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Breaking up is hard to do

Neil Sedaka
Neil Sedaka

One would not normally link the 1962 Neil Sedaka hit with the oil and gas sector but never has the line “Breaking up is hard to do” been more apt than in 2012.

Recently ConocoPhillips, a $92billion business and the US’ third largest petroleum company, officially divided itself in two, separating out the upstream oil and gas production business from the downstream refining, marketing, chemicals and pipelines business.

The former, which will keep the name ConocoPhillips, will be the larger of the two parts with an estimated value of $70billion, whilst the latter, now named Phillips 66, will have a value of circa $22billion.

The decision by ConocoPhillips to split itself in this manner is certainly a brave one, with some commentators describing the move as a “$92billion experiment”.

Many others will be keeping a keen eye on progress especially the global super-majors where increased pressure is being applied by those institutional investors who are now demanding greater returns on their investment.

BP in particular has faced repeated calls to break itself up, especially so following the Deepwater Horizon disaster, with Bob Dudley so far resisting. One can see a logical break-up of BP making sense, but the physiological significance would be huge – much like when BP and Amoco merged back in 1998.

It has been a long-held view that large multinational oil and gas businesses should own every part of the supply chain from the oil or gas field right through to the petrol pump or the gas being used in our homes.

It now seems that this logic is beginning to tire, with the number of break-ups likely to increase in the coming months and years ahead.

Financially, the refining and marketing operations of any multinational operation were large, but with typically lower margins, and as such often acted as a drag on the group’s overall financial performance with the more streamlined downstream operations stealing all the glory.

In developed marketplaces, fuel markets appear to have peaked with alternatives such as bio-fuels and electric transportation becoming increasingly prominent, meaning that, unless “emerging markets” growth accelerates, then petrol sales growth is unlikely to rise significantly from current levels.

In the case of Conoco the split will allow the business to grow faster than many of its integrated oil company peers have been managing of late whilst also delivering a dividend yield of around 3.7%, putting it at the higher end of the sector’s dividend payers in North America, where it has significant exposure, as well as in the Canadian tar sands, Gulf of Mexico and Alaska and more importantly in the onshore horizontal drilling and hydraulic fracturing market, known more commonly as fracking.

It has been interesting to note the market reaction to the ConocoPhillips split, with most market participants welcoming the move.

Some commentators have gone further suggesting that the group should in fact be split up further, to divide the more mature oil and gas-fields from the fast-growing newer prospects.

Again, this concept is one that we feel will be repeated across the oil and gas sector over coming years, especially so in light of the recent “shareholder spring” events and the pressures being placed on companies by shareholders seeking “more bang for their buck”.

Back in the UK, the volatility in oil and gas stocks has certainly continued over recent months.

Ongoing issues in the Eurozone, most notably in Greece, continue to weigh heavily on investor sentiment. We expect such issues to continue certainly for the short to medium term with markets very much maintaining a “risk off” stance.

That said, in periods of such volatility, buying opportunities present themselves, not only for the private investor who can select decent businesses with good dividend yields and competitive Price/Earnings Ratios but also for the industry buyers out there, who no doubt flush with cash will be reviewing various potential takeover targets where share prices have been beaten up since the start of 2012. The rest of this year and potentially 2013 be interesting to say the least.

Alan MacPhee is investment manager at Brewin Dolphin, Aberdeen

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