ExxonMobil (XOM)
As the world’s largest refiner and one of the largest chemical manufacturers, one might think ExxonMobil would be leading the charge in reducing downstream capital investment. However, that's not the case. While the company has reduced downstream capital employed over the last ten years by selling refining, logistics and retail assets, it currently has no explicit divestment plans. During meetings with management last fall, they revealed after a thorough review of the business model, they could identify and attribute real dollars as a result of integration. This is likely because unlike many of its integrated peers, ExxonMobil has true integration between upstream and downstream operations, as opposed to a collection of assets. With 75% of its refineries integrated with chemical or lubricant production, facilities can not only share infrastructure, but ExxonMobil can also optimise its production to capture the highest value output while realising lower costs through feedstock flexibility.
Given the difficulty replicating this type of structure, ExxonMobil realises value where others do not. On the upstream side, the company's push into natural gas is resulting in more ethane production, which can be used for chemicals production. ExxonMobil's advanced chemical plants can process larger amounts of lower cost ethane and other heavy feedstock than competitors. While dispositions of retail, logistics assets or small stakes in refineries may occur to pare the portfolio, it is unlikely to see any large transactions, considering the competitive advantages. Given its record of delivering superior returns, we view ExxonMobil's strategy favourably.
Royal Dutch Shell (RDSB)
Given its size and extent of chemical operations, Royal Dutch Shell is on par with ExxonMobil with regard to downstream investment. However, Shell has not quite delivered the returns of its larger rival, and saw a sharp decline in profitability in 2009. As a result, the company recently undertook plans to improve returns and profitability. A key element of its plan was to shed poor-performing refineries. Since the end of 2009, Shell reduced its total refining capacity by 700,000 bbl/d, brining its total capacity reduction since 2002 to 1.6 million bbl/d. By divesting many smaller facilities, Shell has also increased the size of its average refinery by retaining larger integrated facilities, which should lead to more efficient operations, focused management, and lower costs. On the marketing side, the company is exiting markets where it has limited presence and little growth potential. It is also moving more towards a wholesale supply model, as opposed to retail. Also key to success for Shell and similarly to ExxonMobil, is integration of refining with chemical manufacturing. With integration, Shell has greater feedstock flexibility, and can optimise its output towards higher-value products. While Shell has significantly reduced its downstream footprint and investment, the company is not finished. It still plans for approximately $3 billion worth of downstream assets sales through 2014.
BP (BP.)
BP's efforts to deemphasise refining are primarily focused on the US. Recently, the company announced intentions to sell its Texas City, Texas and Carson, California refineries along with its South West Coast fuels value chain. While several refineries have changed hands in the past year in the US, at 475,000 bbls/d, the Texas City facility is by far the largest and most complex. In this regard, it stands in contrast to other facilities sold or for sale in the US which were smaller and of lower quality. Similar to Marathon's rational for its split, BP cited Texas City's lack of integration with its marketing assets as a driver for its sale. By selling the two refineries, BP will cut its US refining capacity in half. US investment will instead focus on mid-continent and West Coast refineries, with the access and ability to process cost advantaged crudes. The company will also focus on improving its Eastern Hemisphere position to access higher growth markets. Through the divestitures and targeted investments, BP plans to improve overall downstream returns. BP anticipates the US refineries to be sold by 2012. Once competed, BP will have reduced its refining capacity by about 40% since 2000. Given lack of integration and the company's need to raise capital, both sales make sense.
Total (TOT)
Highly exposed to European refining, Total is undergoing efforts to reduce its capacity in the region. Last year, the company closed its 137,000 bbls/d Dunkirk refinery in France. The facility ceased production in September of 2009 due to poor margins and anaemic demand. Total is now in the process of selling its 221,000 bbls/d Lindsey, U.K. refinery along with its U.K. retail network. In its Normandy, France refinery, Total modernised the facility, but also closed one of the production units, reducing overall capacity. As a result, of its actions, Total expects its European refining capacity at the end of the year to be about 1.8 million bbls/d, down from 2.3 million bbls/d in 2006. While the company is invested in chemical projects that provided additional exposure to Asian growth markets, it also divested noncore specialty chemical assets for almost $2 billion in 2010.
ConocoPhillips (COP)
For ConocoPhillips, refining assets make up a larger portion of its asset base relative to other super majors. As a result, returns for the company have lagged its peers'. As part of its return improvement plans, the company plans to reduce its refining capacity and downstream investment. It recently pulled out of a deal to build a refinery in Saudi Arabia. Late last year, the company cancelled an upgrading project and ceased operations at its poor performing 260,000 bbl/d capacity Wilhelmshaven, Germany refinery after failing to find a buyer. As a result, the ConocoPhillips current global refining capacity fell from 2.7 million bbls/d to 2.4 million bbls/d. While not publicly targeting one specific facility, the company is seeking to divest refineries in order to eventually reduce its total capacity to below 1.8 million bbls/d. Since 2003, ConocoPhillips has sold over $6 billion worth of downstream assets and expects another $1 billion of sales in 2011 which likely be a mix of refining and marketing assets. The company is also generally directing less investment towards downstream assets to reduce total investment in the segment over time. Reducing its refining footprint will likely ultimately prove to be a key in narrowing the return gap with its peers.
Chevron (CVX)
After reporting abysmal returns on capital for the downstream segment in 2009, Chevron sought to improve returns by restructuring its operations. Plans called for reducing investment and cutting costs largely through asset divestments. Over the past year, Chevron has successfully executed by exiting marketing and logistics operations domestically and internationally, and by divesting a nonstrategic refinery. Chevron already had the lowest refining capacity of all the major integrated firms before the sale. However, by divesting the 210,000 b/d capacity Pembroke, U.K. refinery, Chevron further reduces its investment in refinery capacity and exits the oversupplied European market. Without Pembroke, almost 90% of Chevron's refining capacity is in Asia Pacific or on the US West Coast. As a result, Chevron is well-positioned to capitalise on Asian markets, where the bulk of refined product demand growth is expected to occur. Facilities on the West Coast can capture export opportunities to Latin America, where lack of refining capacity and ongoing power generation issues create strong demand. The divestments, combined with start up of planned projects, will result in a downstream portfolio with less emphasis on refining, and more on higher margin chemical and lubricant businesses.
Returns on downstream capital employed in 2010 improved to 10% from 2% in 2009, largely due to market factors. Of the 8% improvement, only about 2% came from self-help initiatives. However, management anticipates full realisation of improvement projects, headcount reduction, and divestitures should flow through and increase returns further over the next two years. However, given that the world remains oversupplied, that capacity continues to be built, and that not all Asian economies have robust growth prospects, Chevron is cautious on its outlook for the segment. With this outlook, we see Chevron's recent restructuring as even more valuable. While Chevron already had a relatively small refining base, we believe the divestments further strengthen the company's portfolio, and set the stage for higher returns.
Marathon (MRO)
Of all the actions taken by integrated firms to address lagging downstream returns, Marathon's is likely the most aggressive. Given that it realises very little actual integration between upstream and downstream operations, the company recently announced plans to spin off its midstream and downstream assets into a separate company, Marathon Petroleum Corporation (MPC). By doing so, management believes it can generate higher valuations for its assets. Given its greater reliance on refining relative to many of its peers, Marathon typically traded at a lower multiple. Marathon also committed to increasing investment in expansion and upgrading right before the collapse in refining margins, making the cyclical downturn especially difficult. By spinning off the lower-returning downstream assets, Marathon should fetch a higher valuation for its exploration and production assets.
The company contemplated a similar move a few years ago before refining valuations sank during the recession. A likely motivation for resurrecting the plan is the recovery in refining valuations over the past year. Thanks to a variety of factors, including economic recovery, strong product exports, and widening crude differentials, refining margins have improved considerably since this time last year, boosting stock prices at the same time. Also benefiting refiners has been the recent dislocation between WTI and Brent crude oil, which has created especially strong refining margins for midcontinent refiners. With over half of its refining capacity in the midcontinent, MPC should present an especially attractive opportunity. Meanwhile, operating as a stand alone E&P firm, should allow Marathon to draw more attention to its oil and gas growth opportunities.
Hess (HES)
Hess has relatively little refining capacity relative to its production volumes, and the downstream segment contributes only a small portion of total earnings. However, the company is nonetheless taking steps to improve its position. At its partially owned refinery in the Virgin Islands, Hess is shuttering older and smaller processing units to improve efficiency and reliability, lower costs, and produce a higher-margin product mix. The reconfiguration, expected to be completed in the first quarter of 2011, will also reduce the refinery's capacity from 500,000 to 350,000 b/d.
Murphy Oil Corporation (MUR)
Though not of the size of many the other firms on our list, Murphy is an integrated firm with upstream and downstream assets. However, the company is currently progressing with plans to change that. Last year, Murphy announced plans to sell its three refineries and U.K. refining and marketing operations in 2011. Unlike some other plans by integrated firms, Murphy's plans are much broader in scope relative to its size, and could be possibly more difficult to execute given it is trying to sell all of its refining assets as opposed to one facility. Also, the relatively small size and location of the facilities likely make them some of the less attractive assets on the market. However, given the competitive position of the refineries, divestiture is likely the right decision. Despite retaining marketing assets in the US, Murphy's upstream operations should receive greater attention and potentially a higher multiple from investors once the uncertainty of the refining segment is removed.
