Academic journal article The McKinsey Quarterly

Petroleum: After the Megamergers

Academic journal article The McKinsey Quarterly

Petroleum: After the Megamergers

Article excerpt

Recent deals have raised the ante for midsize players without scale or focus

Two recent historic mergers - between Exxon and Mobil, and BP and Amoco - have rocked the global petroleum industry. Much as the oil shock of 1973 ushered in a new era, the underlying forces at work in the industry will stimulate yet more reshaping in the next few months and years.

The "megamergers" have created a new class of company with advantages based on size and scale. Meanwhile, smaller and more focused players like Huntsman in petrochemicals, Landmark Graphics in exploration information technology, and QuikTrip in gasoline retailing have the skills and cost structures to compete with any company in the industry.(*) Left out in the cold by these two trends are the "mezzo" players: smaller integrated petroleum companies, as well as midsize companies (including the smaller majors) with broad product and geographic coverage but not world-class scale or distinctive skills. These mezzos now find themselves squeezed between the new class of "megamajors," on the one hand, and high-performing specialized players, on the other. As the mezzos seek to gain scale, sharpen their focus, redefine their businesses, or simply get out, their predicament will generate a second wave of mergers and acquisitions, alliances, and divestitures.

Bigger can be better...

The megamergers were consummated because size, relationships, and other structural considerations continue to bestow significant economic advantages on petroleum companies in a number of countries where there are few competitors, the right to own or access reserves is limited, and capital and risk requirements can't be met through financial markets. In other words, where the status quo still holds, significant advantages flow to the biggest petroleum companies. In addition, Exxon and BP were already outperforming most other majors before they merged with Mobil and Amoco, respectively, and the mergers provide a bigger base for leveraging their exploration and operating skills.

Indeed, the megamergers have created a new category of player, and this raises the bar for world-class scale and scope advantages. In petroleum as in pharmaceuticals, the attractiveness of a company depends on its "pipeline," and the new megamajors have the broadest portfolios and (potentially) the lowest cost structures, as well as dominant positions in many of the most promising well-established basins. Even in low-price environments, the megamajors can sustain substantial levels of investment in a number of growth projects - a crucial point, since exploring a significant arena can involve a bet of a billion dollars or more. Of course, midsize players can diversify their bets by sharing the risks of exploration, but this approach has a cost: it limits the upside of any major discovery.

The megamajors have not only increased their size and improved their performance but also enhanced their clout, for they represent such a large share of industry know-how and downstream capacity that they have improved their negotiating positions against the state-owned national oil companies (NOCs). Moreover, the existence of the megamajors makes it more risky for oil service companies such as Halliburton and Schlumberger to continue encroaching on the business of developing and operating wells. These service players now have fewer customers and must compete with their biggest ones - the megamajors - for international opportunities.

... but so can specialization

In the petroleum sector, the emergence of specialist players and "slivers" based on specific products or pieces of the value chain [ILLUSTRATION FOR EXHIBIT 1 OMITTED] is now reshaping some mature markets, such as the United States, as well as select emerging markets. Consider what has already happened to the once cozy relationship between some NOCs of petroleum-producing states and the major petroleum companies. …

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