Chemicals give Exxon half a reason for integration

March 25, 2011

By Christopher Swann
The author is a Reuters Breakingviews columnist. The opinions expressed are his own.

Giant energy firms tend to treat their chemicals units as poor relations. The big exception is Exxon Mobil, whose chemicals business is now benefiting from speedy Asian growth. That gives the biggest oil major an argument for vertical integration that rivals don’t have — but it’s only partially convincing.

Instances of more specialized firms trading at higher valuations suggest that Big Oil’s model of shackling together racy exploration businesses with steady refining operations makes scant sense for investors. Still, Exxon does have a case for keeping some of its businesses under a single roof. Teamwork between the firm’s petrochemicals and refining operations has been particularly lucrative, scoring a return on capital employed for chemicals twice that of rivals, by the company’s reckoning.

This success is partly due to Exxon’s persistence with a business that others have neglected. BP raised $9 billion flogging the bulk of its chemical operations to Ineos in 2005. Five years earlier, Chevron and Phillips Petroleum — before its merger with Conoco — shunted off their businesses into a joint venture, with a view to focusing on drilling. Meanwhile, Exxon’s chemical operation has outshone even pure chemicals firms like BASF with return on capital of around 26 percent in 2010, according to the company, against the German firm’s 13 percent as calculated by Morningstar.

Much of it, though, is down to integration with refining. Most chemicals, especially the more specialized kinds, are made at standalone plants. But 90 percent of Exxon’s operations are linked to refineries. That helps ensure every barrel of oil is optimally used. Shared infrastructure also trims costs. Meanwhile, both businesses require the same kind of obsessive attention to operational minutiae from managers.

Still, it’s only half a case for Exxon’s version of Big Oil integration. The logic remains shaky when extended to exploration. Neither refining nor chemicals benefit much from exploration and production, whose oil and gas output does not always match their needs. And with shareholders in mind, there’s the issue of the conglomerate-style discount investors apply to integrated groups.

With about 16 percent of earnings last year coming from the chemicals division — against just 6 percent at ConocoPhillips, for example — Exxon will gain more than its rivals from surging demand in Asia. But the benefit of Exxon’s prowess at chemistry doesn’t extend to the unstable mixture of refining and exploration.

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