Oil firms' chemical units improve performance

Overall Financial Performance Ranking of Leading Petrochemical Companies [84,042 bytes]

Major oil companies' commodity chemical operations have historically lagged petrochemical companies in financial performance.

In recent years, however, they have improved their operations and closed the performance gap, due largely to restructuring efforts, says New Vernon Associates Inc., Parsippany, N.J.

Performance

The research firm studied the performance of the chemical operations of 7 oil companies and 11 petrochemical companies for 44 commodity chemicals and 12 non-commodity business segments.

"When New Vernon Associates first compared oil and petrochemical company businesses 4 years ago," said the firm, "big oil, as a group, failed to surpass the chemical companies in any of the 11 financial metrics usedellipseto measure financial performance." But in the past 4 years, oil firms have closed the performance gap.

New Vernon Executive Vice-Pres. Charles Neivert said, "During the past 4 years, major oil companies have dramatically restructured their chemical operations through major divestitures, acquisitions, joint ventures, and alliances. In fact, three of the top five overall performers in 1997 were big oil chemical companies."

In its first report 4 years ago, the firm reported that the chemical divisions of vertically integrated oil companies lagged far behind the financial performance of chemical firms. Of particular interest was the fact that, although the oil companies made as much profit per pound as the chemical firms, "they spent too much on assets and squandered feedstock advantages by reaching too far downstream," said New Vernon.

Ranking

The New Vernon Associates study ranks the financial performance of the firms based on asset turnover, earnings before interest and taxes (EBIT), return on assets, cash generation, overhead as a percentage of sales, and six other measurements.

Most of the data needed for the comparison are not reported by the oil companies, many of which report results from their chemical businesses as a single number. For this reason, Neivert says New Vernon conducts "extensive interviews to further define and validate our information."

Since starting its annual analysis in 1994, New Vernon has used historical data to rank the performance of the surveyed companies dating as far back as 1991. In the firm's latest ranking of companies' overall performance, five of the seven oil firms included in the analysis ranked in the top half (see table).

Strategy changes

There are several reasons for the improved performance, says Neivert: "The oil companies have narrowed their focus to a core of downstream products where they have an advantage.

"Amoco exited fibers. Mobil got out of packaging. They no longer have to keep up with competitors on dozens of different fronts. "Their tight focus on downstream commodity products enhances oil company chemical profits far better than product line diversification (does). Ethylene is the most important commodity chemical," Neivert continued, "and ethylene plants associated with refineries have an advantage over other producers. Refineries have the flexibility to optimize feedstocks coming in and optimize profitable non-ethylene products going out. This improves overall profitability."

This sort of "back-integration," as New Vernon calls it, provides no significant cost savings for other commodity chemicals but improves profitability during earnings troughs, says the firm.

"In every company we observed," said Neivert, "we found that there were no periods when an entire chain of products was in the red. An integrated producer of polyethylene, for example, might lose money in polyethylene but offset that with profits in ethylene. A nonintegrated polyethylene producer would simply see red.

"Although an integrated asset base costs more, the profits seem to justify the expenditure," he added.

Neivert believes petrochemical producers can expect increased competition in the future: "As chemical industry performance improves, the gap between the top and bottom producers will narrow. As the cost curve flattens, pressure increases on those companies at the far end of the curve. They are the ones most likely to be swallowed as industry consolidation continues."