Conocophillips Splits, The Right Decision

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abarrelfull wrote on 18 Jul 2011 12:20
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Last week, Conocophillips announced that it was to split into two companies, Upstream and downstream.

ConocoPhillips’ board of directors has approved pursuing the separation of the company’s Refining & Marketing and Exploration & Production businesses into two stand-alone, publicly traded corporations via a tax-free spin of the refining and marketing business to ConocoPhillips shareholders.

This decision is not long after Marathon came to the same conclusion.

Marathon Oil Corporation (NYSE: MRO) (Marathon Oil) announced today that its Board of Directors has approved the spin-off of its downstream business through the distribution of shares of Marathon Petroleum Corporation (MPC) to holders of Marathon Oil common stock.

This two deals go against a century of oil sector strategy, and yet one of the first questions that came to my mind, was why had it taken so long.

Conoco gives their reasons for the transaction:

As a separate company, the Refining and Marketing business of ConocoPhillips will be a leading pure-play independent refiner with a competitive and diverse set of assets. In addition to executing the company’s initiatives to improve downstream returns through portfolio rationalization and other operating efficiencies, the new downstream company will be able to further position its portfolio by pursuing transactions and investments across the value chain.

The real benefit though is focus. Vertically integrated companies have not been very good at managing their refinery assets. They have ignored them, or starved them of necessary investments. The large number of substandard assets for sale by large integrated companies is the most obvious symptom of this.

Take the Chevron Pembroke Refinery for example. Valero agreed to purchase it back in March. A large complex refinery, it produces a very high gasoline yield in a predominantly diesel market. The case of the Stanlow Refinery is similar.

As an independent refining company Conoco Refining will be able to focus on maximising the returns from its refineries, without having to justify every penny of expense/investment to upstream guys who don't understand why refining is different.

At worst, this misunderstanding can be fatal. I recently read the book Drowning in Oil: BP and the Reckless Pursuit of Profit. It argues that the BP Texas City Refinery disaster was at least partly due to a lack of investment, driven by a culture that did not value refineries.

Conglomerates have gone out of fashion in other industries. Its interesting that it has taken so long for the strategy to be questioned in the oil sector.