Centrica, Latin America

A not so crude blend

Issue 7 and Volume 6.

A not so crude blend

The recently announced merger of BP and Amoco gave the global oil industry a rude awakening last month. The deal catapults the two companies into a new league where more opportunities will be available to them than ever before. So where will they go from here?

Siân Green

BP`s merger with Amoco sent tremors through the usually-stable bedrock of the international oil industry last month. But this brave move makes sense for both companies, and with the current oil price slump, the industry seems anything but stable.

The $50bn deal will create BP-Amoco, headquartered in London with a market capitalization of $110bn. BP and Amoco are hoping to close the deal by the end of the year, propelling the two companies into the top tier of the oil industry. The takeover brings to an end a long period of stability among the world`s oil majors, and could mark the beginning of an era of consolidation – particularly if oil prices remain low.

BP-Amoco will be the third largest listed oil company in the world, and Britain`s largest company. It will rival Royal Dutch/Shell and Exxon in both upstream and downstream operations, and will also have the strength to enter new markets.

But aside from moving the companies up into the oil “superleague”, analysts have welcomed the deal. It will bring to an end what is probably BP`s weakest spot – its position in the growing natural gas market. Amoco`s gas business is four times the size of BP`s, and the American company has strong domestic and global positions in this market. Amoco also has a stronger position in chemicals than BP and a greater presence in Latin America. However, BP is stronger in exploration and production, and is also in a better financial position than Amoco.

Amoco was certainly a candidate for acquisition, having suffered under the pressures of low oil prices and tough competition in its domestic markets. The company admits that expansion from this position would be too difficult to achieve, a problem that other US oil companies such as Texaco and Arco are also facing. Amoco announced in July that its second quarter net income had halved to $287m.

BP-Amoco will rival Shell and Exxon on many fronts. In upstream operations, the company will become the world`s second largest publicly owned oil and gas operator in terms of both production (2.9m barrels oil equivalent per day) and reserves (14.8bn barrels oil equivalent per day). It will be the world`s third largest petrochemical business after Shell and BASF, and will have a refining capacity close to that of Exxon`s.

So where will BP-Amoco go from here? The likelihood is that it will initially concentrate on reducing costs and improving profitability. Around 6000 jobs will be lost in the merger – a figure some analysts believe is conservative. But the reputation of BP chief executive Sir John Browne precedes him, and it is unlikely that he will settle for third place in the oil league. Browne will head BP-Amoco from its London base.

Certainly the London headquarters will give BP-Amoco a strong base from which to expand into the European natural gas markets. Natural gas is the fastest growing fossil fuel in terms of demand, and with liberalization taking place in European gas markets, opportunities will arise.

This is certainly the case in the UK, where BP-Amoco will become the largest natural gas producer. It will compete with Centrica in the production, storage, and sales of gas as well as in the trading of gas in the UK spot market. Centrica also has interests in the electricity business in the UK, and may develop this into retail power sales when the market deregulates later this year.

Power generation is an area that a number of oil and gas companies are entering. Total, the French group, is studying investment opportunities world-wide. It sees an opportunity to market gas downstream through independent power projects, the basic idea being to add value further down the gas chain. In January this year, Shell took a 50 per cent stake in US electricity generator InterGen as part of the group`s plan to diversify its global operations and underpin its “well-to-wire” strategy.

Both BP and Amoco currently have limited interests in power generation, mostly in self-generation at refining facilities and combined heat and power operations. However, the merged company`s London base and the deregulating European markets will again offer opportunities for diversification and growth.

In terms of exploration and production, oil companies are increasingly looking to central and Eastern European and developing countries to increase their reserves. Although BP and Amoco between them have operations in the Former Soviet Union, Central and South America, the new group will be more firmly anchored in the western world than its new competitors. It will have more than 70 per cent of its assets in OECD countries. BP-Amoco will undoubtedly use this firm base to seize new opportunities overseas where competition and risks are high and size and strength count.

Other oil companies are likely to feel pressure from this deal; no longer will Shell and Exxon be able to take their dominant positions for granted. However, they may not feel that they need to grow through acquisitions, rather they will attempt to improve their own competitiveness to prevent the new group from making headway in these tough times. If any mergers are to follow in the wake of BP-Amoco, it is more likely to be among the smaller companies that have failed to improve their global positions in recent years.

On paper, BP-Amoco will be a company with an interesting blend of strengths. Building on these, however, will not be an easy task.

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