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BusinessWeek: December 14, 1998 |
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News: Analysis & Commentary
TREMORS FROM CHEAP OIL Plunging prices spur the world's biggest merger and reshape petro politics
And on Dec. 1, it made its first move, announcing the biggest takeover in corporate history: a $75 billion stock deal to purchase Mobil Corp. and forge the world's largest oil company. As the chief executive of $181 billion Exxon Mobil Corp.--a behemoth fully a third larger than No. 2 Royal Dutch/Shell Group--Raymond will be able to seize global opportunities that are unavailable to weaker competitors. STRUGGLING OPEC. What opportunities? Exxon Mobil--and other companies that can compete with its efficiencies and technical skills--will be the leaders in a new era for the energy business. The old order, dominated by the notion of scarce oil and by the political machinations of OPEC, is crumbling. No longer capable of keeping prices high by deliberately withholding supplies, OPEC members are now struggling to survive on a diet of cheap oil. By contrast, producers such as Exxon are thriving--in part because of OPEC's tactics. Denied access to the most easily recovered oil reserves, Exxon, Mobil, and others have honed their skills in harvesting hard-to-reach oil and gas at improbably low costs from remote Asian steppes, deep waters off the coast of Africa, and far above the Arctic Circle. These discoveries--as well as weak demand in Asia--have helped produce an oil glut that is wolfsbane for the cartel: The bigger the glut, it seems, the less able OPEC is to reach agreement on production limits. Following a recent unproductive meeting in late November, the price of West Texas Intermediate, the benchmark U.S. grade, hit $11.13 per barrel on Dec. 1. The first big opportunity that Exxon Mobil may try to explore is a partnership with Saudi Arabia. It has a quarter of the world's oil reserves, and the cheapest to tap. But the Saudis have seen revenues plunge because of declining prices that they have been reduced to borrowing money from tiny Abu Dhabi. Now, the kingdom is ready to deal. On Sept. 25--two decades after Saudi Arabia nationalized its oil industry--Crown Prince Abdullah ibn Abdul-Aziz held a one-hour "tea party" with top executives of seven major U.S. oil companies to discuss possible cooperation. Other Mideast producers are also considering such partnerships. And who is better positioned than the company that will be the biggest by far? Says Fahnestock & Co. analyst Fadel Gheit: "You're talking about a company that can alter the economic landscape of a country." Not everyone can capitalize on this impending shift in power in the world of oil. The global meltdown of many key emerging markets earlier this year was accelerated by deflation in the commodities markets, and in particular in oil. Major losers then--Russia and many other ex-Soviet states, Indonesia, Malaysia, and to a lesser extent Mexico--will suffer even more under the new order. Even if consumption rises dramatically over time, most analysts believe prices should remain in check because of advanced technology and because OPEC nations need to sell as much as they can to maintain their incomes. Russia could be among the biggest victims. According to Moscow's CentreInvest brokerage, it costs $6 to $8 a barrel on average to produce and pipe Russian oil, several times Mideast costs. Together, oil and gas account for almost half of Russia's export earnings. And with its government is close to default on $150 billion in hard-currency debt, the continuing drop in prices is the last thing Russia needs. Other producing nations that count heavily on oil revenue are having to make adjustments as well. Mexico, for instance, has reserves that are relatively cheap to recover, but its state-owned oil company, Pemex, is under pressure. "Pemex isn't generating the cash flow to make the investments that they need," says Rafael Quijano, managing partner of Latin American Petroleum Intelligence Services in Washington. HIGH TECH. Low oil prices are excellent news, of course, for big energy consumers. A sustained $10-per-barrel drop in the price of oil cuts about 0.7 points from the annual U.S. inflation rate over five years and adds about 0.3 points to the U.S. economy's growth, according to an analysis for BUSINESS WEEK last year by Standard & Poor's DRI. That, in fact, is about what has happened over the past year. However the geopolitics play out, and wherever prices go, it clearly pays for producers to have the best technology and lowest costs. Notes Robert P. Peebler, CEO of seismic software developer Landmark Graphics Corp.: "If you're the most productive company, you can take advantage of the low prices, because you're going to have the cash flows to acquire properties. And when you have high prices, you can be more profitable." On the other hand, if you're still operating under the assumption that the earth's petroleum--or at least the cheap stuff--is about to run out, you're not going to thrive in the new oil era. Technology is making it possible to find, produce, and refine oil so efficiently that its supply, at least for practical purposes, is basically unlimited. So oil executives need to be as obsessive about cutting costs as anyone else. "You cannot count on the market to bail you out of bad decisions," Raymond said in a Dec. 2 interview. Hence the merger wave. Says Leo P. Drollas, deputy director of the Center for Global Energy Studies in London: "The industry is looking ahead and seeing low oil prices as far as they can see. The mergers are a defensive action." Internal cost-cutting is no longer enough, Mobil Chairman and CEO Lucio A. Noto said at a Dec. 1 news conference: "The easy things are behind us. The easy finds. The easy cost savings. They're done....We tend to do the smart thing when times are tough. And times are tough now." By joining forces, Exxon and Mobil aim to cut $2.8 billion a year in costs--much of it by eliminating 9,000 jobs, or around 7% of their combined worldwide total of 123,000. Though they'll keep both brand names, they will merge the marketing organizations that support them. "It is good management applied to a bigger asset base," says Rod Peacock, managing director for global energy investment banking at J.P. Morgan Securities Ltd. in London, who advised Exxon on the deal. The merger of Exxon and Mobil will not only create the world's largest oil company, but it also will create one of the world's largest companies of any kind. The combined revenue of Exxon and Mobil for the first nine months of 1998 was $119 billion, vs. $115 billion for No. 1 General Motors Corp. Low oil prices plus divestitures may knock Exxon Mobil down to second place. (Note to numbers watchers: Some sources report higher revenue numbers for Exxon and Mobil, mainly because they include fuel excise taxes that are passed straight to governments.) Does size matter? Yes. The biggest companies--Exxon, Royal Dutch/Shell, and British Petroleum--routinely have a higher return on capital than their smaller kin, says Douglas T. Terreson, a Morgan Stanley Dean Witter analyst. Big companies can defray fixed costs over a wider revenue base. And they can tackle the biggest international projects--without partners, if need be. They can afford not only to explore and sink wells, but to build refineries, petrochemical plants, pipelines--the whole assemblage that host countries desire. Indeed, Mobil may have seen the wisdom of a merger after losing a bid to develop natural gas fields in Turkmenistan because it couldn't match Shell's offer to build a pipeline for $1 billion. Until this year, there had not been a major oil merger since the 1984 combination of Chevron Corp. and Gulf Corp. Then in August, British Petroleum announced a $64 billion deal to buy Amoco Corp. And now Exxon is buying Mobil. Says Terreson: "BP-Amoco was a shock to the system, and Exxon Mobil was a seismic shift. There are going to be several more to follow." That's a good bet. On the same day as the Exxon Mobil deal, France's Total agreed to buy Belgium's PetroFina for $13 billion. Texaco Inc. and Chevron, worried about being left behind, might make natural partners. In a speech to analysts on Dec. 2, Texaco CEO Peter Bijur said: "We will not rush into anything. We don't feel the urge to merge." Conoco Inc., recently spun off from DuPont Co. in the biggest initial public offering ever, could disappear into some other company's embrace soon--this time, probably another oil company. Asked at a news conference how much farther the consolidation might go, Total CEO Thierry Desmarest answered: "The game will go on until the antitrust authorities call it off." The Exxon-Mobil deal certainly rings antitrust bells. It unites the two biggest companies of the Standard Oil Trust, which was broken up by the courts in 1911. But most experts expect the deal to go through--perhaps after the companies divest refineries and gas stations in markets where they have large market shares. In Washington, D.C., for instance, together they sell 35% of all gasoline, says National Petroleum News. Low prices are shaking the world oil industry from top to bottom. The pain is widespread. And old titans may disappear. But as Exxon's deal for Mobil shows, for some players, crisis equals opportunity. Return to top | |
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 TABLE Bringing Together Leaders in Technology UPSTREAM -- Exxon and Mobil are expert in recovering oil from extremely deep waters and the Arctic. A key technology: floating platforms. -- Mobil leads in liquefying natural gas for transportation. Exxon leads in converting natural gas into liquids for chemicals. DOWNSTREAM -- Exxon is a leader in metallocene catalysts, which recover far more usable petroleum products from a barrel of oil than older catalysts. -- Mobil introduced the first fully synthetic engine oil in 1970 and now has more than 50 synthetic oils for cars, planes, and factories. Return to top TABLE The World's Top 10 Oil Companies 1 EXXON MOBIL $181 billion
EXXON MOBIL
REVENUE -- $123 billion REVENUE -- $58 billion
NET INCOME -- $8.5 billion NET INCOME -- $3.3 billion
EMPLOYEES -- 80,000 EMPLOYEES -- 43,000
STRENGTHS -- A strong balance sheet, STRENGTHS Better positioned than
low exploration and production costs, Exxon in oil and natural gas
and excellent return on capital reserves outside North America
COMPANY 1997 REVENUE IN BILLIONS
2 ROYAL DUTCH/ Rich in cash and reserves, but
SHELL under pressure because of high
$129 costs and lackluster earnings.
3 BRITISH Kicked off merger wave with
PETROLEUM August agreement to buy Amoco
$104 ** for $64 billion.
4 TOTAL FINA Total agreed on Dec. 1 to buy
$55 Belgium's PetroFina for $13 billion.
5 ENI $53 Italian government owns 37%
6 TEXACO Recently cancelled joint marketing
$45 deal with Shell in Europe. Merger
with Chevron rumored.
7 ELF AQUITAINE Tried to buy PetroFina but
$45 lost to Total.
8 CHEVRON Merged with Gulf in 1985, but
$35 most think it is a takeover
candidate.
9 REPSOL Oil, gas, and chemical company
$22 sold off by Spanish government.
10 CONOCO After spinoff from DuPont, it's on
$21 list of takeover candidates.
*Assuming current deals are completed. Excludes state-owned companies.
** After pending purchase of Amoco Corp.
DATA: BLOOMBERG FINANCIAL MARKETS, PLATT'S, BUSINESS WEEK
Return to top WHY TRUSTBUSTERS ARE BUSY EVEN WHEN PRICES FALL Prices for gasoline and heating oil are near inflation-adjusted 50-year lows. And excess supply continues to flow from all corners of the globe. Yet, there is no doubt--certainly not in the stock market at any rate--that federal trustbusters will take an extra hard look at the proposed combination of Exxon Corp. and Mobil Corp. The megamerger points up what is becoming a more frequent question for regulators: How do you measure anticompetitive activity and prevent harm to consumers in markets where prices are falling? For the past several years, the Justice Dept. and Federal Trade Commission have struggled with this conundrum. No longer fixating on how companies use market power to raise prices--once the litmus test of antitrust litigation--the agencies now must ask another type of "what if?" Would prices be even lower if this merger didn't happen? Over the past two years, the government has asked that question and concluded that some proposed mergers would impede market forces pushing down prices. The FTC stopped a pair of huge deals in the drug-wholesale business: McKesson Corp.'s plan to acquire AmeriSource Health Corp., and Cardinal Health Inc.'s proposed purchase of Bergen Brunswig Corp. In the office-supply superstore business, it concluded that combining Staples Inc. and Office Depot Inc. would inhibit the fall in prices--even though the companies argued that their greater efficiency would, in fact, accelerate that decline. THE WINDOWS TEST. The question of how quickly prices drop with or without competition is also at the heart of the Justice suit against Microsoft Corp. In its economic analysis of the software industry, Justice has repeatedly argued that Microsoft's prices would be far lower if it had more direct competition. On Dec. 1, Frederick R. Warren-Boulton, the government's expert witness, testified that the price for Microsoft Windows is "significantly above 5%" more than it would have been if Microsoft didn't have 90% of the market. Warren-Boulton, head of a Washington economic consulting firm, argued that while prices of other parts of PCs were falling, the Windows price was an ever larger percentage of the total PC cost. "We see a really dramatic increase in the cost of the operating system relative to the other components in a PC," he said. How to use the tool now being applied to William H. Gates III, the Rockefeller of the computer era, to Exxon and Mobil--the two largest chunks of Rockefeller's Standard Oil trust? There is no one segment of the oil industry that Exxon Mobil will control to the same extent that Microsoft controls the PC industry. Nor will this giant have anything near the market power of the oil trust that the government broke up in 1911. But the government will review carefully the ways in which the Exxon-Mobil merger might reduce competition. Experts believe, for instance, that it will ask for divestiture of some "downstream" operations--refining and retail sales of gasoline--where the two now compete directly. "In regions where the two firms have high shares in the retail gas market, that could require some divestitures," says Stephen Calkins, professor at Wayne State University Law School. But in exploration and development, where competition is brisk, Justice may not demand anything, despite the combined companies' awesome assets. One core concern in the Exxon-Mobil union will be whether proposed cost-cutting will keep prices on a downward trend. Even if the agency concludes that crude oil prices are beyond the control of the companies, the FTC will have to decide which would do more to transmit deflationary pressures down to the pump--super-efficient giants or intense competition among more players. This will be a key concern as the Feds review other oil-patch marriages. In the wake of the Exxon-Mobil deal, other combinations are likely. The FTC is already reviewing British Petroleum Co.'s purchase of Amoco Corp.--which is expected to go forward, but with strings. Those are tricky tasks. But as global competition induces more companies to merge and as deflation takes over more markets, trustbusters will constantly face the pricing question: How low is low enough? Return to top |
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