Bp Case Study - Why Are Big Oil Companies Vertically Integrated?

Why are big oil companies vertically integrated? 

There are five major reasons for big oil companies to vertically integrate:

1. Steady supply

The oil embargo and the consequential scarcity and price increase in 1973 (see exhibit 6) resulted in a crisis for the big oil industries. Since they were dependent on their oil suppliers, they had to deal with the price increase. Vertical integration assures the steady supply of oil and minimises the level of dependency. Not only the amount but also the quality of the supply can be controlled in big, vertically integrated oil companies.

1. Avoidance of new entrants

Since the supply chain of oil is quite complex and requires big companies to be vertically integrated, it takes a great financial effort to enter the market to compete on a same level.

1. Increase of profitability

Improvement of coordination of upstream (production) and downstream (distribution) will lead to synergies and an increase of profitability.

1. Technological economies

As integrated oil companies handle the whole supply chain, they will have more opportunities to increase value to the product by developing new technologies. Especially, in the upstream process it can help to decrease the required input to produce a given output.

1. Cost reduction

Integrating up- and downstream can save time and costs of the selling and buying process that usually occurs between two different companies. In particular, market research, advertising, and sales promotions.

In conclusion, incomplete markets, transportation shortages, and unstable relationships between firms gave oil companies the incentive to integrate vertically, matching the capacities of their production, refining, and marketing operations. BP in particular, saw the advantages coming from unpredictable regulated markets. Thus, they use the integrated structure to expose interbusiness subsidies, and to force businesses to perform more competitively. However, the amount of vertically integrated oil companies decreased from 1979 to 1999, while the non-integrated companies decreased (see exhibit 7).

How favourable were the economics of the oil and gas industry before the BP-Amoco merger? What were the effects of the recent mergers on industry structure and on BP’s profitability?

As prices were on a minimum in 1998 (see exhibit 6) the former industry structure could not persist. The economy of the oil and gas industry was struggling. Especially, the lack of returns compared to other industries and the fact of continuously dropping oil prices forced BP to respond.

Moreover, most of the expansion opportunities were already maxed out. Oil had been discovered in more than 80 countries. Oil and gas field became more challenging to access and to develop efficiently. Thus, gaining profitability was the major driver for further growth.