Last updated: July 18, 2011 7:31 pm

Integrated oil groups

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Separating upstream and downstream operations is the way forward

Break me up before you go-go. Jim Mulva’s parting shot as chairman and chief executive of ConocoPhillips was to proclaim the end of the era of the integrated oil company. Conoco is splitting into its downstream and upstream divisions, in the name of creating shareholder value. Investors have not rushed to join any putative trend: the sector share price reaction has been muted. But the pressure to improve lacklustre shareholder returns could yet change that.

The integrated model used to have a huge advantage: it guaranteed access to resources. That is no longer the case. It now has a pressing disadvantage: it has conceded integrated companies’ stock market premium to nimbler pure-play upstream operators. Marathon was the first integrated group to address this: its split has replaced one company valued by the market at $23bn with two companies worth a combined $36bn.

It is hard to see a ruthlessly streamlined and integrated behemoth such as ExxonMobil imitating this strategy. Other groups, however, should be learning lessons; European integrated oil groups in particular. UBS estimates that they trade at an average 19 per cent discount to net asset value.

Some of these companies are accidents of history. Italy’s Eni controls oil services group Saipem as well as gas and power distribution. That model would not be created today. Meanwhile, BP’s effort to close its post-Macondo 30 per cent discount to NAV is not working: its total return this year is a measly 3 per cent.

The integrated model has the status of a creation myth for many oil executives. That sells their investors short. Marathon set the ball rolling by completely separating upstream and downstream. Conoco is big enough to make a big difference. A sector long on cash and short on ideas needs to be bold enough to embrace and follow their lead.

E-mail the Lex team in confidence at lex@ft.com

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