The Final Finalists
Pitting BP Amoco against Exxon Mobil

by Brian Graney (TMFPanic)

ALEXANDRIA, VA (March 25, 1999) -- After spending the past two days examining the good points and bad points of a potential investment in Pennzoil-Quaker State (NYSE: PZL), it's time to turn our attention to our last two oil and gas study finalists. I'm talking about BP Amoco (NYSE: BPA) and the company that will be Exxon Mobil, the combined operations of Exxon (NYSE: XON) and Mobil (NYSE: MOB).

But first, a quick bit of news from the oil patch, with our own Foolish take included at no extra charge.

First, recent oil study toss-outs Phillips Petroleum and Ultramar Diamond Shamrock decided to end their Diamond 66 U.S. downstream joint venture. This news diminishes the value of our analysis of the two companies somewhat, since we assumed the venture would go through as planned. However, it doesn't really change our feelings on the companies as potential investments. Like a pair of tone deaf tenors, we didn't particularly like what we were hearing out of Phillips and UDS as individuals or as a duet.

In other news, the members of everyone's favorite oil cartel, OPEC, got together in Vienna this week and decided to cut oil production levels by a total of 1.7 million barrels a day in an effort to prop up sagging market prices. A handful of non-OPEC, but still large, oil producing countries decided to join in with voluntary cuts of their own, bringing the total "production reduction" figure to a cool 3 million barrels a day. Not surprisingly, the news warmed the hearts of oil futures traders in New York, who promptly drove oil prices up to $15.34 a barrel as of Wednesday -- a level not seen since last October.

What does this mean to us? Not much, really. OPEC's member nations do not exactly have a stellar track record of sticking to their individual agreed-upon reduction promises. So naturally, some observers (like Jeff and myself) are skeptical. Also, while cutting supply should help oil prices in the near term, the long-term stability of prices remains dependent on sufficient worldwide demand. The Asian economies (which brought on the ongoing oil glut in the first place) seem to be recovering, albeit slowly. But if another unexpected shock sneaks up on the world's oil markets anytime soon and gooses demand again, all bets are off.

On the other hand, rising oil prices are definitely a good thing for large oil and gas exploration and production businesses such as BP Amoco and Exxon Mobil, especially since these companies have been modeling their revenue, margins, and profit projections for this year with lower oil prices in mind. The higher oil prices go, the better the large integrated companies will do.

Still, even with low oil prices, BP Amoco and Exxon Mobil are leading their peers in most profitability measures. This is the main reason why they are finalists in our eyes -- they are outperfoming other companies when times are decidedly bad. When oil prices rise, we expect this outperformance to continue. But even with prices at their lowest levels in more than a decade, BP Amoco and Exxon Mobil have been chugging along, unlike some of the other oil and gas-related companies we have examined.

Instead of looking at the companies individually, we'll look at some key ratios side-by-side. Hopefully, this head-to-head competition will shed some light on which of these two oil and gas heavyweights is better for a long-term investment.

Worldwide Upstream Margins ($ per barrel)
             1997     1998    % change
Exxon        4.59     2.84*     -38%
Mobil        3.45     1.52*     -56%
BP Amoco     4.35     2.09*     -52%

Worldwide Downstream Margins ($ per barrel)
             1997     1998   % change
Exxon        1.04     1.24*     19%
Mobil        1.07     1.13*      6%
BP Amoco     0.89     0.98*     10%

Worldwide Chemical Operating Margins
             1997     1998
Exxon        14%*     12%*
Mobil        10%*      8%*
BP Amoco     14%      12%

Return on Capital Employed
           1997    1998
Exxon      16%      11%
Mobil      14%      10%
BP Amoco   14%       9%
* estimated Sources: BP Amoco, Exxon, Mobil, Merrill Lynch, Motley Fool research

The real strength for Exxon and BP Amoco lies in their exploration and production operations, which are typically the most profitable business lines for an integrated oil and gas company. ROCE from production operations alone can sometimes top 20%, although it's highly doubtful that any of the majors recorded figures that high last year. Only Royal Dutch/Shell, with 1997 upstream margins of $3.72/bbl and estimated 1998 margins of $1.94/barrel, is in the same league as BP Amoco, Exxon, and Mobil in the E&P area. In this case, margins are not represented in percentage terms but rather in dollar terms in order to factor in fluctuations in oil and gas prices.

Likewise, Exxon's refining and marketing operations are also strong. The significant margin expansion posted by the firm last year is a testament to its ability to quickly adjust its business to changing market conditions. Mobil is also relatively strong in this area of the business. However, the downstream end is certainly BP Amoco's Achilles heal. This is an area where we think the company will greatly improve its profitability in the years to come as it integrates and streamlines Amoco's large refining operations. If expected merger "synergies" match the firm's current expectations, then BP Amoco shareholders should see a steady rise in the competitiveness of these operations over the coming years.

The chemicals businesses, while substantial for all three of the companies, are the operations that interest us the least. These are scale businesses, so it takes a huge amount of revenues to consistently generate the operating margins that these companies put up. (For example, Exxon's chemicals unit is the world's third largest with a whopping $14 billion in 1997 revenues.) Since Exxon and Mobil don't typically breakout the financial details of their chemicals units, we've had to make some fairly broad assumptions to come up with any operating margin figures at all. We've tried our best with the limited amount of available information we could dig up.

Tomorrow, we'll throw everything that we've learned about Exxon Mobil and BP Amoco, including our initial looks at both companies linked above, into our oil and gas meat grinder and see if we can reach an investment conclusion. Until then, see you on the message boards.

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