Gas Price Surge Making BP Deals Look Smart
BP, the giant British oil company, still was digesting its purchase of Amoco Corp. two years ago when it agreed to buy Atlantic Richfield Co., the California gasoline powerhouse based in Los Angeles.
Mergers were widespread in the oil patch at the time, as the commodity’s sinking price prompted energy executives to pursue alliances to make up for lost profit. Crude oil was $11 a barrel; self-serve regular gasoline about $1.20 a gallon. And wags suggested that BP, in picking out its takeover targets, merely was going through the alphabet.
No one’s joking now. In light of the surge in oil and gasoline prices since then, BP’s acquisitions and expansion in the huge U.S. market--including its $33-billion buyout of Arco--are looking like masterstrokes of timing.
Crude today sells for nearly $30 a barrel, and regular gasoline tops $2 a gallon in many parts of California and around the country--except, most likely, at your local Arco station.
Arco remains the Wal-Mart of gasoline retailers--undercutting its rivals on price and making it up on volume. That strategy barely has changed in the year the company has been owned by BP, formerly British Petroleum.
In fact, the most notable action BP has taken at Arco, at least in terms of the consumer market, is that it has taken very little action at all. To be sure, BP has lived up to its reputation as a ruthless cost cutter and has slashed personnel and overhead costs. But for California drivers, the local Arco station is little changed under its new owners.
That’s not entirely surprising, because BP, to get the Arco buyout approved, “tried to give the regulators in California some assurance that it wasn’t going to change things with respect to branding and low pricing,” said Christopher Stavros, an analyst with UBS Warburg in New York.
When the BP-Arco merger was announced, one of its most vocal critics was California Atty. Gen. Bill Lockyer, who joined the Federal Trade Commission and others in protesting the combined companies’ domination of oil production in Alaska’s North Slope. BP settled those concerns by selling Arco’s oil and natural gas holdings in Alaska to Phillips Petroleum Co. for $7 billion.
Lockyer still is concerned that there’s too much concentration among the major oil companies for gasoline sales in California but he isn’t placing a particular focus on BP at the moment, a Lockyer spokeswoman said.
For its part, a year after closing the deal, BP says it is not about to fix something that isn’t broken. Arco continues to lead the California market with about 21% of the gasoline sold--and nearly 29% in Southern California.
That’s bad news for many of the state’s other service stations, which are struggling to pass on the rising prices of wholesale gasoline to their customers.
“We remain and will continue to remain a price setter,” BP Chief Executive Sir John Browne said in an interview last week after the company officially put its logo on its Western headquarters in Los Angeles. “This is the distinctive part of the Arco brand.”
BP has been reluctant to tinker with Arco’s formula in the face of the sharp run-up in gasoline prices. That spike in prices, which has forced motorists to grow accustomed to paying $2 or more a gallon, might have given BP the leeway to narrow the discount between Arco and its rivals--typically 3 cents to 5 cents a gallon--to widen BP’s skimpy profit margin at the pump.
Profits Shrinking at Service Stations
BP--like California rivals Chevron Corp. and Tosco Corp., which sells the 76 brand--is making a fatter profit from its refinery operations because of the surge in wholesale gasoline prices.
That is, there’s a big spread between the wholesale price of gas and the price of crude oil used to make it. BP acquired two refineries, including a massive one in Carson, in the Arco deal.
Wholesale prices are high because gasoline supplies are relatively low, even though the refineries are operating at near full capacity. And drivers’ demand for gas remains strong despite $2-plus prices.
But oil companies are having a tougher time earning more money at the retail level because gas station dealers--Arco’s included--are reluctant to keep hiking their prices when so many stations are competing for motorists’ dollars.
Indeed, gains in refining and natural gas helped BP’s first-quarter profit soar 52% from a year earlier, to $4.1 billion. Although BP doesn’t break out Arco’s performance, Browne conceded that there is “pressure on marketing margins.” That means BP isn’t making a whopping profit at the pump.
“Whenever you have a rapid run-up in gasoline prices at the wholesale level, it’s always difficult to pass that through” to motorists who can take their business to other stations nearby, said Stephen A. Smith, an analyst with the investment firm Dain Rauscher Wessels.
UBS’ Stavros goes one step further. “I would argue that for most of this year, it hasn’t been very profitable at all,” he said, referring to the Arco system. The brand is maintaining its push for higher volume sales, he added, “but at the expense of price and probably its profit margins.”
BP, however, asserts that Arco still is generating steady earnings even at the pump.
“We have no reason to change” Arco’s cheaper-price profile, said Bob Malone, who runs BP’s Western U.S. operations from Los Angeles. “The reason we were interested in Arco is because they were, in our minds, the best refiners and had the greatest retail strategy” in its market, he said.
That also includes not tampering with the Arco logo or color scheme at its 1,800 service stations--900 of them in Southern California--in favor of BP’s green, yellow and white. It’s one thing to slap the BP logo on its headquarters building, and quite another to erase the long-standing Arco brand from the California landscape.
“There were a lot of rumors on the street that that was going to occur,” Malone said. He said BP currently has no such plans, but he also said that “we never say never” and noted that the company’s Amoco stations east of the Rockies are getting BP’s colors.
“We’re going to learn a lot as we change the Amoco stations to BP,” he said. Translation: If those stations do well, Arco’s look may get a face lift in the years to come.
Or maybe not, analyst Stavros said. Mass merchandisers--Wal-Mart, Costco and others--are starting to sell low-priced gasoline at their stores, taking dead aim at Arco’s niche, so revamping Arco’s look and market strategy might not be smart, he said.
“Why should you tinker with your business model, and potentially disrupt things to a detriment, especially when other competitors are coming to your market?” he said.
Being very careful about changing Arco’s branding “is a smart move” on BP’s part, given Arco’s double-digit lead in market share in Southern California, said Vivian Burnett, who heads Burnett & Associates, a Tulsa, Okla., firm that tracks the industry.
That’s not lost on BP’s Malone, who ran Alyeska Pipeline Service Co., operator of the 800-mile trans-Alaska oil pipeline, before being named to his current post last year.
Even though the big oil producers have been merging, the survivors’ gas stations are still on the corners of most cities’ major intersections, along with new entrants such as Costco, he said. “So even though there’s been consolidation in the industry, what we now see is a number of [retail] players that didn’t exist two or three years ago.”
BP’s Arco dealers mostly echo those sentiments. Many say it would be imprudent to change the company’s strategy, said Will Woods, executive director of the Automotive Trade Organizations of California, a Tustin-based group that represents gasoline dealers.
“It doesn’t take a rocket scientist to see that that would not be a smart move,” especially because it’s likely that “only two or three of every 100 Arco customers” know that BP owns the company, he added.
But some dealers disagree.
“I look forward to the re-branding of the stations to BP and access to a credit card base” of customers, said Charles Mulcahy, who has owned an Arco station in Wilmington for 20 years. “People like the convenience of a credit card.”
Mulcahy said BP hasn’t made major changes to his operations, but he complained about some minor ones. He said BP now charges him for replacing the lights on his Arco signs and for the Arco stickers he places on his pumps--expenses that total several hundred dollars and that the old Arco provided for free.
BP has hardly been idle with Arco. It has made major changes that aren’t readily apparent to consumers, who pump an average 230,000 gallons a month at each of its stations--nearly double the industry’s average in California.
BP has slashed Arco’s former corporate work force (about 2,500 were laid off), eliminated dozens of management layers, closed redundant offices and otherwise pared Arco’s operating costs. (The Western region that Malone oversees accounts for about half of BP’s overall U.S. operations, which employ 45,000 people.)
Arco’s Assets Give BP West Coast Clout
At the time of the Arco deal, BP predicted that it would wring out $1 billion in costs by combining the two companies, and “we’re absolutely on target--in fact, we’ll be exceeding that goal,” Malone said.
Simultaneously, BP has brought its vast resources and global experience to the exploration, production and refining assets it acquired from both Arco and Amoco. Thanks to those acquisitions, BP has become not only the country’s biggest marketer of gasoline but also its biggest producer of crude oil and natural gas.
Arco’s operations around the globe, stretching from Indonesia and China to the Gulf of Mexico, also have enhanced the reach of BP, which a decade ago was considered a lackluster oil concern. Today, though, BP is considered one of Big Oil’s three “super-majors,” along with Exxon Mobil Corp. and Royal Dutch/Shell Group.
But it’s Arco’s Western U.S. assets that make BP such a powerful force in California.
One of the main reasons Arco can charge lower prices is because BP is truly an “integrated” oil company in the West, and thus is exceptionally efficient. It produces its own oil in Alaska, ships the oil to its own refineries in California and trucks the refined gasoline to its own service stations (or those run by its independent dealers).
Second, Arco long ago stopped issuing credit cards (though it does accept bank ATM cards), and that lowers its financial processing costs by about 3 to 4 cents a gallon. But Arco’s market share shows that its customers are willing to forgo the convenience of credit cards for cheaper gas.
BP’s expansion in the West hasn’t been without controversy. Sen. Ron Wyden (D-Ore.) held a hearing last month to review allegations that BP had manipulated oil prices on the West Coast by imposing unfair wholesale distribution policies and exporting Alaska crude to Asia to tighten West Coast supplies. BP denied any wrongdoing, but Wyden’s office said he continues to investigate the matter.
Meanwhile, the Federal Trade Commission this month said it found no evidence of West Coast pricing collusion among the major oil refiners. The agency’s investigation of possible antitrust violations was launched three years ago amid complaints about widely varying gasoline prices in different parts of California.
For all its emphasis on bare-bones management and cost cutting, BP is trying to be a giving corporate citizen in California--knowing full well that civic boosters bemoaned the loss of Arco’s philanthropic role when the company was bought.
BP vowed to give $10 million a year to various causes and research groups for 10 years, Malone said, and that figure could be as much as $15 million for the first year.
But would that level of philanthropy change if, say, crude oil prices suddenly nose-dived as they did two years ago? No, Malone said, because Arco has proved that it can turn a profit no matter where crude prices go.
“We’ve been as low as $9 a barrel and as high as $34 a barrel,” he said, “and the strategy has held true.”
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Gasoline Giants
A year after buying Atlantic Richfield, British oil company BP has made few changes to the low-price strategy that has made Arco the state’s top gasoline retailer. Here are the major suppliers in Southern California in terms of gallons sold:
Percentage of total gasoline Company sold in Southern California*
BP (Arco): 28.9%
Chevron: 18.6
Equilon (Shell-Texaco venture): 15.2
Exxon Mobil: 15.0
Tosco (76 brand): 14.5
Others: 7.8
* Includes Los Angeles, Orange, Ventura, Riverside and San Bernardino counties.
Sources: Burnett & Associates
