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Review of “Oil Company Crisis: Managing Structure, Profitability & Growth”

October 9, 2011

From time to time I will be reviewing some of the books that I read from variety of subject areas. The first book I will be reviewing here was published by the Oxford Institute for Energy Studies (2003), and authored by Nick Antill and Robert Arnott. The book’s primary focus is on how oil companies manage their structure, make profit, and how they deal with the issue of growth. It does not necessarily deal with oil company crisis in the strict sense of the word.

In the introduction, the authors stated that “oil companies operate in an industry that is capital intensive with long asset lives, and as result published accounts are a fairly worthless measure of profitability and they do not accurately reflect the underlying value of the asset base.” This I partially agree. Yes it is true that the oil industry is capital intensive, nonetheless companies working in the industry must still publish their measure of profitability, whether this will reflect the true profit of such companies or not. Nowadays there are civil society groups such as Revenue Watch (www.revenuewatch.org) and the Publish What You Pay campaign launched in early 2003 by Global Witness, who have the resources and the expertise to monitor the finances of these companies.

In discussing the structure of the oil industry, and in particular the structure of the majors, the authors opined that “over the past ten years the drive by the private oil companies to improve short-term profitability has resulted in exhaustive cost cutting to the extent that growth has been curtailed.” They continued, “growth is now on the agenda again for most of the private oil companies, and they have all started to examine new ways of adding value. In particular, there is a shift towards the examination of corporate structures.”

They also discussed the vertically integrated nature of the majors. According to them, “vertical integration may encourage tendencies toward oligopoly by offering the integrated companies a competitive edge against their less integrated rivals.” I am a proponent of integration, especially when it comes to the oil industry. Integration gives the oil companies quite a number of advantages and opportunities. According to Nick & Arnott, some of the arguments in favour of integration are:

1. Control of supplies

2. Control of markets

3. Access to information

4. Cost savings

5. Spread of risks

6. Building on core competencies and technology, and

7. Parenting and resource utilisation.

They also added that “one good reason to justify vertical integration is to strengthen the firm’s competitive position. And it is for this reason that the oil and gas industry has historically had the urge to integrate. The book also discussed integration in the United States during the days of Rockefeller; integration in Russia and the exception in the Russian oil market (a very interesting piece there), and finally operational integration until the 1970s.

In concluding their discussions on integration (operational integration), they also touched on financial vertical integration. They define financial vertical integration as “when a company owns or controls the cash flow in different stages of the industry. It enables private oil companies to focus on maximising the profitability of each separate business segment.”

The final part of the book looked at the financial strengths of the private oil companies. They argued that “many of the major companies have higher credit rating than that of the countries in which they operate.” And there is more on that, to the extent that most of the oil majors have revenues far bigger than the GDPs of most of the countries they operate in, especially in the developing countries. That I found quite astonishing!

Further, they argued that “the industry is in crisis because the promised growth in value is now out of line with the opportunity sets available. As a consequence companies must revisit the key issues of structure, profitability and growth if they are to differentiate themselves from their competition.”

The book is good for those who wants to understand the structure of the oil and gas industry, and how companies in the industry operate. It makes a good reading and I recommend it favourably!

Next time I will be reviewing a very very interesting book entitled “Escaping The Resource Curse” edited by Macartan Humphreys, Jeffrey D. Sachs, and Joseph E. Stiglitz, all of the Columbia University in New York.

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