Bp and Consolidation of Oil Industry 1998-2002 Case Study

BP and the Consolidation of the Oil Industry, 1998-2002 – Case study

Why are big oil companies vertically integrated?

In oil and gas industry, the market is generally characterized by features of small number of buyers and sellers, frequent transactions, and high asset specificity and intensity. On top of the market, risk management, continuous growth of the companies, and regional restrictions were also playing parts on decisions making regarding to vertical integration. Combined with the BP case, serval issues were identified in the case which demonstrated some of the drivers of vertical integration in major oil companies;

• Unstable relationships between oil firms - This is likely the most important driver of vertical integration.

The limited amount of buyers and sellers in oil industry created a scenario of bilateral oligopolies. Under this market relation, surplus was determined by the collective economics among the players which had problems of complex coordination. As results of the anti-trust law, particularly in oil industry, the horizontal mergers were tightly regulated by authorities. Oil companies merge vertically to reduce players and have a better chance to behave rationally.

• Frequent transaction – Vertical integration is one of the means to address some of the difficulties in transportation and reduce transaction cost.
• Weaken capital stock at the turn of the century spun out a few independents which left the big oil companies vulnerable to exploitation by suppliers or customers.

There are also a few of “to-achieves”;

• To break through the geographical limitation – Vertically integration helped the company overcome regional restrictions.
• To lift the barrier for entry
• To apply price discrimination against competitors by controlling the entire supply chain
• To expand the scope of operation – The development of upstream/downstream chains will take a lot of capital and time while the industry was growing fast.
• To position itself better while negotiating with governments as they prefer to deal with big companies which have means to follow through with commitment rather than a single capacity company.
• To manage the supply chain in order to reach more areas which are potentially profitable.

• To diversify portfolios to hedge against risk – For example, upstream integration assists to maintain the inventory and recoverable reserves

Big oil companies recognized the limitation in their resources and capacities during the operation. However, the soaring demand of oil and lucrative market urged companies to react quickly. One of the quickest way to solve these problems was via vertical integration. The oil companies acquired certain assets to complement their shortfalls thus expanding the companies towards the market needs.

How favourable were the economics of the oil and gas industry before the BP-Amoco merger? What were the effects of the recent mergers on industry structure and on BP’s profitability?