1

01 Survey 1

Survey on Management Strategy of

Independent U.S. Petroleum Companies

Tadashi Maruoka, Research and Planning Department,

Petroleum Energy Center (PEC)

Hideaki Fujii, Energy Research Division, Mitsubishi Research Institute, Inc.

1. Background and Goals

The U.S. petroleum downstream markets have undergone a reshuffling in recent years.

This has been brought about by factors such as reorganization of petroleum business assets

as a result of mega-mergers between Majors, as well as additional capital investment in

refineries or consolidation of refineries in response to the trend toward stricter environmental

regulations under the Clinton administration. The Petroleum Energy Center (PEC)

previously conducted surveys on independent U.S. petroleum companies and North

American petroleum companies in fiscal year 1995 and 1997. In these surveys, strategies

are classified into merchant refinery, technical niche, asset acquisition, alliance with oil

producing countries, business diversification, and capital alliance/merger, etc.

In response to the urgent need for a contemporary reassessment of management strategy

that should take into account rapid changes in the situation surrounding the oil business after

the previous surveys, such as increasing interest in global environmental issues and

mega-mergers between Major petroleum companies, this survey seeks to illuminate the

concepts based on which U.S. independent petroleum companies have reappraised their

business models as of the year 2000. In particular, this survey focuses on the business

situation and management strategies of independent U.S. petroleum refining and marketing

companies, which are rather similar to Japanese petroleum companies in terms of capital

size and business activities.

Specifically, this survey aims to clarify how TOSCO, Valero, Ultramar Diamond Shamrock,

Lyondell-CITGO Refining, Tesoro, and (although it does not fall into the category of

“independent U.S. petroleum refining and marketing company”) Enron achieved rapid growth

from the mid-1990s onward. In addition to investigating the sources of this growth, we also

tried to clarify what sorts of adjustments in their strategy are possible.

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2. Overview

2.1 Main Survey Items

• Changes in the business environment of independent U.S. petroleum refining and

marketing companies and how they are coping with the changes

• Business management situation of six independent U.S. petroleum refining and

marketing companies (TOSCO, Valero Energy, Ultramar Diamond Shamrock,

Lyondell-CITGO Refining, Tesoro Petroleum, and Enron)

• Classification of causes of growth and management strategy of the above six

companies

• Comparison of management strategy models of the six companies and anticipated

changes in the business environment variables

2.2 Method

In addition to discussions in a working group consisting primarily of experts in fields related to

the petroleum industry, relevant documents were examined and fact-finding visits were made

(including interviews at Valero Energy, Ultramar Diamond Shamrock, Tesoro Petroleum,

Enron, and related research institutes).

3. Findings and Conclusions

Presented in the following pages.

Survey on Management Strategy of

Independent U.S. Petroleum Companies

A. Findings

1. Changes in the Business Environment of Independent U.S. Petroleum Refining and

Marketing Companies and How They are Coping with the Changes

The companies under review were classified as either “independent U.S. petroleum refining and

marketing companies” or “major U.S. petroleum companies” (Table 1). Among U.S.

independent petroleum refining and marketing companies, as defined by the survey, six were

selected for individual examinations: TOSCO, Valero, Ultramar Diamond Shamrock,

Lyondell-CITGO Refining, Tesoro, and Enron. Since the mid-1990s, these companies all

succeeded in rapidly expanding their asset bases and realizing comparatively high earnings

based on distinctive management strategies.

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Table 1 Independent U.S. Petroleum Refining and Marketing Companies Covered in

the Survey and Reclassification of Major U.S. Petroleum Companies

Leading Independent U.S. Petroleum

Refining and Marketing Companies Major U.S. Petroleum Companies

CITGO Petroleum Corporation Clark Refining and Marketing,（Premcor）Inc. Enron Corporation Fina, Inc. LYONDELL-CITGO Refining, LP Nerco, Inc. Sonat Inc. Tesoro Petroleum Corporation TOSCO Corporation Ultramar Diamond Shamrock Corporation Valero Energy Corporation The Williams Companies, Inc. There are many, in addition to the above.

Amerada Hess Corporation American Petrofina, Inc. Amoco Corporation Ashland Inc. Atlantic Richfield Co. (ARCO) BP America, Inc. Burlington Northern Inc. Burlington Resources Inc. Chevron Corporation Cities Service The Coastal Corporation Conoco E.I. du Pont de Nemours and Co. Exxon Corporation Getty Oil Gulf Oil Kerr-McGee Corporation Marathon Mobil Corporation Occidental Petroleum Corporation Oryx Energy Company Phillips Petroleum Company Shell Oil Company Standard Oil Co. (Ohio) (SOHIO) Sun Company, Inc. Superior Oil Tenneco Inc. Texaco Inc. Total Petroleum (North America) Ltd. Union Pacific Resources Group, Inc. Unocal Corporation USX Corporation

Total 34 companies.

Note: This survey defines “major U.S.. petroleum companies” as corporations active in the petroleum

refining and marketing business sector in the United States and which were enrolled in the

Financial Reporting System (FRS) during the period from 1974 to 1990. “Independent U.S.

petroleum refining and marketing companies” are corporations that were not enrolled in the FRS

between 1974 and 1990. The companies examined individually for the survey are underlined

in the list above. Note that Equilon Enterprises, LLC, which was formed in a joint venture

between Shell Oil and Texaco, and Motiva Enterprises LLC, which is the result of a joint venture

by Shell Oil, Texaco, and Saudi Aramco, are classified as major U.S. petroleum companies.

Source: Materials prepared by Mitsubishi Research Institute based on data from the U.S. Department of

Energy/Energy Information Administration (2000).

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The extent to which the major U.S. petroleum companies became less involved in the

downstream segments of the U.S. petroleum sector, with increased market competition and

stricter environmental regulations that took place during the nineties, is made clear by an

analysis of the data on the changes in U.S. refineries.

For example, in 1985 the share of total domestic refining capacity accounted for by independent

U.S. petroleum refining and marketing companies was 23.1% and that accounted for by the

major U.S. petroleum companies was 76.9%. The corresponding figures for 1999 are 43.6%

for the independents and 56.4% for the Majors, indicating that the distribution of power within

the industry had changed dramatically (Table 2).

In the area of petroleum product retail assets as well, a real shift has been taking place from the

Majors to the independents (Table 3).

In particular, Petroleum Administration for Defense District 1 (PADD I, East Coast) became the

first region in the U.S. where the independents surpassed the Majors in refining capacity. The

major reason for this is that independents, such as those covered in this survey, have been

strategically purchasing refineries from the Majors (Figure 1).

Table 2 Petroleum Refining Capacity of Independent U.S. Petroleum Refining and

Marketing Companies and Major U.S. Petroleum Companies

Independent U.S. Petroleum Refining and

Marketing Companies Major U.S. Petroleum Companies

% %

Total

1970 5,216,550 40.1 7,807,900 59.9 13,024,450

1975 4,343,590 27.7 11,342,160 72.3 15,685,750

1980 5,478,501 28.6 13,646,768 71.4 19,125,269

1985 3,522,671 23.1 11,742,500 76.9 15,265,171

1990 5,190,274 33.5 10,288,675 66.5 15,478,949

1995 5,551,310 36.2 9,802,830 63.8 15,354,140

1996 5,817,465 37.7 9,615,130 62.3 15,432,595

1997 6,541,810 41.1 9,356,570 58.9 15,898,380

1998 6,775,220 41.3 9,647,450 58.7 16,422,670

1999 7,207,620 43.6 9,333,370 56.4 16,540,990

Source: Materials prepared by Mitsubishi Research Institute based on data from Oil & Gas Journal.

Note: Refer to Table 1 for the definitions of “independent U.S. petroleum refining and marketing

companies” and “major U.S. petroleum companies.”

Table 3 Number of States with Sales Outlets of Petroleum Products

1984 1990 1997

Average for 7 FGIR Companies NA 14 24

Average for major U.S. Petroleum Companies 32 NA 23

CITGO 31 NA 48

TOSCO 0 0 37

Source: Materials prepared by Mitsubishi Research Institute based on data from the U.S. Department of

Energy/Energy Information Administration.

Notes: “FGIR” designates CITGO (a subsidiary of PDV America), Clark Refining & Marketing (currently

Premcor), Ultramar Diamond Shamrock, Koch Industries, Tesoro, TOSCO, and Valero Energy.

“major U.S. Petroleum Companies” designates companies enrolled in the FRS. “NA” stands for

“not applicable.”

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(a) Number of Refineries

(Number)

Independent U.S. Petroleum Refining and Marketing Companies

Major U.S. Petroleum Companies

(Year)

PADD I

PADD II (Number)

Major U.S.

Independent U.S.

(Year)

PADD III(Number)

Independent U.S.

Major U.S.

(Year)

PADD IV(Number)

Independent U.S.

Major U.S.

(Year)

PADD V (Number)

Independent U.S.

Major U.S.

(Year)

(b) Total Refining Capacity (c) Refining Capacity per Refinery

PADD I PADD I Independent U.S. Petroleum Refining and Marketing Companies

Major U.S. Petroleum Companies

Major U.S. Petroleum Companies

Independent U.S. Petroleum Refining and Marketing Companies

(Year) (Year)

PADD II

Major U.S.

Independent U.S.

(Year) (Year)

PADD II

Major U.S.

Independent U.S.

PADD III

Major U.S.

Independent U.S.

(Year)

PADD III

Major U.S.

Independent U.S.

(Year)

PADD IV

Major U.S.

Independent U.S.

(Year)

PADD IV

Major U.S.

Independent U.S.

(Year)

PADD V

Major U.S.

Independent U.S.

(Year)

PADD V

Major U.S.

Independent U.S.

(Year)

Figure 1 Number of Refineries, Total Refining Capacity, and

Refining Capacity per Refinery for Independent U.S.

Petroleum Companies and Major U.S. Petroleum

Companies (Broken Down by Petroleum Administration

for Defense District (PADD))

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Note: This survey defines “major U.S. petroleum companies” as corporations active in the petroleum

refining and marketing business sector in the United States and which were enrolled in the

Financial Reporting System (FRS) during the period from 1974 to 1990. “Independent U.S.

petroleum refining and marketing companies” are corporations that were not enrolled in the FRS

during that period. In addition, Equilon Enterprises, LLC and Motiva Enterprises, LLC are both

included in the major U.S. petroleum companies category.

Source: Materials prepared by Mitsubishi Research Institute’s Energy & Environment Initiative based on

data from Oil & Gas Journal.

2. Classification of Business Management Performance and Growth of Six Independent

U.S. Petroleum Refining and Marketing Companies

In order to gain an accurate picture of the actual business management status of the six

independent U.S. petroleum refining and marketing companies under review, the annual reports

(SEC Form 10-K) filed by these companies and information gathered in fact-finding visits to the

United States were analyzed and the causes for growth were identified. The extent to which

each company engaged in “selection and concentration of management resources” was

examined in detail, and each was classified into growth model categories on the basis of the

combination of management tactics employed (Table 4).

Table 4 Causes for Growth of Six Companies Covered by the Survey (1996–2000)

Causes for growth

Decisive elements influencing strategy Important management tactics

TOSCO

(1) Excellent CEO (Thomas D. O’Malley)

(2) Clearly defined business plans

(3) Clearly defined management philosophy

and the ability to implement it

(4) Strategic acquisition of assets

(5) Thoroughly “Darwinist” approach to

capitalism

(6) Superior ability to raise capital

(1) Pursuit of scale

(a) Acquiring existing assets rather than

building new ones

(b) Abandoning markets where the

company cannot become one of the top

three

(2) Formulating retail strategy based on sales

zones

(3) Giving priority to short-term rather than

long-term performance

(4) Strengthening the company’s financial

strength

(a) Giving priority to maximizing EPS

(shareholder-centered approach)

(b) Employing economists to formulate

financial and investment plans

(c) Selling non-essential and unprofitable

assets in the refining business

(d) Minimizing expenses at headquarters

(only 14 headquarters employees)

Valero

Having as core, processing of residue and

sales of high value added “niche” products,

became scale-oriented through acquisition of

assets.

(1) Diversification of feedstock from almost

residue only by increasing share of heavy

sour crudes

(2) Strategic acquisition of refineries equipped

with sophisticated secondary units

(3) Participation in the retail markets of

petroleum products (since June 2000)

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Causes for growth

Decisive elements influencing strategy Important management tactics

Ultramar

Diamond

Shamrock

(1) Pursuit of both “economies of scale” and

“economies of scope” through mergers

(2) Cost cutting and selling unprofitable assets

(3) Acquisition of assets and focused capital

expenditure

(4) Decision-making capability regarding

projects aimed at increasing its own scale

(1) Geographical expansion of its markets

(West Coast , Canada, U.S. Northeast,

central Texas)

(2) Concentration of management resources in

central U.S. through acquisition of Total

Petroleum

(3) Sale of pipeline interests, closure of Alma

refinery, sale of unprofitable assets

(especially former D/S and Total)

(4) Scale-orientation through plans of joint

venture with competitors (Diamond 66, etc.,

presently a failure)

Lyondell-CITGO

Refining

Margin is assured by stable supply of crude oil

and stable sales of petroleum products are

assured.

(1) Assurance of a stable crude oil procurement

system through an agreement with

Petróleos de Venezuela S.A. (PDVSA)

(2) Assurance of a stable marketing system of

petroleum products through an agreement

with CITGO

Tesoro

(1) Moving away from “vertically integrated

operations”

(2) Strategic acquisition of refineries according

to regional and product niches

(3) Expanding the retail network

(1) Withdrawal from upstream operations and

specialization in downstream operations

(1999)

(2) Aggressive investment to improve

secondary units and purchase of a refinery

in Hawaii from BHP in order to increase

production capacity of premium products of

gasoline and middle distillates, mainly jet

fuel.

(3) Targeting Alaska, Hawaii, and the West

Coast region as its market

(4) Alliance with Wal-Mart to establish and

operate gas stations in 11 states in the

western U.S. (January 2000)

Enron

(1) Expansion of its network from the starting

point of wholesale business

(2) Business expansion based on a new

concept of “Energy Major” (moving away

from the conventional energy company

model)

(1) Knowledge intensive business model

(dependent on income from services)

(2) Online network integration (Enron Online)

(3) Realization of profits as a pioneer in

non-price-competitive businesses (working

to create new markets and deregulations in

overseas markets)

(4) Project (business segment) oriented internal

corporate organization

Source: Materials prepared by Mitsubishi Research Institute’s Energy & Environment Initiative (MIRIEEI).

By classifying the combinations of tactics chosen by the companies during the period covered

by this survey, we can say that TOSCO and Ultramar Diamond Shamrock are oriented toward a

management strategy emphasizing expansion, while Valero and Tesoro are struggling to decide

whether to pursue specialization (concentration) or expansion (Figure 2).

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Legend: EXVI: Movement away from “vertical integration” SAL: Strategic alliances OAL: Alliances with oil producing countries M: Mergers SA: Strategic asset acquisition PN: Product niches AN: Regional niches CL: Cost leadership

Bold lines indicate the tactics utilized by the company in question. Lines linking circles indicate combinations of tactics.

Tosco

Specialization (Concentration)

Expansion

Valero

Specialization (Concentration)

Expansion

Ultramar Diamond Shamrock

Specialization (Concentration)

Lyondell-Citgo Refining

Expansion

Specialization (Concentration)

Expansion

Tesoro

Specialization (Concentration)

Expansion

Source: Materials prepared by Mitsubishi Research Institute’s Energy & Environment Initiative.

Figure 2 Combinations of Strategies Selected by Five Independent

U.S. Petroleum Refining and Marketing Companies

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The petroleum industry in the United States is undergoing a process of dynamic structural

change marked by a shift from integration to disintegration (segmentation), followed by

reintegration (Figure 3).

Online Services

Vert

ical In

tegra

tion

Structural Change

Segmentation

Exploration and

Production

Refining

Transportand

Distribution

Wholesale

Retail

Disintegration

Reintegration

Commercial Investment

En

ron’s

Ne

two

rk

Outsourcing,Risk Management, etc.

Emissions

Natural Gas

Electricity

Climate

Coal

Paper and Wood Pulp

Source: Mitsubishi Research Institute

Figure 3 Characteristics of Enron’s Management Strategy

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3. Comparison of Management Strategy Models of Independent U.S. Petroleum

Refining and Marketing Companies and Anticipated Business Environment Change

Variables

A study was made on anticipated business environment variables likely to affect the

management strategies of independent U.S. petroleum refining and marketing companies in the

years ahead. Whether or not the independent U.S. petroleum refining and marketing

companies will be able to achieve sustainable growth will depend largely on whether each

company’s growth model can appropriately and strategically deal with three key business

environment variables: (1) large-scale mergers and liquidation of assets, (2) environmental

regulations, and (3) crude oil prices and margins (Figure 4). A key factor will be the direction

taken by the independent U.S. petroleum refining and marketing companies in short-term

business orientation and management strategy. This section discusses qualitatively the

possibilities of directions of each of the above-mentioned business environment variables as of

the beginning of 2001.

Source: Mitsubishi Research Institute

Effects of structural changes in the U.S. petroleum downstreammarkets

Temporary is the rapid growth during a

period of asset transfers associated with withdrawal of capital by the Major U.S. petroleum companies from U.S.

downstream sector, a process of concentration and liquidation

Sustainable growth

Slow growth/decline

Rapid growth of

independent U.S. petroleum refining

and marketing companies

Figure 4 “Sustainable Growth” by Independent U.S. Petroleum

Refining and Marketing Companies

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B. Implications

We believe that the prominent independent U.S. petroleum refining and marketing companies

examined in this survey will continue to compete in terms of cost while focusing their

management strategies on realizing economies of scale and economies of scope. However, it

is quite possible that in the process their essence will change in a dynamic way. This is

inevitable because under the principle of market competition, those companies that compete

successfully in terms of cost will remain, while those that fail will be forced to withdraw from the

market.

Figure 5 illustrates transitions in the groupings by type of U.S. petroleum companies over a

period of 20 years. It is clear that over this 20-year period the prevailing business model in the

U.S. petroleum industry has been shifting from that of vertical integration to a disintegrated or

segmented one. Nevertheless, this can also be seen as a part of longer term, continuously

dynamic process. The probability that the U.S. petroleum industry will continue to experience

repeated cycles of integration followed by disintegration (segmentation), followed by

reintegration is high. It is also quite likely that the main players in the industry 20 years from

now will be quite different in substance. Except for Lyondell-CITGO Refining, all of the

independent U.S. petroleum refining and marketing companies examined in this survey have

decision-making capabilities in place to allow for quick response to such changes.

On the other hand, an examination of the petroleum downstream markets from the viewpoint of

supply stability shows that there is room for further evaluation on the trend toward business

segmentation in the competitive market of the United States. For example, when downstream

business is unprofitable, it may be acceptable for a vertically integrated enterprise to continue to

operate downstream since the loss could be covered by the upstream profit. On the other

hand, for companies specializing in the downstream segments based on a cost leadership

strategy, such an approach may not be acceptable in some regions.

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Source: Materials prepared by Mitsubishi Research Institute based on data from Performance Profiles of Major Energy Producers 1999, published by the U.S. Energy Information Administration.

1979 1990 1999

Vertically Integrated Enterprises Vertically Integrated Enterprises

Enterprises Specializing in Upstream Operations

Enterprises Specializing in Upstream Operations

Vertically Integrated Enterprises

Enterprises Specializing in Upstream Operations

Enterprises Specializing in Petroleum Refining and Marketing

Energy Services Enterprises

Figure 5 Transition in Groupings by Type of U.S. Petroleum

Companies (Companies Enrolled in FRS)

Copyright 2001 Petroleum Energy Center. All rights reserved.