Strategic Assessment: Oil and Gas Industry
Porter’s Five Forces that Affect Profitability
BCG Model: Growth and Market Share Analysis
General Electric Model: Industry Attractiveness
Industry Cycle: ADL Model Matrix
PESTEL Model: Industry Trends Analysis
This work is a strategic assessment of the Oil and Gas industry. The aim of the assessment is to establish how attractive the industry is. Industry attractiveness is determined by profitability and growth prospects. The assessment is done from the perspective of Halliburton, Shell UK, Red Spider Technologies and Sterling Energy; companies in the industry. An analysis of the industry based on Porter’s five Forces indicates that there are many entry and exit barriers in the oil industry. The exit and entry barriers minimize the level of competition in the industry thus making it attractive. However, buyer power has been on the rise and consumer concerns have been affecting oil prices adversely.
The BCG Model analysis shows that the industry has some growth potential or prospects that can be tapped into.
An analysis of industry attractiveness based on the General Electric Model reveals that the industry remains attractive; however, individual companies in different sectors have to reassess their competitive strategies. Just like the GE Matrix, a life cycle matrix indicates the oil industry is still tenable or viable. There are companies in the maturity stage but others are still upcoming and there is potential for growth. A personal appreciation of facts is that the whole industry is in its maturity stage. At this stage, finding a niche and protecting the niche should be a key concern for strategists in most companies. Finally, the PESTEL analysis reveals that the industry fluctuates because it is heavily controlled by political players and it is highly susceptible to economic forces.
The first section of this work considers factors that affect profitability in the oil and gas industry based on Porters Five Forces Model. Considering the interplay of the five forces, the oil industry is highly attractive. The threat of substitutes is low, competitor rivalry is low, supplier power is tempered due to few major players that can buy, and there are many exit and entry barriers making a threat of new entry low. However, buyers’ bargaining powers have been on the rise.
The second section considered the growth and market share of the four companies; Halliburton, Shell UK, Red Spider Technologies and Sterling Energy. There has been a decline in the industry based on findings on Shell UK. Sterling Energy and Halliburton have recorded poor results recently but Red Spider recorded astronomical results. This is a pointer to the fact that the industry still has some growth potential but certain sectors within it are on the decline.
The last section of this work considers a PESTEL analysis of the industry. Different players and factors affect trends in the industry. However, political control and economic fluctuations are the core factors affecting operations in the industry.
This section will look into the different companies’ relative power as per Porter’s Five Forces model. A company’s competitive position is largely determined by the industry structure. Porter identified five forces that affect a company’s profitability and hence its attractiveness to the investor.
The first force that affects firms in an industry is a threat of new entry. The threat of new entrants is not a major force in the oil and gas industry. The major reason for this is that the industry is capital intensive. Highly specialized and expensive types of equipment are required in this industry. Only serious companies with a good capital base can afford to enter into the oil and gas industry. Therefore, the barriers to new entry are high despite the industry being lucrative.
The second force that determines the profitability of an industry is the threat of substitutes. There are a number of substitutes for oil and gas. Such substitutes include alternative sources of energy like coal, wind power, animal power, solar energy, nuclear energy, and hydropower. However, demand for oil and gas are very high. Therefore, although there are substitutes, oil extraction and exploration companies like Shell UK’s operations are not largely affected by substitutes. In the oil service sector, companies like Halliburton enjoy buoyant business because there is no way their services can be substituted.
Competitive rivalry in the oil and gas industry is relatively low (Bernayoun & Whittaker, 2009, p. 1). This is occasioned by the many entries and exit barriers. Companies like Shell UK and Sterling Energy have recorded very low growth in the past ten years. This is as a result of conservation efforts, prohibitive capital requirements and lack of scrap value for setups. Entry into the service sectors of the industry is made impossible by high capital requirements. Lack of high competitive rivalry makes the industry very attractive save for the entry and exit barriers.
Supplier power is limited by the fact that the major oil company players are few. Due to industry characteristics, competition is easily defeated through oligopolistic strategies. Some of the suppliers to oil companies are firms in the drilling services sector. However, due to high capital requirements involved say in supply or rigs, small companies are easily weeded out. Few competitors bolster supplier bargaining power but given buyers (oil companies) are also few, the power is neutralized.
Buyer power has been steadily increasing. Oil products are not much differentiated e.g. diesel from shell should be exactly similar to diesel from Abu Dhabi refiners. This lack of product differentiation gives buyers choose as they can get what they want from whosoever. However, industry players are organized into cartels thus controlling markets in an oligopolistic way. Buyer power is increasingly affecting the oil player’s profitability.
Figure 1.1: BCG Matrix
The BCG Model looks into industry attractiveness in terms of a firms market share and growth rate or growth prospects. The industry is divided into or the firms are categorized either as stars, dogs, question marks or cash cows. The BCG model matrix is as shown in Figure 1.1. Stars are those companies that have a high market share coupled with a high growth rate. Cash cows are companies that have a huge market share but low growth rates. Question marks are companies with high growth rates but still have a low market share. The dogs are companies in the decline i.e. they have a low market share as well as a low growth rate.
To determine the place of the oil and gas industry on the BCG Matrix, individual companies’ performance has to be considered. Shell UK is one of the largest operators in the oil industry. However, going by market capitalization, it is lower in ranking to companies like Exxon Mobil Corporation, PetroChina Company Limited, and BP p. l. c. (Shell UK, 2009). However, it has a higher market share compared to companies like Chevron, Petrobras, Encana Corporation, Total S.A. ConocoPhillips and hundreds of other companies around the world (Shell UK, 2009).
At the moment Shell’s focus is on growth and has a record growth rate of about 11% from operations in the recent past. It has over 35 new projects under assessment around the world and these projects should buoy its growth (Shell UK, 2009). The company plans to consolidate its operations by pulling out of unprofitable retail markets and investing more in quality of manufacturing.
Considering its oil reserves, shell in 2009 alone added an equivalent of 7837 million barrels to its oil reserves. The company has a "reserve replacement ratio” of over 288 % (Shell UK, 2009). The additional oil reserves are from new oil fields. The shell oil portfolio runs across all continents of the world. It has oil fields in Nigeria, Russia, Netherlands, Qatar,
Sterling Energy should be Shell’s competitor, however, it is small in size and its level competitors include companies like Heritage Oil Limited, Hunt Oil Company, and Tullow Oil plc (Sterling Energy PLC, 2010). Sterling has its operations in Africa (Cameroon, Madagascar, Mauritania and Gabon) and in the Middle East, particularly Kurdistan (Sterling Energy PLC, 2010). Sterling Energy is a relatively younger player in the industry compared to shell and has a low market share. It reported huge losses in last year’s operations (Sterling Energy PLC, 2010). Sterling Energy reported losses because the company is investing a lot in growth and a lot of restructuring is taking place.
Halliburton, a supplier in the Oil and Gas Industry, was in news headlines recently after it was awarded $500m contracts in Iraq (Halliburton, 2010). Some of Halliburton’s great competitors are Baker Hughes Incorporated and Schlumberger Limited. Going by market capitalization, Halliburton has a lower capital base than Baker Hughes but nearly twice as much as Schlumberger (Halliburton, 2010). Therefore, when it comes to market share index, Halliburton is only second to Baker and Hughes. However, buoyed by political kind of concessions in Iraq the future prospects of growth for Halliburton look promising.
Halliburton’s profits are accumulated from oilfield services (Halliburton, 2010). At the moment China and India are the most attractive countries especially as deep sea drilling becomes more possible due to stabilizing of oil prices after the economic downturn. At the moment Halliburton has contracts enabling it to drill and produces over 900 000 barrels of oil per day especially in the Middle East (Halliburton, 2010). The company
Red Spider is another supplier in the Oil and Gas Industry. Compared to Halliburton, it has a very small market share but due to well-differentiated products, it is highly profitable. As a brand, it is associated with excellence in the production of tools used in the oil and gas industry. Its strategic driver is the development of products that are customized to meet individual customer requirements. It does not produce standard goods; rather it focuses on the customized production of tools. Red Spider Technology registered an astronomical profit of 150% in 2009 (Red Spider Technology, 2010). However, the company does not have a big market share; thus it is a question mark.
Figure 1.2 Industry Attractiveness
All indicators show that despite some level of unpredictability, the industry still has some growth potential. Considering the business strengths of the different companies as described under the BCG model discussion, Shell due to its market share and growth prospects is highly attractive and has a strong business position. Red spider is still developing but it is an attractive and relatively strong company. Halliburton has a high market share and is attractive but its business position could easily be challenged. Sterling energy shows that some companies in the industry need for structurally related investment if they are to bring in some income.
ADL Matrix Model
Looking at the strengths of the four companies, shell and Halliburton have a dominant competitive position. However, they seem to be mature companies and the focus at the moment is on holding the market share rather than increasing the market share. Red Spider technologies are still a young company with great growth prospect buoyed by technology and differentiated products. The industry for it is tenable and it should consider improvements as it selectively pushes for a wider market share. Sterling Energy is relatively small and has a favourable market position. However, it is at the moment focused on consolidation i.e. identifying a niche and protecting it. The oil and gas industry, in general, is tenable but companies have to focus more on finding niches and protecting the niches.
The oil and Gas industry is highly susceptible to political and economic changes or manipulations (Hawdon, 1985, p. 7). This industry is tightly controlled by political players. The oil industry in itself is oligopolistic in nature; major players are organized into a controlling bloc i.e. OPEC. This organization regulates and lobbies for higher prices on behalf of the oil producers. There are a number of countries that dominate oil production. Any disruptions or conflicts of any sort in those countries, necessarily, translate into problems in the whole industry. Apart from OPEC countries related manipulation, the United States plays a critical role in the control of the worldwide oil and gas industry. America emerged a key player in oil due to the toll of World War I and II on Britain. Due to lowered reserves in the US, there has been continued reliance on foreign oil sources.
Oil and gas as sources of energy are the most demanded commodities all around the world. The prices of oil and gas are largely determined by geopolitical factors in oil and gas producing countries or nations. Another source of confusion in the oil market is what Yergin (2008, p. 88) calls arbitrage. This is where powerful politicians manipulate players into securing distribution contracts and then sell the same contracts at more exorbitant prices to other players. Political interference in the operation of oil and gas markets makes the industry very unattractive.
In the recent past, between 2004 and 2008, the industry flourished due to high oil and gas prices on the world market. The economic downturn that took a toll on most industries did not spare the industry. The prices of oil have plummeted leading to many oil drillers and refiners like Shell UK reducing operations. The price of oil plays a critical role in determining the performance of companies in the industry.
The prices of oil are largely determined by geopolitical interests and worldwide demand. Economic fluctuations have a direct impact on the operations of oil companies. The recent economic downturn
The oil and gas industry has continued to grow and diversify; Technology has buoyed the industry. Currently, offshore drilling is the new sector in the industry that is growing very fast. Offshore drilling has provided a new avenue or arena that was previously untapped. As companies go into offshore exploration and extraction the companies in the industry have a buoyant business. Companies that specialize in the production of equipment e.g. Red Spider Technologies, continue to innovate as to meet new market spheres and niches. Technology has greatly driven the industry through facilitating towards the identification of new avenues but also enabling utilization or exploitation of existing reserves. The industry is technology intensive because only drilling companies that promise quality work get contracts. Quality work in this industry is guaranteed by equipment designs and durability, crew competency and capacity to finance operations (Falola & Genova, 2005, p. 114).
Environmentally, the oil and gas industry is under great attacks from environmental activists. The oil and gas industry contributes in a big way to climate change. Current environment-related legislation and regulations tend to limit exploration and drilling exercises. Progressively, environmental concern and regulation is tending towards minimizing use of oil as a product (Orszulik, 1996, p.188). Environmental degradation associated with the oil and gas industry starts with the extraction process. The debate on offshore drilling has been intense because the effects of such like drilling on tectonic stability are not clear (Orszulik, 1996, p.181). Secondly, the drilling and crude petroleum transportation and refining process involves consumption of enough energy and emission of harmful gasses. The oil and gas drilling industry is associated with a lot of energy consumption, an enormous generation of waste, and more critically, emission of harmful gasses into the atmosphere.
Legal stipulations determine operations in the oil and gas industry. Energy is a field of interest for every socio-political entity (Frank, 1966, p.15). For well functioning political organizations, a policy is only supported and enforced through legislation. Legislation plays a critical role in entrenching and augmenting or cementing political interest or positions on any given issues. In the run-up to the 2008 elections in America, there was heated debate on the issue of offshore drilling. Despite the challenges or opposition to offshore drilling from a number of interest groups, the current government has instituted legislation that favours offshore drilling. Most drilling companies operate in more than one country. Each country has its own legislation on drilling and exploration activities. Unless legislation is followed, many challenges follow in terms of contract related complications (Frank, 1966, p. 65).
This paper presented an analysis of the oil and gas industry with a perspective on Shell UK, Sterling Energy, Red Spider Technologies and Halliburton. A five forces analysis of the industry shows that the industry is profitable for companies already inside. There are many exit and entry barriers making the industry attractive, especially for capital-intensive investors. The BCG model
A PESTEL analysis indicated that Due to the heavy vested interests in the oil and Gas industry, the market is often very unpredictable. However, as shown on the GE industry attractiveness Matrix, the industry still has some growth potential that can easily be tapped into by a bullish investor. It has to be a bullish investor because the industry is capital intensive and there are a lot of market manipulators that affect operations. The industry is profitable but requires high capital investment. Therefore, on a very high, medium, low and very low scale of attractiveness, this industry has medium attractiveness.
The Oil and Gas drilling industry’s life cycle, the industry is at its peak. The industry is at its peak because most oil and natural gas producers especially the OPEC countries are operating at a greater capacity than ever before. However, capacity is expected to lower due to depletion of the oil and gas reserves around the world. Many oil fields are depleting faster than has ever been imagined. Petroleum and natural gas are non-renewable sources of energy. It is estimated that the vastest oil and gas reserves, going by current consumption rates, will be depleted in the next 100 years. The oil and gas industry has reached its peak and will enjoy peak performance due to ease of oil exploration and extraction enabled by technology. However, competition and depletion of the non-renewable
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