprises US 8.7 41 Occidental US 8.3 42 Houston Industries US 8.1 43 Peco Energy US 7.8 44 Burlington Resources US 7.8 45 Kyushu Electric Japan 7.5 46 PowerGen UK 7.0 47 American Electric Power US 6.9 48 United Utilities UK 6.5 Source: Datastream electric power companies such as Southern, Duke and PG & E who market gas as well as generating and distributing electricity The industry ranking including power companies, gas companies and service companies now looks different to table 1, even when state owned companies are excluded from the classification. The big fish have got bigger - but the pond is distinctly larger. 5.3.The "Super Major Theory" The existence of a trio of ‘super majors' has raised questions as to whether this group could dominate the petroleum industry. This was a concern investigated by the European Commission in its review of both the Exxon-Mobil and BP Amoco/Arco acquisitions. It has been termed the "super major theory". There is no unique theory, but the common theme is the assertion that the super majors will be in a position, usually at some stage in the future, to exert dominance. The European Commission's particular concern was that there would be future collective dominance in the exploration and production sector. It was asserted that the " super majors" would dominate the non-OPEC exploration sector. As existing non-OPEC producing assets mature and decline, this would, in time, result in the super majors dominating non-OPEC production. It was then asserted that OPEC and the super majors would potentially have an alignment of interests which would result in competitive conditions conducive to active or tacit collusion between the two blocks as to crude oil output levels. In such a scenario, it was the Commission's contention that the two blocks would, through collusion made possible by the very structure of the market in the E&P sector, manipulate crude oil prices to a level which generates maximum rent for the incumbents (i.e., the OPEC states and the super majors) but which would be insufficient to sustain a number of existing oil producers or to stimulate the entry of new entrants. BP Amoco argued strongly that this hypothesis was flawed. This was mainly because it considers that the E&P sector is competitive and that, as a result, the super majors do not have unique advantages that could generate future dominance. A number of factors were cited to support this argument: 1. The super majors do not have dominant access to technology, know how and skilled labour (see section 3.2 above). Such knowledge is not proprietary and is available to any industry participant from oil service companies. 2. Financial resources and strength do not reside uniquely in the super majors. Capital market deregulation has made it possible for sound borrowers to access finance freely on competitive terms. 3. Resource owners - host governments - are very unlikely to permit a group of three companies to dominate development and production of their resources. Host governments regularly diversify their allocation of licences. Most blocks are shared. Operatorship is usually spread between a number of different companies. ‘New areas' such as the Caspian and deepwater Angola have seen a wide allocation of awards. 4. Small E&P companies have been successful in discovering and developing oil and gas in frontier regions. Specific successes include Triton in Colombia, Hunt in Yemen, Cairn in Bangladesh and Anadarko in Algeria. Large integrated companies - but not super majors - have also been successful e.g. Elf in Angola. 5. Super majors are not and will not be in a position to control levels of oil production either now or in the future. In practice control over both production and field abandonment is severely constrained by a number of factors: The companies in a vast majority of cases do not operate under exclusive licenses - but rather as joint venture partnerships. Companies are precluded from controlling production. The ultimate control of production levels lies with host governments. 6. The super majors may be the largest private petroleum companies by several measures. However, as tables 3 and 4 show, their total share of world reserves or production is still small and well below any measures of dominant shares. Even in the narrowest measure, the three super majors together only comprise 15.6% of non-OPEC oil production. Other private companies and state companies in both OPEC and non-OPEC countries comprise the balance. This argument is consistent with the conclusion in section 5.2 above that the industry is now wider than had previously been the case. To be convincing, any version of the super major theory would require a number of conditions to hold: 1. The super majors' existing share of a relevant market must be high. As tables 3 and 4 show this does not hold today. The super majors would need to have a dominant control of particular skills, technology or know how or a substantially superior access to financial resources. 2. Host governments would need to permit the super majors to control production volumes and asset abandonment. Table 3: World Oil Reserves Table 4: World Oil Production These conditions do not hold today and cannot reasonably be expected to hold at any time in the future. The competition authorities have shown greater and more specific concerns about competition in downstream oil markets. In the US particular attention has been given to market shares in geographically defined gasoline markets (often down to the city level) and to control over infrastructure such as terminals. Undertakings as to divestment and other matters have ensured that downstream markets remain competitive. 5.4.New Drivers of Competitive Advantage This paper has so far argued that the petroleum industry as had been known in the 1970s and 1980s has now changed fundamentally. The players have changed. Existing players are consolidating; new players are entering. Previous endowments are eroding. There are no technological barriers to entry. Industry boundaries have shifted, widened and blurred. Some existing players are investing along the value chain into other sectors such as gas marketing and power that had previously been effectively closed to the petroleum industry. It is also argued that, while the new ‘super majors' are consolidating to improve performance, partly through cost reduction, it is wrong to presume that their size will cause them to be dominant in the petroleum industry. The future industry structure will accordingly be determined by the competitive environment and sources of competitive advantage. The petroleum sector looks set to operate in increasingly open and competitive markets. Three factors seem set to influence this. First, the process of deregulation, especially in the electric power industry and to an almost similar extent in the natural gas business looks set to continue. Deregulation is deepening and widening globally. Second, host governments are progressively opening their natural resources to international investment. There have been recent openings in areas such as the Caspian, Venezuela, Brazil, Algeria and Iran. Opening is under discussion in Kuwait, Iraq and Saudi Arabia. And finally, it can reasonably be expected that the competition authorities will strive to continue to ensure that competition prevails in all stages of the industry. Consolidation has been permitted, albeit with undertakings in certain cases, but there is no evidence to indicate that the authorities intend to change the structure of the industry through competition policy. The structure of the industry will accordingly most likely be determined by the degree to which various players establish and apply sources of competitive advantage in open markets. The analysis in section 5.3 above indicated that size alone is not a source of competitive advantage. Super majors will not be successful merely because they are large. Experience elsewhere implies that size is often a source of complexity and thus a disadvantage. In a changing industry flexibility and speed of response is usually more valuable. Where are the new sources of competitive advantage likely to reside? John Kay in his book ‘Foundations of Corporate Success' used a framework which identified four generic dimensions which can drive competitive advantage: strategic assets; reputation; technology; and corporate architecture. This framework can be applied to the petroleum industry: Strategic Assets: In the petroleum industry of the next decade strategic assets can be expected to include: large, low cost oil fields large, low cost gas fields with low cost access to markets refineries that are advantaged by configuration, geography and costs significant retail market shares with low logistical costs and advantaged supply and a strong convenience offer ideal sites that integrate refining and petrochemicals Existing players own existing strategic assets but this will not necessarily ensure that they will retain such competitive advantages. Producing assets mature and will need to be replaced by new discoveries. New strategic assets will be created and sustained through building on three characteristics: technology; reputation; and architecture. Technology: as already noted, proprietary technology does not bestow competitive advantage in the petroleum industry today, except in the special case of petrochemicals. Nevertheless, technological skills and applications can be expected to be a source of future competitive advantage in a number of dimensions: innovation in the application of technology. The best examples of this have been in the upstream sector, especially in deepwater and subsea applications. positioning for leadership in face of step changes in technology in areas such as new fuel specifications, renewables, low carbon technology, fuel cells and the hydrogen economy. application of IT to reduce operating costs, lead moves into e-commerce, nurture a learning culture and to help sculpt new corporate structures. Reputation: the petroleum industry has long been one where discretionary decisions (e.g. licence or concessions awards) have been important. Reputation will become an increasingly important factor: to be a preferred partner in the development of new resources and markets that are being opened to international investment to be seen by consumers, communities and governments as being environmentally sound and responsible in terms of operations and product quality to be seen as ethically sound by all stakeholders to develop a strong brand that can permit the leveraging of marketing operations Architecture: the successful company will develop and apply a corporate architecture or structure that nurtures behaviours that generate competitive advantage. From today's standpoint such characteristics include low costs, openness, flexibility, learning orientation and empowerment. In the future the characteristics may change: the key is to be strong in the skills that are scarce. In short, competitive advantage can be expected to stem mostly from key competences. Existing asset positions will be beneficial, but not sufficient conditions for future competitive advantage. The era of change now seems well established in the petroleum industry. Change seems to be dominant. Change causes a reranking of competitive advantage and a resulting new industry structure. The industrial consolidation of 1998/9 had not been widely predicted, especially in the form that has transpired. Change and openness coupled with new market entrants point to further changes in competitive advantage in coming years. There are two broad views of the future of the industry: one where consolidation causes new advantages for the new larger players; and the other where new entrants result in industrial atomisation or disintegration. Section 5.3 argued that the consolidated super majors cannot be expected to be dominantly advantaged. The industrial battleground thus looks likely to be in terms of core competences with the struggle between the existing players, who build on strengths and combine low costs with flexibility, and new entrants with sector specific honed skills, aggression and dynamism. 6.Conclusions The analysis in this paper highlights that the petroleum industry is now in a period of change. The seeds of change initially lay in the OPEC nationalisations of the 1970s. The pressures for change accelerated during the 1990s, driven by opening markets, deregulation and low prices and margins. The pressures manifested themselves in low industry profitability. Sectorial consolidation selectively improved profitability. 1998/9 then saw the emergence of the most dramatic period of consolidation and change for at least seventy years. Three new ‘super majors' have emerged as the globally largest private industry players. As mergers are completed, the focus will be on the delivery of enhanced profitability, initially through cost reduction. A new industry structure is emerging but further change is anticipated. New players with specialised skills are entering the industry. The industry boundaries have widened and blurred in face of deregulation of gas and power and the entry of state companies into internationally competitive markets. The super majors have the potential to improve profitability but will not have unique advantages that could allow them to dominate the industry. The new petroleum industry will be increasingly competitive. Existing strategic assets will provide some advantage to incumbents. However, longer term competitive advantage looks set to be driven predominantly by core competences. Skills, knowledge, flexibility and dynamism are likely to be even more important than absolute size or incumbency. by Peter Davies Go to top of page Contact Us Copyright © 2000 The Centre for Energy, Petroleum and Mineral Law and Policy. All Rights Reserved. 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