BP Amoco-ARCO merger promises to change the oil industry's landscape

Contributing to this article were:

Anne Rhodes,
Associate Managing Editor-News

David Knott,
Senior Editor

Patrick Crow,
Energy Policies Editor

Steven Poruban
Staff Writer

• BP Amoco-Arco key operating areas [80,357 bytes]
• How BP Amoco-Arco combined production compares [99,091 bytes]
• BP Amoco-Arco rankings by sector [139,636 bytes]

The accelerating consolidation of the petroleum industry has taken another major leap forward with the announcement that BP Amoco plc and ARCO plan to merge.

Rumors that BP Amoco and ARCO were discussing a possible merger were leaked to the press in late March, causing both companies to immediately confirm the reports but say nothing else. News that the two had reached a definitive merger agreement followed on Apr. 1 (OGJ, Apr. 5, 1999, p. 38).

Unlike the creation of BP Amoco at the end of last year, the deal with ARCO is a takeover, although the firms described it as a merger for legal reasons. This is reflected in the fact that the name of the combined companies will be BP Amoco plc.

The merged firm will have an estimated market capitalization of nearly $190 billion, making it the world's second largest oil company behind Exxon Mobil, assuming that merger goes through as planned. It also will remove another major oil company from the industry roster.

Nowhere will the effects of this latest in a string of industry megamergers be felt more strongly than in Alaska, where BP Amoco and ARCO both have major interests. The firms expect to achieve the biggest portion of their savings by combining operations in this state.

Together, they hold the leases to a reported 860,000 acres of onshore, state-owned lands. BP Amoco also owns 50% of Alyeska Pipeline Service Co., which operates the Trans-Alaska Pipeline System, and ARCO owns 21%.

Driving forces

Contrary to a popular belief that BP Amoco CEO John Browne is bent on snatching up other majors to build his petroleum company into the world's largest, ARCO Chairman Mike Bowlin revealed that he was the one who approached Browne on the subject of a possible merger. Bowlin said he believed the firms' overlay of assets would create the strongest petroleum company in the world, and so flew to London to discuss the possibility with Browne, although he did not say when this first meeting took place.

Serious negotiations began in January of this year. The merger was driven by the perception of extended low oil prices-a fact that will surprise no one.

Bowlin is quick to point out that ARCO did not choose this route to cost reduction because it had to. In fact, ARCO achieved many improvements during 1998. ARCO's major upstream position in Alaska, however, makes it especially vulnerable to price collapses such as the one the industry has experienced since early 1998.

"Over the course of the year," said Bowlin in ARCO's 1998 annual report, "we took important steps to position the company for future growth. We exited two lines of business-coal and chemicals-as part of our desire to focus on our core operations. At the same time, we added muscle in areas where we believe we can be a leading competitor."

"We strengthened operations in the North Sea, Indonesia, Venezuela, and Alaska through the acquisition of Union Texas Petroleum. We also acquired a hefty interest in a key gas resource offshore Malaysia and Thailand.

"In brief, we revamped our asset base and sharpened our focus on the oil and gas business by concentrating our activities and capital resources in a few key areas around the world. This will enable us to achieve economies of scale and improve profitability in the areas where we choose to operate."

But in the end, the economies of scale apparently were not enough to satisfy Bowlin.

Wood Mackenzie Consultants Ltd., Edinburgh, speculates that BP probably studied the possibility of taking over ARCO at the same time it was in discussions with Amoco, but opted to merge with Amoco first because of the latter's larger U.S. refining, marketing, and chemicals businesses.

Before the BP-Amoco merger announcement, there had been speculation that ARCO was on BP's list of potential targets. One source said that BP and ARCO had talked a little before the negotiations with Amoco, but that the only substantial merger talks before the BP-Amoco deal had been between BP and Mobil Corp.

Exxon-Mobil perspective

It is unclear how the U.S. Federal Trade Commission will view the BP Amoco and ARCO merger, in light of the Exxon Corp.-Mobil Corp. union.

Three months ago, FTC Chairman Robert Pitofsky warned, "If the merger trend continues in the oil industry, we would take that consolidation into account each time we review a deal" (OGJ, Jan. 11, 1999, p. 31).

Given this comment, one analyst theorized that Browne may have proposed the union with ARCO as a strategic "blocking merger."

The analyst said, "The simultaneous mergers of Exxon and Mobil, and BP-Amoco and ARCO, could make FTC so concerned about consolidation in the oil market that they reject both mergers.

"That's a win-win situation for Browne. If he gets to merge with ARCO, he wins. If he doesn't, but blocks his competition from merging, he still wins."

Combined operations

The merged BP Amoco-ARCO expects to achieve synergy savings of $1 billion/year by 2001. About $710 million of the savings are expected from the exploration and production sector, including $200 million from streamlining Alaskan operations. About $110 million in savings are targeted from refining and marketing operations, and $180 million from corporate cost cuts.

If approved, the all-share merger transaction will be accounted for as a purchase.

Browne described the deal as "a compelling strategic and geographic fit of quality assets." One of the keys to this meshing of assets is the major position both companies hold in production on Alaska's North Slope.

In a joint press release, the firms said, "The deal will substantially boost BP Amoco's reserves and production, giving it the largest oil output of any non-state company, and will consolidate its position in Alaska, where the resulting synergies and cost-savings are likely to increase the region's competitiveness and significantly encourage future investment."

Browne said, "For BP Amoco, the strategic rationale for this deal is the immense potential it offers for future growth. In Alaska in particular, the synergies we can achieve from combining our operations will greatly increase the competitiveness of the state in the face of uncertain oil prices and provide a strong incentive for significant investment in existing and future fields."

ARCO owns two key refineries on the U.S. West Coast: a 255,000 b/d plant at Carson, Calif., and a 202,000 b/d plant at Ferndale, Wash. It also has two small topping refineries in Alaska, with a combined capacity of 27,000 b/d.

The partners say the California and Washington refineries are two of the most efficient in the region.

ARCO also is the largest retail marketer in five western states. Adding ARCO's top-notch West Coast U.S. retail network to BP Amoco's retail holdings east of the Rocky Mountains gives the merged firm coast-to-coast reach in products marketing in the U.S.

In the U.S. upstream, combining with ARCO will add 360,000 boed to BP Amoco's oil and gas production. Half of this output is gas, coming chiefly from ARCO's 82% stake in Vastar Resources Inc., a leading U.S. independent exploration and production company (OGJ, Dec. 7, 1998, p. 27).

Internationally, the merger will add significant production volumes in Southeast Asia, most notably in Indonesia, where ARCO has a net share of as much as 8 tcf of gas in Tangguh field, which is expected to feed a key liquefied natural gas (LNG) project in the region. The deal also adds ARCO's gas reserves in the South China Sea, Malaysia, Thailand, and Qatar, and its oil interests in Algeria, Venezuela, the Caspian region, and Russia.

In the U.K., ARCO's oil and gas production is more than 100,000 boed. And the firms say their fields there are complementary. Together, they will become the largest single supplier of U.K. continental shelf gas.

"The addition of ARCO's international assets powerfully strengthens our global portfolio," said Browne. "Most significantly, it gives us a major platform for upstream growth in Asia, where we will now have world-class gas reserves ready to supply Japan, (South) Korea, and other key markets when recovery comes to the region, which it undoubtedly will."

Wood Mackenzie pointed out that BP Amoco's absorption of ARCO will bring the company significant and profitable synergies in key areas: "Missing from the combined BP Amoco portfolio was a U.S. West Coast refining and marketing position and a material upstream and downstream standing in Asia-Pacific.

"Apart from the Asian downstream position, ARCO plugs most of these gaps and brings, in addition, the ability for BP Amoco to operate the core Alaskan assets in a more coordinated manner that could lead to increased value from the region.

"Furthermore, the overlap in Alaska and the U.S. Lower 48, and to a certain extent internationally, is an opportunity to cut costsellipseARCO also has some significant undeveloped international upstream assets that could underpin production growth for BP Amoco well into the future."

The analyst was not as sanguine as Bowlin about ARCO's recent performance. Last year, ARCO wrote off $629 million in exploration costs. This, combined with weak non-U.S. earnings, has made ARCO's share price underperform the U.S. Oil Index in recent months.

"BP Amoco may believe that the time is right to buy ARCO now and apply its own business practices to the ARCO portfolio, to unlock its longer-term value," said Wood Mackenzie.

Integration of ARCO

A BP Amoco official told OGJ that no target date has been set for closure of the deal as yet, but that the two parties hope to have the takeover completed by yearend.

The two companies are understood to be in no great rush to undertake the merger, with a major reason thought to be their acceptance that U.S. regulatory authorities will be immersed in the planned Exxon-Mobil merger for much of 1999.

In the meantime, BP Amoco plans to establish a ring-fenced team of BP and Amoco and ARCO executives to look into planning the integration. The effective isolation of the team is intended to prevent the absorption of ARCO from affecting the current splicing of BP and Amoco.

BP Amoco status

Meanwhile, the BP Amoco official said the integration of BP and Amoco is "way ahead of schedule"-that it is about three-quarters complete and should be finished well before yearend.

BP Amoco's decision to take over ARCO before its own internal reorganization is completed took the investment community by surprise and triggered another round of speculation about potential petroleum company mergers. The official said only that BP and Amoco "don't see anything else in the immediate future."

Yet it appears the BP Amoco checkbook is still open in case other investment opportunities arise, as on Apr. 6, the supermajor announced a purchase to boost its presence in the solar power market (see story, p. 25).

One potential hurdle for the integration of BP Amoco with ARCO is what Innovest Strategic Value Advisors, New York, considers to be ARCO's comparatively poor performance in environmental issues.

"Eco-efficiency is an excellent proxy for management quality, the primary determinant of stock market performance," said Innovest. The investment analyst carried out a study of the environmental and stock market performances of 13 companies, including BP, Amoco, and ARCO.

"ARCO was one of the lower-rated companies," said Innovest, "which implies less-sophisticated management with lower share-price appreciation, thereby making the company's acquisition price more attractive.

Innovest contends that ARCO has "greater relative environmental risk exposure (than does BP Amoco) andellipse less capacity to manage that risk. Other risk factors include high exposure to the increasingly likely California ban on MTBE use in gasoline (OGJ, Apr. 5, 1999, p. 39)

"Bringing ARCO up to BP environmental standards will likely be more difficult than it was with Amoco, since Amoco had relatively good eco-efficiency performance. Delays in bringing ARCO environmental and overall management performance up to BP standards may slow BP's share price appreciation."

Alaska overlap

BP Amoco's and ARCO's Alaska holdings are seen as both a key benefit, and a key potential obstacle to, the planned merger. Among the potential obstacles is the unprecedented acreage position the combined firm would have in Alaska.

While the U.S. Federal Trade Commission historically concerns itself only with retail competition, Alaska law mandates that no single company can hold leases to more than 500,000 onshore state-owned acres. With 860,000 acres of leaseholdings, a merged BP Amoco-ARCO would greatly exceed Alaska's 500,000-acre limit. This could mean the firm would have to give up some of its acreage.

At a press conference in Anchorage, BP Amoco said it would be willing to relinquish acreage, if necessary.

In addition to consolidating their positions in oil production, Browne says the merger of the two biggest North Slope operators could help unlock the potential for large volumes of Alaskan gas that "are currently uneconomic to develop but could make an enormous contribution to the energy needs of the U.S. in the next century.

"We have proprietary BP Amoco technology that we believe may allow us to convert some of that gas into liquids that can be transported through the existing oil pipeline. We have plans to build a $70 million pilot plant on the North Slope to test that technology, and if it is successful, we will consider full-scale development."

Despite BP Amoco's excitement over a potential combination of its Alaska assets with ARCO's, others are more doubtful. Alaska Gov. Tony Knowles has appointed a cabinet-level team to review the proposed merger of the two largest producers of Alaska North Slope oil.

"While mergers and consolidations are increasingly common as oil companies seek to be more competitive, the proposed merger of BP (Amoco) and ARCO could have significant impacts on Alaska jobs and families," said Knowles. "The merger also presents an opportunity to build on the accomplishments we have made with industry over the past 4 years.

"I have asked four of the top officials in my administration with expertise in oil and gas issues to review the merger proposal in detail and analyze how it will affect the state. We need to ensure that Alaska's interests are protected in any such major consolidation."

Knowles added, "The state of Alaska has enjoyed a strong, mutually productive partnership with BP and ARCO, and I would expect that to continue, regardless of any industry restructuring that may take place. Much has been achieved in the past years, including the development of new jobs and the opening of new areas to leasing. We have made tremendous strides in improving the safe transportation of oil with new tractor and ocean tugs and the commitment to new double-hulled tankers. Continued progress in these areas must be part of any industry consolidation."

Reaction

Industry analysts generally view the BP Amoco-ARCO merger as mutually beneficial, although many are waiting to see whether it prompts further mergers or drives other firms to become serial acquirers.

David L. Bole, vice-president, corporate research and development for Randall & Dewey Inc., Houston, said, "From most viewpoints, this appears to be an excellent fit and will strengthen BP's already formidable position in the industry."

He added, "The (U.S.) industry will pay a great deal of attention to BP's plans for Vastar. Vastar has certainly outperformed its peer group during the current industry downturn, and it's not yet clear how their strategy will match with BP Amoco plc."

With regard to a possible domino effect, Bole said, "It's certainly interesting that BP is continuing on its merger trail. I'm not sure what pressure this will put on competitors to follow suit now that Exxon-Mobil and BP Amoco have pulled away from the pack. Will other companies feel competitive pressures to execute similar acquisition strategies?"

Larry Goldstein, president of Petroleum Industry Research Foundation Inc., New York, sees no major overlaps between BP Amoco and ARCO. "There are a few complications economically and philosophically," he said, "especially with ARCO's investment strategy in Russia.

"But overall, this merger is a very smart strategic move. It's a natural transition for BP, which will get a home for its Alaskan crude production at ARCO's West Coast refineries."

Goldstein predicted, "These mergers are going to trigger other events. I don't think we're anywhere near the end game.

"Even with the recovery in oil prices, the industry has not yet seen the cessation of downsizing. They're still distrustful of higher prices. They're not willing to accept them as a norm yet.

"Oil companies are still focused on reducing their costs. Their price and demand factors are a given. The only thing they have control of is costs."

Wood Mackenzie said the BP Amoco takeover of ARCO emphasizes that other U.S. middle-tier major oil companies-notably Texaco Inc., Chev- ron Corp., and Conoco Inc.-face considerable problems in competing with the new supermajors.

"Companies like Texaco face declining (U.S.) production, which is unlikely to be significantly turned around by production from deepwater Gulf of Mexico assets. Furthermore, these companies are sanctioned from operating in some countries where growth is obtainable. Therefore, merging with another U.S. medium-sized integrated company will not solve these problems.

"Many of the European integrated oil companies are unlikely to want to combine with a U.S. partner because of the exposure to U.S. refining and marketing," said Wood Mackenzie.

Among potential options for U.S. integrated firms, the analyst identified "non-organic growth" through acquiring assets spun off as a result of recent megamergers, and acquisition of privatized national oil companies such as Brazil's Petroleo Brasileiro SA or Thailand's Petroleum Authority of Thailand.

Philip Verleger, of PK Verleger LLC and Brattle Group, Boston, says the companies are a natural fit in several ways: their Alaskan operations, their emphasis on environmental protection, and their marketing innovations.

"ARCO has developed a reasonably lean operation, which fits very well with the BP Amoco style. The question I have is, since ARCO already is so lean, how are they going to achieve significant savings?"

Verleger added, "Browne has demonstrated he is quite possibly the one senior executive in the oil industry who is on a par with the executives of the Silicon Valley computer firms. BP has demonstrated that it is much less bureaucratic than almost any of the other big companies. Its emphasis on growth and shareholder value has paid enormous benefits to the BP shareholders."

Verleger also predicts there are more oil industry megamergers to come: "Within 5 years, there may be only four major oil companies (based) in the U.S.," he said.