Is the Integrated Oil and Gas Model Burned Out?

INDUSTRY REPORT: To boost returns, integrated firms are shedding downstream assets

Allen Good 29 March, 2011 | 11:20AM

ExxonMobil (XOM
As the world’s largest refiner and one of the largest chemical manufacturers, one might think ExxonMobil would be leading the charge in reducing downstream capital investment. However, that's not the case. While the company has reduced downstream capital employed over the last ten years by selling refining, logistics and retail assets, it currently has no explicit divestment plans. During meetings with management last fall, they revealed after a thorough review of the business model, they could identify and attribute real dollars as a result of integration. This is likely because unlike many of its integrated peers, ExxonMobil has true integration between upstream and downstream operations, as opposed to a collection of assets. With 75% of its refineries integrated with chemical or lubricant production, facilities can not only share infrastructure, but ExxonMobil can also optimise its production to capture the highest value output while realising lower costs through feedstock flexibility.

Given the difficulty replicating this type of structure, ExxonMobil realises value where others do not. On the upstream side, the company's push into natural gas is resulting in more ethane production, which can be used for chemicals production. ExxonMobil's advanced chemical plants can process larger amounts of lower cost ethane and other heavy feedstock than competitors. While dispositions of retail, logistics assets or small stakes in refineries may occur to pare the portfolio, it is unlikely to see any large transactions, considering the competitive advantages. Given its record of delivering superior returns, we view ExxonMobil's strategy favourably.

Royal Dutch Shell (RDSB
Given its size and extent of chemical operations, Royal Dutch Shell is on par with ExxonMobil with regard to downstream investment. However, Shell has not quite delivered the returns of its larger rival, and saw a sharp decline in profitability in 2009. As a result, the company recently undertook plans to improve returns and profitability. A key element of its plan was to shed poor-performing refineries. Since the end of 2009, Shell reduced its total refining capacity by 700,000 bbl/d, brining its total capacity reduction since 2002 to 1.6 million bbl/d. By divesting many smaller facilities, Shell has also increased the size of its average refinery by retaining larger integrated facilities, which should lead to more efficient operations, focused management, and lower costs. On the marketing side, the company is exiting markets where it has limited presence and little growth potential. It is also moving more towards a wholesale supply model, as opposed to retail. Also key to success for Shell and similarly to ExxonMobil, is integration of refining with chemical manufacturing. With integration, Shell has greater feedstock flexibility, and can optimise its output towards higher-value products. While Shell has significantly reduced its downstream footprint and investment, the company is not finished. It still plans for approximately $3 billion worth of downstream assets sales through 2014.

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About Author

Allen Good  Allen Good is a senior stock analyst covering the oil and gas industries.

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