IEEJ: December 2000

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Oil Industry Restructuring and the Majors’ Strategies1

Ken Koyama

Manager, International Trend Analysis Group

Institute of Energy Economics, Japan

1. Crude oil prices and the Majors’ profits

Financial results of the integrated and large-scale international oil companies

(hereafter referred to as the Majors) depend on a wide range of factors including world

economic trends, their production and sales records of oil, natural gas and others, the

competitive environment on markets, and ups/downs in the cost of various business

operations. Above all, crude oil price is the most influential factor on their profits.

Actually, the records of the principal Majors’ earnings since 1998 confirm that ups or

downs in their earnings have conspicuously reflected the crude oil price moves.

For example, net profits of the eight U.S.- and U.K.-based Majors’2 in 1998,

when the crude oil price plummeted considerably, stayed at $14.0 billion3, down 59%

from $33.9 billion in the previous year (Fig. 1). The primary reason for the sharp

profit decline is nothing but the nose-diving profits in the upstream sector, the principal

source of their profits, due to the crude oil prices flagging very low4.

1 This study was commissioned by the Agency of Natural Resources and Energy, Ministry of International Trade and Industry, Japan, and conducted by the author and a research team in IEEJ during FY 1999. IEEJ would like to thank MITI, as we are now able to publish this report under permission by MITI. 2 The eight Majors at this point of time were Exxon, Mobil, Royal Dutch Shell, BP, Amoco, ARCO, Texaco and Chevron. 3 It should be noted that the profit amounts stated in the annual reports might reflect different definitions of different companies. 4 For the background of the Majors’ falling profits in 1998, see Ken Koyama, “Sekiyu teikakaku ni yoru kokusai sekiyu sijo heno eikyo (Impacts of Cheap Oil on International Oil Market)” (Enerugi Keizai, the 2000 Spring issue, IEEJ).

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By company, RD Shell, Texaco and ARCO were among the companies having

registered particularly worsening profits. Above all, the profits of RD Shell remained

at $400 million, down 95% from the previous year, because the company reckoned up

$4.2 billion of special adjustment cost (losses) at 1998 yearend partly in its effort to

dispose of “bad assets” in the process of single-handed restructuring detailed later.

Conversely, while most companies had their profits slumping by 50% or more, Exxon

posted just a 25% decline and thus demonstrated the capability of yielding gains more

constantly than its rivals even amid the falling crude oil prices.

The worsening profits urged the Majors to axe their capital spending. When

combined, capital spending of the eight Majors has been on a constant rise until 1998,

reaching a high of $51.6 billion in that year. But, in reflection to wretched business

records in 1998, their capital spending plunged 21% to $40.8 billion in the subsequent

year of 1999. The breakdown of their capital spending cuts unveils that spending was

trimmed by 18% in the upstream sector, and by 33% in the downstream sector. What’s

noteworthy is the belt-tightening move reached even the upstream sector, where money

used to be poured constantly.

The profit trend in 1999 conspicuously shows a completely contrary move to the

“shrinking cycle” described above. That is, in 1999, the net profits of the U.S.- and

U.K.-based six Majors5 totaled $26.2 billion, up 87% over the previous year. Of it,

the upstream sector yielded $20.1 billion, up 167% over a year ago, while the

downstream sector produced $6.3 billion, down 34% from a year earlier. This

apparently shows that the upstream sector, where profits rapidly recovered especially

5 As a result of mergers among the Majors, the eight companies cited in the footnote 2 became six: Exxon Mobil, RD Shell, BP Amoco, ARCO, Texaco and Chevron.

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thanks to the soaring crude oil prices, contributed to sending overall gains up (Fig. 1).

On the other hand, despite the sharply improving profits in the upstream sector, overall

profits remained below the 1997 level. It is because the soaring crude oil prices

squeezed the downstream profits, relatively constant in the past few years, and because

reckoning of the cost of restructuring, notably mergers, more than offset the improved

profits6.

Fig. 1 Net Profits of the U.S. and U.K. based Majors

By company, RD Shell and ARCO, among others, posted particularly favorable

6 For the background of business records of the six Majors in 1999, see Masayuki Fujita, “Eibei Major 6 sha no 1999 nen shueki doko (Profits of US and UK based Six Majors in 1999” (IEEJ homepage, updated in May 2000).

(Source)Prepared from the Majors' annual report, etc.

-5

0

5

10

15

20

25

30

35

40

1991 1992 1993 1994 1995 1996 1997 1998 1999

TexacoChevronArcoAmocoBPRDShellMobilExxon

（Billion $）

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gains in 1999. In the case of RD Shell, profits amounted to $8.6 billion, up 2,353%

over a year ago. Though we have to take into account an unusual factor that the

company reckoned $4.2 billion of special adjustment cost in 1998, the favorable result

can be attributed to the company’s successful efforts for cost reduction through its

unilateral restructuring.

Meanwhile, turning the eyes on RD Shell’s rivals, such as Exxon Mobil and BP

Amoco, it is noteworthy that in 1999 the former earned $7.9 billion, down a bit by 2%

from the consolidated profits of Exxon and Mobil a year ago. For one thing, the slight

decline is attributable to the flagging downstream profits (down 65%) largely in the

European and American markets despite increase in upstream profits by 76% over a

year ago. For the other, reckoning of the $470 million cost of the merger of Exxon and

Mobil pressed the profits. Yet, even in 1998, when many rivals registered considerable

losses, Exxon Mobil posted a relatively constant profit albeit volatile crude oil prices.

It should be noted that the limited losses in 1998 was a background factor of the

company’s 1999 performances, which remained nearly unchanged from the previous

year.

BP Amoco posted net profits of $5.0 billion, up 56% over a year ago. Though

failing to reach a total of $6.7 billion recorded in 1997 by the then separated BP and

Amoco, the greatest contributor to the better performances was a sharp 72% rise in the

upstream profits. On the other hand, the company’s downstream profits shrank by

49% from a year ago due to the falling margins in the European and American markets.

Meanwhile, Arco, whose merger with BP Amoco was approved after entering 2000,

improved its performance remarkably in 1999 and recorded net profits of $1.4 billion,

up 215% over a year ago. As a result, the combined net profits of BP Amoco and

Arco amounted to $6.4 billion in 1999. The profits, the third largest after RD Shell

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and Exxon Mobil, are wide apart from the remaining oil companies. In this point, too,

it is apparent that these top three companies, the so-called super Majors now, have

established a dominant position that overwhelms the rest.

Given their improved performances in 1999, the Majors’ capital spending is

expected to pick up in 2000. A survey7 by Solomon Smith Burney, a U.S.-based

investment bank, foresees in 2000 a moderate recovery of capital spending by the six

Majors to $42.7 billion, up 5% over a year earlier. Capital spending in the upstream

sector, the source of profits, is projected to increase by 8%. Yet, given the spiraling

crude oil prices and resultant soaring upstream profits right now, even the expected

growth of spending appears rather conservative (Fig. 2). Perhaps the conservative

projection reflects their recognition that current high prices are unsustainable in the

future, and also due to the influence of such factors as strong requests/pressures upon

the Majors for better investment efficiency8.

Certainly, under such an economic environment as now, the requests for

increasing investment efficiency and restricting over-investment are very likely to keep

working. But, the crude oil price having stayed high to date will surely boost the

Majors’ cash flow in 2000. Then, because upstream investments originally offer a

source of profits, and because particularly high returns on investment can be expected

from the over-$20 price environment, it appears quite probable that capital spending

plans can be reviewed (for upward revision) in the days toward the yearend9.

7 See the Middle East Economic Survey (February 28, 2000) for the bank’s survey, originally published in February 2000. 8 Given the requests for improving investment efficiency and curbing excessive capital spending, some Majors currently move to advance the share buy-back programs. In specific terms, BP Amoco has a plan to purchase 10% ($17-billion-worth) of its outstanding stocks, and RD Shell to buy $4-billion-worth stocks, among others. 9 Solomon Smith Burney in its survey announced July 2000 revised the world’s upstream spending plans for 2000 (of a total of 145 companies) upward by 20% over the previous survey.

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Fig. 2 The Majors’ Upstream Capital Spending

2. Development of the international oil industry restructuring

2-1. Rationalization/restructuring and big merger deals

Amid the international oil market environment described in the preceding section,

the Majors have committed to take various initiatives for full-scale rationalization,

efficiency improvement and cost reductions since 1998. Originally the moves toward

drastic business integration, strategic alliances, asset sales and restructuring started first

from the downstream sector where profitability was lower. Since 1998, the moves

have accelerated, or unrolled more drastically than ever10.

10 For the details about the evolution in the oil industry restructuring from BP-Mobil strategic alliance in European downstream operations to full-scale streamlining/restructuring moves, including mega merger, see Hisashi Miyamori and Masayuki Fujita, “Major no teikei, gappei no ugoki: Karyu jigyo teikei kara super Major tanjo made (Majors’ Moves to Alliances & Mergers – From Downstream Business Alliances

(Source)Prepared from the Majors' annual report and a survey by Solomon Smith Burney (MEES, 2000/02/28).

0

5

10

15

20

25

30

35

40

1997 1998 1999 2000

TexacoChevronArcoBP AmocoRDShellExxonMobil

(Billion $)

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While the contents of full-scale initiatives to get slimmer and increase efficiency

vary depending on companies, they can roughly be grouped into two: those centering on

single-handed restructuring and others oriented toward mergers & business integration.

As clearly noted from the discussion so far, RD Shell represents the former, and

BP and Amoco (plus Arco) as well as Exxon and Mobil fall in the latter. Since 1998

when not only the falling crude oil prices hit its upstream sector but also the Asian

economic crisis devastated its operations across Asia, RD Shell has launched into

full-scale unilateral restructuring. The contents of restructuring were as drastic as

selling 40% of petrochemical operations, cutting the cost by $2.5 billion11, curbing the

capital expenditure to $11 billion a year, and reckoning special losses of $4.2 billion.

By implementing these restructuring efforts, the company intended to achieve a profit

ratio of 14% by 200112.

In the background, there were some reasons why Shell chose the unilateral

restructuring option. For instance, though having striven for streamlining & efficiency

improvement for years, Shell still had larger room for unilateral restructuring (than

other company like Exxon). It is also cited that Shell already has acquired on its own

account enough assets, which promise a profit-making ability and a future growth that

suit the industry’s leading company13.

Actually, entering 1999, Shell’s profits improved considerably along with

progress in its restructuring plan. Taking cost reduction as an example, the company

achieved $2-billion cost cuts in 1999 and is continuing its efforts to attain by 2001 a

to the Birth of Super Majors)” (IEEJ, International Energy Analysis, 1999 March issue). 11 Later, the cost-cutting target was revised upward to $4 billion. 12 Also, in order to encourage swifter decision-making, information transmission and implementation, the company made a significant restructuring in its management organization. 13 For example, during our overseas interview surveys, these views were expressed by Mr. Steve Terry of Petroleum Economics Limited, among others.

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$4-billion reduction, an upwardly revised target. Of course, the upstream sector’s big

gains from the soaring crude oil price contributed much to the rebounding performance

in 1999. Yet, many agree that the rationalization efforts under self-initiative have

contributed as well.

On the other hand, it is BP Amoco, Arco, Exxon Mobil, and Total Fina Elf that

tried to increase efficiency and strengthen competitiveness through the

merger/integration option. Naturally there are different reasons of different companies

behind their mergers/integration. However, the objectives of this option can roughly

be grouped as follows.

(a) To pursue the possibility of additional cost reductions by virtue of merger.

(b) To strengthen asset portfolio to improve profitability and secure future growth.

(c) To seek the merits gained by enlarging corporate size and strength.

The first objective, applicable to all mergers & integration, appears to have

proven particularly significant for Exxon and others having committed to single-handed

restructuring thoroughly in the point that they could find a new possibility for massive

cost reductions14. The second objective, also applicable to all mergers, provides a

significant point as well. Including Exxon Mobil and BP Amoco (Arco), there are too

many cases to mention. For example, BP Amoco (Arco) fortified the assets, including

the North American gas assets, Asian gas assets, Alaskan upstream assets and U.S. West

Coast downstream assets. The third objective is also applicable to various cases. It is

often pointed out that BP’s takeover of Amoco and Arco is a typical case where to seek

a corporate size was one of the objectives.

14 Actually, mergers were expected to produce a big cost reduction effect, put at $3.8 billion yearly by Exxon Mobil in its 1999 Annual Report, and at $4.0 billion by BP Amoco in its plan released July 1999.

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As often rumored when BP and Amoco merged, some viewed15 that BP, long

positioned as the “top runner of the second group,” intended to join the “true top

group.” That is, behind the successive mergers with Amoco and Arco, there was an

ambition of BP to be a super Major having a real ability to rival the two oil giants,

Exxon and RD Shell16.

Also, the recent big merger frenzy probably reflected pressures from shareholders

or the stock market that worked strong on the oil companies. Namely, as mergers

among big companies worldwide have taken place in various sectors, including

information/communications, finance and automobiles, since the second half of the

1990s, to advance rationalization, increase efficiency and strengthen the basis for

management by virtue of mergers became a “boom” on the stock market. Some point

out that, under such circumstances, there was a composition in which the companies

having failed to ride on the boom were exposed to strong pressures17. Conversely, the

companies that hammered out a positive stance toward merger-based rationalization and

competitiveness buildups were highly evaluated on the stock market. In short, rising

share values rewarded them. As British and American private firms are always

professed for “shareholders’ interests first,” the strong likelihood is that such a climate

has encouraged the mergers in many cases.

With these situations in the background, triggered by the announcement of BP –

Amoco merger in August 1998, a series of big merger deals has unrolled. The merger

frenzy is summarized below.

15 See Hisashi Miyamori, “Shin kyodai Major BP Amoco no tanjo: Sijo saidai no kigyo gappei goi (The Birth of New Oil Giant, BP Amoco: An Agreement on Biggest Ever Corporate Merger)” (IEEJ, International Energy Analysis, 1998 September issue). 16 Many experts expressed this view during our overseas interview surveys made under this study project. 17 This view was also expressed many experts, including Mr. Steve Terry of Petroleum Economics Limited cited before.

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Aug. 1998, BP and Amoco announced a merger plan.

Dec. 1998, Total and Petro Fina announced a merger plan.

Dec. 1998, Exxon and Mobil announced a merger plan.

Dec. 1998, BP – Amoco merger approved (U.S. Federal Trade Commission – FTC).

Mar. 1999, BP Amoco announced a merger plan with Arco.

Mar. 1999, Total – Fina merger approved (European Commission – EC)

July 1999, Total Fina announced a plan to take over Elf.

Nov. 1999, Exxon – Mobil merger approved (FTC)

Feb. 2000, Total Fina – Elf merger approved (EC)

Apr. 2000, BP Amoco – Arco merger approved (FTC)

Table 1 Outline of Super Majors (1999 Records)

Exxon

Mobil RD Shell BP Amoco (Arco)

Financial indicators Turnover ($1 billion) Net profits ($1 billion)

185.5 7.9

149.7 8.6

114.2 6.4

Operating indicators Oil reserves (Billion bbl) Oil production (10,000 B/D) Gas reserves (TCF) Gas production (BCF/D) Refining capacity (10,000 B/D) Product sales (10,000 B/D)

11.8 252 56.8 10.3 598 889

9.8 227 58.5 8.2 321 680

10.5 268 45.4 8.4 328 557

(Note) For Exxon Mobil, crude oil throughput is stated instead of refining capacity.

(Source) Prepared from the super Majors’ annual reports, etc.

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Certainly, under such an economic environment as now, the requests for

increasing investment efficiency and restricting over-investment are very likely to keep

working. But, the crude oil price having stayed high to date will surely boost the

Majors’ cash flow in 2000. Then, because upstream investments originally offer a

source of profits, and because particularly high returns on investment can be expected

from the over-$20 price environment, it appears quite probable that capital spending

plans can be reviewed (for upward revision) in the days toward the yearend18.

2-1. Regulatory bodies’ responses to big mergers

As already mentioned, big merger plans have been announced one after another

after BP and Amoco expressed their will to merge. After reviewed and approved by

relevant regulatory bodies, namely the U.S. Federal Trade Commission (FTC) and the

European Commission (EC), these plans have finally and officially been implemented

to date.

Yet, in the processes of the reviews, which ultimately approved the mergers, and

of their talks with the companies to merge, the regulatory bodies required that a wide

variety of assets should be sold as a condition of approval. The assets for sale include

crude oil and natural gas production assets in the upstream sector, and refineries, oil

tank farms, pipelines and service stations in the downstream sector. It is also noted the

sell-assets rule laid as a condition of approval became more stringent gradually (Table

2).

Behind these regulatory bodies’ responses, there were concerns for consumers’

disadvantage that can occur if, as a result of big mergers, the market became less

18 Solomon Smith Burney in its survey announced July 2000 revised the world’s upstream spending plans for 2000 (of a total of 145 companies) upward by 20% over the previous survey.

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competitive with a smaller number of principal players, who might exercise a market

power once grabbing a dominant market share.

To monitor consumers’ disadvantage caused by excessive market power has been

among the duties of the regulatory bodies. However, it is important to note their

recognition that merger-based rationalization & efficiency gains could have a favorable

effect on cost reduction and that, amid industry-wide restructuring under way in various

sectors globally, firms could strengthen their international competitiveness through

mergers. Thus the regulatory bodies have not necessarily denied, or opposed to, all

mergers19. Nonetheless, the big mergers one after another made the regulatory bodies

alerted. It appears the regulatory bodies came to conclude that growing concerns

overshadowed expectations for “positive” effects of mergers.

When reviewing a big merger plan, regulatory bodies take the following steps.

Firstly, they split the affected market into segments, then analyze and examine each

segment. By doing so, they can identify its specific problems of the proposed merger.

When making a review by segmenting an affected market, a “hurdle” consisting

of certain conditions & criteria is given. If the first hurdle is not cleared, the case will

be scrutinized in the subsequent process of stricter review. For example, the EC makes

a first-stage review on a merger plan during the first month after it is filed. A

second-stage review is started only when obvious problems are found during the

first-stage review, or when more information is needed for making a fair judgment.

FTC on its part takes the Herfindahl index as a yardstick designed to measure the degree

of market concentration20, and a full-scale review is to be carried out when a planned

19 For the stance taken by regulatory bodies until around early 1999, see Ken Koyama [op. cit. pp35 – 36]. 20 According to the FTC, the market in question is considered to be “competitive” when the Herfindahl index remains below 1,000, while a merger is apparently problematic if it raises the index above 1,800. The 1,000 – 1,800 range is a gray zone. At any rate, when the indicator is caused to jump by 50 points

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merger is worried to cause problems21.

Table 2 Conditions of the Merger Approval Set by Regulatory Bodies Merger of BP and Amoco U.S. Federal Trade Commission (FTC) approved the merger conditional upon the sales of: 134 service stations (SSs) and 9 oil terminals

Merger of Exxon and Mobil (1) European Commission (EC) approved the merger conditional upon: Sale of Mobil’s 30% interests in the fuel oil business, a joint venture (JV) in Europe between BP

Amoco and Mobil. Liquidation of the BP Amoco – Mobile alliance in lubricant business (Mobil’s interests 51%) in

proportion to interests. Sale of Mobil’s 28% interests in Aral, a JV fuel oil retailer in Germany. Sale of MEGAS, a Dutch gas marketer which is Mobil’s 100% subsidiary Sale of Exxon’s 25% interests in Thyssengas, a gas transport/distribution company in western

Germany. (2) FTC approved the merger conditional upon the sales of: Mobil’s all marketing assets in the central part along the Atlantic coasts and Exxon’s all marketing

assets in the U.S. northeastern part (a total of 1,740 SSs). Mobil’s gasoline marketing business in the U.S. southern part (319 SSs). Exxon’s Benicia refinery in California and the whole of Exxon’s marketing assets in California (360

SSs). The terminal and 12 SSs held in Guam by Exxon. Mobil’s interests (11.49%) in Colonial Pipeline (transport capacity 2 million B/D), or Exxon’s

interests (48.8%) in Plantation Pipeline. Mobil’s interests (3.0845%) in TAPS (Trans Alaska Pipeline System).

Merger of Total Fina and Elf EC approved the merger conditional upon: Sale of 70 SSs on the French highways. Sale of all or part of interests in the three pipelines (SPMR, DMN and other) and 17 product storage

terminals. Sale of Elf Aquitaine’s LPG distribution facilities in France. Opening to third parties of supply-related facilities in Lyon and Toulouse Airports.

Merger of BP Amoco and Arco (1) EC approved the merger conditional upon the sale of: Arco’s interests in the gas pipeline running from gas fields in the southern North Sea to the U.K.

mainland and the gas-processing terminal. (2) FTC approved the merger conditional upon the sale of: Arco’s all crude oil production-related assets in the Alaskan North Slope. Arco’s all assets of crude oil-related businesses in Cushing. The plural number of distribution terminals within the U.S. 136 SSs

(Source) Prepared from various reference materials.

or more, all the cases are subject to reviews. 21 For the outline of FTC’s merger reviews, see “1992 Horizontal Merger Guidelines” on FTC homepage

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In this way, the merger reviews by regulatory bodies resulted in more stringent

conditioning. But, contrary to the strict requirement, it is also characteristic that the

regulatory bodies consider the present international oil market very competitive.

Namely, including the state-run oil corporations, the Majors, and independent firms in

the upstream sector, and such entrants as hypermarkets in the downstream sector, a large

number of players are active on the international oil market today. A widely accepted

recognition is that even the recent big merger deals have not caused a drastic change in

the competitive environment22. The question is, not a weakening competition or a

stronger market power across the international oil market, but the concerns for a

possibility that a dominant market power can be exercised in a specific area or country.

In this point, the particulars of the BP Amoco – Arco merger give the most typical

example. In response to the merger plan of the two companies, the FTC pointed out

the following problems:

(a) The merger can considerably hamper competition in the Alaskan upstream sector,

because the combined company would account for over 70% of crude oil production

there;

(b) The combined company can have an undesirable market power at each stage of

crude oil marketing, refining and retailing on the U.S. West Coast market where the

Alaskan crude oil is shipped;

(c) The resulting company would hold massive shares in the crude oil pipeline and

storage capacities in Cushing, Oklahoma, which can have an impact on the price of

(http://www.ftc.gov). 22 For example, when they reviewed a series of recent merger deals, the EC and the FTC alike examined the actual state of competition in the world’s upstream sector and concluded that markets were very competitive as a whole.

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a US bench- mark crude oil, WTI.

At first BP Amoco intended to rebuff the judgment by taking a lawsuit.

However, in order to get the merger approved, BP Amoco after all decided a

compromise under which the company agreed to sell Arco’s Alaskan assets to Philips

for $7 billion and to sell within four months the whole of crude oil-related businesses

run by Arco in Cushing. Consequentially the FTC accepted the compromise offered

by BP Amoco and officially approved BP Amoco to take over Arco conditional on these

asset sales23.

The BP Amoco – Arco case is not an exception. As summarized in Table 2, in

the Exxon – Mobil case, the European Commission worried the resulting dominant

downstream market share would hamper competition and ordered Mobil to sell its

assets in the European downstream sector, where the company started a strategic

alliance with the-then BP in 199624. Also, in Total Fina – Elf case, the EC put such

conditions as selling retail assets in order to restrict a very high market share in France.

Thus, it appears the regulatory bodies particularly worried that these big mergers

would result in a dominant market power and hamper competition, based on which they

imposed the stringent rule to sell as many assets as necessary in particular in the

downstream sector. This is because they hold a dominant share and a strong influential

power on the downstream (refining, marketing) sector as shown in Table 1. This is

also because petroleum product price rises, if caused by a market power or hampered

competition, could produce so visible direct impacts on consumers that they could

23 See Hisashi Miyamori, “FTC, BP Amoco/Arco no gappei wo shonin (FTC Approved BP Amoco – Arco Merger Deal)” (IEEJ homepage, May 2000). 24 The $1.5 billion-worth interests Mobil held in European fuel businesses under business integration with BP were sold to BP. Also, it was agreed to split the interests in lubricant businesses between Exxon Mobil and BP Amoco in proportion to original equities held.

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easily become a politically sensitive issue25.

In this way, with the BP Amoco – Arco merger approved finally, the international

oil industry witnessed the birth of gigantic oil companies, like Exxon Mobil, RD Shell,

BP Amoco (Arco) and TotalFinaElf. Considering these developments combined with

the regulatory bodies’ responses, the following implications can be drawn about the

possibility of the oil industry’s further restructuring ahead.

Judging from the economic and market environment today, the strong likelihood

is that pressures for even higher efficiency & stronger competitiveness would keep

working industry-wide on both the oil companies outside the recent big mergers and the

resulting super Majors. If so, as long as oil companies can find combinations that

enable them to fortify competitiveness by choosing the merger/integration option, new

restructuring moves appears inevitable.

However, given that the degree of market concentration is actually inching up and

that the regulatory bodies have mounting concerns for hampered competition and

dominant market power, it appears quite probable that they would put stringent ever

conditions when approving new merger plans, particularly those among oil giants, if any.

Namely, in an attempt to prevent a dominant market share, the regulatory bodies are

very likely to impose such requirements as selling more assets than ever. The expected

stringent response appears to work as a “disincentive” to the possibility of big merger

deals, which exist potentially, by trimming the economic merits that oil companies

expect to gain from their merger.

In this context, a possible path of the international oil industry’s restructuring is

25 Particularly it appeared important that the West Coast traditionally has the higher gasoline prices in the U.S. and that gasoline prices rises, if any, were prone to become a political issue due to the imminent U.S. presidential election in November 2000.

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that future developments will be led by the Majors belonging to the second or third

groups as well as independents, rather than a new wave of big mergers among the

recently-born super Majors. Of course, a possibility cannot be ruled that the super

Majors will get involved in an astonishing merger deal on a global scale. Yet, it is

more likely that in unfolding merger deals, the super Majors will focus on the

acquisition of assets that are not only significant in prompting the company growth in

the future but also helpful in grabbing comparative advantages in know-how,

accumulation and market access in a particular area. From this standpoint, the super

Majors’ moves to increase promising natural gas (downstream) assets and electricity

market-related assets are noteworthy26.

3. Majors’ investment & management strategies ahead

3-1. Priority investments in upstream businesses

Triggered by the BP – Amoco merger announced in August 1998, the

international oil industry’s restructuring has rapidly advanced to date. As a result,

giant oil companies, like Exxon Mobil, RD Shell and BP Amoco (Arco), each having

more powerful management strength than ever, are now on the international oil market

as players. From now on, investment & management strategies to be unrolled by these

giants are likely to pose crucially important points in considering a future course of the

world’s oil & energy markets.

Of course, different companies can have different investment & management

26 The best example is that, in July 2000, BP Amoco acquired the whole of Vaster (86% of its interests held by Arco) in hopes to strengthen its position in upstream (gas) businesses in the Gulf of Mexico. Also, some expressed during our overseas interview surveys that a company like British Gas of the U.K., among others, would be a target of takeovers as a means to bolster the Majors’ gas downstream businesses.

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strategies in reflection to their specific conditions, such as market environment around

them, the assets they hold, their views on future market developments. Yet, from the

results of our overseas interview surveys, we can figure out something like common

“directions” of the Majors’ strategies in following points.

First, the upstream sector is very likely to become an increasingly important

business field for the Majors. Considering that the upstream sector has always been

the greatest contributor to the Majors’ profits, it sounds just natural27. Yet, for the

Majors, the importance of the upstream sector can be intensified more than ever by

newly emerging factors since the 1990s. They include the falling development cost &

expanding potentials of oil/gas commercial production in deep seas by virtue of

advanced technologies, and greater business chances thanks to spreading moves among

oil-producing countries, including those in the Middle East, to foreign capital

introduction into their upstream sectors28.

As long as they can expect higher returns than in the downstream sector as

detailed later, to step up their commitments to upstream businesses is a natural course

for the Majors as private firms that pursue maximization of profits. Meanwhile,

regarding crude oil price that has a crucial impact on the balance of profitability

between upstream and downstream businesses, it appears few Majors believe that prices

as high as the ones now are sustainable in the medium and long run. As a criterion

referred to when deciding an upstream investment, or assuming the lowest crude oil

price that determines a break-even point of a project, most of the Majors seem to put the

crude oil price below $20 a barrel. Despite such a “conservative” price assumption,

27 On average the performances in 1991 – 99 showed that, when combined, the upstream sector yielded 73% of total profits of the U.K.- and U.S.-based six Majors (Exxon Mobil, RD Shell, BP Amoco, Chevron, Texaco and Arco). 28 See Ken Koyama [op. cit.].

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19

the upstream businesses are counted as more profitable operations than others29 judging

from the assets and technologies held by the Majors at present. That’s why priority

investments are very likely there.

However, priority investments do not mean to simply pour an increasing amount

of investments. In the economic environment today, a rather important subject is how

to increase investment efficiency. Oversized investments and resultant deterioration in

investment efficiency (returns on invested capital) must be avoided by all means.

Indeed, judging from their latest investment strategies, the Majors seem to select

investment targets/projects by thoroughly reviewing their upstream assets and setting

clear-cut priorities from the standpoint of which ones can contribute best to the

company’s profitability at present and in the future. Accordingly, low-prioritized

upstream assets can be sold even if they are expected yield certain level of profits.

Also, disposal, sales and exchanges of assets are likely from the standpoint of risk

diversification.

In this context, the likelihood is that, while trying to add effective assets in

improving their portfolios, the Majors will intensify such moves as sales and exchanges

of the assets by reviewing those currently at hand30.

Of course, for the Majors, to select investment targets by priority does not mean

to concentrate their investments in specific targets alone. With their upstream assets

lying across the world, the Majors will select their projects, largely high-prioritized ones

among a wide variety of potentials, in an attempt to secure the highest possible

29 For example, John Brown, CEO of BP Amoco, stated at a briefing held for financial analysts in July 2000 that profits could grow by 10%/year without resting on “special prices/margins.” 30 Examples of such moves include: Exxon Mobil exchanged its interests in the Gulf of Mexico with Conoco; RD Shell sold some of its interests in Egyptian deep-sea blocks to Exxon Mobil, sold Malanpaya project in the Philippines to Texaco, and exchanged the North Sea assets with Talisman; BP Amoco sold its crude oil assets in Canada and disposed of its interests in Pedelnales oilfields in Venezuela.

IEEJ: December 2000

20

profitability. At the same time, amid the risk-studded market environment today, it

seems the Majors are trying to optimize their portfolios by diversifying upstream

investment targets.

3-2. Restructuring of downstream business strategies

On downstream business operations, the Majors are very likely to consider drastic

restructuring strategies, including the disposal and sales of massive assets, on top of

stepped-up cost reduction/streamlining efforts. As already discussed, downstream

businesses on average have contributed less to overall profits and so far failed to raise

returns on investment as high as in the upstream sector.

Aside from the poorer profit records in the past, the Majors appear “not

optimistic” about the future of the downstream sector. Particularly they seem to have a

view that the refining sector has a wide variety of structural problems31.

The first of such problems is a possibility that excess capacity persistent in the

refining business can keep hampering the improvement of margins. On the already

mature European and American markets, a slowdown in the oil demand growth is

counted as inevitable. Particularly a demand growth can hardly be expected in the

industrial, commercial and residential sectors, where switching to rivaling fuels,

typically natural gas is likely to advance more than ever. Only transport fuel demand

is expected to have a significant growth potential. However, massive fuel efficiency

gains by technological development and development & dissemination of natural

gas-based fuel cell vehicles, electric cars, etc. can put a brake on demand growth in the

31 All the super Majors to which we made interview surveys under this study project pointed out structural problems in the downstream sector.

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21

long run32. On the other hand, a problem of refining capacity is the presence of

“capacity creep,” where the existing capacity is on the moderate rise through the

elimination of the bottlenecks, thus posing potential supply pressures33.

Even in the developing countries where oil demand has a high growth rate,

refining businesses do not necessarily permit an optimistic view. For example, on the

fast-growing Asian market, the outbreak of the economic crisis sent the demand

shrinking, thus making excess refining capacity conspicuous at a stroke34. Worse,

because big refineries have been put on stream35 in India and Taiwan, among others,

overcapacity of the refining sector is unlikely to dissipate for the near future.

Second, under the situation where overcapacity sends, or likely to send, refining

margins plunging; refiners are facing new and huge investment burdens in response to

upgrading of product specifications. Now that environmental commitments are

attached an increasing importance worldwide, petroleum product quality standards are

toughened in the industrialized and developing countries alike in their effort to tame

such familiar environmental problems as air pollution. The degree of tightening, as

well as stringency of quality standards, varies depending on regions or countries. Yet,

as a common point, they are all directed toward tougher standards.

The best example is the less sulfur-content fuel programs planned by many

32 According to study results, which analyzed the impacts of greater ownership of fuel-efficient vehicles and fuel cell vehicles on the matured Japanese transport fuel market, the transport fuel demand growth can considerably lesson, or go downward, depending on scenarios. For details, see Takahiro Sakaguchi, “Influence of Diffusion of Fuel-Efficient Motor Vehicles on Gasoline Demand for Individual User Owned Passenger Cars” (IEEJ, homepage, May 2000), and Yuji Morita & Atsushi Sugiyama, “Development and Diffusion of Fuel Cell Powered Automotive Vehicles and Its Impacts” (IEEJ, homepage, July, 2000). 33 According to our overseas interview surveys, capacity creep has particularly grave impacts on the European market by squeezing refining margins there. 34 On the issue of the Asian economic crisis and refining overcapacity, see Ken Koyama, “Economic Crisis and Asian Oil Market” (IEEJ, Energy in Japan, March 1999). 35 In India Reliance Co.’s new refinery (total capacity 540,000 B/D) was commissioned in July 1999. Formossa Plastics’ new refinery (first-phase capacity 150,000 B/D) in Taiwan became operational in

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22

governments by introducing stricter sulfur standards36. It is pointed out that the

stricter-ever standards cannot fully be met by the selected use of low-sulfur crude oil in

processing. That is, new and additional secondary capacity construction investments

are unavoidable. Given the fierce competition unfolding on the retail market with

hypermarkets, etc., on top of the presence of overcapacity in the refining sector, a

widely agreed view is that the clamored huge investments37 for meeting stringent

standards involve a big uncertainty in economics.

In recognition of the stern environment around downstream operations, the

Majors believe they need to accelerate their conventional cost reduction & streamlining

effort further. Also, in some cases, chiefly in the pursuit of higher efficiency and cost

reduction of downstream operations, they can be required to consider business

integration, mergers and the like. In addition, a possibility cannot be ruled out that, by

shifting business weight to upstream operations, the Majors will dispose of downstream

assets with lower priorities, while respecting a balance between upstream and

downstream operations, particularly the need for risk dispersion.

Actually, throughout the 1990s, and in the process having led to the latest merger

approvals, many downstream assets, sold by the Majors, were acquired by independents,

such as Tosco and Varelo. Given these moves together with the situations described

above, the strong likelihood is that the downstream sector continues to undergo drastic

January 2000. 36 The U.S. Clean Air Act Amendment of 1990 and Europe’s Auto Oil Program 2 slated to be introduced in 2005, among others, are expected to put sulfur standards for diesel below 50 PPM, around one-tenth of present levels. Following these trends in the U.S. and Europe, Japan on her part is planning to tighten sulfur standards. 37 For example, it is pointed out that, once Europe introduces the stricter standards, investment burdens on the European oil industry as a whole could reach $23 billion. For further information, see Koji Ito and Masami Soga, “Jidosha nenryoyu ni kansuru oshu no hinsitsu kyoka to sekiyu sangyo no taio (Tightened Standards for Automotive Fuel Oils and Oil Industry’s Responses in Europe)” (IEEJ, the 351st Regular Briefing of Study Results, April 8, 1999).

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23

restructuring. This is because the Majors are likely to close, or sell their downstream

assets to the rivaling Majors or independents, depending on specific strategies taken38.

3-3. Positive commitments to natural gas businesses

Given a high demand growth expected ahead, the Majors are aggressively

committing to natural gas businesses. Actually since the 1990s, all the Majors alike

have successfully boosted natural gas reserves and increased gas production and sales

through exploration & development39.

Also, a series of big mergers since 1998, where Exxon added Mobil’s gas assets

and BP did Amoco’s North American gas assets as well as Arco’s Asian gas assets,

unveiled an apparent move to strengthen gas portfolios. As is well known, this move

has been pointed out as one of the “drivers” of recent mergers.

Perhaps the aggressive commitments to natural gas is backed by the widely

accepted recognition, for the reasons listed below, that gas is the fastest-growing energy

source when energy demand expands along with economic growth40.

(a) Concerns over environment make gas advantageous because it is

“environmentally friendly” than other fossil fuels with respect to emission of

CO2, Sox, NOx, etc.

(b) Development and dissemination has been promoted of efficient gas utilization

38 For example, BP Amoco announced July 2000 that it would sell Alliance refinery (250,000 B/D) in the U.S. to Tosco for $670 million. Meanwhile, BP Amoco announced that, including Alliance refinery, the company planned to dispose of more than 500,000 B/D, which was equivalent to 15% of its total refining capacity. Also, Exxon Mobil closed Clyde refinery in Australia, and RD Shell plans to trim its refining capacity in the Asia Pacific regionwide (excl. Japan) by 300,000 B/D-strong. 39 For example, in 1991 – 1999, total crude oil output of the six U.S.- and U.K.-based Majors cited before grew 0.4%, while their combined natural gas output increased higher at 1.4%. 40 U.S. DOE/EIA put in its “International Energy Outlook 2000” that the world’s natural gas demand would grow 3.2%/year on average in 1997 – 2020, much faster than primary energy as a whole (up 2.1%) and oil (up 1.9%).

IEEJ: December 2000

24

technologies, notably the combined cycle gas turbine (CCGT).

(c) Amid the liberalization and deregulation moves, the European and American

markets, among others, have favorable conditions emerging for the choice of

gas-fired power generation, like CCGT, which involves a smaller initial

investment and a shorter lead-time.

(d) Infrastructure construction critical to gas utilization, such as pipelines and LNG

terminals, is in progress as well.

As already mentioned, the Majors have already secured ample natural gas

reserves. But, from a business perspective, what’s important for them is how to realize

profits from the assets acquired in the form of reserves41. In this sense, liberalization

& deregulation in progress worldwide not only on electricity markets, the most

promising natural gas utilization sector, but also on natural gas markets themselves, can

be very significant for the Majors as the move offers them a greater business

opportunity than ever. Namely, if the Majors enter the increasingly deregulated

electricity & gas markets, instead of simply acting as sellers of gas, they can create

demand for their gas reserves and commercialize the assets, as well as seeking profits

from new operations.42.

Also, what’s noteworthy of natural gas is that the recent development &

utilization of the technologies to synthesize high-quality liquid fuels from gas offers the

potential for creation of new business fields43. A good example is the liquid-fuel

41 Due to its physical properties, natural gas often involves massive costs that incur in its transportation from producing area to consumers. In either of pipeline or LNG transportation, natural gas requires so huge initial investments that the suppliers generally can decide such investments only after they could secure constant outlets on a long-term contract basis. Thus, natural gas involves a complicated and time-consuming process from the discovery of reserves to the security of actual profits. 42 On this point, see Yasuhiro Koide, “Majors’ Downstream Gas Business Strategies as Potential Newcomers in Japanese Market” (IEEJ, Energy in Japan, November 1999). 43 See Yasuhiro Koide, “Tennen gas wo genryo to sita kohinn nenryo no gosei ni tuite (Synthesis

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25

synthesis technologies, which are so-called gas-to-liquid (GTL) technology. In recent

days, helped by the favorable winds of the falling development costs, the Majors have

materialized the projects to build demonstration or commercial plants 44 . These

commitments to GTL are spurring great interest, because resultant liquid fuels, virtually

sulfur-free, prove to have extremely clean physical properties.

Potentials of GTL development are noteworthy particularly for the reasons below.

(a) For the refining business, which requires massive capacity investments to upgrade

the product qualities despite the refining margins expected to remain low, GTL is

one of promising options to supply clean liquid fuels.

(b) If synthesized liquid fuels gain price competitiveness in the market place, the

Majors can maximize utilization of the natural gas assets, including those not

suitable to conventional development approaches (pipeline export or LNG

transportation).

At any rate, from the medium- and long-range viewpoint, natural gas, having the

highest growth potential, is expected to expand its market share certainly. It is quite

understandable that the Majors, from the standpoints of securing corporate growth and

profits in the future, strengthen their business commitments to natural gas, greatly

expected as a promising principal energy source on international markets, with various

approaches in diverse fields45.

Technology of High-quality Fuels from Natural Gas)” (IEEJ, International Energy Analysis, 1999 February issue). 44 For example, RD Shell was reported in June 2000 that the company now considered, jointly with PERTAMINA, Indonesia’s state-run oil corporation, a project to build a GTL commercial plant having the world’s largest capacity at 70,000 B/D. Among others, BP Amoco also announced its plan to construct a GTL pilot plant, where the company’s natural gas resources from Alaska would be processed. 45 As good examples of the Majors’ commitments to gas and electricity markets, RD Shell incorporated Pulse Energy, a gas & electricity marketing company, in Australia (owned 40% by Shell), and started talks on business expansion of InterGen, an electric utility, with Bechtel, the partner. Among others, BP Amoco started up (September 1999) BP Gas & Power as a new business unit engaged in electricity & gas

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26

3-4. Commitments to the Asian market

For the Majors, which intend to seek higher investment efficiency, expand profits

and secure corporate growth in the future simultaneously, it is a matter of crucial

importance to tackle the Asian market where sharply growing energy demand is

expected.

Asia’s energy demand, though temporarily stagnated due to the economic crisis

having occurred in 1997, picked up again in reflection to the rapid economic recovery

since 199946. Bolstered by the strong economic growth expected to continue ahead, a

generally agreed view is that Asia’s energy demand will be on the constant rise in the

long run47.

In addition to the demand growth, the moves to liberalize and deregulate the

energy market are also under way in Asia48, which can be counted as greater-ever

chances for entry into the expanding market.

Thus, across Asia, the Majors are now unfolding aggressive approaches to grab a

big business chance and get into the promising market there. Particularly they appear

eager to increase their business operations in the natural gas market, which has opened

businesses in hopes to put the company’s gas reserves to best use. 46 According to BP Amoco’s Statistical Review of World Energy 2000, primary energy consumption in all the Asia Pacific areas but China totaled 1.50 billion tons oil equivalent in 1999, up 2.5% over a year ago. However, with China included, Asia Pacific’s primary energy consumption fell by 2.3% from a year earlier. This is because China, the largest energy consumer in Asia, consumed 11% less coals, its principal energy source, than in a year ago amid closures of inefficient medium & small coalmines. 47 For example, the U.S. DOE/EIA put in its “International Energy Outlook 2000” that energy demand would grow 3.7% a year over 1997 – 2020 in the Asian developing areas. By source, natural gas demand will be up 7%, and oil demand up 3.0%, over the same period. 48 On oil-industry deregulatory trends by the Asian governments, see Seiji Tanimoto, “Saikin no Asia sekiyu sijo wo meguru doko (Recent Trends over the Asian Oil Market)” (IEEJ, International Energy Analysis, 2000 January issue). On electricity- & gas-market deregulatory moves in South Korea, Taiwan, etc., see Yasuhiro Koide, “Asian LNG Market at a Turning Point and Japan’s Option” (IEEJ, the 362nd Regular Briefing of Study Results, May 25, 2000).

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27

to entrants wider as a result of deregulation & liberalization, and for which demand is

expected to grow highest partly thanks to favorable condition due to environmental

concerns.

In Asia, the Majors have been long involved in LNG projects bound for natural

gas importing-countries (Japan, South Korea and Taiwan), particularly in such principal

sectors as upstream and liquefaction, and thus played a key role as sellers. Today,

LNG demand is likely to surge in both South Korea and Taiwan49 back by progress in

infrastructure construction, including trunk pipelines and LNG receiving terminals.

Also, Japan, seriously in need of a clean energy to attain the CO2 reduction target

pledged at COP3, has mounting expectations for natural gas after the JCO critical

accident on September 30, 1999, which hardened the unfavorable winds against nuclear

power. Given these recent developments, the Majors are trying to strengthen their

sales to the existing LNG importers.

In addition, the Majors started gearing up for approaching India and China, huge

energy consumers, now that it became clear that the countries wouldn’t be able to cover

the recently surging natural gas demand with domestic gas production alone. On the

Indian market, Oman LNG (joined by RD Shell), ADGAS (by BP Amoco), Malaysia

Tiga (by RD Shell) and Ras Gas (by Exxon Mobil), among others, have already

confirmed LNG import contracts. Majors’ moves to get involved in receiving terminal

construction & marketing on the Indian market are noted as well.

Under such circumstances, most noteworthy right now are the Majors’ moves

over the Chinese natural gas market. Because an outlook for China’s natural gas

49 LNG demand is projected to increase from 12.97 million tons in 1999 to about 22.00 million tons by 2010 in South Korea, and from 4.16 million tons to some 11.00 million tons in Taiwan over the same period.

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28

supply and demand balance suggests a possibility that the country needs natural gas

imports of nearly 35 million tons LNG equivalent in 202050, the Majors show strong

interest in that market where a rapid growth is very likely. In specific terms, BP

Amoco, Total Fina Elf (plus GDF) and RD Shell (plus Marubeni and Osaka Gas),

among others, reportedly expressed their interests in the LNG project in Shenzhen,

Guangdong province, which is under consideration now. Besides LNG potentials,

there are pipeline-based natural gas supply projects. Including a pipeline gas project

originating from Kovykta gas fields, East Siberia (involving BP Amoco), a pipeline

project from Sakhalin (Exxon Mobil), and a pipeline construction project called

“Western Gas To East”51 which runs from the Tarim to Shanghai, the Majors are trying

to tap the Chinese market with a wide variety of approaches.

Conceding that foreign firms’, notably the Majors’, financial and technological

capabilities are indispensable for the efficient implementation of these giant projects,

the Chinese side intends to facilitate natural gas development & utilization by

advancing foreign capital introduction. Given these moves on the Chinese side, BP

Amoco, among others, is moving to deepen its ties with state-run CNPC and SINOPEC,

the key players on the Chinese oil and natural gas markets, by building up equity

relations with them52.

In this way, the Majors are stepping up their marketing & entries into the Asian

50 See Yasuhiro Koide [2000] in footnote 48. 51 ”Western Gas To East” is a project to construct a nearly 4,200km-long trunk pipeline from the Tarim basin to Shanghai in an attempt to exploit gas supplies there. In the Tarim, natural gas reserves have been confirmed one after another since 1999, which reportedly amount to over 400 billion cubic meters. It has been estimated that with about $7 billion required for pipeline construction alone, this project costs a total of $14 billion when the upstream portion is included. In hopes to secure necessary funds and technologies for the project, the Chinese government plans to encourage foreign capital introduction and shows a stance to permit the Majority equity participation. 52 BP Amoco announced in March 2000 that, given IPO of Petro China, a CNPC subsidiary, it would purchase 20% of Petro China’s newly issued shares (10% of the total). Also, in June 2000, BP Amoco announced its will to acquire 2.2% of SINOPEC of which IPO was slated for the fall of 2000.

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29

market53, particularly the natural gas market, where progress is likely in market

liberalization, on top of considerable demand increases. In the process of advancing

market liberalization in Asia, the Majors are likely to unroll the strategy, which puts

entries into the Asian markets for natural gas downstream businesses or electricity, in

hopes for effective utilization of natural gas upstream assets of their own as discussed

before.

3-5 Commitments to further rationalization and cost cuts

As already noted, the Majors attained good performances in 1999 partly thanks to

the soaring crude oil prices. Yet, even in the favorable situation, the Majors are not

slackening the rein to drive streamlining & cost-cutting efforts forward. To achieve

the cost reduction targets54 they put forth by themselves, the Majors are making various

commitments.

One of their specific commitments, though partly overlapping with what’s

discussed so far, is restructuring of portfolio by reviewing the assets at hand, which

includes liquidation and sale of “inferior” assets. From now on, the strong likelihood

is that the Majors will spur the moves to sell downstream assets55 that lose the priority

in building up a better portfolio, as well as the moves to exchange with, or sell to, the

rivaling Majors and/or independents upstream assets of lesser importance56.

Needless to say, the Majors intend to continue conventional efforts to slash

53 In regard to the oil sector, the Chinese market, also marking sharp rises in demand and in imports, attracts mounting attention. For example, Exxon Mobil, jointly with Saudi ARAMCO, participated in a capacity expansion project of Fujian Refinery in Fujian province. BP Amoco on its part decided to join a petrochemical project, etc. 54 For example, RD Shell is endeavoring for a cost reduction target of $4 billion/year by 2002, BP Amoco also $4 billion/year, and Exxon Mobil $3.8 billion. 55 BP Amoco unveiled on July 2000 its decision to sell Alliance Refinery in the U.S. to Tosco for $670 million, which is counted as part of its rationalization.

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30

redundant personnel and excess capacity57. This is likely to work as a strong driving

force in the coming 1 – 2 years particularly on the Majors that realized big mergers,

because to create extra room for cost reduction is one of the objectives that motivated

them to carry on the deals. Also, pressed by further rationalization & cost reduction

needs, the firms having committed to single-handed restructuring efforts, such as RD

Shell, Chevron, Texaco and independents, can select (a review on) business integration,

mergers and other new options to break through the pressures.

Aside from portfolio reviews, excess personnel/capacity reduction and

rationalization-motivated mergers, cost reduction by virtue of technological innovation,

application of advanced technologies is very important as well. Actually, a wide

variety of innovative technologies, like three-dimensional seismic survey and horizontal

drilling, developed and put to a wide use in the upstream sector during the 1990s

enabled the Majors to lower the production/development costs and increase

commercially recoverable reserves. These technologies are highly evaluated as

contributing much to strengthening their profits and corporate strength. In the days

ahead, the likelihood is that stepped-up effort will be made to cut the operating cost in

all business segments through not only enhanced technological development but also

the pursuit of the so-called “knowledge management58.”

In addition to these moves, emerging in recent years have been the efforts for cost

56 See footnote 30 on the Majors’ liquidation, sale and exchanges of their upstream assets. 57 For example, Exxon Mobil plans to cut its personnel by late 2002 as many as 16,000 down from late 1998 records. RD Shell also intends to cut 18,000 personnel by 2000 yearend. 58 Knowledge management is a notion defined as the efforts to increase efficiency of business operations and decrease costs by constructing and using a system designed for optimal utilization of usable information, such as knowledge, know-how, learning and expertise accumulated within an organization. In a sense, the evolution of information technology (IT) revolution in recent years can be rated as fulfilling a key role. On the “knowledge management”, see the Japan National Oil Corporation, “Oil/Natural Gas Operations and Knowledge Management” (JNOC, Oil/Gas Review, 1999 December issue).

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31

reduction & efficiency improvement with new approaches endorsed by advance in the

so-called information technology (IT) revolution. A representative of such approaches

is utilization of commercial trading on the Internet, or the so-called “e-commerce”. At

present, the Majors’ e-commerce utilization centers on net-based procurement of fuels,

parts, equipment, etc., net-based trading in such products as crude oil, natural gas

and electricity, and information exchanges in the upstream sector, etc. The Majors

announced, or under planning, opening of various web sites59. Through effective use

of e-commerce, the Majors reportedly hope achieving considerable cost cuts and

efficiency gains60.

This is because e-commerce has:

(a) A competitive effect by getting many sellers approached on the net;

(b) A rationalization effect by eliminating intermediate dealers;

(c) A market development effect on the net;

(d) A rationalization effect by streamlining paper & administrative works.

At this point of time, the effect of the e-commerce can hardly be evaluated yet.

What’s certain is the Majors are getting deeply interested in e-commerce as a new cost

cutting & efficiency increasing option, and intensify their commitments to it. Among

the Majors, there are gaps, with Chevron, BP Amoco and RD Shell particularly positive

toward e-commerce, while Exxon Mobil being seen as “conservative.” And yet, as

an industry-wide direction, efforts for cost cuts & efficiency gains by virtue of

information technology, notably e-commerce, are very likely to become the needs of the

59 For example, BP Amoco and RD Shell announced their participation in such on-line market as Intercontinental Exchange, Ocean Connect Com, Levelsea Com, etc., Chevron in Petrocosm Marketplace, Upstream Info Com, Retailers Market Exchange Com, etc., and Exxon Mobil in Bunkerstem, etc. 60 According to a survey made by Goldman Sachs, procurement cost cuts expected from the use of e-commerce would reach the $10–20 billion per year for the oil industry as a whole (MEES dated April 10, 2000).

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times. To what extent e-commerce gets rooted in the oil industry, a representative of

the old economy is very worthy to note.

4. Implications for Japan

4-1. Impacts of oil industry restructuring on the price determination.

As a result of the drastic restructuring since 1998, the international oil market has

a smaller number of competitors due to the mergers among the Majors, the key players

on the market, and concurrently witnessed the birth of the super Majors, each having a

gigantic size. As already stated, the three super Majors, when combined, hold as much

as 10% of crude oil production and 29% of petroleum product sales across the world.

Will these results of restructuring have a great impact on the price determination

in the international market? In other words, on the post-restructuring market, are the

newly born key players likely to have a stronger market power and exercise a massive

influence on the pricing? These questions can be of great concern for Japan, the

world’s second largest oil consumer and importer.

The answer to these questions might be “no” in principle. In short, the reason

for the answer is that today’s international oil market is so competitive as a whole that

even gigantic-sized Majors cannot exercise market power to control the price.

Let’s check the market by sector in this point. First, the upstream sector is

discussed. Many players of various kinds are present and active in the upstream sector

of the international oil market. Beside the Majors, they include state-run oil

corporations of producing countries, independent oil companies and exploration- &

development-specialist firms. Certainly the Majors represent the presence of private

firms having powerful management strength. Yet, they do not occupy so much

position as menacing other players across the market in regard to such upstream

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33

operations as acquisition of mining blocks, crude oil production and development. Of

course, as the merger of BP Amoco and Arco aroused the worries for a dominant market

power held by the resulting company in the Alaskan upstream sector, there is a

possibility that the Majors can exercise a stronger influence on a specific area. But, on

the international market, it is not the Majors but oil-producing countries (their state-run

oil corporations) that have a far greater influence. Particularly, based on the

recognition that the OPEC’s commitments to coherent production curtailments and

closer alliances bolstered the soaring crude oil prices since 1999, a stronger market

power of OPEC members might be a concern for the oil market forces right now.

It is also noted that, as a result of the regulatory bodies’ order mentioned earlier

and the Majors’ own initiatives toward portfolio enhancement, the Majors are releasing

their upstream assets to the market, which gives non-Major firms growing chances for

upstream asset acquisitions. Actually, when they reviewed a series of recent big

mergers, the EC and the FTC examined the state of the world’s oil upstream sector,

including the possibility of a stronger market power held by the Majors, and concluded

that the market as a whole had few problems under the present conditions.

On the other hand, now that the top three Majors hold 30% of the world’s refining

capacity and product sales, the downstream sector is in a situation where worries for a

greater influence to be exercised are not surprising.

To start with, because the refining sector is a crude oil-consuming sector, the

recent restructuring resulted in the birth of big “consumers” on the crude oil market.

But, because they earn the greater part of their profits from upstream operations, it’s

quite understandable if the Majors potentially hope the crude oil price to stay high

rather than hovering too low. However, as far as judging from the Majors’ investment

behaviors, etc., they are acting as the price taker and apparently intend to maintain or

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34

increase their crude oil production within the framework. Namely, a reasonable

interpretation is that the Majors basically leave crude oil price determination to the

OPEC’s production adjustment and excess capacity control, as well as to the transaction

by numerous players in the crude oil futures market. As already discussed, in the

pursuit of management efficiency gains, the Majors are expected to review refining

business strategies and advance asset liquidation/sales. On these accounts, the Majors’

move to strengthen their influence is least likely.

On the other hand, the refining sector is the petroleum product supply sector.

When combined with their high share in the product-marketing sector, the Majors

certainly have a greater influence on the product market than on the crude oil market.

Especially the concerns for a stronger market power on a specific area/market are real.

For this reason, the regulatory bodies ordered them to sell some assets before merging,

which were already detailed. But, from the worldwide perspectives, the downstream

sector is exposed to fierce competition due to:

(a) The presence of overcapacity as a structural problem;

(b) Deregulation under way chiefly in the West and mushrooming entrants into

refining/marketing sectors who exert a great influence on the market, among

others.

Thus, practically it’s not easy for the Majors to cause decoupling of the product

prices from competitive price levels by exercising their market power.

On the contrary, it seems the Majors are actually taking a strategy to seek

optimization of overall business operations through price competition with “new

entrants”61 as well as the sale of rather unprofitable downstream assets. Thus, at this

61 The best example is “Price Watch,” a pricing strategy that Exxon took in 1996 in order to fight against the hypermarkets in the British gasoline market. For details, see Ken Koyama “Oil Companies’

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point of time, the possibility that the Majors can exercise their market power on the

product market does not pose a serious issue at global levels. However, if

mergers/business integration among the Majors unrolled further ahead, it could become

a big concern subject to stricter scrutinizing by the regulatory bodies.

4-2 Majors’ investment & management strategies and implications for Japan

From now on, the investment & management strategies unfolded by international

oil companies, particularly the Majors, are likely to affect the Japanese energy industries

& markets in various ways. What impacts and implications the Majors can produce on

Japan through their investment & management strategies are discussed below by

dividing the affected sectors into three, namely the upstream sector, the downstream

sector, and the gas & electricity market.

First, in the upstream sector, where the Majors have built up the stout-ever

management strength, the Japanese firms, already considerably inferior to the Majors in

competitiveness and strength, will inevitably be left behind further. Yet, aside from

such a disadvantage, the Japanese firms can have greater business chances depending on

the Majors’ investment & management strategies ahead. That is, as discussed in the

preceding section, the Majors are expected to advance restructuring and liquidation/sale

of assets in an attempt to optimize their asset portfolios. Then, not a few assets can be

on sale, not necessarily because they are unprofitable, but simply because they are

prioritized lower in a portfolio even when they can yield certain profits. In this sense,

the Majors’ post-restructuring investment & management strategies enshrine a possible

path to expanding and spurring trading of assets. This will provide the chances for

Downstream Strategies for Survival: A Study on the European Market and Its Implication to Japan” (IEEJ, Energy in Japan, September 1998)

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asset acquisition & additions for all players participating in the market, including the

Japanese firms.

Foreign capital introduction under way into oil-producing countries’ upstream

sectors today also offers the international oil industry overall a good chance to widen

new business & investment opportunities. However, among high-profile foreign

capital introduction projects in recent years, particularly those in Iran, Iraq, the Caspian

nations and Russia, many are found not merely having numerous resource/development

potentials but also very risky in various ways in political and economic terms. The

Majors’ approaches to such projects unveil that, while joining as one of core member,

they often avoid a single-handed participation/investment in any projects for risk

diversification reasons. This situation potentially contains a chance for non-Major

firms to participate in the oil-producing countries’ projects to invite foreign company by

becoming a partner of a Majors-led consortium62.

The Japanese firms can link such potential opportunities to real business chances

by carefully examining the Majors’ moves to asset disposal/sale as well as progress in

the producing countries’ foreign capital introduction, then taking swift actions. Of

course, hasty responses should be averted. When offered the Majors’ assets on sale or

upstream investments in the producing countries, it is essential to scrutinize each offer

specifically from the standpoint of economic rationality in order to avoid acquisition of

unprofitable assets or participation under disadvantageous conditions. To this end, the

Japanese firms need to strengthen their system for information gathering & analysis.

62 Needless to say, only those who can demonstrate the host oil-producing countries as well as the majors that they have a superiority in such areas as capital, technology, marketing etc., and their participation contributes to the project somehow are entitled to be partners.

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Given that Arabian Oil lost its interests in Saudi Arabia63 and that growing

voices call for a review on the Japan’s oil policy, the climates around oversea oil

development by the Japanese firm is drastically changing64. Amid the currents, the

Japanese firms will be increasingly required to expand and develop their overseas oil

development with emphasis on efficiency improvement. In this sense, to grasp various

changing situations in the international oil market and industry today and upgrade the

capability to grab potential opportunities contained in such changes is a matter of

extreme importance for Japan and the Japanese firms.

Second, focusing on the downstream sector, impacts of the Majors’

rationalization strategies are likely. As already discussed, the Majors are expected to

review their downstream business strategies and take various initiatives to further

reduce costs and increase efficiency. Particularly on the Asian market where refining

overcapacity became conspicuous after the Asian economic crisis, the likelihood is that

the Majors will accelerate their efforts for efficiency gains & streamlining, which can

greatly affect Japan as well.

To begin with, their streamlining & efficiency increase efforts can lead to

curtailments of excess capacities/facilities in the refining & marketing sectors

industry-wide. Resultant higher efficiency industry-wide will help improve margins

63 In 1961 Arabian Oil started oil production from Khafji oilfields spreading offshore the Neutral Zone provided between Saudi Arabia and Kuwait. Crude oil produced and imported by the company into Japan reached a total of 420.93 million tons by FY1998, and Arabian Oil has been Japan’s leading firm in Japan’s oil development overseas. However, on February 27, 2000, during the talks with the Saudis on renewal of its interests, the company failed to make an agreement on the Saudi requests for railway construction, and thus had its interests expiring. 64 On June 22, 2000, the Basic Policy Subcommittee of the Oil Development Committee, a unit of the Petroleum Council, which has reviewed Japan’s overseas oil development policy, announced that further efficiency gains should be called for. Concurrently, the Subcommittee stated that it would recommend the government to drop the long-standing numerical target, 1.20 million B/D of overseas crude oil development, in reflection to Arabian Oil’s failure in its interests renewal and poor performances by the Japanese firms engaged in overseas oil development.

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across the market, which, in turn, can work positively on the Japanese oil industry. For

example, given the continuing situation of overcapacity, how the Majors operate their

refining assets in Singapore, the refining center in Asia, or if they move more drastically

by re-positioning the assets and put them on a list for liquidation/sale, can have

considerable impacts on refining margins region wide.

Though working positively on improving margins market-wide, progress in the

Majors’ rationalization/cost reduction within the Asian market can worsen cost

competitiveness of the Japanese refiners/marketers in Asia provided that they were

slower in rationalization. The operating cost of the Japanese firms, though sharply

lowered by management efforts over the past few years, still remains high by

international standards, partly due to Japan’s specific factors such as high labor cost,

expensive land cost and stringent environmental standards65. For the Japanese firms,

to pursue stepped-up cost reduction efforts is essential in retaining/acquiring

competitiveness in the Asian market. From this standpoint, the Majors’ moves toward

rationalization/efficiency gains should be carefully watched.

What’s discussed above is applicable to, not merely the Asian market overall, but

also Japan’s market at home. As a result of industry’s restructuring in recent years, the

Japanese downstream sector too has undergone advancing integration into four big

groups, including NipponMitsubishi (plus Cosmo Oil), Exxon Mobil group companies,

Showa Shell-Japan Energy alliance, and Idemitsu. Each group is getting slimmer and

slashing costs through its own management efforts. Yet, a possibility cannot be ruled

out that Exxon Mobil, reputed as the top runner in cost competitiveness, will enhance its

65 According to IEEJ’s estimates, Japan’s refining cost averaged ¥4,377/kl as of 1996, thus staying higher than South Korea’s (¥1,703/kl) and Singapore’s (¥2,230/kl). As a result of subsequent rationalization efforts, Japan’s refining cost has reportedly been lowered these days to around ¥3,000/kl, though cost gaps still remain.

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efforts and widen the gaps against its rivals in market competitiveness and management

strength.

If the Japanese oil companies hope to acquire cost competitiveness tuned to the

Majors’ pace of thorough rationalization, what they have to do is not limited to

acceleration of a wide range of conventional streamlining endeavors. At this point of

time, the top priority for them might be to initiate drastic strategies & actions effective

in the elimination of refining overcapacity, having reached an estimated nearly 1-million

B/D, and in the disposal of unprofitable retailing assets.

Third, discussed are the implications the Major’s investment & management

strategies ahead have for the Japanese gas & electricity markets. They are all very

interested in Japan’s gas & electricity markets, now becoming increasingly liberalized

with deregulation under way.

Focusing on the natural gas market first, to expand natural gas sales to the

Japanese market is very significant for the Majors because of the reasons listed below.

a. The Japanese LNG import market is the world’s largest in size66, not to mention in

Asia,

b. The market has been growing steadily since LNG imports from Alaska began in

1969,

c. Backed by favorable winds of environmental issues, natural gas demand is

expected to grow highest among primary energy sources67,

d. Japan’s LNG imports are expected to increase considerably in absolute terms (size),

66 In FY1999, Japan’s LNG imports were the world’s largest at 69.3 billion cubic meters, followed by South Korea’s at 17.5 bcm. 67 The government’s Long-term Energy Supply and Demand Outlook released June 1998 put that Japan’s natural gas demand would increase from 48.20 million tons (LNG equivalent) in FY1996 to 60.90 million tons (base case) by 2010.

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though the growth rate will be lower than other existing LNG importers, like South

Korea and Taiwan, as well as China and India likely to become newly emerging

LNG importers, and,

e. Particularly, compared with newly emerging importers, like China and India, Japan

involves extremely limited economic risks in project startups, investment recovery,

etc.68

On the other hand, while Japan’s natural gas demand is expected to grow,

traditional LNG buyers, namely electric and gas utilities, have already covered their

needs for the years to around 2005 with the existing contracts, etc. Because a widely

agreed view is that supply-demand gaps set to broaden conspicuously only after that

time, the Majors, among others, are likely to plan marketing campaigns for Japan’s

traditional LNG buyers by targeting the Japanese market from 2005 onward.

However, deregulation of the electricity & gas markets69 having rapidly evolved

since the 1990s added a new element to the potentials of the Japanese market from the

Majors’ perspectives. Introduction of competition into the power generation market,

partial liberalization of the power retail market, and liberalization of natural gas supplies

to large consumers offered extra chances to the Majors, which used to approach the

Japanese market simply as natural gas sellers. Namely, in some cases, they can enter

the deregulated markets directly as new players, thus grabbing a real chance to utilize

their natural gas upstream assets by themselves, on top of earning profits in the

68 On LNG outlooks for South Korea, Taiwan, China, India and others, as well as on risks on the Indian market, see Yasuhiro Koide [2000] in the footnote 48. 69 As for the electricity market, the power generation market became open for competition by the introduction of IPP bidding system under the Electric Utilities Industry Law as amended in 1995. When the Electric Utilities Industry Law was amended again in 1999, partial liberalization of the retail sector was decided and has been in practice since April 2000. As for the gas market, the Gas Utilities Industry Law as amended in 1995 liberalized gas supplies to large customers, each consuming over 2.00 million cubic meters. Later, as a result of the amendment in 1999, the scope of eligible customers was widened

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markets70.

Right now, while carefully watching the effects of market deregulation &

liberalization moves, the Majors, among others, are probably waiting for a chance to

enter the Japanese market in the future71. For years, the Majors and the Japanese

electric and gas utilities have maintained the seller-and-customer relation. Although it

is certain that this relation will remain in the long run, a new element, or rivalry in the

same market place, can occur depending on future developments. In addition, now

that the Japanese oil companies also plan to enter the electricity and gas markets where

liberalization is in progress, the Majors can also have a rivaling relation with them.

Given their superiority in technology, capital, management efficiency, possession

of captive natural gas assets, etc., what approaches the Majors will take on the Japanese

gas and electricity markets poses a key point when considering the future of Japan’s

energy market72. On the other hand, the speed and degree of electricity & gas market

liberalization and deregulation, as well as institutional design of markets is a very

important factor to influence the Major’s approach. Thus, energy market deregulation

needs careful examination and discussion among the Japanese energy industries,

consumers and policy-makers.

to those consuming over 1.00 million cubic meters each. 70 On the trends of the Majors’ approaches to the Japanese gas & electricity markets, see Yasuhiro Koide [1999] in the footnote 42. 71 For example, RD Shell incorporated Shell Gas & Power in Tokyo, July 2000, in order to pursue the potentials of gas & electricity businesses in Japan. Similarly BP Amoco established in Singapore BP Gas & Power, responsible for power & gas business expansion on the Asian market, including Japan, which already started relevant activities. 72 The Majors are not the only foreign firms that intend to approach Japan’s power & gas markets. Enron, a U.S. energy firm, has steadily been building its foothold since 1999 through the incorporation of its Japanese unit. For further information, see Masayuki Fujita, “Business Strategies of Enron” (IEEJ, International Energy Analysis, 2000 March issue).