Introduction
Since the mid XX century, the oil industry occupies a leading position in the global energy sector. A prerequisite for the implementation of large-scale long-term investments in the oil industry under the condition of a favorable outlook for oil demand in the world market is the availability of relevant geological reserves of oil in a particular region and the world at large. OPEC-countries account for over 40% of world oil production. Especially, the Middle East, particularly the Gulf basin, where there are the largest oil fields in the world, is rich for oil reserves (OPEC, 2015). Oil is extracted in 100 countries around the world. Russia, Saudi Arabia, the USA, China, Iran, Canada, Iraq, the UAE, Kuwait and Venezuela, which closes the top ten, are the leading crude oil producers (Central Intelligence Agency, 2014).
Over the past 50 years, we have seen a few related to the oil market crises, which were both economic and political. However, in the second half of 2014, there was a drop in oil prices, which by the speed of formation of the crisis exceeded anything we have seen ever before. If we compare this decline to the fact that occurred in the mid-1980s, it is necessary not only to apply the adjustment to inflation, but also take into account that the dollar was much stronger than a basket of currencies compared to current situation. Given factors as the level of maximum oil prices prior to fall, the amount of falling prices is quite comparable.
In general, oil producers around the world are in trouble due to a collapse in prices. In the latter it is decided to blame the US shale oil industry, which in a matter of years provided the market glut. Meanwhile, shale oil producers are experiencing the era of cheap oil particularly difficult. However, so far they operate in spite of everything, although a wave of bankruptcies of oil companies in North America has already begun (Olson, 2016).
It should be noted that as the USA occupies one of the leading positions among oil producers, its Halliburton Company is one of the leading global services companies, which provides a full range of advanced technologies and services for the oil and gas industry, namely from the determination of hydrocarbon fields, fields’ simulation prior to drilling, formation evaluation, construction and completion of wells and production optimization. Therefore, the purpose of the assignment is to analyze the position of this company in the oil industry and consider strategic options available to this provider. In order to complete the assignment, secondary data research methods will be used for collecting necessary data (Halliburton, 2016).
Halliburton’s Current Situation
As it was stated above, the USA occupies the third position among oil producers globally. Oil refineries are concentrated along the Atlantic coasts (Northeast port centers, where companies are engaged in processing imported oil and along the main route of the pipeline). Today, in the United States and the world in general, the oil market is one of the most monopolized. Free, non-monopolized market plays a secondary role. It accounts for 3-5% of the international oil trade. It has balanced the supply and demand for oil. The level of prices in this market is based on the reference prices of monopolized market and is consistently lower (about 1/4). Almost all US oil production and refining industry belong to private owners (Central Intelligence Agency, n. d.).
The main driving force behind the rise in oil prices is not its deficit, but the breach (untrue or expected) of the global oil market operation. Another factor that greatly affects the growth of prices for “black gold” is referred to as depreciation of the dollar. One more factor that has impact on the price of oil is the unsatisfactory condition of the US economy and other industrialized countries, where investors and speculators simply throw surplus funds in commodity assets.
In turn, the US oil companies argue that they are significantly lower than the profitability of companies that operate in other areas of business. Thus, as of January 2016, the cost of capital (the rate of return an investor expects to receive on his/her investment, taking into account the risks associated with this investment) in the oil and gas business (production and distribution) was 8.37% and 5.97% correspondingly and integrated oil companies bring 10.2%. However, investors in companies that produce tobacco and beverage got 11.82% (there are only 20 companies, while oil production consists of 351 companies), the investors in the online retail – almost 11%, etc. (Cost of Capital by Sector (US), 2016). However, according to the International Energy Agency, the USA will become the world’s leading oil manufacturer by 2017 (Credit Suisse, 2015).
Market structure of oil industry can be described as oligopoly with dominance of several large companies by market capitalization, namely Exxon Mobil, PetroChina, Chevron, Royal Dutch Shell and Sinopec in 2015 (STATISTA, 2015b). Speaking about the market capitalization of the oil field service providers in the USA, the leading place is occupied by Schlumberger with almost $107 billion, while Halliburton takes 4th position with over $37 billion (STATISTA, 2015c). Figure 1 shows that Halliburton occupies 2nd position by revenue (STATISTA, 2015a).
Figure 1. Dominant Global Oil Field Service Providers by Revenue, 2015
Leading companies are so large that the output of each of them can influence the sectoral proposal. Thereby the firm can influence the market price, that is, to have market power. In the oil industry the product is standardized. Entrance to the industry is extremely limited by various barriers. They relate primarily to the economies of scale, which acts as the major cause of widespread and long-term preservation of oligopolistic structures (Grewal, 2014).
In order to define opportunities and risks, which Halliburton can face, Five Forces Model by Porter should be used. It is applied to understand the structure of the industry, the analysis of its attractiveness in terms of profit, competition assessment and development of business strategies (Grewal, 2014). Concerning threats from new entrants, as it was stated above, there are high barriers of entry, including high cost of capital, environmental legislation, economies of scale, geopolitical aspects, etc. Threat of substitute is low as the product is standardized and includes energy sources. Bargaining power of buyers is low, both from industrial and individual customers. Bargaining power of suppliers is high because OPEC-countries account for over 40% of world oil production. The providers include the oil mining and extraction companies. Intensity of competition is also very high because the product is standardized and the market value of different companies confirms business rivalry.
It is necessary to analyze Halliburton’s financial position. Company’s current ratio, which demonstrates its liquidity, has increased by almost 60% in 2015 compared to 2014. It means that Halliburton can easily disburse its short-term liabilities. However, its dependence on the borrowed funds has also increased because Shareholder’s Equity has decreased and long-term debt has risen. Return on equity showed negative result due to the fact that the cost exceeds the sales revenue. Thus, the company operates at a loss, manufacturing and selling this product (Halliburton, 2016).
Different Types of Strategic Options
World oil prices continue to show a negative trend against the background of investors’ fears of excess in the oil market after the US Department of Energy showed statistics on stocks of raw materials in the country. Due to such situation, the necessity to reconsider strategic options appeared. There are two basic forms of behavior of firms in an oligopolistic structure, namely an unincorporated and corporate behavior. The small number of key players of oligopolistic market favors the agreement between them. Several oligopolistic firms can directly agree on a joint strategy and tactics, establish favorable to each partner prices and to divide the market among them, determining the optimal size of the industry proposal and the share of each participant in industry production. The main idea of this conspiracy is to establish the production volume and prices at a level that maximizes profit for the entire group of contracting companies (monopoly profits) (Mankiw, 2014).
Falling market creates, as a rule, favorable conditions for equity operators and service companies, which can improve their assets and operational capabilities through strategic acquisitions. In 2015, in the oil and gas sector of the world economy despite the sharp decline in oil prices, the cost of authorized proposed M & A reached $323 billion. This amount is not simply a historical maximum for a specified period, but it also exceeds the previous record by nearly $100 billion (Mattioli and Cimilluca, 2015).
If at the national level the monopoly regulation of prices is illegal, such restrictions are not applied at the international practice. The example of international oil cartel OPEC is the most paradigmatic case. Over the past 30 years, OPEC has repeatedly sharply limited the supply of oil to the world market and bid up the price of oil and oil products. Currently, during the global financial crisis, OPEC regulates world oil prices by introducing quotas for oil production (Krugman and Wells, 2012).
Modern economists G. Galbraith and P. Samuelson has repeatedly stressed in their writings that today, there is no need for leading companies to enter into public contracts. They can silently work out some strategy equally beneficial to all. There are many forms of this hidden conspiracy.
A model of leadership in prices is one of them. This model describes a situation, in which there are a large number of firms in the industry, but only one major company plays the role of a clear leader. The leader determines the pricing policy followed by all the others. The leader usually sets prices that meet the interests of even the “closing” of the company, the weakest in the market and with the highest costs. At the same time, company leader takes the “cream” in the form of exclusively high profits. In some cases, the leader can displace small businesses from the market. Leader significantly reduces the cost, and small firms cannot compete and go from the market. After that, the leader of the firm raises prices to a profitable level, and it takes the vacant niche (Mankiw, 2014). Thus, the strategic option for Halliburton will be suggested below.
Strategic Option for Halliburton
For Halliburton the strategic option of creation of cartel is suggested. In general, in the world, the cartels had a sharply negative effect on the market economy. Therefore, legislation in all countries controls the economy and prevents their appearance. In modern conditions, the importance of price competition has fallen markedly. This circumstance, as well as the tightening of antitrust laws has led to a decrease in the value of the cartel in its classical form. Modern cartels, if they exist, do not concern prices and quotas, but the sharing of expensive equipment conditions, the joint implementation of investment projects expensive, etc. (Krugman and Wells, 2012).
In order to make cartel operate, it requires a number of conditions. First, the demand for the product of cartel should be price inelastic, while the product itself should not have a close substitute. Oil is the best product, which meets these requirements. Second, all participants in the cartel must follow the rules of the game. This condition is often violated, because a very large potential gains from exceeding the quota of production, and sales volume increase at a higher price determined by the cartel. Company renegade gets higher profits, but the risk of serious spoil relationships with partners (Mankiw, 2014).
If considering Ansoff matrix, for Halliburton the recommended strategic position concerns market penetration strategy (existing product – existing market) through the increase in market share in the long-term period (Grewal, 2014). For Halliburton it is recommended to negotiate with Enbridge as the US Department of Justice has stated about prosecution of the merger with Baker Hughes. Since the deal was announced in November 2014, oil prices have fallen by 55%. Then the deal was estimated at $34.6 billion, but today it could worth $25 billion, taking into account the fall of the company’s shares. To save the deal, Halliburton was willing to sell part of its assets. The merger of Halliburton and Baker Hughes could help companies reduce costs and cope with the fall in oil prices. In addition, the association could help companies compete more effectively with the largest oilfield services company Schlumberger (Phippen, 2016). However, operating in Canada, Halliburton can cooperate with the largest Canadian oil field service supplier. Such cooperation is sign of the times, the trend, which additionally to a major oil business the smaller one follows. Customer coarsens, projects become more ambitious. To match, smaller companies set cooperation.
Conclusion
Today, Halliburton offers a wide range of equipment, services and integrated solutions for the exploration and development of drilling and production of hydrocarbons. The company operates in the oligopolistic market with specific features, namely standardized product, high barriers to entry and presence of large companies, which hold the biggest market share. Within the last several years the prices in oil industry decreased greatly (Halliburton, 2016).
Some of the factors, which caused such change, were described above. The growth of oil shale mining has been the main engine of industry and economic recovery in 2009-2014. The main growth of new jobs in 2007-2014 was due to growth in oil and gas production. There is the vulnerability of the entire US economy from the situation in the mining industry of the country. In previous years, this role the oil in the economy did not show. Applied Five Forces Model of Porter showed that there are high barriers of entry, bargaining power of suppliers and intensity of competition, while threat of substitute and bargaining power of buyers are low. Concerning Halliburton’s financial condition, even despite positive liquidity ratios of the company, the condition is unsatisfactory as the company greatly depends on borrowed funds and has negative return on investment. Therefore, based on the performed analysis, the strategic option of creation of cartel was suggested. If considering Ansoff matrix, for Halliburton the recommended strategic position concerns market penetration strategy (existing product – existing market) through the increase in market share in the long-term period. The reason is that oil meets necessary requirements and the company has the ability to negotiate with the Canadian largest oil field service provider.
References
Central Intelligence Agency (2014). Country Comparison: Crude Oil – Production. [online]. Available from <https://www.cia.gov/library/publications/the-world-factbook/rankorder/2241rank.html> [Accessed: 12 April 2016]
Central Intelligence Agency (2014). North America: United States. [online]. Available from <https://www.cia.gov/library/publications/the-world-factbook/geos/us.html> [Accessed: 12 April 2016]
Cost of Capital by Sector (US) (2016). [online]. Available from <http://pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/wacc.htm> [Accessed: 12 April 2016]
Credit Suisse (2015). Global Investment Returns Yearbook 2015. [online]. Available from <http://www.investering.dk/documents/10655/157815/Credit+Suisse/0c0ceeb5-c5af-464d-be00-fb1378cb0412> [Accessed: 12 April 2016]
Grewal, D. (2014). M: Marketing. New York: McGraw-Hill/Irwin.
Halliburton (2016). Notice of Annual Meeting of Stockholders. 2016 Proxy Statement. 2015 Annual Report on Form 10-K. [online]. Available from <http://ir.halliburton.com/phoenix.zhtml%3Fc%3D67605%26p%3Dirol-reportsAnnual> [Accessed: 12 April 2016]
Krugman, P. and Wells, R. (2012). Microeconomics, 3rd ed. New York: Worth Publishers.
Mankiw, N. G. (2014). Principles of Microeconomics, 7th ed. Boston: South-Western College Pub.
Mattioli, D. and Cimilluca, D. (2015). Energy M&A Surges Despite Oil Slump. [online]. Available 20 September 2015 from <http://www.wsj.com/articles/energy-m-a-surges-despite-oil-slump-1443629069> [Accessed: 12 April 2016]
Olson, B. (2016). Oil Plunge Sparks Bankruptcy Concerns. [online]. Available 11 January 2016 from <http://www.wsj.com/articles/oil-plunge-sparks-bankruptcy-concerns-1452560335> [Accessed: 12 April 2016]
OPEC (2015). Annual Statistical Bulletin: Organization of the Petroleum Exporting Countries. [online]. Available from <http://www.opec.org/opec_web/static_files_project/media/downloads/publications/ASB2015.pdf> [Accessed: 12 April 2016]
Phippen, J. W. (2016). The End of Halliburton’s Merger With Baker Hughes. [online]. Available from <http://www.theatlantic.com/national/archive/2016/04/haliburton-baker-hughes-merger/477144/> [Accessed: 12 April 2016]
STATISTA (2015a). 2015 ranking of leading global oil equipment and oil services providers based on revenue (in billion U.S. dollars). [online]. Available from < http://www.statista.com/statistics/272713/top-oil-equipment-and-oil-services-providers-based-on-revenue/> [Accessed: 12 April 2016]
STATISTA (2015b). Top 10 oil and gas companies worldwide based on market value in 2015 (in billion U.S. dollars). [online]. Available from <http://www.statista.com/statistics/272709/top-10-oil-and-gas-companies-worldwide-based-on-market-value/> [Accessed: 12 April 2016]
STATISTA (2015c). Top U.S. oil/gas service and equipment providers based on market value in 2015 (in billion U.S. dollars). [online]. Available from <http://www.statista.com/statistics/241630/top-us-oil-gas-service-and-equipment-providers-based-on-market-value/> [Accessed: 12 April 2016]
