COLUMN-Conoco gives up the supermajor dream-Campbell

Thu Jul 14, 2011 12:38pm EDT

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-- Robert Campbell is a Reuters market analyst. The views expressed are his own. --

By Robert Campbell

NEW YORK, July 14 (Reuters) - ConocoPhillips has hit on a neat trick for dealing with its unwanted oil refineries at a time when plenty of plants are on the block and there are few buyers: it has decided to give them away.

Conoco (COP.N) announced on Thursday it would spin off its downstream arm to shareholders by mid-2012, arguing that owning refineries was no longer an advantage in gaining access to new opportunities to explore for, and produce oil and gas.

Stock markets applauded the move, which comes less than four months after the company's strategy meeting when it said its downstream focus was solely on shedding less profitable refineries.

Clearly the outperformance of the shares of smaller rival Marathon Oil (MRO.N) following its own decision to lop off its refining arm focused Conoco managers' thoughts. (See Chart 1)

As recently as March, Conoco had talked of reducing its worldwide refining capacity of 2.4 million bpd by 500,000 bpd.

A slide on page 82 of its strategy presentation (see link) implied that seven of its 16 refineries were candidates for divestment or closure.

So is this a trend? Is it the unwinding of the supermajor movement from the late 1990s that saw the biggest oil companies race to bulk up, arguing they needed massive scale to tackle costly projects like deepwater and oil sands?

Is it also an admission that the Golden Age of refining, which saw even the least efficient U.S. refineries become hugely valuable as fuel demand soared before collapsing in 2008, is at an end?

It's hard to say, but there seems to be more at play here than just responding to equity investors' demand for more "pure play" companies. Refining may be struggling but in some places, like the U.S. Midwest, it is again enormously profitable.

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Chart 1: r.reuters.com/cup62s

Conoco's strategy: r.reuters.com/vep62s

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MAJORS' CAST-OFFS

Unlike Marathon, which had an enviable collection of refineries concentrated in the U.S. Midwest, where cheap crude and costly products produce bumper profits, most of Conoco's assets are scattered outside that region and are under pressure.

First of all, a large number are the oil majors' cast-offs, cannily purchased in the 1990s by Tom O'Malley, who gained fame and fortune for his contrarian bets on refining, buying up unwanted plants for a fraction of their cost as the majors sought to bolster profitability.

O'Malley sold the plants to Phillips at a huge profit in 2001 as the (short-lived) Golden Age of refining began.

With neither scale nor niche advantages, they're not exactly premium assets, unless you can buy them for very little.

For instance, ConocoPhillips has a big refining presence on the U.S. East Coast, where margins are battered by high costs, heavy competition and a reliance on costly, imported light, sweet crude.

It also has a jumble of European assets, some acquired as part of the company's earlier effort to buy its way into the supermajor ranks, including a small refinery in Ireland and another at Wilhelmshaven in Germany that has all but been permanently shut down.

Elsewhere, California's low-carbon fuel standard looks set to heap pressure on Conoco's two refineries there by curbing crude oil choices and cutting further into petroleum demand.

Oil demand in the rest of the United States is already forecast to drop lower, so while plants in the Midwest, which is structurally short of refined products, will be relatively shielded, less efficient refineries on the Gulf Coast will be fighting for their lives.

At the same time at least four refineries are up for sale in the United States along with a slew of plants in Europe so it is not exactly a sellers' market, as evidenced by the reemergence of Mr O'Malley with his third refinery buyout vehicle, PBF Energy.

So is this the end of the supermajor era or is it just Conoco, which arguably never quite got to supermajor status, throwing in the towel after a decade of costly empire-building?

Certainly all the supermajors, even ExxonMobil, are selectively cutting refining.

Shell, Chevron and Total have all closed or sold refineries in Europe recently and BP is exiting much of its U.S. portfolio after cutting back sharply in Europe.

But they all seem to see some value in retaining at least their best performing refineries.

For Conoco, a company that has relied heavily on acquisitions in its upstream business, it may be that the drag of its refineries on its share price was perhaps getting too heavy to sustain its model of buying up smaller players.

Rather than accept discounted prices and delay as it negotiated the sale of individual plants the company has opted for a swift amputation of its downstream arm. (Editing by Alden Bentley)

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