IOC asset sales open new doors for GCC’s expansion

Year-on-year earnings results for some of the world’s largest oil companies continued to suffer heavy blows as the global economy struggled to recover in 2013. Shell saw earnings fall 38%; ExxonMobil, 27%; and Chevron 18%, all over the twelve month period.

Earnings were brought down by refining operations in Europe, where the economy remains stagnant, and Asia, amid growing supply from China and the Middle East.

“2013 did not get us fully out of the economic slump of past few years, it has been a mixed bag of results coming from the IOCs, particularly within their refining and petrochemicals sectors” said Saji Sam, principal at A.T. Kearney Middle East’s energy practice in a telephoned interview.

This may be good news for the GCC’s NOCs and sovereign funds. As the IOCs look to replenish existing reserves while navigating the end of easy-oil by investing in more expensive oil plays, they will look to raise cash through asset sales.

“The quest to finance expensive upstream projects will continue to put pressure on the downstream portfolios of IOCs, with further likely divestments of assets that are sub-scale, low complexity and not integrated within their global systems,” said Mirko Rubeis, principal at the Boston Consulting Group, in an emailed statement.

Earlier this year, Shell announced that it would increase the pace of asset sales to $15 billion for 2014-15 between its upstream and downstream divisions. Asset sales between 2010 and 2012, only amounted to $21 billion in proceeds.

Last month, Shell sold off its downstream assets in Australia to Vitol and the Abu Dhabi Investment Council for approximately $2.2 billion, according to the Australian Financial Review.

“We are making hard choices in our world-wide portfolio to improve Shell’s capital efficiency,” said Ben van Beurden, Shell’s recently appointed CEO.

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At the time of writing, Shell was also in the midst of selling its retail operations in Italy, to Kuwait Petroleum International.

As Europe’s demand remains stagnant, the continent’s older refining capacity will become increasingly challenged. “Since 2008, already 15 refineries closed in Europe, representing about 1.7 million bpd,” said Rubeis.

“The European thirst for diesel is enormous but if you look at the refineries, not many of them are middle distillate focused,” added Sam.

“Five or six years back, the US refined product supply-demand was in favour of European refiners, the gasoline length of European refiners could be shipped to the US, while diesel could be back-hauled to Europe to meet its shortage.”

Nowadays, American demand for gasoline is declining while bio-fuels continue to eat into gasoline markets. This downward trend will only accelerate as demand for gasoline imports into the United States continues to erode.

Simultaneously, new distillates exports will increasingly target the market from Russia, given the country’s expected upgrades following the changes in the export tax regime; from the Middle East, given the region’s large capacity additions; and from the US, which is benefiting from low crude and gas prices.

But Europe’s woes are, in many ways the Middle East’s joys. Refinery Mega-projects in Saudi Arabia such as in Jubail, Yanbu and Jazan, with a combined capacity of 1.2 million bpd, will continue to cut into European markets.

Increased competition in Europe from the Middle East and Asian refiners, will continue to push IOC earnings down, increasingly the likelihood of more sell-offs. Naturally that raises the question of why national oil companies would look to invest in aging and challenged assets, which could even compete with their domestic refineries.

The GCC expects to add another 2.7 million bpd of refining capacity by 2020, and so the challenge for the region will be to place products, not crude. From this point of view, refining assets may not be so attractive.

But Rubeis points out that entire segments of IOCs could still be relevant because of capabilities, and, opportunistically because of the very low multiples at which certain assets are offered. “Companies that are virtually not capital constrained and have a long term investment horizon may find certain downstream assets divested by IOCs attractive”, he said.

After all, over a five-year cycle, the downstream segments of ExxonMobil, Shell and Chevron still returned a ROACE respectively of 23%, 13% and 7%,” he said. Such returns might still be very lucrative for Middle Eastern and Asian investors.

“They could buy Western downstream assets at attractive valuations, for market integration and diversification,” said Robin Mills, head of consulting at Manaar Energy.

But Mills advises they proceed with caution, pointing out that, the investors would have to be very selective and have a plan for adding value, to avoid being trapped in the same pattern of unprofitability.

Factbox:
– 38% Shell’s earnings fell this much in FY2013.
– $2.2 billion Shell sold its downstream assets in Australia for this much.
– 2.7 million The GCC will add this much bpd refining capacity by 2020.