Back in 1909, the Department of Justice sued Standard Oil of New Jersey under the Sherman Antitrust Act if 1890. When the case was finished in 1911, the largest oil company in the world was forced to break up. From that breakup emerged oil giants Exxon Mobil (XOM 0.03%), Chevron (CVX 1.27%), and Amoco, which we know now as part of BP.
Now, more than 100 years since that fateful court decision, these major oil companies should break up again. Not because they are in violation of antitrust laws, but because it is a good business decision. This may seem like a completely off the wall idea, but here are three reasons why it should happen.
Big Oil needs focus
Go through any earnings transcript for a big oil company, and you are pretty much guaranteed to come across the word "focus" at least a dozen times. Each one of them claims to be focused on creating shareholder value, operational efficiencies or some other "critical" focus. Here is the problem, though: It is extremely difficult to be a focused company when several parts have very different drivers for success.
The best way to look at this is the at the individual parts of upstream and downstream marriage. As an exploration and production company, the goal is to get the best price on your production. With these integrated oil companies supplying their own refineries, though, the best price may not always be possible.
Chevron has given us a glaring example of this recently. The company's interim earnings report stated that the company has realized prices of $96.73 and $104.62 per barrel of domestic and international crude, respectively. This means that, on average, the company realized price was $3 to $13 less than the benchmarks West Texas Intermediate and Brent. While there are several factors that can contribute to this, supplying its own refineries is a major aspect of that.
One would assume that these companies supplying their own refiners would give them a major leg up, but that may not be as much the case, either. Total (TOT +0.00%) has so far shuttered two of its refineries in Europe this year because of high crude costs, and increasing competition from American refiners continue to make European refiners miserable. Also, Exxon's most recent quarter was mired with problems with both margins and volumes declining at its refineries.
By trying to play both sides of the value chain, these companies have struggled to create value with either of them. If CEO's like Rex Tillerson -- who has gone on record saying that Exxon is more than just focused, it is 'laser-focused' on profitability and value -- truly have the courage of their convictions, then they should consider a breakup.
Make a mountain of cash for investment
Something to note about the refineries owned by these companies is that they have been around for a long time. Sure, they have all been upgraded and expanded multiple times, but after being on the balance sheet for so long, these assets have been depreciating for quite a long time. So, even though Exxon may claim to have $44 billion in capital employed in its downstream and chemical business, rest assured that the value of these assets is much greater than that.
Now, imagine if Exxon were to spin off those assets in an IPO. Just to give an idea of the size we're talking about here, Exxon's refining capacity is 5.4 million barrels per day, making it 75% larger than Valero (VLO 0.48%), the largest independent refiner.
Using Valero's $24 billion in enterprise value as a guide, we can can roughly guess that Exxon's refining arm alone is worth $42 billion on the open market, and that doesn't include the 23 million tons per year of chemical manufacturing capacity.
By spinning off these downstream assets, Exxon and the rest of the members of big oil would have mountains of cash to invest. This would allow these companies to pursue more active drilling and exploration programs, or even gobble up a few US based shale drillers. So far, the shale oil and gas boom has eluded big oil, but a large buyout could change that very quickly.
It's been done before and proven successful
Last year, ConocoPhillips (COP +0.13%) decided to part ways with its downstream operations in the Phillips 66 (PSX +1.94%) spinoff. Prior to that, Conoco was struggling to grow profitability because its upstream assets were scattered across the globe, and its refining arm was only bringing in 13% of its net earnings. The breakup of the company has shown to be a major spark that both ends of the company needed.
The sell-off of the refining assets gave a much needed injection of capital to ConocoPhillips to help complete its asset turnover and create a more American-centric exploration and production company. Since that time the company has seen a 47% uptick in its production from its shale oil assets to over 200,000 barrels per day, and plans to grow this even further.
At the same time, we have seen Phillips 66 have its own impressive run, but for entirely different reasons. The company has been generating gobs of cash and has been returning it to shareholders through a strong dividend, as well as an ambitious share buyback program. This past quarter, the company announced it was buying back another $1 billion in shares on top of the $2 billion it announced last year, and the company has recently announced it is upping its dividend by 25%.
ConocoPhillips isn't the only one either, Marathon Oil -- a former Standard Oil company -- has divided up along the upstream/downstream side into Marathon Petroleum, and Hess has been selling off its downstream assets as well. These moves have been proving to be successful, and their success should make the boards of big oil think of doing the same as well.
What a Fool believes
Upon hearing Standard Oil would need to break up, John D. Rockefeller turned to his golf partner and said these three words:
"Buy Standard Oil."
His intuition proved right. Two years later, Mr. Rockefeller's net worth climbed to its peak, and a large part of that growth came from the breakup of Standard. The players in big oil should take a good, hard look at the fate of Standard Oil and ConocoPhillips experiment, because it could be the next big growth catalyst for them.
