Chevron Prepares to Swallow Caltex, Forge Clearer Asian Strategy

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Caltex, the giant Asia-Pacific venture of Chevron and Texaco, is bracing itself for upheaval in coming weeks, as its parents finally move to complete their merger. The 65-year-old venture will lose its traditional autonomy, as it's folded into a single corporate structure. But from this shakeup should emerge a stronger and more focused network of downstream and upstream operations, which include various upstream and power projects pursued independently by the parents in Asia. If all goes well, Chevron Texaco should be better placed to penetrate emerging markets such as China, to flesh out a regional gas and power strategy, and to run its oil supply business more efficiently. While the Caltex brand name will survive, the operation -- with refining capacity of 846,000 barrels per day and an extensive retail network -- will be firmly integrated into Chevron Texaco's corporate structure. Jock McKenzie -- chairman of the main downstream arm, Caltex Corp. -- will remain, for now at least, as president of regional products in Singapore, reporting to downstream head Patricia Woertz. Caltex's upstream operation in Indonesia, which has been run separately from the downstream, will report to Chevron's overseas petroleum chief, Peter Robertson. Caltex's "traditional autonomy won't be compromised, it will be folded completely into Chevron. In that sense, Caltex is dead," says one regional analyst. "It is being converted from a semi-autonomous operating joint venture into one of the time zone legs of Chevron," he adds. An equity analyst comments that the merger "should at least make some management decisions easier. It always seemed like there was something of a management void [at Caltex], because it was a 50-50 joint venture. They might be able to make some harder, faster decisions." One source says that past reports of arguments between the co-owners were exaggerated, but that it wasn't easy to forge significant investment plans for Caltex. Size Matters Caltex's core downstream markets were built decades ago, on the back of Chevron's crude oil supply from the Mideast Gulf. More recently, Caltex, Chevron, and Texaco -- pursuing loosely coordinated but separate strategies -- have struggled to penetrate new markets such as China, India, and Vietnam. The integrated Chevron Texaco is expected to target China, in particular, more aggressively, enjoying the "better ammunition" of an integrated major. "Integration gives size. And size does mean something, especially in the new and expanding markets," says one source. "It's much easier for a BP or Shell to go into these countries with a variety of things in their catalog." BP and Royal Dutch/Shell are chasing oil retailing and gas chain opportunities in China, backed by big equity investments in state firms. As a taste of things to come, Chevron and state China National Offshore Oil Corp. (CNOOC) recently signed a preliminary agreement on gas cooperation in Australia and China. This involves CNOOC studying the feasibility of acquiring an equity stake in 9.6 trillion cubic feet of untapped gas reserves in the Gorgon fields off Western Australia. CNOOC's liquefied natural gas import project at Guangdong, China, holds the key to commercializing Gorgon, analysts say. Chevron will have a majority interest in the Gorgon fields after the Texaco merger. Texaco and Chevron have existing oil exploration and production programs offshore China, in the Bohai Bay and South China Sea. Chevron hopes the combination of these will create an attractive prospect for long-term oil production, on the doorstep of a high-growth market. In parallel, the enlarged major will forge the gas and power assets of Chevron, Texaco, and Caltex into a single portfolio, while seeking to take advantage of Caltex's regional brand recognition in that sector's downstream. Caltex has strong relationships in key consumer South Korea through its local LG-Caltex venture, which has acquired several power plants and distribution companies that use imported liquefied natural gas. Texaco has power interests elsewhere, including Thailand, Indonesia, and the Philippines. Upstream, Chevron has gas interests in Australia's North West Shelf and Gorgon projects, as well as in Thailand and Papua New Guinea. Texaco has gas interests in Gorgon, the Malampaya development in the Philippines, and offshore Indonesia. In general, both Chevron and Texaco are weak in Asian gas development, but hope to develop the sector into a money-spinner. Trading Places In oil trading, Chevron, Texaco, and Caltex have again functioned independently, often on opposite sides of the buy-sell equation. In this and other areas -- such as lubricants, risk management, and international customer management -- the unified major will seek to create an integrated system. This should, for example, be able to exploit better the region's aviation and bunker markets. Crude supply could also be better managed in Indonesia, where the upstream arm of Caltex has split its 700,000 b/d or so of crude production between Chevron and Texaco, obliging the downstream Caltex -- the main lifter -- to bid against others for supplies. There may be similar opportunities on the West Africa-Asia trade axis: Chevron and Texaco have substantial oil production in Angola and Nigeria, with Asia an important swing market. Caltex's downstream assets, depressed by regional refining overcapacity and weak margins since Asia's economic crisis of 1997-98, will get a hard look, with Chevron likely to be more ruthless in its decisions. But rationalization won't be easy. One complication is that Caltex controls only 50% of operating arms in Australia and South Korea, two of its biggest markets. Another is that buyers for depressed Asian assets are thin on the ground. "Chevron will look very hard at the economics of all that supply and cut a bunch of it," predicts one regional observer. "If you are going to bring Caltex into the 21st century, you will have to spend an awful lot of money on refining," he adds, pointing to the spread of tighter product specifications across the region. "I would shed any downstream [asset] that's not paying for itself," comments another pundit. Caltex has, in recent years, pulled out of refining in Japan and Bahrain, and rationalized operations in Thailand -- although plans to cut its equity in the Thai venture have been delayed until the climate improves. The firm has explored -- so far unsuccessfully -- possible partnerships with rivals in Australia and South Africa. Action in Australia could be a priority for Chevron, analysts reckon. Depressed Profits What's clear is that Caltex is no longer the cash cow that helped its parents through rough times in the past, and allowed it to preserve its autonomy. The Caltex group -- including upstream and downstream arms -- reported bumper profits of $1.2 billion in 1996, but a mere $143 million in 1998. Earnings have since recovered some ground, buoyed by high oil prices at the upstream arm -- but the downstream operation remains depressed by the region's refining overcapacity and weak margins (see table). After adjustments for foreign currency movements, inventories, and other items, Chevron reported a $79 million loss from its half share of Caltex's downstream operations in 2000, following a $35 million loss in 1999. In a speech earlier this year, Caltex head McKenzie said, "Refining margins are creeping upward, but still remain under pressure. We see real recovery only in the 2004/05 timeframe." He added that, "The downstream industry in Asia-Pacific faces many challenges as we move tentatively out of the most difficult operating period in memory. The prospect is for an improved environment, but [one] far more challenging than in the past." Chevron is keeping quiet on precise plans for Caltex, pending the merger's scheduled completion in early October. But the firm points out that it plans to implement $1.2 billion in savings within nine months of the merger, adding: "We will have one corporate headquarters instead of two or three." Of those savings, $300 million will come from the global consolidation of corporate functions. In a 1999 revamp, Caltex moved its headquarters move from Dallas to Singapore, and restructured its organization on functional instead of geographical lines. Regional sources say that Chevron's selection of senior executives was a highly competitive process, in which few Caltex people made the grade. As for Singapore's role in the merged entity, the regional products operation will be coordinated from there -- a similar approach to Shell's -- as could Asian gas and power. Any withdrawal from Singapore would be a controversial move, with political ramifications. Caltex Group Highlights ($ million) 1H'01 2000 1999 Sales 8,275 20,267 14,970 Total Revenue 8,367 20,432 15,291 Costs 7,817 19,344 14,511 Pre-tax Profit 550 1,088 780 Net Profit 279 519 390 Chevron Texaco Cost Savings* Sector Saving ($million) Exploration 300 Production 350 R&D 50 Total Upstream 700 Other Operations 200 Corporate 300 Total Pre-tax 1,200 *Within six to nine months of merger.

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