By Daniel P. Barzach
Frustration and anger have been rapidly mounting since the April 20 explosion of BP’s Deepwater Horizon Rig in the Gulf of Mexico. As thousands of barrels of crude have been spewing into the gulf daily, a public outcry has taken form. Liberals and conservatives alike have bemoaned this environmental catastrophe. With a goal of making the behemoth BP squirm, some have promoted a boycott.
Public evidence of this boycott is readily available. On the heavily trafficked social networking site Facebook, over 700,000 people have “liked” the “Boycott BP” group started shortly after the spill. Countless other smaller groups have sprung up and a recent Wall Street Journal article spotlighted the vandalism of BP signs and placards all around New York City exclaiming “BP = Boycott Pollution.”
This public resentment toward BP is natural and justified. I am just as infuriated by this as the mainstream public and want nothing more than to see BP accountable for its actions. But perhaps a boycott is not the right answer. Others questioned the effectiveness of a boycott, pointing out the collateral damage to the 10,000 private franchisees who own BP gas stations, and to the innocent workers whose jobs and livelihoods are at the mercy of this mammoth oil conglomerate.
All of these points are certainly convincing; however, I see another, more pecuniary, flaw with a large-scale boycott of BP’s retail locations. Recently, I rummaged through BP’s 2009 annual report and despite having to stifle nausea during the section dedicated to “Safety and Operational Performance,” I stumbled across some interesting data regarding the breakdown of their income statement.
Typically, oil companies have two major divisions — Exploration and Production, and Refining and Marketing. BP is no exception and in its annual report aptly describes each division. Exploration and Production consists of all upstream and midstream activities. “Upstream activities involve oil and gas exploration and field development and production. Midstream activities involve the ownership and management of crude oil and natural gas pipelines, processing facilities and export terminals.” The Refining and Marketing division is “responsible for the supply and trading, refining, manufacturing, marketing, and transportation of crude oil, petroleum, petrochemicals products and related services to wholesale and retail customers.”
Of course, the retail BP stations we see on street corners are part of the Refining and Marketing division. In 2009, BP listed their total revenue at $239.272 billion, with a breakdown by division showing Refining and Marketing contributing 78.7 percent and Exploration and Production contributing 21.3 percent. Statistics like these provide fuel for the public boycott.
A breakdown of earnings, however, tells a completely different story. Replacement cost profit, the standard oil-industry profit metric, which allows for the volatility in oil prices, shows that in 2009, Exploration and Production contributed a whopping 97.1 percent whereas Refining and Marketing only accounted for about 2.9 percent of earnings. I concede that 2009 was a particularly morbid year for Refining and Marketing because of low oil prices, but when running the numbers for 2008, in which the industry experienced a surge in oil prices, Refining and Marketing still only contributed 9.8 percent.
This tremendous discrepancy between top line and bottom line contributions is staggering, but typical in the oil-industry. This is due to relatively high margins in Exploration and Production and conversely low margins in Refining and Marketing. Moreover, BP is one of the largest traders of crude oil on the open market, grossing $35.625 billion of their Refining and Marketing revenue from trading activity.
In the short-term, it is unlikely the American public will decrease their dependence on fossil fuels. If we don’t buy at BP, we’ll be buying our gasoline elsewhere. As a result, if the BP boycotts work, BP’s competitors will likely have a shortage due to a fixed supply and drastically increased demand. A natural solution will be to seek additional fuel on the open market. As a major player, BP stands to benefit from this.
If BP’s revenue is less than satisfactory in retail, it will be made up for in their trading activity. This augmented trading would naturally improve revenues in Exploration and Production to satisfy the increased demand. The same Exploration and Production division that was responsible for the very spill the public is looking to punish. Furthermore, a large-scale boycott would be benefitting BP’s most profitable division, which earns exponentially more profit per dollar in revenue than its Refining and Marketing counterpart.
So, a large-scale boycott of BP’s retail locations could possibly yield an increase in profits for the oil giant if revenue is directed away from low margin Refining and Marketing toward high margin Exploration and Production. This conclusion is undoubtedly startling and even devilishly ironic. But perhaps, the best way for the public to actively hurt BP is to buy exclusively from them.
Daniel Barzach is portfolio manager of the Mason Investment Fund at The College of William and Mary in Williamsburg, VA. He resides in West Hartford and is doing research with an international business and marketing professor on design-driven management practices. He was a finalist at the Michigan Undergraduate Investment Conference in which he pitched Murphy Oil Corporation (NYSE:MUR).
