exxonmobil merger - carlos gonzalez

Horizontal Mergers:

Exxon/Mobil

2014

INDUSTRIAL ORGANIZATION CARLOS GONZLEZ

UNIVERSIDAD AUTNOMA DE MADRID |

Horizontal Mergers: Exxon/Mobil 1

Universidad Autnoma de Madrid

Facultad de Ciencias Econmicas y Empresariales

International Economy

Industrial Organization

Ciudad Universitaria de Cantoblanco, 28049 Madrid

http://www.uam.es/ss/Satellite/Economicas/es/home

[email protected]

2 Horizontal Mergers: Exxon/Mobil

1. Index Abstract ............................................................................................................................ 3

1. Introduction............................................................................................................... 4

2. Background ................................................................................................................ 6

3. The Merger ................................................................................................................ 9

4. Economic Implications ............................................................................................ 13

5. Results of the Union ................................................................................................ 22

6. Conclusion ............................................................................................................... 24

References ...................................................................................................................... 25

Appendix ......................................................................................................................... 27


Abstract

Regarding the market system, economic theory has designed how the general

framework should be structured seeking the best welfare outcome possible. For this,

the goal is to reach conditions of competition aiming to yield the lowest cost possible

for individuals and profitable operations for firms. However, theory needs few controls

and real life demand much attention in how markets develop themselves. One of this

issues is the power concentration of firms that can be attained by business operations

as the mergers, which tends to eliminate players from the market and to gather power

in less firms. Then, authorities own a set of rules put in place in order to avoid negative

market shares by evaluating the economic implications of such operations. In the

following document we approach how merger are assessed by EU and US authorities

taking as a case study, one of the most important companies unions as it was the Exxon-

Mobil merger in the oil and gas industry. Is it right to allow raises in market power of

such important sector? How do we measure the global impact? How authorities

proceed? Are some of the question to be answered in this work.


1. Introduction

Aiming to achieve several economic goals, firms rely in broad strategic and operational

options like competing with prices or developing differentiation assets looking to get the

most from the market. Another set of tactics have been widely used as it is mergers &

acquisitions which encompasses a large series of factors but basically focused on the

union of two or more firms in order to gain financial, operational or strategic

advantages.

Several good things are brought with these unions where firms can obtain new

industrial capacities, additional brands, complementary assets, larger market shares,

technology, human resources as well as adding another element in the supply chain or

even removing one competitor from the field. So, it seems obvious that these actions

are valid plays for companies but consumers may be harmed by mergers especially if

those are among competitors, which are defined as horizontal mergers while unions

upstream or downstream in line for producing the same product are known as vertical

mergers.

One of the main issues with horizontal mergers (HM) is that players increase their

market power and their capacity of charging higher prices to consumers as they

approach to a less competitive field. Then, as consumers welfare may get affected the

economic analysis has stated that regulations on this may be applied in order to

guarantee a kinder environment for markets. However, HM are not always harmful as

they can develop efficiency gains with no price impact and bringing positive results to

most players. Moreover, there are mergers in low concentration markets that does not

impact consumers or even cases where the outcome of rising the market concentration

is better than leaving a company to fail by applying a sort of rescue.

Therefore, as the conditions and variables may broadly vary authorities have been

entitled to establish rules for measuring the impact of such strategy with the power of

ruling out any of them impacting in negative way the market configuration. In this work

we will address a practical and real merger case for understanding its economic

implications as well as the methodology usually applied by regulators in order to

evaluate its possible effects and how to proceed for the best outcome possible.

In the past 3 decades mergers have been a very common business practice and some of

them have lead all business news because of its large implications in media, competitors,

economist regulators and of course consumers. In Europe, for instance, 5.486 mergers

notification have been received by the EU regulator and 97% of them have been

approved.


Source: (European Comission, 2014)

Looking at the high approval rate shown in the chart, we can assume that efficiency gains

have been expected in each of the approved cases or in contrary no consumers welfare

lose has been verified. In United States the merger tendency is pretty similar, in fact due

to the large yield of multinationalization a great part of the most important mergers

have been executed within this 2 regions, or even with influence in most continents

The oil industry is also one of the most important and strategic in the world, the volume

of its operations represents the largest single commodity globally traded, playing a main

role in most business competitive strategies. Reviewing sectorial figures we find that

53% percent of oil traded volume is done between 2 or more countries, accounting for

10% of world merchandise commercial exchange.

Source: (International Trade Centre, 2014)

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Notifications Case withdrawn - Phase 2 Case withdrawn - Phase 2 % approval

Figure 1: UE merger statistics 1990-2014 (Two scale chart: # of merger and % of approval)

- 500 1,000 1,500 2,000 2,500 3,000 3,500

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MillionsMineral fuels, oils, distillation products, etc Electrical, electronic equipment

Machinery, nuclear reactors, boilers, etc Vehicles other than railway, tramway

Pearls, precious stones, metals, coins, etc Plastics and articles thereof

Figure 2: Top world exported products by value - 2009-2012 (Millions of USD)


Such relevance and development has engine several interesting merger strategies as the

one were going to analyze in this research. One of the most important mergers in the

world occurred in 1998 when Exxon and Mobil got together, constituting the sixth major

worldwide merger in terms of transaction value.

The union of these giants, not only had economic implications regarding the effects of

mergers, but in many other elements of the market system. Given that both companies

participated in wide range of operations relating the energy industry and in different

regions, the evaluation of the business agreement becomes very complex, and for this

reason were going to concentrate the analysis just in the horizontal merger implications

in global terms.

The idea is to review few historic aspects of the industry, to study in general terms each

one of the companies before the merger, contextualize the conditions under which the

union was held and the economic implications resulting from this process. We will also

evaluate the EU commission analysis and what is the methodology they use for

addressing this sort of entrepreneurial decisions, including what should have been the

outcome of the Herfindahl-Hirschman Index.

Thus, we aim to present a practical work giving a quick understanding of the economic

scenario together with the aspects affecting the market conditions and a clear

description of how authorities proceed in order to guarantee the balance between

producers and consumers. In this sense the document is divided in for main sections:

we make a Background review (2) before going into the details and conditions of the

Merger (3), after this we will join the Economic implications (4) appraisal for finally

summarize the business, institutional and economic Results (5).

2. Background

In the first part of this section wed like to comment in few lines how the industry was

created and where the big oil firms come from.

The creation of an oiled world.

Samuel Kier, the so called Grandfather of the Oil Industry in America developed a

medicine named Kiers Rock Oil sold around 1849 for 50 cents the bottle. (Mann, 2009).

Then, in 1853 Francis Brewer took a sample of Rock Oil, from Oil creek to the chemical

department of his university Dartmouth College where George Bissell, another fellow

student, in a visit to the school crossed by a sample of this liquid and send it to the

University of Yale. Professor Benjamin Silliman suggested that the Kier Rock Oil could be


distilled to produce kerosene. Bissell end it up buying some acres in the area and

organized the first company of oil called the Pennsylvania Rock Oil & Co in 1854.

Bissell was the first one to envisioned profit for selling the kerosene for lighting,

(Stephen Land - The History Channel, 2010) but he needed funding for guaranteeing

supply which required, according to his project, to drill the ground and obtain more

quantity of the black oil. As usually happens no much people believed in this kind of

ideas, but he persisted hiring his future partner Edwin Drake a former railroad conductor

to drill his oil field. Drake was sent to Titusville working for the former Penn Rock Oil &

Co, now Seneca Oil Co, where after several failure attempts Drake brought a Kiers Rock

Oil employee William Uncle Billy Smith who finally pumped the first oil well in 1859.

(Mann, 2009)

In parallel Kier also went to the University of Pennsylvania in Philadelphia and professor

Curtis Booth recommended to distil the oil and produce illuminant to compete with

whale oil for lighting lamps. His cheaper product, made in a tiny adapted whisky

distillery, was now called carbon oil and with his previous selling experience, he obtained

increasing acceptance of his special lamp with oil rock illuminant (which came with a

special lamp) driving these to the first sales of oil as energy source in America. Another

pioneer, Charles Lockhart who in 1961 built the first commercial scale oil refinery,

produced 250 barrels a day making the starting point in the industry and the birth of a

new economy to come. (Mann, 2009)

While before Kier, Drake and Lockhart were working in USA, in the other side of the

ocean, Ignacy Lukasiewicz using Dr. Abraham Gesner techniques also produced

kerosene in 1853 from wells in Poland and in Romania 4 years later where they built

their first distillery which product was used in public lamps of Bucharest. (LESCAROUX &

RECH, 2013)

Nevertheless, the big guy of the oil industry was still to come a 23 years old born in the

state of New York, whose first work was as bookkeeping and has the name of John

Davidson Rockefeller. (Chernow, 1998). It was in 1862 when he first arrived to Titusville

and soon he founded in Cleveland, Ohio a small refinery where they improved the

method using sulfuric acid for avoiding the lamps to smoke. They soon founded the

Standard Oil Company of Ohio with a value of 1.000.000 USD grouping two refineries

and a distribution company altogether managed just 10% of Cleveland total refining

capacity.

By 1877 Standard Oil controlled more than 90% of the oil refineries in US and in 1900

between 80-90% of the transportation and distribution business, keeping relatively

cheap prices between 0.7$ and 1$/bbl. (LESCAROUX & RECH, 2013) (Popove, 2010). It

was a growing but still reduced industry in the United Stated by that time. Expansion to

other countries became a reality selling oil to Europe, Latin America, South Africa and


China. With almost no competition in the sector, the industry encountered one

competitor from another side; a huge one.

The energy consumption in United Stated started a change in sources configuration,

from 1775 to 1850 the only important energy source was exclusively wood, giving the

throne to coal which became by far the main energy source with an impressive growth

given the extensive use for heating, railroads and at the end of the 19th century for

electricity; finally a nascent oil and electrical power source made their appearance in the

scheme.

Leading the young oil industry still new with not much regulations, Rockefeller gained

many enemies in his way. The first setback was the application of the Sherman Antitrust

Act (Late 19th century) that prohibited any king of conglomerate organization which

restricted the free trade within the United States. (United States History, 2014),

favorably Standard Oil didnt receive much consequences with this one. In 1901

President Roosevelt ordered an investigation which forced the dissolution of the

Standard Oil trust by an Us Supreme Court decision.

Thirty four independent companies resulted from this division some of them became

big player in the business initially called Standard Oil of New Jersey, Standard Oil of New

York and Standard Oil of California became later on Exxon, Mobil and Chevron

respectively. At this point Rockefeller was in the center of the stage, and became a target

for newspaper researchers, an undesirable issue.

In Europe Industry was developing at the same time but in a different rhythm. One of

the first companies related with petroleum was the Shell Transport from England,

initially dedicated to standard shipping and then in oil transporter. They were importing

the product from Borneo, Russia and Japan and were the first to use the Suez Canal for

oil transportation giving them and special advantage against the big American regarding

the Asian market; Rockefeller made an offer for buying the company but it was rejected.

Shell made also an agreement with Dutch Royal Petroleum Company setting operations

in Netherlands, Russia and the region of Azerbaijan which converted the company in the

provider of 75% of the oil outside US. Another important company in Europe was

Branobel in the Caucasus region, that later disappeared after the Russian Revolution

intervention.

By 1938 the United States produced 21 trillion barrels of oil (4.900 quadrillions of Btu

Erreur ! Source du renvoi introuvable. scale) times more than the Soviet Union (the first

producer by 1900) and 64% of worlds oil consumption. In spite of this amazing growth,

coal was still the first energy source in the United State, at this point supported by the

use in electrical generation; also huge spreading technology. Around 1950 the lines of

oil and coal crossed each others (Figure 3) leaving the black liquid to go way higher over

the black solid. Between 1900 and 1920 Samuel J. Schurr and Bruce Netschert calculated


that total energy consumption in United States registered an amazing growth of 123%

(A, 2004)

Source: (Etemad & Luciani, 2014)

From 1940, when oil exceeded coal as main energy source the industry became a huge

global market controlled by few companies all of them coming from the powerful

economies of that time (Great Britain, France and United States). In fact, just 7

companies in the world were managing a great part of world economy The Seven Sisters:

The Anglo-Persian Oil Company (eventually BP), Gulf Oil, Standard Oil of California

(SoCal), Texaco (Chevron), Royal Dutch Shell, Standard Oil of New Jersey (Esso, then

Exxon) and Standard Oil Company of New York (Socony, then Mobil) all of them

signatories of the Red Line Agreement (US Department of State, 2014) stating that none

of them will pursue oil interest on the Middle East for not fighting for a market

advantage between themselves risking the loose their position, and this represented the

first cartel of oil also known as the The Consortium of Iran; the controlled 85% of world

oil reserves.

Since then all major sisters were involved in the oil huge business but the power

distribution started to have different configuration after the 90s.

3. The Merger

Oil industry mergers.

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Figure 3: Estimation of world primary energy production 1900-1980 (TWh)


High merger activities was experienced from 1994 reflecting technological changes,

globalized markets, transformation of the form and means for competing and a more

dynamic financial market. The oil intensified each year its strategic factor for the

development of nations, in consequence huge efforts brought: new discovered reserves,

innovative processes along the supply chain, cost reduction of information, raise of

intermediate markets, entry barriers weakening bringing specialized emerging firms to

the field, an increasing activity on financial instruments in spot, forward and futures,

price fluctuations and the fear for another price shocks fueled the creation of new

market strategies.

Major horizontal merger started during 1998 beginning with the announcement of the

union between BP and Amoco that projected $2 billion of savings. Seeking to improve

cost efficiency the Exxon-Mobil merger followed as the second one of the year which

concluded with a third one between the French Total acquiring the Belgian PetroFina. It

didnt stop, this last merger Total-Fina win a hostile bid in 1999 getting Elf Aquitaine

which led them to become the fourth largest oil company. Then, on the same year BP-

Amanco also bought Arco with the some remedies required by the US regulator, which

in 2000 denied a merger between Chevron and Texaco that resulted after in a takeover.

It wasnt over yet, other major movements were played, DuPont was acquired by

Conoco who then bought Gulf Canada Resources in 2001. Phillips Petroleum acquired

the largest US independent refiner that ended in a Conoco-DuPont-GulfCanada merger

with Conoco-Tosco becoming the sixth largest oil firm.

Part of these business tactics were made regarding at the large influence of the OPEC

cartel in the market, especially in the control on prices. OPEC had also an strong power

in geopolitical as evidenced in their position to the previous oils shocks were oil was first

time used as threating method when the OPEC claimed that they would stop US oil

supply if they supported Israel in the Yom Kippur war against Egypt and Syria.

Goals

The purpose of this union was the adaptation to market conditions through the

combination of complementary assets. Several specific objectives pushed their interest:

Exxon-Mobil would have stronger presence all over the world leveraging their

initial activity of exploration for reserves

Stronger position to invest in important programs with high risk/return

Geographic expertise, for example: Exxon had experience in deepwater

exploration in Wet Africa and Mobil in production in Nigeria and Equatorial

Guinea. In the Caspian region Exxon was present in Azerbaijan, and Mobil in

Kazakhstan and Turkmenistan. Joining also capacities in South America, Russia

and Eastern Canada

They could obtain savings by reducing duplicate facilities and excess of capacity.


It was also expected to reduce costs by the combination of administrative

operations.

The application of best business practice had generated synergy benefits.

Joining research and development programs had enhanced their knowledge and

capacity, pushing forward new technology development.

Of course, before the process you can predict many positive results but risk come along

with the operation that can impact in the opposite way if synergies are not attained. The

volume of resources used in this kind of deal is enormous and as far as it goes the risk

also increases. When firms like these, with tradition and very large size decide to merge

the post-merger integration becomes very complex; its not a huge firm buying a little

one that atomically have to join the buyer structure.

The goal of efficiency gain then, its a very challenging matter and there are some

exercises that may have a better idea of what would have happened as regarding to

rivals stock prices (Motta, 2004). We plotted historic prices from some competitors to

take a look at reactions and it shows no clear pattern of a negative reaction in rivals, In

the specific case of BP it seems a very positive reaction during that period but can be

due to the own expectations coming from its previous mentioned merger

Source: (Yahoo Finance, 2014)

In general, might not be useful to apply this technic because all firms were executing, in

very close timeline, mergers & acquisitions where the environment was quite uncertain.

Notwithstanding, we see that Exxon prices rose what could mean positive expectations

from shareholders, in fact zooming into the specific dates of the announcement we can

see that the cumulative return in the 2 weeks prior the date was 14.8% for Mobil (MOB)

Figure 4: Merging firms share stock prices - 1997 - 2001 ($)

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and -0.5% for Exxon (XON) and by 2 weeks after the cumulative returns passed to 20.6%

and 3.1% respectively; evidencing good expectation of efficiency gains.

Nevertheless, the announcement of the merger specialist predicted a $2.8 billion

savings in efficiency gains for the first operating year. By 2000 the company reported a

$4.6 billion benefit from synergies.

The deal

The market value of Exxon by that time was

close to 3 times higher than Mobils with a rate

of Market Value/ Book Value of 4 points for the

first and 3.1 for the second (Table 1).

The total operation was for 1.030 million of

shares at $72 which resulted in $74.2 billion

operation. It was clearly higher at 26% above

the market price at that time and 291% above

the book price. This reflects that the value of

acquiring the firm would lead to larger returns

as they were willing to pay even more than the

market was willing to pay for its shares.

As the buyer paid 1.32 shares for each Mobils

share the initial 780 million of them resulted in the mentioned 1.030 shares for Mobil in

the total shares distribution. This means that in pre-merger terms the distribution was

75%-25% but the premium paid led to a final 70%-30% composition of each company

participation.

Table 2: Merger financial terms

Pre-Merger

Dollar Amounts Percentage

Exxon Mobil Total Exxon Mobil

Share Price(1) $72.00 $75.25

Shares Outstanding (million)(2) 2,431 780

Total Market Value (billion) $175.00 $58.70 $233.70 74.90% 25.10%

Exchange Terms

Exxon shares per Mobil's 1.32 1

Post-Merger

Number of Shares (million) 2,431 1,030 3,461 70.20% 29.80%

Source: (Weston, 2002)

Exxon Mobil

Market Value (billion) $175.00 $58.70

Book Value (billion) $43.70 $19.00

Market Value / Book Value 4.0 3.1

LTM Net Income (million) $7,410 $3,272

PE Ratio 23.6 17.9

Total Paid (billion) $74.20

Premium Over Market

Amount $15.50

From Market Value 26.41%

Premium Over Book

Amount $55.20

From Total Paid 290.53%

Table 1: Merging firms, financial values



4. Economic Implications

Definitions

Horizontal mergers go normally against competition theories as they reduce the number

of rivals in the market which technically would lead them to higher market power and

the ability to increase prices; which would result in prejudice of consumers welfare.

Another negative effect that may result from a horizontal merger is the configuration of

a more favorable environment for collusion. And with it, many distortions causing higher

prices, less competition and negative impacts to consumers:

The more an industry is already characterized by the co-existence of factors

favoring collusive outcomes, the more risky to allow the merger

Entry barriers favoring less competition

Absence of counterpart power

Coordination for the volume of supply, increasing prices

In the other hand, mergers have the ability to bring efficiency gains as it was expected

in the case of Exxon-Mobil where firms can reduce their costs thereby in theory leading

to a reduction of market price, or at least not a higher increment of it. As we saw in the

previous section, Exxon-Mobil were able to reduce their costs but this was not

evidenced in oil related products prices, where we have experienced since the date of

the oil the merger wave a steady price raise.

Source: (BP, 2013)

Such efficiency gains may come from different sources as:

Economies of scale or scope

Enhanced production configuration

Synergies in R&D

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Figure 5: Crude oil prices 1960 - 2012($/barrel)


Efficiency gains

Merger

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Increase Market Power Decrease consumer

surplus Decrease total welfare

Ambiguous effect on welfare

The rise of market power can be outweighed by a price decrease

Marketing and/or distribution rationalization

Reorganization, keeping best managers

Hence, efficiency gains becomes the key factor in order to decide whether the merger

would bring positive outcomes to the market or not. Such responsibility is in the hands

of authorities in each country or region, in the case of Europe is European Commission

for competition matters, who are in charge of evaluating the merger conditions and rule

the approval procedure. They will approve mergers if they argued gains could be

attained just by merging, this means that if for example they claim reduction cost in any

activity they must prove that the only way to reduce it is by merging and not by other

mean.

Source: own diagramming based on (Motta, 2004)

It worth to mention that even with gaining efficiencies this doesnt guarantee that firms

would reduce their costs and have less power for marking prices. Authorities expect that

the decision will encourage company to do so, and the market will naturally push them

towards the positive goal.

Merger Guidelines

Seeking for evaluate the outcome of a merger and the required gains, regulators will use

methods aiming to guarantee that such efficiencies are to be obtained. We will make a

description of the procedures applied by authorities for this matter, based on EU

commission guidelines.

The fundamentals for analyzing a horizontal merger are defined in the market

assessment approach which in general works by defining relevant markets specified in

product and geographic terms. The goal is to set a series of conditions regarding the

firms activity, by which authorities are able to assess with more or less exactitude its

market power.

Figure 6: Horizontal merger unilateral effects scheme


The EU defines:

Relevant Product Markets: A relevant product market comprises all those

products and/or services which are regarded as interchangeable or substitutable

by the consumer, by reason of the products' characteristics, their prices and their

intended use.

Relevant Geographic Market: comprises the area in which the undertakings

concerned are involved in the supply and demand of products or services, in

which the conditions of competition are sufficiently homogeneous and which

can be distinguished from neighboring areas because the conditions of

competition are appreciably different in those area.

In addition to these concepts, new advanced procedures have been added to the EU

guidelines in what is considered a major contribution to the evaluation of HM through

modern economic analysis, where its stated that the assessment of mergers needs to

go beyond the definition of relevant markets and the calculation of market shares.

For doing the relevant market assessment regulators use the SSNIP test (Small but

significant and non-transitory increase in price), also known as the Hypothetical

Monopolist test. The idea is to identify the smallest relevant market where a

hypothetical monopolist or cartel could impose a profitable price in a non-transitory

shape. Authorities may hold a series of interviews to consumers regarding at their

decisions if the tested product experiences an increase of 5% for at least one year, so, if

buyers are willing to switch to an alternative product to the point that this change is not

convenient for the company is considered that there is not a relevant market in terms

of market configuration.

Criteria must be testes looking for clarify the market reaction to prices or supplied

quantities, other configurations are:

Own-price elasticity of demand: percentage change in the quantity demanded

that follows a 1% increase in the price of a product.

Cross-Price elasticity between two products A and B: percentage change in the

demand for product B after an increase of 1% in the price of product A.

Price correlation test: how price series of different products evolve over time.

Price differences: Two products in the same market will tend to have the same

price.

The relevant geographic market is tested similarly, focused on the changes that can

occurred in the movement of products from other areas if prices are modified,

transportation cost becomes a key agent in this test.

For the issue of market concentration regulators apply the Herfindahl-Hirschman Index

(HHI or H index) that basically measures how much a given market is concentrated by a


reduced amount of firms reaching a considerable market power by which they can profit

either by price control or by collusion. Each regulator is entitled to set a series of

parameters indicating when a market concentration is not favorable for the consumers

welfare. The H index is considered a mathematical measure of the price-cost margin

relation and a measure of monopoly power. The application is done obtaining the

market share of the sector by firm and then adding the squares of the market share of

all of them.

If the result is below 1.000 the market concentration is not considered harmful, by

contrary levels above that, regulators will disapprove or intervene in the merger

decision.

Table 3: Scheme for market concentration analysis. US Guidelines

HHI HHI - Decision

Low 1000 1800 Only if is less than 50 points

All other cases Investigation is required

Source: (Motta, 2004)

In general weve seen how to assess a market when horizontal mergers are being

developed. In the following sub-section we will relate these tools in the Exxon-Mobil

case.

EU commission analysis

The commission received the notification of the merger on May 1999 mainly because

concerns on competition in northwest Scotland. Nevertheless, having received the

notification of a specific element they are forced to make a complete analysis beginning

by the general industry analysis and the approaching specific cases.

a) Parties and the operation:

Exxon Corporation a diversified company active world-wide in the exploration,

development, production and sale of crude oil and natural gas (1). Refining and

sale of refined petroleum products (2). The development, production and sale of

various chemical products (3). Production and sale of coal and minerals (4) and

power generation (5). Mobil was also a diversified company active world-wide in

the same 3 first operations where Exxon did.

The commission received the terms of the deal (Erreur ! Source du renvoi

introuvable., Erreur ! Source du renvoi introuvable.) where it was indicated that

Mobil will merge a wholly owned subsidiary of Exxon, with Mobil as the surviving

corporation. As a result Exxon would hold 100% of Mobils issued and

outstanding voting securities. As we saw previously each holder of Mobil


common stock will receive 1.32 shares of Exxon common stock for each share of

Mobil common stock. Resulting in in Exxon shareholders owning approximately

70% of the merge organization, the 30% for Mobils shareholders.

b) Competitive Assessment:

For studying the market the commission used the usual division of the oil and

gas sector. Upstream: including exploration, development and production and

downstream: refining, sales, distribution and oils transforming process. Each one

of these value processes will be evaluated in terms of competition.

c) Relevant Product Market for: exploration, development and production:

Although is usually argued that exploration, development, production and sales

are too closely connected, the EC considers that exploration constitutes a

separate product market. Exploration has 2 different clients, the host country

researching for reserves to sell or to exploit and the second one is when real

pumping is going to be set by the selected firm granted to do it.

The EC also agreed that in this phase youre not sure what would be the mix of

the mineral youre going to extract between oils and gases, thereby is not

justified to make a distinction between exploration for oil and for natural gas.

For the rest of the processes (Development, production and sales) gas and oil are

treated with large differentiations, where cost and prices are far away so a

Relevant Product Market for each one of the final product will be established.

At the end the EC suggested that is not necessary for the appraisal of the effects

on competition to define precisely the Relevant Product Market according to the

various stages of the exploration, development, production and sales of

respectively oil and natural gas.

d) Relevant Geographic Market for: exploration, development and production:

From the perspective of European demand the EC considered that the

exploration market is world-wide in scope. For the development, production and

sales of crude oil a world-wide scope was defined too. For gas the geographic

market would be restricted to the EEA, Algeria and Russia.

Regarding smaller geographic areas within the region the relevant geographic

market was left open because it wasnt expected to alter the conclusion of the

competitive assessment

e) Market players:


The industry is characterized by the active presence of 3 main groups: 1) The

State-owned produced, 2) the majors (Mostly former seven sisters), which are

vertically integrated oil companies with international operations and 3) a

multitude of substantially smaller oil companies.

f) Effects of the merger in competition:

Concerns in the EC were valid. Exxon-Mobil merger together with the other

major acquisition of BP-Amoco-Arco will join Shell in building a fourth-tier of

competitors. Any measure you wanted to apply as market capitalization,

reserves granted, oil and gas production; any of them would show a large gap

between these super majors and the remaining firms.

With this environment, the three super majors could be in the future in a

privileged position to explore and develop future important reserves against the

other players in the market. The advantage of large financial strength might lead

to riskier and more profitable investments where the other players would find

hard to bid for

Given that the typical time lapse between the first stages of exploration and the

first production varies between 5 and 15 years, there is the possibility that new

non-OPEC reserves and production would be influenced to a significant extent

by the super majors.

With this scenario the competitive constraints limiting OPECs ability to work as

a cartel would have been lessened. The 3 majors firms would have the same

interests as OPEC that may yield to alignment on the OPEC decisions of limiting

output to certain level without fear that others could benefit from it. This would

have clearly translated into the strengthening of the cartels dominant position

in the crude oil market through the creation of an oligopolistic design. The

possibility to rise prices would lead also to trigger new explorations.

On the basis of the foregoing, the EC concluded that the operation raised serious

concerns in regard of the compatibility with the Common Market and the

functioning of the EEA agreement, so further investigation would have been

held. To this, the parties contested the Commissions on mainly two grounds.

First, the super majors would still be facing competitive constraints from smaller

oil companies. Secondly, host countries control oil and gas production and in any

case would have no incentives to let oil companies restrict production.

The investigation confirmed that small explorers do not seem to believe that the

emergence of a new class of super majors would threaten their position. Because


of size differences they would not compete for the same type of exploration

rights and they would not be dependent on the bigger explorers to sell their oil.

In addition, majors such as Chevron, Texaco, Elf or Total would all seem to have

unchanged capacity to explore and develop fields anywhere in the world. The

parties have provided numerous examples of the involvement of majors in

current projects all over the world. In addition to this, the market investigation

confirmed that typical concession contracts between governments and

explorers-producers prohibit the latter from limiting their output

Regarding natural gas, it was considered a low possibility that parties together

with the super majors could control the EEA production affecting competition.

Norway had a string position delivering gas, so a collective dominance didnt

seem a probable outcome. At the end, the Commission concluded that the

concentration wouldnt lead to the creation or strengthening of a dominant

position on the markets for the exploration, development, production and sale

of crude oil and natural gas

HH Index

Using the data available we made the concentration analysis before the merger and the

one estimated by adding Exxon and Mobil participation. There are few ways to calculate

the index, in this case we use annual revenue as indicator of the market share. We

obtained the data of 280 companies involved in the oil and gas industry, the first 20

sharing a 68% of the whole market

Table 4: HH Index before merger (1998-1999)

Ranking Company Revenue Market

Share (%) Market Share^2

1 Royal Dutch/Shell 171,964 11.65 135.78

2 Exxon 137,242 9.30 86.48

3 British Petroleum (including U.S.) 87,584 5.93 35.22

4 Mobil 65,906 4.47 19.94

5 Texaco 46,667 3.16 10.00

6 Elf Aquitaine 45,087 3.06 9.33

7 Chevron 41,950 2.84 8.08

8 National Iranian Oil 40,890 2.77 7.68

9 Amoco 36,287 2.46 6.05

10 China National 36,250 2.46 6.03

11 Ente Nazionale Idrocarb 34,997 2.37 5.62

12 Petroleosde Venezuela SA 34,801 2.36 5.56

13 Petroleos Mexicanos 34,035 2.31 5.32

14 Total 32,781 2.22 4.93

15 Shell 28,959 1.96 3.85

16 Petroleo Brasileiro SA 27,944 1.89 3.59



The previous market share yielded a low market concentration thanks to a significant

group of important firms and a large number of second and their-tier oil and gas

companies. The level was at that time in 389.35 which is low enough for a market

structure. Its important to remind that after 1999 other larger mergers were executed,

so not only the merger of Exxon with Mobil will change the market share but the other

unions will also affect the structure. Hence, the configuration was going to be

importantly impacted by these new unions and HHI should be required. We show in

Table 5 the new distribution of concentration after these new business deals.

Table 5: HH Index after the Merger

Source: (Weston, 2002), * This table shows just merging firms as the HH total

index will only be affected by HHI which in the cases of not merging firms

remain as 0, so does not modifies the result.

The aforementioned mergers resulted in this new market structure with Exxon-

Mobil having the leading position and a market share of 13% 4 points over the

second in the ranking. The first 10 oil companies grabbed a 57% of global sales, while

the remaining 43% was shared among other 262 firms. At the end the new HHI rose

by 110 points reaching a 583.32 total market concentration. Comparing this addition

with authorities guidelines (Table 3) we can noticed that in a global scale evaluation

the merger would have been approved, as indeed happened, as the result is far

below of the thresholds expected for analysis.

17 Nigerian National Petroleum 25,808 1.75 3.06

18 Kuwait Petroleum 23,572 1.60 2.55

19 Nippon Oil 22,020 1.49 2.23

20 Repsol SA 21,947 1.49 2.21

21-280 260 firms 479,083 32.46 25.83

1,475,774 100 389.35

Ranking Firms Revenues (millions)

HHI before mergers

Share after merger

HHI after merger

HHI New HHI

Concentration before merger 389

1 Exxon-Mobil 203,148 106.43 13.77 189.49 83.06 472.41

2 BP Amoco-Arco 143,143 72.16 9.70 94.08 21.92 494.33

3 BP-Amoco 123,871 41.27 8.39 70.45 29.18 523.51

4 TotalFinal-ElfAquitaine 98,220 22.30 6.66 44.30 22.00 545.51

5 Chevron-Texaco 88,617 18.08 6.00 36.06 17.98 563.49

6 Phillips-Conoco 66,492 11.19 4.51 20.30 9.11 572.60

7 Total-PetroFina 53,133 6.84 3.60 12.96 6.12 578.72

8 Phillips-Tosco 43,870 4.48 2.97 8.84 4.36 583.08

9 Conoco-GulfCanada 22,622 2.11 1.53 2.35 0.24 583.32

11-272 262 firms 632,658 104.49 42.87

1,475,774 Total 583.32


Resolution

Given the actual panorama in general terms the EU commission allowed the agreement

in its general terms by arguing: Therefore, the Commission concludes that the

concentration will not lead to the creation or strengthening of a dominant position on

the markets for the exploration, development, production and sale of crude oil and

natural gas.

The investigation was held deeper in reviewing also each particular cases in specific

regions for example:

Gas to Liquid technologies: The EU was concerned of a possible creation of

dominant position in this kind of technologies. They finally agreed that the

concentration will not lead to the creation or strengthening of a dominant

position on the markets for the exploration, development, production and sale

of crude oil and natural gas.

Or in the case of underground storage of natural gas where the result was: that

the barriers to entry for potential competitors in the market for swing capacity

in the south of Germany will be increased as a consequence of the concentration.

Therefore, the concentration strengthens the dominant position of Ruhrgas in

the market for swing capacity in the South of Germany (Munich area).

Other markets that appraised were: 1) Base oils, additives and lubricants, 2)

Refining and marketing of fuels, 3) Austrian specific market, 4) France

motorways, 5) Germany, 6) Luxembourg, 7) Netherlands, 8) The United Kingdom,

9) Aviation lubricants and 10) Aviation fuels.

Some remedies were accepted by the incumbents as in 1) the Dutch wholesale

transmission market of natural gas, 2) German long-distance wholesale

transmission market, 3) Underground storage facilities serving the south of

Germany, 4) Base oil manufacturing capacity to be sold to BP-Amoco, 5) Dispose

Mobils share in Aral and to terminate its participation in the fuel part of the

BP/Mobil joint venture avoiding the rise of oligopoly conditions in Austria,

French toll motorways, Germany, Luxembourg, the Netherlands and the UK, 6)

Divest is Exxons world-wide aviation lubricants business with commercial

airlines, to a purchaser approved by the Commission, finally 7) To sell aviation

fuel pipeline capacity from the Coryton refinery to Gatwick airport equivalent to

Mobils 1998 sales volumes at Gatwick.

According with this elements of the resolution the final decision was then: On condition

that the commitments summarized in paragraphs 826 to 862, and laid out in detail in

the Annex, are fully complied with, the concentration notified on 3 May 1999 consisting

of the merger between Exxon Corporation and Mobil Corporation is declared compatible

with the common market and the functioning of the EEA Agreement.


5. Results of the Union

The aftermath for the merger of Exxon and Mobil have been with not doubt a successful

history. The economic side, dedicated to provide a kinder environment for consumers is

a subject of large discussions. The theory states that in order to increase consumers

welfare is necessary to attain gains by efficiencies that would lead to a cost reduction

transformed in better prices for consumers. Its not risky to ensure that such efficiencies

have been obtained but the question remains in if these gains have been translated to

final consumers.

Measuring this factors, seeking to evaluate consumers benefit is not an easy task, oil

prices have experienced maybe the largest rise in history (Figure 5) due to multiple

reasons different from the market power held by Exxon-Mobil. Moreover, the

production cost for oil and gas has also been significantly modified by new technologies,

reserves more complicated to exploit, the impact of the fracking and other elements

that certainly alter the cost matrix.

We can see here, the complete perspective of Exxon and then Exxon-Mobil market trade

volume and share prices.

Source: (Yahoo Finance, 2014)

In the figure above, since 1997 the merging firm market value has drawn a increasing

line, trend that seems going hand by hand with international prices. This evolution

makes difficult to see, in a brief evaluation if the success of the union is thanks to

efficiency obtained by themselves or leveraged by oil prices. Analyst suggest that this

0

20

40

60

80

100

120

0

50,000,000

100,000,000

150,000,000

200,000,000

250,000,000

Volume Day High Day Low Close

Figure 7: Exxon-Mobil market performance 1980 - 2014 (Two scale volume and price in US$)


comes from both sides, as efficiency in various elements of its value chain have been

registered.

By taking current available data we updated the HH Index, this time not using 280 firms

as we did before but the first 106 with information available and we plot it to review

how the sector global sales are actually distributed.

Figure 8: Oil & Gas firms' results and market share (2013

Ranking Company Country Revenue Profits

($Billion) Assets

($Billion) Market value

($Billion) Market share

Market share^2

1 ExxonMobil United States 328 36.13 208.34 362.53 11.99 143.66

2 Royal Dutch/Shell Netherlands 307 25.31 216.95 203.52 11.20 125.47

3 BP UK 249 22.63 206.91 225.93 9.11 83.00

4 Chevron United States 185 14.10 124.81 126.80 6.75 45.60

5 ConocoPhillips United States 162 13.62 107.00 83.99 5.93 35.18

6 Total France 145 14.51 125.47 154.74 5.29 28.02

7 ENI Italy 83 9.87 91.03 114.42 3.03 9.21

8 Valero Energy United States 82 3.59 32.77 33.17 3.00 9.00

9 SInopec China 70 4.35 56.78 57.05 2.57 6.59

10 Petrobras Brazil 58 10.15 76.64 99.82 2.13 4.55

11 Statoil Group Norway 58 4.55 42.20 55.21 2.11 4.46

12 Repsol-YPF Spain 48 2.65 51.41 34.12 1.74 3.03

13 PetroChina China 47 12.43 73.68 172.23 1.71 2.94

14 Marathon Oil United States 44 3.05 25.99 25.87 1.62 2.64

15 SK Corp South Korea 42 1.63 41.64 7.95 1.52 2.32

16 Gazprom Russia 36 7.24 104.56 184.37 1.33 1.77

17 Nippon Oil Japan 36 1.23 32.58 11.11 1.30 1.68

18 Lukoil Holding Russia 35 4.40 29.62 65.12 1.28 1.64

19 Sunoco United States 31 0.97 9.93 10.11 1.14 1.30

20 Indian Oil India 30 1.25 19.34 14.62 1.10 1.21

21 86 firms 661 82.97 844.80 1,210.13 24.13 10.46

2,738 276.63 2,522.45 3,253 100 523.73

Source: (Forbes, 2014)

Recalling that were not using the same number of firms, we calculated the HHI

obtaining a level of concentration of 523 which is a little bit lower than the one

registered near 2000, just after the merger in 583. Now the first 20 oil enterprises gather

a 75% of total sales.

Being one of top 10 world public companies, and having not any claim in the EU

commission after the merger, we can presume a successful operation with not

significant impact in its power to set prices in prejudice of consumers.


6. Conclusion

Weve seen through this analysis several interesting aspects regarding horizontal

mergers. In one side, economic theory suggest that merger may affect the market by

using the merged power for controlling prices in prejudice of consumers; except in cases

where the union enables efficiency gains. In the other side, we showed that merger is a

very common practice in most of the cases theyre approved. In order to balance

consumer and suppliers benefits, policies have been designed to entitled special

authorities with the power to decide weather is convenient or nor this king of business

operation.

Reviewing the Exxon-Mobil case study within the oil industry, we presented how

authorities assess horizontal mergers using a set of rules and tools in order to measure

the probable power gain that may conduct them to rise prices. Additionally, we

implemented one of this tools the HH Index which measures concentration and gives to

evaluators a very important clue of the impact of such unions. They found that in Exxon-

Mobil case as well as the other oil industry mergers, there was not general threat as they

approved the operation. Furthermore, we saw how in specific relevant product and

geographic markets some remedies must be taken in order to control the merging

power. Thus, we approached the main guideline for assessing markets and horizontal

merger using the Exxon-Mobil.

The high financial benefits coming from mergers is so high, as we saw in Exxon-Mobil,

that firms will go with these strategies as much as they can, thereby authorities must

play a relevant role in guaranteeing a competitive market configuration. New guidelines

encompasses new ideas for improving how these cases are addressed as the one that

claims that not only the concentration analysis should be done but further evaluating

tools. We expect then, successful merger in benefit of consumers.


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Appendix (European Commision, 1999)

From Mergerdata we obtained the following summary of the Exxon-Mobil merger.

(Mergedata, 2014)

Type of merger and general concerns

Theory of harm possible competitive effect(s)

Single

dominance

Unilateral

effect

Collective

dominance

Vertical

effect

Multi-market

effect

YES NO YES NO NO

Relevant markets identified

Relevant markets

Relevant market Combined

marketshare (min)

Pre-merger

HHI

Delta HHI

Market 1 The EEA merchant market for base oils 40 1100 600-1600

Market 2 The Market for motor fuel retailing in France

Market 3 The Market for motor fuel retailing in Germany

Main findings in the first relevant market

Elimination of competition

Main findings in Market 1

Merger eliminates a potential future entrant:

Merger eliminates a recent entrant:

Merger eliminates a "maverick":

Merging firms are close competitors: YES

Factors conducive to coordination

Factors

stable market shares: NO

Symmetric market shares post-merger:

Symmetric costs in the market post-merger:

Symmetric capacities in the market post-merger:

Transparency (easy to monitor competitors):

Deterrent mechanism (retaliation possible): YES

Past coordination:

Excess margins/profits:


Import competition:

Incentives for price increases

Incentives for price increases

Customers have large switching costs:

Capacity constraints (among competitors): NO

Inelastic demand:

Increasing industry/demand:

Declining industry/demand:

Fast technological development/innovation:

Historical abuse of dominance:

Entry barriers

Entry Barriers

High entry barriers: YES

New competitors cannot enter within two years:

New entry cannot defeat competitive concerns:

Scale economies prevent entry:

Essential facilities prevent entry:

Intellectual property rights prevent entry:

Non horizontal factors

Non-horizontal factors

Purchasing power:

Countervailing buyer power exist (among the merged entities' customers):

Likely input foreclosure post-merger:

Likely customer foreclosure post-merger: YES

Multi market contact:

Efficiency gains

Efficiency gains

Large efficiencies result from the merger:

Failing firm evidence (rescue merger, i.e. one of the parties is insolvent):

exxonmobil merger - carlos gonzalez

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