14 January 2002 16:15 [Source: ICIS news]
Are the big oil companies getting jittery about their chemicals investments? Hardly. But they are questioning seriously their ability to make decent returns from the businesses they have.
Sometimes, drastic measures are needed to deal with difficult times, and current conditions in chemicals are the worst most executives have seen in years. The operational cutbacks aside, however, the logic of the link between oil and chemicals prevails.
It is certain that at times like this management will ask just how much worse business can become and whether there have been any fundamental changes. It is not possible to answer the first question; the answer to the second is an emphatic no: the link between petrochemicals and long term economic growth remains. No matter how you look at it, the oil companies with their advantages of feedstock access, potential for integration and similar business expertise are the natural home for petrochemicals. Some companies – Shell is the primary example - have proved that you should stick to what you know best and that you can make major changes in chemicals while retaining the integrity of the business. But perhaps integrity is the wrong word. The key to the oil/chemicals relationship is integration. The true benefits at the oil/chemicals interface can be realised, but not easily.
Analysis from consultants Arthur D Little (ADL) stands out at the moment because it shows that although chemicals are in the trough compared to oil, over the cycle they have performed better than upstream and downstream businesses. (ADL looked at the return on fixed assets for chemicals from the big three oil companies, Shell, BP and ExxonMobil between 1993 and 2000). Chemicals can outperform other key parts of the oil business, although from the current perspective such comparative performance seems a long way off.
Chemicals are not a counter to cyclicality, ADL’s John Goldhill and Ian Diamond suggest. Chemicals are relative small fry and have only accounted for 12% of ‘big oil’ earnings since 1990. The ADL consultants are not alone in believing that e-business will moderate top of the cycle earnings, driving future earnings contributions down to some extent.
Yet, other often heard arguments for integration are more persuasive. Integrated companies can optimise the refinery/chemicals interface making best use of refinery product streams. Common practices, processes and systems can mean a lot. The oil company chemical affiliates also certainly benefit from the investment clout of their parents. Adding an ethylene cracker and derivatives units to a larger inward investment project can tip the balance in the investing company’s favour with the host country.
The chemicals downturn, though, at a time of exceptional earnings elsewhere based on the high oil price, has highlighted the negative aspects and the differences between chemicals and other parts of the oil business. Refineries are run as profit centres, for instance; chemicals tend to be run along business unit lines. Diversification is definitely yesterday’s concept. A multi-industry portfolio necessitates a lot of complexity and a great deal of senior management time.
The oil companies revel in complexity. It is questionable, though, whether their top managers do. ADL recognises the benefits of better cross-stream integration but Diamond and Goldhill say that companies can increase returns on capital employed in base petrochemicals by as much as 2% to 5% by implementing best practices.
Optimising product flows with refineries is a key point, using low alternative value feedstocks in the cracker, as is the ability to maximise value from streams in the refinery or the chemical plant. Shared infrastructure and resources are vitally important as is the ability to integrate capital projects when major refinery upgrades come along.
The barriers to true integration, however, remain, and are largely organisational or cultural. Companies still use conventional transfer pricing and conflicting business methods or processes. Different objectives and economics make competition for corporate funding all the more acute and tend to slow the decision making process. Some companies take a different approach aimed at overcoming the cultural barriers. Exxon fosters a strong 'general interest' mindset among employees, for example. Spain's Repsol uses one organisation to run refineries and base petrochemicals.
To optimise chemicals’ performance companies are having to take a somewhat different approach and be more creative. The oil company affiliates should be good at what they do but they have to work harder at integrating better and deriving more value from the clear advantages they have. The key to better, above average performance when the upturn comes will depend greatly on the clever implementation of e-business and the sort of cultural mind-set that enables significant further optimisation of business processes.
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