Mgt4023 Strategic Management : Energy Assessment Answers

Provide recommendations as to how the joint venture can be improved

Answer:

Introduction:

In general sense, the energy projects tends to be bigger and more complex ones along with being risky and expensive at the same time. The companies involved in the energy sector often form joint ventures (JV) for spreading out the risk of the project and expense. Such joint ventures also take care of the provision of resources and the capabilities required coping with the factor of intricacy. However, these structures are often stated to be complex themselves and are frequently bedeviled by misalignment of strategies.

Shortcomings within the process of decision making along with in governance add to the challenge existing in operations. It has often been found that when the multi-owner structures are organized at the initial level, inadequate consideration is offered to many of the governance challenges that would rise perpetually (Hiatt, Grandy and Lee 2015). Similarly, the process of decision making is characteristically not designed in dealing effectively with more complex and multi-stakeholder issues.

The first joint venture commenced in Egypt in the year 1911, at a time when the industry of oil and gas is stated to be at its immaturity level. According to McGeown and Barthélemy (2016), the Anglo-Egyptian Oilfields Company was the marriage of two private organizations, namely the British Petroleum (BP) and the Royal Dutch Shell. This joint venture company went on to become the key player in the industry, and it played a significant responsibility for over a period of fifty years, until it got nationalized in the year 1964 as the Egyptian General petroleum Corporation (EGPC). In the years that followed, the oil and gas industry has prolonged and shifted itself from where it was, and joint ventures have contributed in a major way in that success.

Joint Ventures in Oil and Gas Industry:

Joint Ventures are generally stated to be partnerships between two organizations or between the country’s government and a company. In Egypt, all the international investors within the oil and gas industry needs to partner with the government in forming joint ventures for investigation and mining of the natural resources. In some ways, it can be stated that Egypt greatly benefits from the model of joint venture in the industry of oil and gas. However, as the world persists to suffer the consequence of low prices of oil, augmented flexibility in the model of joint venture helping Egypt in maintaining its status as one of the key players in the present market.

According to Hany Helmy, a man who is having an experience of forty years in the oil and gas industry working for BP, GUPCO, presently a private advisor, states the relationship between the international oil company (IOC) and the national oil company as nuptials (Shuen, Feiler and Teece 2014). The government and the IOC generally take up the parental role and together they produce their child: Joint venture. The most important part is the working of the company and the government at tandem for facilitating the joint venture to thrive. If one of the investor leaves the scenario, the Joint Venture gets affected, similar to the affecting of children when their parents get divorced. A change in investor has the ability in affecting the performance of the JV.

JV s are stated to be a common affair in the oil and gas industry as they have the ability in providing benefits without the economic risks of an acquisition and merger, as per the 2015 Ernst & Young report on the joint venture (Groves 2016). The exploration of the oil and gas can at times be a tad expensive and risky for a single organization or a nation to finance. A joint venture has the ability in spreading the financial burden out. The joint venture assists organizations and the countries in accessing the supplementary technology and infrastructure compulsory in fully exploring and extracting the resources. Joint Venture is stated to be the foundation of everything in the business. Helmy has exclusive experience with the structure of JV, working 12 long years for Gulf of Suez Petroleum Company (GUPCO), one of the most primitive public-private JVs existing in Egypt (Steffen 2015).

Shell- BP Joint Venture:

Shell petroleum Company that has been the subsidiary of the Royal Dutch Shell, proclaimed that the attainment of the 50 per cent shareholding in British Petroleum within Africa would offer them a bigger share in the market. At a time when Royal Dutch Shell plc first unresolved a conquest of the UK rival BP Group plc in the month of April, 2015, the barrel price of Brent crude oil was perched around the $65 mark (Gupta 2016). Shell stated that the merger would be working with the trading of oil in the mid $70s per barrel. Some months later, it was stated that the deal would be working with oil hovering in the mid-60s.

As per Reddy and Xie (2017), Shell and British Petroleum have been administering a joint venture partnership, sharing assets on the downstream behaviors of the commercial oil marketing manufacturing. The two companies jointly own the Kenya Petroleum Refineries. This approval takes into account the commencement of fresh and exhilarating chapter for Shell within Kenya. For the very first time in decades, the companies in Joint Venture would be operating under the brand name of Shell.

As per Yemen et al. (2017), BP publicized its decision in bailing out from the Kenyan market in mid 2005, mentioning lower returns on the distribution and sale of the oil products in Kenya, opening the tenders to the interested bidders in London. This negotiation lasted around a year with BP operating as a joint venture partner of Shell, though it has emerged as one of the dominant players in the market (Bairi, Murali Manohar and Kundu 2013). On previous occasions, Shell owned 50 per cent stake in BP. The agreement for purchase did not affect the BP employees, having operating within the same premises as used by their rivals Shell. The main priority of theirs is to work with the government, the staffs and the partner of joint venture in ensuring a smooth evolution. Kenya’s monopoly laws do not recognize a solitary player in controlling 50 per cent of the market share.

Motivation factor for Shell-BP JV:

The main motivation for Shell in going for the joint venture with BP Group is to reduce its cost of operations from $46 million in the year 2015 to $40 million in 2016 (Shuen, Feiler and Teece 2014). These reductions in cost are anticipated to result in big savings, directly adding to the free cash flow of the organization. For Shell-BP JV, the synergies of operation are expected in spreading around the four key areas; selling, general and administrative (or SG&A) expenses, procurement, shipping and marketing, and examination. The joint venture entity’s superimposes certain operational areas that are expected to result in practices and assets contributing towards the savings of cost. It is imperative to find that 40 per cent of the operating cost of company would be in expenditures of staffs with Shell planning to right size the strength of employees, expecting a benefit merger of Shell-BP (Thomas et al. 2016). The focus would be on production of the assets. The main aim would be in limiting activities of exploration where considerable discoveries can be prepared with reasonably lower expenditure.

Joint venture in energy sector, its challenges and benefits:

There would be certain challenges for Shell with Wood Mac identifying the few ‘key success factors’ for the amalgamation to work. This takes into account the distended organization able to exploit the synergies in cost, particularly within BP’s LNG and Shell exploring operations. It also needs to improve on the defense of its leadership of LNG through finding of new sources of demand and supply. Temporarily, it would be up to Shell in motivating the momentum in the oil and gas industry of Brazil as the country’s incompletely state-owned oil company Petroleo Brasilero S.A. slashing its investment seeking in selling $14 billion of the assets for dealing with the massive debt lumber.

The only question that exists is whether the merger will work. As per Shuen, Feiler and Teece 2014, the fact lingers that Shell would be taking in a big bet on the price of the oil per barrel at $50 over the period of next couple of years. However, it might be a good reason in thinking that the oil would indeed be getting back to the level. After all, the employees of the firm are stated to be smart enough whose main business is in looking ahead in order to practice for the future.

Shell agreed in joint venturing the BP Group is stated to be significant mainly for the UK pension savers. Before the joint venture took place, Shell accounted for around 10 per cent of the UK related dividend proceeds. The acquiring of their rival BP would be augmenting this atleast by 1 per cent. Shell would be digging in on the collection of probable riskier assets. The shares of BP have started falling nearly by a third within the last year as the company has been experiencing certain troubled projects in Brazil and costs connected with the commencement of a fresh liquefied Natural Gas (LNG) project within Australia on the factor of shares (Ghandi and Lin 2014).

Shell is experiencing lot of risks in issuing shares and in the process of paying out cash to the shareholders of BP. A result of this would be the stretching of their balance sheet that would be putting in some strain on the dividend. This would result in redirecting of the cash flows in paying down the liability ahead of increasing the dividend. The company highlighted on the dividend of the previous year that would be remaining unchanged, but for the UK pension shareholders, awareness is required on the 17 per cent of UK FTSE All Share income correlated to oil and gas.

According to Mitchell and Mitchell (2014), the JV of BP and Shell is generally seen as the strategically elegant and favorable move, but with the oil prices staying lower for a longer period of time, it would be good news for the consumers of UK. However, it could put pressure on the dividends of UK and be unfavorable to the pension investors of UK. The acquisition of the BP by Shell took place for two key reasons. The first being, although BP and Shell some of the first-class assets, it has been struggling in developing them in the smooth fashion in the recent years. Shell comprises of a broader expertise pool and considerably greater contact to the capital of investment. Secondly, this offers Shell an existence in the productive zone off the Brazilian coast , ensuring that the own production of Shell is preserved over the medium phrase, taking away the need in making bigger discoveries to counterbalance natural depletion (Graham 2017).

Slamming of Shell BP Group Merger:

The immense thrust in the prices of crude oil has been seen as the increasing trend of activities in joint venture in the sector of oil and gas. The lesser prices of crude oil poses a perfect time for the energy companies for undertaking the investments at much cheaper rates, waiting for the prices to increase again. The deal between the two organizations is mainly based on the positive assumptions over the market of LNG and the partnership of BP with the state-administered oil company of Brazil, Petroleo Brasileiro Petrobas SA. It is generally believed that that the future market of LNG is not intense as it was expected to be. The LNG market faces disequilibrium with the inequality in supply and demand. Within the last three years, the demand for LNG has fallen flat, though there remains an expectation that the supply of LNG would be boosted in near future. Experts have suggested this merger to be a disaster (McGeown and Barthélemy 2016).

In the recent scenario, Petrobas experienced the largest scandal of corruption within Brazil. BP was having a minority pledge in the Rio de Janeiro based organization (Grant 2013). Industry experts have expressed their doubts regarding the production forecast of Shell from their collective entity in Brazil. As per Shell, with merger their motive was manufacturing around 550,000 barrels of oil corresponding per day for the period of next ten years, which is stated to be four times as high as the present production of Shell (Akpanvan 2016). Shell stated that their joining with the BP Group is more for boosting their gas potential. However, in July 2016, Shell stated that the global industry issues and stricter purse filaments led to its delay in making a final investment decision.

Recommendation:

Shell’s combination with BP can be improved through enhancement of free cash flow. The addition of the portfolio growth of BP, especially from Australia and Brazil, amalgamated with the synergies of pre-tax of $3.5 billion should be able to enhance the free cash flow of Shell. This augments the dividend potential of Shell in any sensibly predictable environment of oil price. Shell has been a leading player in the global LNG and deep water. The amalgamation with the BP balances the strategy of Shell in growing these themes. There is an expectation of the combination to hasten and de-risk the strategy.

The joint venture between Shell and BP symbolizes a marvelous opportunity in creating a value for both the company’s shareholders, especially in the LNG and deep water. The amalgamation with BP should be having a stronger platform in refocusing the company, in creating a simpler and more spirited Shell. The main aim should be in reducing costs, capital spending and continuing in making the influential decisions on options and portfolio.

Conclusion:

It can be concluded that the industry of energy is the king of joint ventures. There is existence of two driving forces behind this incident. In the first instance, exploration of energy and production is stated to be expensive. Smaller firms cannot simply pay for the development of the resources they have exposed. Exploration of energy is a risky business, joint ventures would be great for the spreading of the risk, just as Shell did with the merger of BP. Shell’s motivation in merging with BP is for mitigation of risk, increasing flexibility in generating fresh prospects and preserving the flow of cash for the improvement of projects.

References:

Akpanvan, E.N., 2016. Creation of Value for Matured Companies Through Mergers and Acquisitions: A Review of Literature. Browser Download This Paper.

Bairi, J., Murali Manohar, B. and Kundu, G.K., 2013. Knowledge acquisition by outsourced service providers from aging workforce of oil and gas industry: A study. VINE, 43(1), pp.39-56.

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Ghandi, A. and Lin, C.Y.C., 2014. Oil and gas service contracts around the world: a review. Energy Strategy Reviews, 3, pp.63-71.

Graham, C., 2017. The future is not what it used to be: oil and gas strategies for a carbon-conscious world. The APPEA Journal, 57(2), pp.459-461.

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Groves, C., 2016. An Analysis of the Drivers of Exploration and Production Restructuring.

Gupta, K., 2016. Oil price shocks, competition, and oil & gas stock returns—Global evidence. Energy Economics, 57, pp.140-153.

Hiatt, S.R., Grandy, J.B. and Lee, B.H., 2015. Organizational responses to public and private politics: An analysis of climate change activists and US oil and gas firms. Organization Science, 26(6), pp.1769-1786.

McGeown, P. and Barthélemy, A., 2016. Recent Developments in EU Merger Control. Journal of European Competition Law & Practice, 7(8), pp.549-565.

Mitchell, J.V. and Mitchell, B., 2014. Structural crisis in the oil and gas industry. Energy Policy, 64, pp.36-42.

Reddy, K.S. and Xie, E., 2017. Cross-border mergers and acquisitions by oil and gas multinational enterprises: Geography-based view of energy strategy. Renewable and Sustainable Energy Reviews, 72, pp.961-980.

Shuen, A., Feiler, P.F. and Teece, D.J., 2014. Dynamic capabilities in the upstream oil and gas sector: Managing next generation competition. Energy Strategy Reviews, 3, pp.5-13.

Steffen, B.J., 2015. Use of MAC Clauses to Mitigate and Litigate Acquisition Risk. American Bankruptcy Institute Journal, 34(6), p.24.

Thomas, M., Thomas, M., Cardot, R. and Cardot, R., 2016. The latest boom in mergers and acquisitions. Should we be worried?. Strategic Direction, 32(6), pp.2-4.

Yemen, G., Yemen, G., Lenox, M., Lenox, M., Harris, J.D., Harris, J.D., Lenox, M., Lenox, M., Harris, J.D., Harris, J.D. and Yemen, G., 2017. BP: Beyond Petroleum. Darden Business Publishing Cases, pp.1-16.