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Major Integrated Oil & Gas: Standard Oil, Super-Majors, and Resource Nationalism

By  +Follow February 6, 2014 9:28AM
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Vertically integrated oil and gas companies, otherwise known as the “majors,” "big oil," or "super-majors," differ from the rest of the industry for the simple fact that their operations involve the integration of most or all aspects of the value chain, from exploration to marketing and retail.

Conversely, most of the industry is only involved in one of three streams. Drilling-exploration companies and independent producers constitute the bulk of the oil and gas industry’s upstream segment, while pipeline companies make up its midstream or transportation segment, and refiner-marketers represent the downstream segment, processing resources for any number of end-users, and handling the marketing and retail sale of petroleum products. Oil and gas services companies, for their part, are not tied by ownership to one specific segment of the industry but have the equipment and expertise that allows them to make profits from contracting out a number of services to all segments of the industry.

Vertically Integrated Oil Companies: When the Whole is Greater than the Sum of its Parts

Major-integrated companies stand apart for more than just their total or near-total ownership and operation of the entire supply chain (however impressive a feat of organization this might be on its own merits). “Big oil,” the so-called “super-majors,” are also significant because they are the most visible face of the oil and gas industry.

The huge market-caps and densely layered corporate structures of companies like ExxonMobil (XOM) , Chevron (CVX) , and BP plc (BP) exceed the capacities of many of the far-flung nation-states in which they operate, and the ubiquitous presence of retail gas stations brings big oil to the constant attention of the public — a level of exposure that can quickly become a public relations challenge when prices at the pump suddenly increase.

Victims of Their Own Size

Greater public presence can also backfire when the never-ending quest to secure reserve replacements goes catastrophically wrong and a company becomes synonymous with an environmental disaster. The archetypal (but by no means most recent) case is the Exxon Valdez catastrophe that occurred in Alaska back in 1989, an event whose name became a metonym for the company for many years. It was only with enormous effort and at great cost that the company was able to rehabilitate its image in the court of public opinion.

The broad range of operations of vertically integrated oil giants also makes them difficult stocks to assess. This is explained to some extent by the fact that majors do not spread themselves across the three different segments of the industry in equal proportion, but also because each segment operates according to very different parameters.

When looking at the income statement of an Exxon or a Chevron, then, it is important to keep in mind that fundamentals such as earnings-per-share, while still important, are less descriptively valuable than other metrics. Due to their size, integrated companies are not growth stocks, and this puts a premium on the size of the dividend payout. But more crucial still perhaps are a company’s reserve estimates and production statistics.

Upstream Operations Make the Rest Possible

In trying to form a preliminary sense of the long-term health of a big oil company, a good rule of thumb is to start with exploration and production results. No matter what else a super-major does, nothing will be more important than its ability to replenish reserves on a yearly basis. To put this into perspective, it is a common occurrence to see revenue from upstream operations subsidizing the other segments of a company.

The anxiety over replacement reserves is in part a function of the sheer size of integrated majors. As the industry rushed to consolidate in the 1990s, these companies found themselves having to exceed ever larger output expectations every year in order to please Wall Street investors. But a sense of urgency is also built into the very geology of the business, as oil and gas wells are by definition finite and diminishing assets.

The Era of Mergers & Acquisitions

Towards the close of the 1990's, a serious downturn in oil prices forced the industry into a period of consolidation. In an effort to hedge against price fluctuations and redeploy substantial cash reserves, the largest privately-owned major oil companies embarked on a spectacular series of mergers and acquisitions that resulted in the creation of several "super-major" firms. BP acquired Amoco in 1998, and ARCO in 2000, Exxon and Mobil merged in 1999, France's Total merged with Petrofina in 1999 and Elf Aquitaine in 2000, Chevron bought out Texaco in 2001, and Conoco Inc. moved in with Philips Petroleum in 2002.

The following are the six "super-majors" that emerged from this activity, with their current market-caps:

·         ExxonMobil (XOM)  - $392.60 billion

·         Royal Dutch Shell ($RDS.A) - $224.86 billion (Netherlands)

·         Chevron (CVX)  - $211 billion

·         BP plc (BP)  - $145.50 billion (United Kingdom)

·         Total S.A. (TOT)  - $128.07 billion (France)

·         ConocoPhillips (COP)  - $78.43 billion

Aside from creating some of the largest multi-national corporations the world had yet seen, the industry's transformation at the turn of the millenium also created new difficulties, particularly with regard to finding new reserves in order to replace diminishing ones. While these companies were more powerful, and had greater global presence, they also had to find and secure larger reserves in order to keep up with greater production output. To this end, all six of the super-majors found themselves initiating or deepening ties with unsavory, authoritarian regimes throughout the developping world.

But many of these projects would prove costly, both in terms of money invested as well as in the court of public opinion. Perhaps more importantly, however, was the fact that while the super-majors had their hands full solidifying production-sharing contracts with client regimes, back in the United States, technological advances were allowing independent exploration and production companies to tap into massive oil and especially natural gas reserves locked withing shale formations deep beneatht he surface of the earth. Unlike their larger relatives, they were able to do so in a low-cost and business-friendly environment, snapping up the best acreage, and leading in 10 short years to what is now ubiquitously known as the "shale boom."

Resource Nationalism in the New Millennium

The subject of replacement reserves is also intimately connected to one of the most serious challenges with which super-majors have had to grapple in the last three decades, and that is the relatively new form of resource nationalism that has, as if overnight in some instances, led to the creation of truly massive state-owned oil companies in rapidly developing countries like China, Brazil, and Russia.

Prior to the arrival of the state-owned super-majors, the world’s largest integrated companies were all more or less various concentrations of the leftovers of John D. Rockefeller’s Standard Oil Company, after it was broken up by the US Supreme Court in 1911 after serial violations of antitrust laws in the effort to establish an industry monopoly.

The state-owned companies operate in a very different environment than their free-market predecessors, primarily because their operatational goals are determined by the interestes of the State, and less by the whims of the market, or shareholders.

In the meantime, however, a whole new class of vertically integrated, state-owned companies has come online. Several of them trade shares publicly, and they are:

·         PetroChina Co. Ltd. ($PTR) - $273.60 billion

·         China Petroleum & Chemical Corp. (SNP) - $90.41 billion

·         Petroleo Brasileiro ($PBR) - $71.94 billion

·         Ecopetrol (EC) - $70.60 billion (Colombia)

·         YPF S.A. (YPF) - $9.14 billion (Argentina)

·         Petrobras Argentina SA (PZE) - $898.56 million

PetroChina is currently the industry’s second-largest entity, with a market cap of $276.48 billion. But there are other state-run giants that are even larger in size, though in some instances exact estimates are hard to come by. The Kingdom of Saudi Arabia’s Aramco has been said to be worth up to $10 trillion, while the National Iranian Oil Company has been pegged at as much as half of that. Russia’s Gazprom doesn’t trade shares on US markets, but is valued at around $100 billion, and the same goes for Malaysia’s Petronas, estimates at around $14 billion. There is also Petroleos de Venezuela S.A., whose size is difficult to determine in dollars, but can be guessed in a number of ways. For starters, in 2010 the company reported proven reserve estimates of nearly 300 billion barrels of oil, and over 20 billion cubic meters of natural gas.

There are also a number of oil giants that are partially state-owned:

·         Eni SpA (E)  - $80.61 billion, 30 percent-owned by the government of Italy

·         Statoil ASA (STO)  - $75.12 billion, 67 percent-owned by the government of Norway

·         Sasol Ltd (SSL)  - $$28.71 billion, partially owned by the government of South Africa

Super-Majors are Still Holding Most of the Cards

Despite their size, to say nothing of the size of the domestic reserves on which these companies sit, however, they are not likely to want to put their Western, free-market predecessors out of business any time soon.

In fact, the long-standing, wide-ranging expertise of the old guard is key to implementing much-needed infrastructure upgrades, as well as to obtaining the know-how and equipment necessary to tap what are widely believed to be unconventional plays with vast potential, whether these are located far offshore, or deep beneath the earth’s surface in shale and limestone formations.

This development is so significant for big oil because it raises serious obstacles to the preferred model of production-sharing contracts that were used to guarantee outright ownership over a significant percentage of the reserves from a project. The advent of these new and formidable negotiating partners does not by any means preclude the ability of big oil to continue being profitable and dominant for a long time to come, but it will certainly make for more equally-weighted arrangements than those to which companies have become accustomed over the years.

While big oil is probably not going to see its influence over and role in the global energy economy diminished any time soon, there is no doubt that the international scene is becoming a more restrictive and expensive environment in which to do business. But while these sprawling corporate entities may be more exposed to risk than their high dividend payouts and large treasure-chests would seem suggest, it is this bulk that also insulates them from seemingly momentous developments like the shale boom that many have suggested would be the undoing of big oil.

DISCLOSURE: The views and opinions expressed in this article are those of the authors, and do not represent the views of equities.com. Readers should not consider statements made by the author as formal recommendations and should consult their financial advisor before making any investment decisions.

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