British Petroleum - Analysis and Recommendations
...nclude marketing and trading of natural gas, natural gas liquid, new market development, liquefied natural gas, solar and renewables. The activities in “Refining and Marketing” segment include oil supply and trading as well as refining and marketing. Chemicals activities include petrochemicals manufacturing and marketing. In September 2003, BP merged its Russian assets into those of Tyumen Oil Co. (TNK), creating TNK-BP. This joint venture represents the single largest foreign investment in Russia. BP's share is valued at about $7.7b. Competitive Landscape The players in the Upstream Energy Industry can be categorized into four main types: 1. Vertically Integrated “Supermajors”: They are the familiar BP, ExxonMobil, ChevronTexaco, Shell and TotalFinaElf. They have the most geographical and functional scope, and are vertically integrated. 2. State-owned companies: Members of OPEC typically fall into this category. Saudi Aramco, the biggest private oil company in Saudi Arabia with reserves around 10-20 times those of majors is an example. The OPEC members together hold more than 60% of the world’s conventional petroleum reserves, and even though the cooperation among members is not complete, have the pricing power. Russian Gazprom is another example of a state-owned company that has approximately 30% of the world's Natural Gas Reserves. 3. Quasi-state-owned companies: Prime examples of such companies are PetroChina and Lukoil. PetroChina is a public company, but 90% of it is owned by privately held CNPC. The Exploration industry is heavily regulated in China. Lukoil is a public Russian Company, but the markets are not completely open in Russia. The disagreement between President Putin and former Yukos CEO Khodorkovsky that resulted in the CEOs arrest is a case in point. This arrest put a sudden end to a developing joint ownership deal between ExxonMobil and Yukos . 4. Secondary Players: They are the service providers (e.g., Halliburton, Schlumberger, Baker Hughes etc.) and non-integrated players (e.g., Occidental, Anadarko, Apache etc.). The Service providers provide services mostly to the majors. Their revenues and margins are much lower compared to the majors. The non-integrated players have limited geographical scope, limited functional scope or both. They are about 5% of the size of majors in terms of revenue, but their margins are much higher. However, their limited scope means limited diversification, and consequently increased sensitivity to crude prices and seasonal effects. Competitor Analysis The players most similar to BP in terms of resources and capabilities are the integrated supermajors. We therefore focus mainly on ExxonMobil, Shell, and ChevronTexaco in this section. The players in the upstream segment of the Petroleum Energy Industry use expertise in Geology and Seismic Imaging to find new reserves. Once a reserve is identified as potentially cost-effective, the reserve is “proven” by drilling. A company’s expertise in technology can be compared to others by comparing the total number of exploratory wells drilled, and the percentage of those that turned out to be productive. In 2003, the majors drilled approximately 35-40 exploratory wells. BP and ExxonMobil, the closest competitor in terms of revenue, had success rates of 70% and 58% respectively. Another metric that can be used to compare performance/capability is “Reserves Replacement”, i.e., the amount of new reserves found as a percentage of the amount produced. BP led the majors in both drilling success percentage and Reserves Replacement (Exhibit 5). In terms of expenses, BP leads the pack in R&D Expenses as a percentage of Sales, has the lowest Exploration expenses, and is the second to last in total number of wells . However, BP’s average cost of production per barrel is among the highest. These facts imply that BP is able to find new reserves more efficiently than the rest, but is not able “produce” as efficiently . BP trailed the pack in upstream profit margins, ROA and ROE. Since BP is the top performer in terms of Resources and Capabilities, the poor financial performance can be improved by increased operational efficiency. Strategic Issues The industry and competitor analysis reveals five main strategic issues that are relevant to BP in the 3 to 5 year term: • OPEC’s pricing power with 60% of Oil reserves • Russia as a major new supplier with 38% of Natural Gas reserves • Increasing demand from economic growth in China and India • Limited oil reserves that are estimated to run out in 70 years • Increasing demand for substitutes because of the above factors and pollution We will address how BP should respond to each of these issues in the following sections. Strategic Issue: Petrochina and the increasing demand in China A subsidiary of state-owned Chinese National Petroleum Company (CNPC), PetroChina was created in 1999. PetroChina’s exploration and production activities have been mainly limited to China. Since the energy demand in China is increasing rapidly, PetroChina is expected to compete with BP in gaining access to various oil and gas fields in the world, especially in Southeast Asia. The political and financial support of Chinese government will help PetroChina in negotiations with oil-owning countries. To counter PetroChina’s competition, BP must solidify its reputation as the technology leader and pursue joint ventures with CNPC or PetroChina. Strategic Issue: Russia’s emergence as a major supplier After the collapse of the Soviet Union, Russia emerged as a major supplier of energy sources. Russia’s exploration and production activities have been mostly limited to low-cost oil wells using outdated technology. State-controlled pipelines and gas fields, unclear tax policies and property rights and lack of focus on downstream operations are keeping Russia from realizing its full potential. Some of these issues could be converted into opportunities by BP since Russian companies will need assistance as they begin tapping into new oil wells in more difficult environments in Caspian Sea and Siberia. We recommend that BP try very hard to create joint ventures with Russian companies. BP should avoid 100% ownership of oil fields since the investment climate is not entirely favorable to foreign companies. In addition, BP should lobby US and UK governments for the liberalization of the gas sector that is completely state-owned. Both Russia and China have been producing from low-cost wells so far, and have not invested too much in acquiring technology expertise. As they pursue more difficult sources for oil and gas, joint ventures will benefit both BP and Russia/China. Strategic Issue: Rising threat of viable substitutes Among the substitutes that are of interest to BP, we consider liquefied natural gas (LNG) to be the most viable oil substitute. LNG’s usage is increasing steadily in Europe and Asia, and the production cost is estimated to stabilize in the near future. BP should increase its investment in LNG production. Non-conventional oil production and refining technology is expected to become economically viable and account for 6% of total oil production by 2030 (Exhibit 3). BP Canada is currently producing limited amounts of non-conventional oil and we recommend no change in the level of participation in this arena. Strategic Issue: Limited Reserves Oil and gas reserves formed through natural processes spanning millions of years. Based on the current consumption rate, the general consensus seems to be that the known reserves can supply oil and gas for another 70 years. Technological advancements, which are resulting in consumption and production efficiencies, and discoveries in difficult terrains, could very well increase the life of these resources. Non-hydrocarbon based energy sources will become viable substitutes of oil in the future, and should also contribute to increasing the consumption life of oil and gas. On the other hand, even though technology has led to more frequent new discoveries, the size of newly discovered wells has reduced significantly. Since 1970, new discoveries have increased by 15%-20% but the volume of discovered reserves has declined from 30 mboe/well to 10 mboe/well (mboe: million barrels of oil equivalent). Even though the reserves are limited, they provide a huge source of revenue for both the producers and governments (in taxes). BP’s 21 billion barrels of reserves are expected to last for at least another 30 years. Hence, on balance, we do not believe that limited reserves is a relevant issue in formulating the near-term strategy for BP. BP should continue profiting from its high-margin exploration and production operations. Strategic Issue: OPEC’s pricing Power A few years after the formation of OPEC by the world’s biggest oil rich countries; almost all the member countries terminated private ownership of the oil production facilities in their countries. However, these state-owned companies did not keep pace with the technological advances in exploration and production. As natural gas gains momentum as a viable substitute to oil, OPEC’s power will weaken since Russia is the single largest owner of proven Gas Reserves. BP and other majors who are technologically superior have therefore stand a chance of gaining bargaining power over OPEC. Though OPEC will remain a major supplier of energy sources in the future (Exhibit 4), OPEC needs the technological expertise and BP’s strength in this area could be leveraged to develop a broad partnership with the OPEC nations. Strategic Issue: Compliance with Environmental Regulations Governments are beginning to introduce country-specific regulations that mandate lesser emissions, water pollution and surface damage. The Kyoto protocol, if ratified by the oil-producing nations, will certainly inc...