01 Survey 1 Survey on Management Strategy of Petroleum Companies Tadashi Maruoka, Research and Planning Department, Petroleum Energy Center (PEC) Hideaki Fujii, Energy Research Division, Mitsubishi Research Institute, Inc. 1. Background and Goals The U.S. petroleum downstream markets have undergone a reshuffling in recent years. This has been brought about by factors such as reorganization of petroleum business assets as a result of mega-mergers between Majors, as well as additional capital investment in refineries or consolidation of refineries in response to the trend toward stricter environmental regulations under the Clinton administration. The Petroleum Energy Center (PEC) previously conducted surveys on independent U.S. petroleum companies and North American petroleum companies in fiscal year 1995 and 1997. In these surveys, strategies are classified into merchant refinery, technical niche, asset acquisition, alliance with oil producing countries, business diversification, and capital alliance/merger, etc. In response to the urgent need for a contemporary reassessment of management strategy that should take into account rapid changes in the situation surrounding the oil business after the previous surveys, such as increasing interest in global environmental issues and mega-mergers between Major petroleum companies, this survey seeks to illuminate the concepts based on which U.S. independent petroleum companies have reappraised their business models as of the year 2000. In particular, this survey focuses on the business situation and management strategies of independent U.S. petroleum refining and marketing companies, which are rather similar to Japanese petroleum companies in terms of capital size and business activities. Specifically, this survey aims to clarify how TOSCO, Valero, Ultramar Diamond Shamrock, Lyondell-CITGO Refining, Tesoro, and (although it does not fall into the category of independent U.S. petroleum refining and marketing company ) Enron achieved rapid growth from the mid-1990s onward. In addition to investigating the sources of this growth, we also tried to clarify what sorts of adjustments in their strategy are possible. 1
2. Overview 2.1 Main Survey Items Changes in the business environment of independent U.S. petroleum refining and marketing companies and how they are coping with the changes Business management situation of six independent U.S. petroleum refining and marketing companies (TOSCO, Valero Energy, Ultramar Diamond Shamrock, Lyondell-CITGO Refining, Tesoro Petroleum, and Enron) Classification of causes of growth and management strategy of the above six companies Comparison of management strategy models of the six companies and anticipated changes in the business environment variables 2.2 Method In addition to discussions in a working group consisting primarily of experts in fields related to the petroleum industry, relevant documents were examined and fact-finding visits were made (including interviews at Valero Energy, Ultramar Diamond Shamrock, Tesoro Petroleum, Enron, and related research institutes). 3. Findings and Conclusions Presented in the following pages. Survey on Management Strategy of Petroleum Companies A. Findings 1. Changes in the Business Environment of Petroleum Refining and Marketing Companies and How They are Coping with the Changes The companies under review were classified as either independent U.S. petroleum refining and marketing companies or major U.S. petroleum companies (Table 1). Among U.S. independent petroleum refining and marketing companies, as defined by the survey, six were selected for individual examinations: TOSCO, Valero, Ultramar Diamond Shamrock, Lyondell-CITGO Refining, Tesoro, and Enron. Since the mid-1990s, these companies all succeeded in rapidly expanding their asset bases and realizing comparatively high earnings based on distinctive management strategies. 2
Table 1 Petroleum Refining and Marketing Companies Covered in the Survey and Reclassification of Petroleum Companies Leading Petroleum Refining and Marketing Companies CITGO Petroleum Corporation Clark Refining and Marketing,(Premcor)Inc. Enron Corporation Fina, Inc. LYONDELL-CITGO Refining, LP Nerco, Inc. Sonat Inc. Tesoro Petroleum Corporation TOSCO Corporation Ultramar Diamond Shamrock Corporation Valero Energy Corporation The Williams Companies, Inc. There are many, in addition to the above. Petroleum Companies Amerada Hess Corporation American Petrofina, Inc. Amoco Corporation Ashland Inc. Atlantic Richfield Co. (ARCO) BP America, Inc. Burlington Northern Inc. Burlington Resources Inc. Chevron Corporation Cities Service The Coastal Corporation Conoco E.I. du Pont de Nemours and Co. Exxon Corporation Getty Oil Gulf Oil Kerr-McGee Corporation Marathon Mobil Corporation Occidental Petroleum Corporation Oryx Energy Company Phillips Petroleum Company Shell Oil Company Standard Oil Co. (Ohio) (SOHIO) Sun Company, Inc. Superior Oil Tenneco Inc. Texaco Inc. Total Petroleum (North America) Ltd. Union Pacific Resources Group, Inc. Unocal Corporation USX Corporation Total 34 companies. Note: This survey defines major U.S.. petroleum companies as corporations active in the petroleum refining and marketing business sector in the United States and which were enrolled in the Financial Reporting System (FRS) during the period from 1974 to 1990. petroleum refining and marketing companies are corporations that were not enrolled in the FRS between 1974 and 1990. The companies examined individually for the survey are underlined in the list above. Note that Equilon Enterprises, LLC, which was formed in a joint venture between Shell Oil and Texaco, and Motiva Enterprises LLC, which is the result of a joint venture by Shell Oil, Texaco, and Saudi Aramco, are classified as major U.S. petroleum companies. Source: Materials prepared by Mitsubishi Research Institute based on data from the U.S. Department of Energy/Energy Information Administration (2000). 3
The extent to which the major U.S. petroleum companies became less involved in the downstream segments of the U.S. petroleum sector, with increased market competition and stricter environmental regulations that took place during the nineties, is made clear by an analysis of the data on the changes in U.S. refineries. For example, in 1985 the share of total domestic refining capacity accounted for by independent U.S. petroleum refining and marketing companies was 23.1% and that accounted for by the major U.S. petroleum companies was 76.9%. The corresponding figures for 1999 are 43.6% for the independents and 56.4% for the Majors, indicating that the distribution of power within the industry had changed dramatically (Table 2). In the area of petroleum product retail assets as well, a real shift has been taking place from the Majors to the independents (Table 3). In particular, Petroleum Administration for Defense District 1 (PADD I, East Coast) became the first region in the U.S. where the independents surpassed the Majors in refining capacity. The major reason for this is that independents, such as those covered in this survey, have been strategically purchasing refineries from the Majors (Figure 1). Table 2 Petroleum Refining Capacity of Petroleum Refining and Marketing Companies and Petroleum Companies Petroleum Refining and Petroleum Companies Marketing Companies Total % % 1970 5,216,550 40.1 7,807,900 59.9 13,024,450 1975 4,343,590 27.7 11,342,160 72.3 15,685,750 1980 5,478,501 28.6 13,646,768 71.4 19,125,269 1985 3,522,671 23.1 11,742,500 76.9 15,265,171 1990 5,190,274 33.5 10,288,675 66.5 15,478,949 1995 5,551,310 36.2 9,802,830 63.8 15,354,140 1996 5,817,465 37.7 9,615,130 62.3 15,432,595 1997 6,541,810 41.1 9,356,570 58.9 15,898,380 1998 6,775,220 41.3 9,647,450 58.7 16,422,670 1999 7,207,620 43.6 9,333,370 56.4 16,540,990 Source: Materials prepared by Mitsubishi Research Institute based on data from Oil & Gas Journal. Note: Refer to Table 1 for the definitions of independent U.S. petroleum refining and marketing companies and major U.S. petroleum companies. Table 3 Number of States with Sales Outlets of Petroleum Products 1984 1990 1997 Average for 7 FGIR Companies NA 14 24 Average for major U.S. Petroleum Companies 32 NA 23 CITGO 31 NA 48 TOSCO 0 0 37 Source: Materials prepared by Mitsubishi Research Institute based on data from the U.S. Department of Energy/Energy Information Administration. Notes: FGIR designates CITGO (a subsidiary of PDV America), Clark Refining & Marketing (currently Premcor), Ultramar Diamond Shamrock, Koch Industries, Tesoro, TOSCO, and Valero Energy. major U.S. Petroleum Companies designates companies enrolled in the FRS. NA stands for not applicable. 4
(a) Number of Refineries (b) Total Refining Capacity (c) Refining Capacity per Refinery (Number) PADD I Petroleum Refining and Marketing Companies Petroleum Companies Petroleum Companies PADD I Petroleum Refining and Marketing Companies Petroleum Companies PADD I Petroleum Refining and Marketing Companies (Number) PADD II PADD II PADD II (Number) PADD III PADD III PADD III (Number) PADD IV PADD IV PADD IV (Number) PADD V PADD V PADD V Figure 1 Number of Refineries, Total Refining Capacity, and Refining Capacity per Refinery for Petroleum Companies and Petroleum Companies (Broken Down by Petroleum Administration for Defense District (PADD)) 5
Note: This survey defines major U.S. petroleum companies as corporations active in the petroleum refining and marketing business sector in the United States and which were enrolled in the Financial Reporting System (FRS) during the period from 1974 to 1990. petroleum refining and marketing companies are corporations that were not enrolled in the FRS during that period. In addition, Equilon Enterprises, LLC and Motiva Enterprises, LLC are both included in the major U.S. petroleum companies category. Source: Materials prepared by Mitsubishi Research Institute s Energy & Environment Initiative based on data from Oil & Gas Journal. 2. Classification of Business Management Performance and Growth of Six Independent U.S. Petroleum Refining and Marketing Companies In order to gain an accurate picture of the actual business management status of the six independent U.S. petroleum refining and marketing companies under review, the annual reports (SEC Form 10-K) filed by these companies and information gathered in fact-finding visits to the United States were analyzed and the causes for growth were identified. The extent to which each company engaged in selection and concentration of management resources was examined in detail, and each was classified into growth model categories on the basis of the combination of management tactics employed (Table 4). Table 4 Causes for Growth of Six Companies Covered by the Survey (1996 2000) Causes for growth TOSCO Valero Decisive elements influencing strategy (1) Excellent CEO (Thomas D. O Malley) (2) Clearly defined business plans (3) Clearly defined management philosophy and the ability to implement it (4) Strategic acquisition of assets (5) Thoroughly Darwinist approach to capitalism (6) Superior ability to raise capital Having as core, processing of residue and sales of high value added niche products, became scale-oriented through acquisition of assets. Important management tactics (1) Pursuit of scale (a) Acquiring existing assets rather than building new ones (b) Abandoning markets where the company cannot become one of the top three (2) Formulating retail strategy based on sales zones (3) Giving priority to short-term rather than long-term performance (4) Strengthening the company s financial strength (a) Giving priority to maximizing EPS (shareholder-centered approach) (b) Employing economists to formulate financial and investment plans (c) Selling non-essential and unprofitable assets in the refining business (d) Minimizing expenses at headquarters (only 14 headquarters employees) (1) Diversification of feedstock from almost residue only by increasing share of heavy sour crudes (2) Strategic acquisition of refineries equipped with sophisticated secondary units (3) Participation in the retail markets of petroleum products (since June 2000) 6
Causes for growth Ultramar Diamond Shamrock Lyondell-CITGO Refining Tesoro Enron Decisive elements influencing strategy (1) Pursuit of both economies of scale and economies of scope through mergers (2) Cost cutting and selling unprofitable assets (3) Acquisition of assets and focused capital expenditure (4) Decision-making capability regarding projects aimed at increasing its own scale Margin is assured by stable supply of crude oil and stable sales of petroleum products are assured. (1) Moving away from vertically integrated operations (2) Strategic acquisition of refineries according to regional and product niches (3) Expanding the retail network (1) Expansion of its network from the starting point of wholesale business (2) Business expansion based on a new concept of Energy Major (moving away from the conventional energy company model) Important management tactics (1) Geographical expansion of its markets (West Coast, Canada, U.S. Northeast, central Texas) (2) Concentration of management resources in central U.S. through acquisition of Total Petroleum (3) Sale of pipeline interests, closure of Alma refinery, sale of unprofitable assets (especially former D/S and Total) (4) Scale-orientation through plans of joint venture with competitors (Diamond 66, etc., presently a failure) (1) Assurance of a stable crude oil procurement system through an agreement with Petróleos de Venezuela S.A. (PDVSA) (2) Assurance of a stable marketing system of petroleum products through an agreement with CITGO (1) Withdrawal from upstream operations and specialization in downstream operations (1999) (2) Aggressive investment to improve secondary units and purchase of a refinery in Hawaii from BHP in order to increase production capacity of premium products of gasoline and middle distillates, mainly jet fuel. (3) Targeting Alaska, Hawaii, and the West Coast region as its market (4) Alliance with Wal-Mart to establish and operate gas stations in 11 states in the western U.S. (January 2000) (1) Knowledge intensive business model (dependent on income from services) (2) Online network integration (Enron Online) (3) Realization of profits as a pioneer in non-price-competitive businesses (working to create new markets and deregulations in overseas markets) (4) Project (business segment) oriented internal corporate organization Source: Materials prepared by Mitsubishi Research Institute s Energy & Environment Initiative (MIRIEEI). By classifying the combinations of tactics chosen by the companies during the period covered by this survey, we can say that TOSCO and Ultramar Diamond Shamrock are oriented toward a management strategy emphasizing expansion, while Valero and Tesoro are struggling to decide whether to pursue specialization (concentration) or expansion (Figure 2). 7
Tosco Specialization (Concentration) Valero Specialization (Concentration) Expansion Expansion Ultramar Diamond Shamrock Specialization (Concentration) Lyondell-Citgo Refining Specialization (Concentration) Expansion Expansion Tesoro Specialization (Concentration) Legend: EXVI: Movement away from vertical integration SAL: Strategic alliances OAL: Alliances with oil producing countries M: Mergers SA: Strategic asset acquisition PN: Product niches AN: Regional niches CL: Cost leadership Bold lines indicate the tactics utilized by the company in question. Lines linking circles indicate combinations of tactics. Expansion Source: Materials prepared by Mitsubishi Research Institute s Energy & Environment Initiative. Figure 2 Combinations of Strategies Selected by Five Independent U.S. Petroleum Refining and Marketing Companies 8
The petroleum industry in the United States is undergoing a process of dynamic structural change marked by a shift from integration to disintegration (segmentation), followed by reintegration (Figure 3). Segmentation Commercial Investment Emissions Exploration and Production Natural Gas Refining Electricity Vertical Integration Transport and Distribution Enron s Network Climate Wholesale Coal Retail Paper and Wood Pulp Structural Change Disintegration Reintegration Outsourcing, Risk Management, etc. Online Services Source: Mitsubishi Research Institute Figure 3 Characteristics of Enron s Management Strategy 9
3. Comparison of Management Strategy Models of Petroleum Refining and Marketing Companies and Anticipated Business Environment Change Variables A study was made on anticipated business environment variables likely to affect the management strategies of independent U.S. petroleum refining and marketing companies in the years ahead. Whether or not the independent U.S. petroleum refining and marketing companies will be able to achieve sustainable growth will depend largely on whether each company s growth model can appropriately and strategically deal with three key business environment variables: (1) large-scale mergers and liquidation of assets, (2) environmental regulations, and (3) crude oil prices and margins (Figure 4). A key factor will be the direction taken by the independent U.S. petroleum refining and marketing companies in short-term business orientation and management strategy. This section discusses qualitatively the possibilities of directions of each of the above-mentioned business environment variables as of the beginning of 2001. Effects of structural changes in the U.S. petroleum downstream markets Sustainable growth Rapid growth of independent U.S. petroleum refining and marketing companies Temporary is the rapid growth during a period of asset transfers associated with withdrawal of capital by the Major U.S. petroleum companies from U.S. downstream sector, a process of concentration and liquidation Slow growth/decline Source: Mitsubishi Research Institute Figure 4 Sustainable Growth by Petroleum Refining and Marketing Companies 10
B. Implications We believe that the prominent independent U.S. petroleum refining and marketing companies examined in this survey will continue to compete in terms of cost while focusing their management strategies on realizing economies of scale and economies of scope. However, it is quite possible that in the process their essence will change in a dynamic way. This is inevitable because under the principle of market competition, those companies that compete successfully in terms of cost will remain, while those that fail will be forced to withdraw from the market. Figure 5 illustrates transitions in the groupings by type of U.S. petroleum companies over a period of 20 years. It is clear that over this 20-year period the prevailing business model in the U.S. petroleum industry has been shifting from that of vertical integration to a disintegrated or segmented one. Nevertheless, this can also be seen as a part of longer term, continuously dynamic process. The probability that the U.S. petroleum industry will continue to experience repeated cycles of integration followed by disintegration (segmentation), followed by reintegration is high. It is also quite likely that the main players in the industry 20 years from now will be quite different in substance. Except for Lyondell-CITGO Refining, all of the independent U.S. petroleum refining and marketing companies examined in this survey have decision-making capabilities in place to allow for quick response to such changes. On the other hand, an examination of the petroleum downstream markets from the viewpoint of supply stability shows that there is room for further evaluation on the trend toward business segmentation in the competitive market of the United States. For example, when downstream business is unprofitable, it may be acceptable for a vertically integrated enterprise to continue to operate downstream since the loss could be covered by the upstream profit. On the other hand, for companies specializing in the downstream segments based on a cost leadership strategy, such an approach may not be acceptable in some regions. 11
1979 1990 1999 Vertically Integrated Enterprises Vertically Integrated Enterprises Vertically Integrated Enterprises Enterprises Specializing in Upstream Operations Enterprises Specializing in Upstream Operations Enterprises Specializing in Petroleum Refining and Marketing Enterprises Specializing in Upstream Operations Energy Services Enterprises Source: Materials prepared by Mitsubishi Research Institute based on data from Performance Profiles of Major Energy Producers 1999, published by the U.S. Energy Information Administration. Figure 5 Transition in Groupings by Type of U.S. Petroleum Companies (Companies Enrolled in FRS) Copyright 2001 Petroleum Energy Center. All rights reserved. 12