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Integrated Big Oil model proves its worth

Wall Street challenged the model, but Big Oil has proven the methods might just help withstand the downturn

A few years ago, Wall Street had a message for Big Oil: bigger isn't necessarily better. The supermajors' sprawling businesses that incorporated exploration, production, refining, transport and trading operations around the world, the bankers argued, were too large and complex for investors to understand. The oil companies were urged to break up the businesses to "unlock value." 

Struggling refining operations that had become bloated and failed to keep up with the shift in global demand to Asia would be hived off into new businesses. That would give investors direct access to the supermajors' exploration and production businesses, which were throwing off cash with crude prices at more than $100/barrel.

Some heeded the advice. In a closely watched move, ConocoPhillips, the smallest of the majors, split its business into two separate independent companies. The upstream business kept the ConocoPhillips name, while the unloved refining business was re-branded Phillips 66. Marathon Oil, too, splits its upstream and downstream operations. But the rest resisted the bankers' calls. Yes, the majors' downstream businesses needed restructuring and investment, they said, but the integrated business model remained sound, and would help the companies weather the storm when the inevitable oil price bust came.

Now that the oil price bust has come, the latter have largely been vindicated as the integrated model has proven its worth. In recent quarters the majors' downstream businesses have been a bright spot for the industry for the first time in years. Shell, for instance, saw profits from its downstream unit in the first quarter rise by 68% to $2.6bn compared with a year earlier - a period that included the crude price losing half its value. 

Over the same period the company's upstream earnings fell by more than $5bn from $5.7bn to just $675m. BP's downstream profits doubled over the same period to $2.16bn, making up 85% of the company's Q1 earnings. The story has been the same across the majors. 

Downstream profits

And companies have been quick to claim credit. ExxonMobil's chief executive Rex Tillerson told analysts in May that his company's better than expected results "reflect the strength of our integrated businesses amid global economic challenges, uncertainties and price volatility."

By contrast, the upstream businesses that were spun off are struggling to cope with the lower oil price. ConocoPhillips, which bills itself as the world's largest independent, has been forced to slash spending by a third and pare back its production growth targets for the next couple years. Since ConocoPhillips was broken up in May 2012, the downstream-focused Phillips 66 spin off has performed much better. Since the companies started trading separately, Phillips 66's share price has risen by around 130% while ConocoPhillips' share price has fallen by around 12%.

What is behind the resurgence of the majors' downstream businesses? As in previous downturns, lower and volatile oil prices have boosted refining margins. Lower crude prices mean lower feedstock costs for refiners. And in spite of the crude glut, gasoline markets, especially in the Atlantic Basin, have been tight owing to higher than usual refinery maintenance and outages, which has helped boost margins. 

For the European IOCs, the profit per barrel processed has risen to around $8 this year, twice that of 2013 and four times what the refiners were getting in 2009. Those levels are probably not sustainable, but it has given a much-needed short-term boost to the majors' bottom lines.

On top of the swing in the market, the majors are also starting to reap the benefits of a multi-year restructuring of their refining businesses. Shell, BP and Total have all shed more than a fifth of their refining capacity over the past five years - more than 2 million barrels/day in total - exiting refineries in European and other developed markets where demand, and profits, had dried up. 

Shell, for instance, has shuttered facilities in Germany and sold off stakes in refineries in the UK, Sweden, Turkey, the Czech Republic, Norway and elsewhere. Its refining business is now focused on Asia, where demand is surging. BP has offloaded major refineries in Texas City and Carson in the US. Total has halved its footprint in Europe and opened two new facilities in the Middle East.

The majors have also spent billions upgrading their facilities to better match shifting supply and demand patterns. Deutsche Bank reckons the European majors have taken around $18bn in impairments since 2009 related to the restructuring of their refining businesses. These losses have contributed to the abysmal performance of the majors' refineries.

The downstream remains a difficult place to operate. Oil demand is in structural stagnation or decline in much of the developed world. And in developing markets where demand is growing, governments continue to subsidise fuel costs for consumers, usually at the expense of the refiners. Regulations are heavy and facilities are dangerous and accident-prone. 

But it appears the businesses have turned the corner. "Glance through the results of the most recent quarters and it is hard not to discern a notable improvement in performance," Deutsche Bank analysts wrote in a recent note. "Moreover, with many of the benefits from reshaping still to come, cash improvement looks like a feature that may actually prove sustainable, something that should go a long way to help offset the now more pressing upstream pain."

All this suggests that after years of derision, the integrated model that has been a staple of the industry since Standard Oil's days may be coming back into fashion, especially if oil prices remain low. 

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