new energy majors, The

Electric Perspectives, Jan/Feb 2000 by McQuade, Owen, Wagman, David, Blume, Eric R

UPSTREAM, DOWNSTREAM,

MIDSTREAM-CONVERGENCE

OFFERS ENERGY COMPANIES NEW CHANNELS FOR BOTH DIVERSIFICATION AND SPECIALIZATION.

IN A GLOBAL MARKETPLACE, the "energy company" is replacing the old notion of oil, gas, coal, and electricity companies. These new energy companies are driven by the realization that the end consumer does not want a particular fuel but the services derived from burning that fuel-heat, light, motive power, etc. The energy company focuses on the services created in selling these fuels in a usable form. Often, the best solution for the consumer may be to sell less of the product supplied and instead to offer a complete energy solutions service whereby the company has effectively outsourced its energy management....

This trend toward the creation of an integrated energy industry means that resource-based ownership no longer gives a company competitive advantage. The focus is now on the end user and the process of integrating toward them is no longer the traditional asset-based vertical integration method seen historically in the oil sector. The vertically integrated monopoly utility is gone and in its place is a range of companies operating in the various segments of the value chain. (See Figure 1.) Energy companies are pursuing a variety of strategies that seize opportunities in this disaggregation process: Some seek vertical integration or horizontal expansion into other value chains, while others are looking to specialize within one segment.

The new vertical and horizontal integration goes beyond the oil producer buying a refining and marketing business or the gas producer buying a pipeline company. Today's energy company looks beyond the confines of its segment to form links via third parties to the end user. Energy utilities are linking with telecommunications companies; power equipment manufacturers are entering joint ventures with developers; upstream oil and gas companies are entering the power sector; and natural gas companies are forming alliances with petrochemical companies.

Although some industry players may operate in a niche in the oil or gas segment of the energy supply chain, they have to keep abreast of developments throughout the entire energy value chain from production through transportation or transmission to the final energy consumer. If they do not, they will face major competitive surprises that will originate in another segment of the energy value chain.

International Oil Companies

In 1997, there were a number of innovative alliances in the oil sector. BP and Mobil formed an alliance in Europe, which built on their strengths in each partner's downstream businesses. Shell formed a number of alliances in the United States and was expected to form an alliance of its downstream assets with Texaco but ended negotiations in November 1998.

In August 1998, BP and Amoco announced that they would merge. This took the energy world by surprise. Many in the industry knew that both companies had been talking to each other, but all had assumed that they were planning an alliance similar to BPS successful alliance with Mobil in Europe. The BP/Amoco deal was followed a few months later by the announcement that Exxon and Mobil would merge to form the largest oil major.

The megamergers were consummated because the size, range, and scope of the relationships continue to offer significant advantages to oil 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 cannot be met through financial markets. Moreover, BP and Exxon were already outperforming most of the other majors before their respective mergers with Amoco and Mobil, and both companies now have an even bigger base for leveraging their operating skills.

The BP/Amoco merger catapulted the new organization into the top three oil majors alongside Shell and Exxon/ Mobil. When announced, the deal was the largest industrial merger ever and created Britain's largest company with a combined capitalization of $110 billion at the time of the merger and a target of annual pretax earnings of at least $2 billion by the end of 2000.

Comparing both companies' operations shows that the merger is well balanced. There is little overlap in geographical terms, and both companies have complementary assets. Amoco's strength in gas marketing, particularly in the United States, gives the combined entity a more downstream focus. Although BP Amoco now has some power generation assets, the company argues that the oil business should be kept separate from electricity distribution. However, the acquisition of Amoco's vast gas reserves has made the company move downstream, and it has launched a global gas marketing business. Although the venture will include power generation assets, it will not enter the electricity retailing market. BP Amoco sees the oil and gas industry as more about trading commodities, whereas the utility business is about serving the end user-an activity in which it is not interested.