For Marathon Oil (MRO) Chief Executive Officer Clarence P. Cazalot Jr., the breaking point came in mid-2008: Profits from its refineries plunged by more than $1 billion during the second quarter, even as crude surged toward an all-time high of $147.27 a barrel that summer. How could that be? The Houston-based company was having to buy 95 percent of the oil it turned into gasoline from rivals because its 2,300 wells were too far away or pumped the wrong kind of crude.
Marathon’s chief decided it was time to quit the refining business and stick to drilling for oil. “There’s not a CEO out there who wants to run a smaller company, but shareholders don’t pay me to just run a big company,” said Cazalot in late August, a couple of months after Marathon spun off its refineries, pipelines, and truck stops into an entity called Marathon Petroleum (MPC).
The well-to-filling-station business model that made John D. Rockefeller one of the richest men of his age increasingly is being assailed by industry insiders and Wall Street analysts as a drag on profits and stock prices. Rockefeller pioneered oil industry integration in the late 19th century by joining crude exploration, refineries, and gas stations under the Standard Oil (SOCU) umbrella to guarantee a market for his oil and capture profits all along the production and marketing chain. It’s the template used by all of the supermajors. Yet shareholders in Royal Dutch Shell (RYDAF) and ExxonMobil (XOM) may be missing out as those companies cling to refineries despite volatile returns. Shares of Marathon, which ranks No. 10 among U.S. oil producers by market value, are up 22 percent hits year, vs. 7 percent for Exxon and 3.8 percent for Shell.
Marathon’s move is being copied by ConocoPhillips (COP). The No. 3 U.S. crude producer plans to hive off its refining business next year, a move the company claims will unlock $20 billion in shareholder value. Meanwhile, Wall Street is pressing BP (BP), which is still struggling to recover $44 billion in market value lost in last year’s Gulf of Mexico disaster, to sell a network of fuel-making plants that Deutsche Bank (DB) says could fetch the equivalent of half a year’s profit.
Cazalot, who was exploration chief at Texaco before joining Marathon in 2000, was once an earnest devotee of integration. He spent more than $8 billion to buy out a partner’s stake in Marathon’s refineries and upgrade plants in Michigan and Louisiana. Yet Marathon kept striking oil in Angola, Norway, and other places far from its Midwest and Gulf Coast refineries. More than 70 percent of its crude now comes from Africa and Europe. Exxon and Chevron (CVX) have positioned refineries near their oil fields or have configured their plant so they can process the cheapest types of crudes. “I sat there and said, ‘Where is the industrial logic of keeping these assets together?’ There was no real physical integration,” says Cazalot, sitting in his office on the top floor of the 41-story Marathon Oil Tower.
ConocoPhillips CEO James J. Mulva told analysts in July that the integrated model that made sense for the company for 10 years no longer works. Profit from the refining, pipeline, and chemical assets Mulva intends to spin off shrank to 7.9 percent of the company’s total last year from more than 11 percent in 2009.
For the supermajors—Exxon, Shell, BP, and Chevron—refining crude into products such as gasoline, diesel, and jet fuel generated a combined $1 trillion in sales last year. Spinning off plants, distribution channels, and convenience stores as stand-alone companies may be the quickest way to give shareholders a windfall, says Jonathan Dison, a managing director at Bender Consulting, a strategy firm in Austin, Tex., that has advised BP and Shell. U.S. refining margins are at a 25-year high. When those margins shrink, as they inevitably do because of economic trends and seasonal demand changes, the supermajors may find it’s too late to cash in Marathon-style. Says Dison: “They have all brought in consultants to figure out whether spinning off refining would be a good idea.”