Big Oil could unlock big value by ditching dogma
By Christopher Swann
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
Big Oil could unlock big value for shareholders. But to get there it needs to slaughter an industry sacred cow: the integration of the exploration and production business with refining and other activities. This model worked for decades but today accords a conglomerate discount to the likes of Exxon Mobil, Shell and BP. Splitting up, as smaller Marathon is doing, could add tens of billions of dollars to shareholders’ portfolios.
The world’s big oil firms know they have a problem. Where a decade ago their shares fetched price-to-earnings multiples in the high teens, today they languish on valuations ranging from around seven times earnings for BP to 12 times for Exxon, despite the tripling of oil prices over the period. With majors increasingly locked out of oil-rich nations, the difficulty of ramping up production bears much of the blame.
But so, too, does a growing distaste for complexity among investors. Largely for historical reasons today’s oil giants are ungainly combinations of higher growth exploration businesses shackled to sluggish refining and marketing operations.
Simple valuation measures hint at a shareholder preference for purity. While the integrated majors as a group trade at around nine times 2011 earnings, pure exploration companies in the United States command multiples closer to 20 times, with independent refiners on roughly 14 times. Even allowing for the swifter growth of these smaller companies, investors are clearly penalizing Big Oil.
Oppenheimer believes the U.S. majors could boost their valuations 20 percent by spinning off their refining and marketing operations. By this calculus, a partition would add $15 to Exxon’s $78 share price — or $80 billion to its $380 billion market cap. Slower growing leviathans don’t deserve the racier values accorded to the independents. Yet even a modest increase in P/E multiples could be a boon for investors.
Look at it this way: valuing Exxon’s E&P business at 13 times 2011 earnings — far below the independents — would yield a stand-alone value of $382 billion, according to research by Madison Williams. Assuming a conservative multiple of 10 times for the downstream businesses makes them worth $78 billion, Madison Williams calculates.
Set against such a bounty, the justifications for integration seem increasingly threadbare. Executives argue that clumping refiners and explorers together offers a natural hedge. In theory when falling crude prices hurt production, the cracking business gets relief from lower input costs. Exxon, for example, fared relatively well during the slide in oil prices of 2008, when its shares fell a mere 15 percent.
Still, on closer examination it seems Exxon was shielded more by its size and a lack of debt, rather than integration. Featherweight rival Marathon, for example, fell 55 percent over the year. Indeed the much vaunted commodity protection is often an illusion. Crude prices and refining margins are frequently correlated, since both are led by fuel demand and economic growth. When crude prices tumbled in 2008, crack spreads followed.
Big Oil also claims that technology developed in one part of the business can be used in another. Yet with the possible exception of liquefying natural gas, energy experts struggle to think what these supposed synergies might be. Besides, technology can be easily bought or hired: none of the majors seems to have objected to relying on oil services firms like Schlumberger for technology and Transocean for rigs.
Finally, energy majors contend that refining expertise helps clinch access to reserves in oil-rich nations. A company that can also offer refining expertise, they say, is more likely to be granted exploration rights. This may have been true decades ago when large national oil companies were less sophisticated. Now they are more than capable of developing their own refining operations or inking joint ventures.
So the benefits of integration are hard to pin down. By contrast splitting up would make oil firms far easier for investors to value. It would also surely sharpen management focus, since very different skills are required to run exploration and refining operations. And there is no reason to fear that oil giants would have to give up the scale they need to compete with national titans. Newly liberated exploration and production companies could simply hook up. Most of the smaller integrated oil companies, like Marathon and Murphy Oil, have already reached these conclusions. It may not be long before the majors do too.