Operation and Competition Situation of the UK Oil and Gas Industry - Essay Example

OPERATION AND COMPETITION SITUATION OF UK OIL & GAS INDUSTRY Contents 0 Introduction and rationale for selected sector 3 2.0 Introduction and rationale for chosen companies 4 2.1 BP 5 2.2 Cairn 5 2.3 Premier 5 3.0 Financial and Non-financial ratio analysis 5 3.1 Financial ratio analysis 5 3.2 Non-financial ratio 8 4.0 Aims and objectives 9 5.0 Critical Competition Analysis 10 5.1 Threat of new entrants 10 5.2 Threat of substitute products 11 5.3 Bargaining power of customers 11 5.4 Bargaining power of suppliers 12 5.5 Intensity of competitive rivalry 13 6.0 Critical Environmental Scan 13 6.1 Political 13 6.2 Economic 14 6.3 Social 15 6.4 Technical 15 7.0 Plan/timetable 16 References 16 Operation and Competition Situation of UK Oil & Gas Industry 1.0 Introduction and rationale for selected sector The oil and gas sector has remained an important contributor to economic development and the gross domestic product (GDP) of the United Kingdom (Sassen, 2011). Within the industry, crude oil is said to be the largest segment of the UK market, accounting for up to 52.7% of the market’s overall volume (MarketLine, 2013). Table 1 gives the market value of the oil and gas industry as a correlation of the industry’s contribution to the economic growth of the country. Table 1: UK Oil and Gas Market Value Year Market Value in $ billion Market Value in £ billion Market Value in ϵ billion % Growth 2008 68.6 43.3 53.4 2009 42.2 26.6 32.8 (38.5%) 2010 52.7 33.3 41.0 25% 2011 69.6 43.9 54.2 32.1% 2012 65.7 41.4 51.1 (5.7%) CAGR: 2008-12 (1.1%) Source: MarketLine From table 1, it is seen that the sector’s contribution to the economic outlook of UK alone has not fallen below £25 billion in a year since 2008. The major rationale for selecting this industry however is that, regardless of its important place in UK’s economy, growth in the sector has not been steady in the last few years as seen in figure 1 below. The paper therefore tries to critique the cause and finds solutions from the perspective of selected companies. Figure 1: UK Oil and Gas Market Value and Growth 2.0 Introduction and rationale for chosen companies Three major companies are focused on in this paper. They are Cairn Energy plc, Premier Oil plc, and BP. Figure 2: Daily Production of Companies Source: Treneman (2013) 2.1 BP BP was selected to be a general representation of larger oil and gas companies whose daily production is beyond 1,000,000 barrels a day. On the whole, the rationale behind the selection of BP is the diversity and differences it offers in its business and marketing approaches as a large company. 2.2 Cairn The selection of Cairn was for the reason of the fact that the company gave a perfect representation of smaller oil and gas companies whose daily production is below 35,000 barrels a day. The company also uses a focus strategic option, which makes it possible to compare this strategic option with other companies to determine its effects. 2.3 Premier As depicted in figure 2, it will be seen that in terms of production units, it can be said that the selection of Premier have been made based on medium market size with production above 35,000 barrels but less than 100,000 barrels. This is an important rationale to pursue, given the fact that the individual growth of these companies will turn out to be collective growth of the oil and gas industry in the UK (Ferguson, 2004). 3.0 Financial and Non-financial ratio analysis 3.1 Financial ratio analysis A total of 10 major financial ratios will be focused on in the study. Gross profit margin: This is a type of profitability financial ratio that measures financial health by estimating proportion of money left over from the company’s revenues after accounting for the cost of goods sold (COGS) (Weston, 1990). This gross profit margin is selected to determine how financially healthy the companies are, which is; ...................... (1) Net profit margin: This is another profitability measure that determines how much each pound earned by the company is turned into profits (Houston and Brigham, 2009). This is selected in the study to determine financial discipline of the companies. The formula for net profit margin is given as ................... (2) Return on capital employed (ROCE): Another profitability ratio, ROCE measures the return on sum of shareholders’ equity and debt liability (Weygandt, Kieso & Kell, 1996). It could therefore be seen as the ratio of earnings before interest and tax (EBIT) and capital employed. Its equation is given below. .......................... (3) Asset turnover ratio: This is an efficiency financial ratio that measures the quantum of sales generated per pound of assets (Weygandt, Kieso & Kell, 2006). This is selected for the study to have a vivid understanding of the companies’ efficiency in terms of how well they deploy assets. In this study, asset turnover is expressed as the ratio of revenue generated by the companies in a year over total assets declared within that same time frame. Its formula is given below ..................... (4) Sales revenue to capital employed ratio (SRCER): As the name implies, the SRCER gives the measure of a company’s ability to raise sales revenue through the utilisation of its assets (Epstein and Jermakowicz, 2007). It is therefore worked out with the formula below. ...................... (5) Current Ratio: The current ratio will be used in the study as a liquidity test that measures the companies’ ability to pay for their short-term obligations. In this study, current ratio is expressed as the current asset of the companies in a year over the current liabilities incurred within that same time frame (Williams et al., 2008). The formula to be used in determining current ratio is given below. .................. (6) Acid-test ratio: Still on liquidity, the acid-test ratio (ATR) shall be used to find the companies’ ability to cover their immediate liabilities through the use of short-term assets such that they do not have to sell inventory (Watanabe, 2007). This financial measure is expected to comprise several fiscal positions including cash, account receivable, short-term investments, and current liabilities showed in the equation below. .................. (7) Gearing ratio: Under financial gearing, the gearing ratio shall be used to find the ratio of equity to borrowed funds of the companies (Wild, 2010). Based on equation (8), it can be noted that high gearing ratio indicates that the company has high proportion of debt to equity whiles low gearing ratio indicates that there is low proportion of debt to equity. ................................. (8) Long-term debt: Finding long-term debt shall help in finding financial gearing. This will be done by looking at the sum of loans and financial obligations that last over a year (Zane, Kane and Marcus, 2004). Earnings per share: This is simply the part of the companies’ profits which they allocate to each outstanding share of common stock they have (Alexander, Britton and Jorissen, 2005). Earnings per share is expressed as the ratio of the companys profit as expressed by the difference between net income and dividends on preferred stock and average outstanding pence per share of common stock. ......................... (9) 3.2 Non-financial ratio There shall be three non-financial ratios. Share price: Given the total sellable stock of each company, the share price will be viewed as the price of each share. A study of the share price over time gives information of behavior of investors where increasing share price shows higher investor endorsement, and vice versa (Barr, 2004). Good will: This is to be used as an intangible asset that values the company’s employee relations, customer relations, solid customer base, brand name, and other patents that gives premium value for acquisition. Good will is important because it promotes number of investors who will be willing to trade in the company’s shares (Barr, 2004). Employee turnover ratio: Employees are the engine of growth as they form the human resource base that works to improve productivity. The employee turnover ratio shall therefore be used to find the rate at which employees leave the companies as against the rate at which new ones are hired (Usher, 2007). Available Reserves: this is measured s a difference between the companies’ excess reserve and funds the companies borrow from a discount window. It is important in knowing the future security of the companies this is because companies are free to use the reserve as it does not use this to repay any debt (Usher, 2007). 4.0 Aims and objectives Whiles engaging in this overall study, the ultimate aim is to know how well the companies are placed to playing their internal financial and non-financial roles to ensuring that on an individual basis, they can record growth that will be translated into the overall growth of the oil and gas sector in UK. To achieve this aim, these specific objectives will be outlined. 1. What has been the financial outlook of the companies in the past 5 years? 2. How well are the companies placed to gain competitive advantage through Porter’s 5 forces? 3. What are the environmental factors (PEST analysis) that influence the business activities of the companies? Based on the specific objectives, it is seen that the use of Porter’s Five Forces makes it possible to know the level of competition that companies face both within their local market and the larger global market (Porter, Argyres and McGahan, 2011). The companies are analysed in the following ways for their critical competition. Also, through PEST analysis, Brown & Anthony (2011) noted that it is possible to undertake a critical environmental scan of companies to know the external factors that affect their business positioning. 5.0 Critical Competition Analysis 5.1 Threat of new entrants The UK oil and gas industry operates a perfect market structure. What this means is that it is possible for new entrants to be registered unto the market with little or no restrictions (Coyne and Subramaniam, 1996). This situation however comes with its own effects on the three companies as far as competition is concerned. For example, the smaller companies are seen to be the ones that will be at the worse threat to new entrants. The threat to new entrants for Cairn Energy and Premier Oil is expected to increase further with increasing size of the new entrants (Nigel, 2008). 5.2 Threat of substitute products Substitute products for the produce of oil and gas companies are very limited. This is particularly because oil and gas products are refined to many different forms, making it difficult to have a single product that substitutes it perfectly. Meanwhile, vehicles constitute one of the major consumption output for the oil and gas companies. From the figure given below, the competition with electric cars is better seen because must traditional cars depend on products of crude oil, which are petrol and diesel. Meanwhile, figure 3 shows that crude oil dominates natural gas market. Figure 3: UK oil and gas market category segmentation 5.3 Bargaining power of customers Bargaining power of customers refers to the extent to which customers have the ability to put companies under pressure to review prices (Porter, 2008). As far as the companies in question are concerned, they would be seen as producers who do not sell off their products to the ordinary customer on the street. With this said, it would be noted that oil prices are determined through a global automatic adjustment system, which is not determined or influenced by the customer in any way(Hoskisson, 2012). 5.4 Bargaining power of suppliers Kotler (1997) noted that where the activities of suppliers have direct influence on the production levels of companies it raises the bargaining power of suppliers up. At the same time, when there are fewer suppliers, the bargaining power of suppliers goes further up (Werner, 1984). From this perspective, BP can be said to be the company with the best outlook to overcome bargaining power of suppliers. An indication of this is the operating incomes of the companies as showed below, which puts them in a position to own assets that they would have otherwise outsourced from suppliers. Figure 4: Operating income of companies From figure 4, it would be seen that BP has the highest operating income, which puts them in a better position to depend less on their suppliers. 5.5 Intensity of competitive rivalry The intensity of competitive rivalry is the point where the need to compare the companies in a competitive manner results Raco (2013). From figure 4, one may get the impression that BP has a form of competitive advantage with its operating revenue that the two other companies cannot compete with at all (Sprigings and Allen, 2007). 6.0 Critical Environmental Scan Four major aspects of the companies are selected and analysed below. 6.1 Political Politically, all three companies are faced with the geographic segmentation of the UK market in relation to the larger European Union market. This is because there is that free movement of trade based on the political demarcation of the EU. In effect, the larger the UK market value, the more advantageous the companies within the country will be positioned to trade. From table 2, it is seen that the UK fails to dominate other EU countries, which is a major political issue for the three companies. Table 2: UK oil and gas market geography segmentation Having said this, Brown (2008) noted that oil and gas companies doing business from UK have a major political advantage when it comes to international credibility to sell products in most markets across the world. This point is made against the backdrop that some countries have often suffered international sanctions, which limit the sale of oil products and thus limiting the business outlook of the companies in those countries. 6.2 Economic There are three stages of economic analysis that can be performed for the three companies. In each of these three areas also, it would be noted that the companies respond different. The first of this is the global economic stage, where the global economic outlook has been noted to be a major issue in affecting the oil and gas business (Harnish, 2011). Clearly, when there is global recession, industrial demand for oil and gas goes down and so the companies are affected negatively. On this stage, diversity is a major way by which the companies can continue to stay in business and be profitable. The second stage is the national economic outlook of UK. Here, all three companies have a major advantage with the strength of the British Pound when used as a major international currency in trading. The third stage is the individual company economic outlook, whereby the ability of the companies to be revenue driven can be said to be a major issue in determining growth. Here, BP can be said to be far ahead of the two other companies. 6.3 Social The social aspect of this PEST analysis looks more into the social activities and demography of people and how this influences the demand for oil and gas products (Kouzes and Posner, 2008). In this respect, the first issue that can be talked about is world population growth, where it is known that the world’s population has been increasing over the past two decades (Aamot, 2010). Meanwhile, with increases in world population, the need for more industries and forms of transport becomes imminent. Having said this, it can be noted that from an external social perspective, the companies stand a chance of recording sustainable market base, given the fact that oil and gas are needed to satisfy most needs of the growing population. A trend in the social dynamic of the UK and other parts of the world that comes as a disadvantage to the companies however has to do with the shift to the preference for electric cars. 6.4 Technical The technical aspect of the PEST analysis refers to the extent to which the expertise, logistics and industrial framework needed to carry out production can be said to be in place or lacking for the oil and gas companies (Hass, Horst and Ziemski, 2008). In this, reference can be made to the increasing numbers of educational programmes and courses that are taken in the field of oil and gas. These courses come with improved number of human capital that can be relied upon by the companies in meeting their human resource needs. Again, with new discoveries of oil fines being made year in and year out, the number of companies specialising in the production of materials and equipment needed and used in oil and gas has increased. This therefore puts the three companies at a very favourable position to succeed, as far as technical environment is concerned. 7.0 Plan/timetable Stage Date of completion Selection of industry Selection of topics Gathering of data Preparation of draft Vetting of draft Writing of main project Vetting of main project Completion References Aamot, G. (2010). Driving Change’ panel: Farm-to-table entrepreneurs influence others by living their mission. MinnPost. 4(2); 23-25 Alexander, D., Britton, A. and Jorissen, A. (2005). International Financial Reporting and Analysis, Second Edition, Singapore: John Wiley & Sons, Inc. Barr, N. (2004). 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