ConocoPhillips Halts Refining Binge 10 Years Later
(Corrects rise in Marathon Oil’s market value in final two paragraphs of story originally published July 15.)
ConocoPhillips (COP) Chief Executive Officer Jim Mulva, the longest-serving U.S. oil CEO, is abandoning a decade-long effort to compete with the world’s biggest refiners amid a growing glut of crude-processing plants.
ConocoPhillips plans to spin off its refining business by the end of June to focus on so-called upstream projects such as drilling for crude and natural gas in Texas, Norway, China and the U.K., Mulva said yesterday. Analysts including Oppenheimer & Co.’s Fadel Gheit, who panned Mulva in 2001 at the start of his bid to amass a refining empire, now are praising him for admitting it hasn’t worked.
Mulva will retire when the spinoff is complete.
ConocoPhillips follows Marathon Oil Corp. (MRO), Chevron Corp. (CVX) and Exxon Mobil Corp. (XOM) in seeking to shrink or exit refining businesses. With 97 percent of its crude-processing capacity located in the U.S. and Europe, Houston-based ConocoPhillips’s refineries will face acute competition from new plants in emerging markets such as India that are closer to faster-growing markets such as China, said Andy Steinhubl, a senior partner at Bain & Co.
“Clearly there’s a trend under way with regard to reducing exposure to refining,” said Simon Flowers, head of corporate analysis at oil consultant Wood Mackenzie Ltd. in Edinburgh. “So long as the upstream remains a highly attractive business and refining is in a state of overcapacity worldwide, oil companies are going to look at every option from peripheral asset sales to de-mergers.”
Mulva, 65, told analysts and investors during a conference call yesterday that the spinoff will allow the company to focus on oil and gas projects, which aren’t as subject to the seasonal and macroeconomic fluctuations inherent to the refining industry.
“I think this is a brilliant move by the Conoco management,” Michael Holland, who oversees more than $4 billion at New York-based Holland & Co., said on Bloomberg Television’s “Bloomberg Surveillance” with Tom Keene. “It’s a very smart thing to do.”
While the margins earned from turning West Texas crude and similar grades of crude into gasoline and diesel in the U.S. climbed to a 25-year high of $35 a barrel yesterday, integrated oil companies that engage in exploration along with refining have been reducing their refinery holdings to lower the volatility of their earnings.
Crude Price Swings
Oil-processing plants are vulnerable to swings in crude prices and to fluctuations in consumer demand. Ten-day volatility in the benchmark futures contract traded on the New York Mercantile Exchange reached 67.8 on May 17, the highest level since April 2009, according to data compiled by Bloomberg.
“I love it,” Gheit said yesterday after the spinoff was announced. The New York-based Oppenheimer analyst rates ConocoPhillips stock “outperform.”
Oppenheimer puts the market value of ConocoPhillips’s exploration and production business at $90 billion to $100 billion, according to a report dated today. The value of the refining company may be $25 billion to $30 billion, Oppenheimer said. The estimates may change depending on how ConocoPhillips divides its properties and how planned asset sales proceed, Gheit said.
ConocoPhillips rose 81 cents, or 1.1 percent, to $76.42 at 4:15 p.m. in New York Stock Exchange composite trading. At that price, the company’s market value is about $108 billion.
Still, the spinoff may damage ConocoPhillips’s ability to fund new exploration or production projects, said Mark Gilman, a New York-based analyst for Benchmark Co. The oil company won’t have the refiner’s ample cash flow to distribute as it chooses once the businesses are separate, he said.
Although refining accounted for just 1.7 percent of ConocoPhillips’s net income last year, the business generated 71 percent of the company’s revenue, according to data compiled by Bloomberg. Oil and gas production accounted for 81 percent of net income and 25 percent of revenue.
“Cash generation, whether it be from operations or asset sales, is now captive to each newly created entity that’s going to generate it,” Gilman said in a telephone interview. “Previously, you had the ability to allocate across a broader portfolio. You don’t have the ability to take cash from one entity to the other that you did.”
Standard & Poor’s, Moody’s Investors Service and Fitch Ratings each said they are reviewing ConocoPhillips’ credit rating profile with possible negative implications following the spinoff announcement. The ratings agencies cited the company’s uncertain outlook and less diverse mix of assets following the split into two companies.
Mulva began acquiring refineries in 2001 when, as CEO of Phillips Petroleum Co., he led the $8.37 billion purchase of Tosco Corp. The move disappointed analysts such as Gheit, then with Fahnestock & Co., who wanted ConocoPhillips to pursue oil and gas projects instead.
At the time, Mulva defended the Tosco deal as a necessary move to compete with rivals such as Exxon Mobil and BP Plc, which were swallowing smaller companies to expand market share and cut costs. Less than a year after the Tosco transaction, Mulva engineered the $25 billion combination of Conoco Inc. and Phillips to add to the company’s refineries and retail stations.
The integrated model was the best approach for ConocoPhillips for about a decade, allowing it to expand its base of resources and increase earnings as the company benefited from its size and scope, Mulva said on yesterday’s conference call. A changing environment, which includes more competition for resources, means a move to split ConocoPhillips into two “pure-play” companies will help boost value for shareholders and improve the chances of success for the management team, he said.
For Marathon investors, the Houston-based company’s June 30 spinoff of its refining unit, Marathon Petroleum Corp., has been an unqualified win. In the six months since the separation was announced, shareholders have reaped a 28 percent return.
Marathon Oil shares, which were valued at $40.53 the day before the spinoff was announced in January, closed July 13 at $31.71. When combined with the half-share in Marathon Petroleum distributed for each parent company share, an investor held $51.69 in stock in both companies as of the July 13 close.
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